We recently posted an article regarding the allocability of indirect costs, in which the Court of Appeals (Federal Circuit) ruled that a contractor’s IR&D costs were unallocable to its Government contracts.  At the conclusion of that article, we noted, “although the Court’s continued insistence on a ‘bright line’ allocability ‘test’ should concern all government contract cost accountants, another contractor with a stronger fact pattern might well prevail.” While we don’t claim prescience, BearingPoint recently illustrated before the Armed Services Board of Contract Appeals (ASBCA) how a government contractor might refute assertions that its costs were not allocable to a contract, and thus demonstrate cost allocability.

The ASBCA decision (found here in its entirety), captioned as ASBCA Nos. 55354 & 55555 and dated October 16, 2009, included a fairly complex set of facts and issues involving BearingPoint’s work in the Iraq theater of operations.  BearingPoint was awarded a cost-plus-fixed-fee, level-of-effort (CPFF/LOE) type contract by the US Agency for International Development (USAID) for “economic recovery, reform and sustained growth in Iraq.” In the first case (No. 55354), the USAID disallowed various costs incurred by BearingPoint in executing its contract.  Among the disallowed costs were:  labor costs associated with the subcontractor providing physical security for BearingPoint, rental costs associated with leasing ground transportation used to move about the countryside, housing costs for personnel in-country, and the cost of miscellaneous items such as “radio rental, telephone cards, equipment … and supplies.”  The costs were disallowed (generally) because of a lack of sufficient supporting documentation or because they were unreasonable in amount. Regardless of the rationale for the contracting officer’s final decision, at trial the Government argued that the disputed costs were “unallocable for insufficient documentation“ to prove they were allocable to the contract.

The Government’s position was that “allocability determinations hinge upon contemporaneous documentation establishing a nexus between contract work and costs.”  Since, as a general matter, “a contractor bears the burden of proof on the issue of allocability” (citing Lockheed-Georgia Co., A Div. Of Lockheed Corp., ASBCA No. 27660, 90-3 BCA ¶ 22,957 at 115,278), the Government argued that BearingPoint’s failure to provide robust documentation upon request led to a conclusion that the costs were unallocable to the contract, and thus unallowable.

In making its argument, the Government relied upon DCAA audit reports questioning more than $4.5 million of BearingPoint’s subcontraxtor’s costs because the subcontractor (Custer Battles) was “unable to provide sufficient supporting data” or DCAA was “unable to apply sufficient audit procedures to allow us to adequately verify the costs claimed” by Custer Battles. (The amount of questioned costs subsequently was reduced to $3.9 million.) DCAA’s position was that it needed to review 100% of Custer Battle’s claimed costs because the auditors deemed its accounting system to be inadequate. The parties became deadlocked; USAID insisted that BearingPoint support 100% of Custer Battles’ costs and BearingPoint said the documentation was both not required and not available.  In the words of the USAID contracting officer (Ms. Kolstrom), she “could not determine allocability.  [Although she had] all these [Custer Battles] invoices showing all these people, really there’s no proof that these people really existed and worked on the BearingPoint project, nothing.”

The ASBCA rejected the Government’s argument “that the disputed labor charges are unallocable for insufficient documentation.”  The Court found that—

The contract clauses do not impose the stringent requirements of either “nice neat little files” that Ms. Kolstrom sought or the contemporaneous records for which AID appears to be arguing. Thus, the Allowable Cost and Payment clause, which was incorporated in the contract, imposed no requirement that BearingPoint substantiate labor costs with time sheets, as Ms. Kolstrom insisted. The Audit and Records clause, which was also part of the contract, looks to ‘all records and other evidence sufficient to reflect properly all costs claimed to have been incurred...in performance of this contract.’ The clause prescribes no form that the ‘records’ or the ‘other evidence’ must take, and in fact we have read the clause more liberally than AID’s position suggests. … And AID’s Documentation for Payment clause, which was incorporated, contemplates cost reporting ‘prepared from the books and records of the Contractor,’ without describing the requisite level of detail. These clauses are consistent with FAR 31.201-2(d), which speaks broadly of a contractor’s responsibility to maintain documentation ‘adequate to demonstrate that costs claimed...are allocable to the contract.’

