Our old friend “Cajun CPA” requests that we update readers on the controversy regarding whether or not government contractors must issue potential layoff notices to employees as required by the Worker Adjustment and Retraining Notification (WARN) Act, given that Sequestration is nearing and program funding is likely to be endangered starting in January (the same way that the carrier pigeon might be said to be “endangered”). When we last addressed this topic, we told readers that “we are not going to breathlessly issue alert bulletins about the progress—or lack thereof—of the looming doomsday scenario known as ‘sequestration’.” But what can we do? Our readers have spoken.

And in truth, there are some legitimate issues buried in the muck of the political B.S. that in the modern election cycle in the United States. So, securely cloaked in the foregoing rationale, let us begin.

In our last post, we told you that the Department of Labor had issued its opinion that the WARN Act would not require defense contractors to issue employee layoff notices in November (just one week before the election). According to the Dept. of Labor, providing WARN Act notices “would be inconsistent with the purpose” of the legislation, and would result in an “inefficient use of resources”.

The Dept. of Labor opinion had this to say about WARN Act requirements:

‘The purpose of [the] WARN Act [is] to provide notice to workers so alternative employment or necessary training can be obtained on a timely basis.’ … Generally, the WARN Act requires employers with at least 100 employees to provide written notice at least 60 days before ordering a plant closing or mass layoff to: ‘affected employees’ – either through notice to their representative, or to each affected employee if the employees are not represented; to the state entity designated to provide rapid response activities under the Workforce Investment Act; and to the local government. … A ‘plant closing’ or a ‘mass layoff’ is defined in terms of numbers of workers at a single site of employment who suffer an ‘employment loss.’ … ‘Affected employees’ are employees ‘who may reasonably be expected to experience an employment loss as a consequence of a proposed plant closing or mass layoff by their employer.’ … An ‘employment loss’ is defined as a termination from employment other than a termination for cause, voluntary departure, or retirement; a layoff for more than 6 months; or a reduction in hours of more than 50 percent in each month of a 6-month period. …

Based on the foregoing recital, the Dept. of Labor concluded that—

These statutory provisions demonstrate that the WARN Act is designed to require employers to provide notice to those workers who are reasonably likely to lose their jobs or suffer other serious employment consequences, but not to those workers who will suffer no such consequences or who have only a speculative chance of suffering them.

The Obama Administration took additional action in addition to issuing the Dept. of Labor opinion. On September 28, 2012, the Office of Management and Budget (OMB)—which is an organizational entity within the Executive Office of the President—issued a Memo entitled “Guidance on Allowable Contracting Costs Associated with the Worker Adjustment and Retraining Notice (WARN) Act.” The OMB Memo was issued with the expressed intent of “minimize[ing] the potential for waste and disruption associated with the issuance of unwarranted layoff notices.” It stated—

Specifically, if (1) sequestration occurs and an agency terminates or modifies a contract that necessitates that the contractor order a plant closing or mass layoff of a type subject to WARN Act requirements, and (2) that contractor has followed a course of action consistent with DOL guidance; then any resulting employee· compensation costs for WARN Act liability as determined by a court, as well as attorneys' fees and other litigation costs (irrespective of litigation outcome), would qualify as allowable costs and be covered by the contracting agency, if otherwise reasonable and allocable.

Well, then. According to the OMB, contractors that follow the Dept. of Labor guidance and do not issue WARN Act notices in early November—and who are required to pay damages to affected employees for failing to do so—will be able to pass those damages (and associated legal fees and other costs) back to their customers as allowable costs. That would seem to settle that.

But let’s notice the next paragraph in the OMB Memo, which stated—

This guidance does not alter existing rights, responsibilities, obligations, or limitations under individual contract provisions or the governing cost principles set forth in the Federal Acquisition Regulation (FAR) and other applicable law. Thus, agencies may treat as allowable other costs potentially associated with sequestration, including WARN Act-related costs arising under .circumstances not specified .in this guidance, based on the usual cost principles of allocability, al!owability, and reasonableness as set forth in the FAR.

So the OMB promise to cover contractors’ WARN Act liabilities is not all-encompassing. It simply covers the exact circumstances it covers. And it begs the question as to exactly how covered costs are to be reimbursed.

Follow us through a thought experiment, if you would.

Contractor A has two firm, fixed-priced contracts with the DOD. Those two contracts constitute 95% of its total annual revenue and 90% of its workforce is busy executing one of those two contracts. On January 3, 2013, it receives notice that both contracts are to be Terminated for Convenience, effective immediately. Consistent with the FAR Termination for Convenience contract clause, the contractor stops work and issues layoff notices to its employees. The employees get severance pay, but they are laid-off the same week they receive notice. One or more employees file suit, alleging that the contractor knew Sequestration was looming and yet failed to issue required WARN Act notices. The contractor incurs $1,000,000 in legal fees and related costs, and settles with each of the 100 affected employees for individual payments of $50,000—for a total of $6,000,000 in additional costs incurred by following the Dept. of Labor opinion and guidance. It desires reimbursement from its government customers, but how?

Its two contracts were firm, fixed-price. By definition, the price is fixed and does not change regardless of the contractor’s actual costs, whether direct or indirect. The price is the same no matter how much ostensibly allowable costs are incurred. So that ain’t happening.

Well, maybe the contractor can seek reimbursement as part of its Termination Settlement Proposal. Frankly, we see that as the contractor’s best hope in this scenario. But a successful outcome is far from guaranteed. It is going to have to convince its Termination Contracting Officer (TCO) that its legal costs were allowable under the applicable Cost Principle and that its settlement costs were reasonable. Then it will have to address with the costs in question were direct or indirect—and whether allocation of them to the two terminated contracts resulted in a loss at completion (which would have to be factored into the settlement amount). It may have to argue with auditors whether the settlement payments were allowable employee compensation, or perhaps they were unallowable legal fees (since there was a settlement) or unallowable penalties. The auditors (and perhaps the TCO) will be pointing to the second paragraph we quoted from the OMB Memo—the part about “This guidance does not alter existing rights, responsibilities, obligations, or limitations under individual contract provisions or the governing cost principles set forth in the Federal Acquisition Regulation (FAR) and other applicable law.”—and they are going to say that some or all of that $6,000,000 is unallowable by operation of those Cost Principles. It’s not going to be a fun exercise, in our view.

So, as you can see, although OMB may have offered some comfort to government contractors, it was certainly not a warm blanket of comfort. Instead, it’s more of a gauzy veil of comfort—thin and easily penetrated.

And the OMB Memo sure seemed to upset Republican legislators.

We will continue with this ongoing saga in the next article.