*****

… the nub of the matter for us is the extraordinary imbalance in the cases presented by the parties. For its part, BearingPoint, as the party with the burden of proof on allocability, presented a robust prima facie case. Thus, BearingPoint presented credible testimony from Ms. Swan, Mr. Bourne and Mr. Dulle, supported by documents. … In the face of BearingPoint’s strong case, we are unable to repose confidence in AID’s evidence. Although other possible government witnesses could have shed light on the labor disallowances at issue, only Ms. Kolstrom testified. She offered confused testimony that we have not found credible, and it reasonably cannot be said that AID overcame BearingPoint’s strong prima facie showing.

To sum up, the DCAA’s inability to audit “outside the box” of its own audit program and its refusal to move beyond its finding that Custer Battles’ accounting system was inadequate, based on the realities of contracting in a war zone, coupled with a contracting officer’s unwillingness or inability to use the discretion given to her by statute and regulation, led to a “deadlock” and litigation.  This time, the contractor prevailed (assuming no reversal on appeal). One would hope both DCAA and contracting officers would learn from this case and seek to avoid future litigation.

The second appeal (No. 55555) was also interesting, but addressed different issues. As part of its contract, BearingPoint employees worked six days per week “without premium pay.” Because the employees were working in a combat zone, they were entitled to salary “uplifts” of 25 percent for “danger pay” and 25 percent for being assigned to a permanent duty post in a hazardous area—i.e., a 50% salary increase.  The question in the second appeal revolved around how the salary increase was to be calculated—whether it should be calculated on a 40 or a 48 hour-per-work week salary.  The Government asserted (based on a DCAA audit report) that the annual employee salaries should have been uplifted by 50 percent and then divided by 52 weeks to arrive at the weekly employee labor cost, while BearingPoint argued that the annual salaries should have been divided by 2,080 hours (52 weeks of 40 hours each) and then uplifted by 50 percent and then multiplied by the actual hours work to arrive at the labor billing amount.

For example, assume an employee earns an annual salary of $100,000 per year.  Under the Government’s methodology, the employee would receive an uplift of 50 percent to $150,000, which would then be divided by 52 to derive a weekly labor cost of $2,885.  Under BearingPoint’s methodology, the employee’s annual salary of $100,000 would be divided by 2,080 hours to derive an hourly pay rate of $48.08, which would be uplifted by 50 percent to equal $72.12; that amount would be multiplied by a 48-hour work week to derive a weekly labor cost of $3,462.  In this example, the difference between the two methods is $577 per week, or $30,000 per year per employee.

The Court found in favor of the Government on the second appeal.  Without going into overmuch detail regarding the language of the Department of State Standardized Regulations (DSSR) or specific contract language, suffice it to say that the Court found that the applicable regulations and contract terms plainly called for the uplifts to be applied to employees’ salaries, not an hourly pay rate. As the Court reasoned—

The most that BearingPoint’s arguments lead to is ambiguity. Whether the arguments relate to the undefined nature of the workweek to which basic compensation applies or otherwise, ambiguity cannot yield recovery on this record. If the ambiguity were deemed patent, then BearingPoint must establish that it raised the issue before bidding. … We have found no evidence that BearingPoint did so.  Alternatively, if the ambiguity were deemed latent, then BearingPoint must establish that it relied upon its current interpretation in bidding.  We have likewise found no evidence that it did so.

In addition, the Court found that BearingPoint failed to cap the salaries of its employees, which was not in compliance with specific contract terms.  Again, BearingPoint’s arguments to the contrary were unavailing.  As before, the Court found that BearingPoint’s arguments led (at most) to a patent ambiguity, which created an obligation on BearingPoint’s part to raise the issue before bidding, which it had not done.

We have reported several times on the Commission on Wartime Contracting, and its views on both DCMA oversight of DOD contractors deployed in the battlefield and the adequacy of those contractors’ “business systems.”  In her last testimony before the CWC, former DCAA Director April Stephenson accused contractor KBR of billing the Government for $19.7 million in prohibited “private security costs” and noted that “we completed our audit of KBR’s security cost submission and concluded that the information provided by KBR was not adequate for determining the amount and extent of prohibited private security costs billed to the government … but we estimated that the private security costs could be at least $100 million.”  In the midst of ineffective audits, contracting officer timidity, and political grandstanding, it is up to the Courts to determine what the facts are and whether billed costs are reasonable, allowable and allocable.

As these two BearingPoint cases show, that is sometimes a difficult chore.  We hope that both the Government and its contractors learn from these cases and reach a negotiated settlement on disputed issues before resorting to litigation.