I’m getting too old for this stuff.

I’ve seen too much, and now I’m seeing too much stuff repeat. There’s no reason this stuff has to repeat except for incompetence. Not you. You’re good. It’s your boss. And their boss. Those folks are clowns and, if they weren’t so great at politics, they would be deservedly booted out from Executive Row on their well-padded derrieres.

So … here we go.

Nearly six months ago I published a blog article about inflation. Here’s a link to it. You remember that time, don’t you? Inflation was running at historic highs and everyone was concerned.

First Rant: “Historic highs” if you discount all the other times inflation was at similar—or even higher—rates. But since we have memories that are hazy about last week, it’s not really surprising that almost nobody remembers history. Hello? Whip Inflation Now? Anybody? Yeah, like that. History is dead. Nobody has any historical context anymore. Trust me, 8.5% inflation isn’t too bad in historical terms. In 1917, annual inflation almost hit 18%. In 1946, annual inflation did hit 18%. In the 1970’s inflation sucked. So, there is plenty of “lessons learned” related to managing contracts and suppliers in an inflationary environment. But none of you—and none of your bosses—implemented any of those lessons. How do I know that? Keep reading.

So, anyway. I published that article. I thought it had some interesting and potentially useful content. I even spoke on the topic to a fairly well-attended Government Contract Pricing conference. Well, the conference was well-attended. My presentation? Not so much. Everybody seemed to be at the other session, where DCAA and DCMA were talking about inflation using government-approved talking points that didn’t offer much in the way of new, innovative, thinking. (Okay. Do I sound bitter about that? I’m not. Not really. I mean, I understand the thought. Who is Nick Sanders, anyway? Nobody of any consequence.)

In that now aged and forgotten-in-the-sands-of-time article, I wrote—

That’s a nice legal position, but when your mid-tier and lower-tier suppliers—and your small business suppliers—begin to go bankrupt because the costs of performing the contracts exceed their available cash flow, and your “reprocurement costs” associated with Terminations for Default are meaningless because the suppliers are bankrupt and can’t pay—and in many cases there will be no other suppliers to perform in any case—and when your programs start to fall behind schedule and now you have to report Nunn-McCurdy breaches to Congress … well. At that point you will realize—far too late—that your lawyers’ advice wasn’t so smart after all, because you didn’t deliver your weapon systems and your contractor services to your warfighters, even though you adhered to contractual policies and procedures.

Not incidentally, delivering goods, services and weapon systems to the warfighters is, fundamentally, the entire job of the Department of Defense’s back office.

The memo seemingly ignores history, when inflationary pressures (among other factors) led to the United States Government bailing-out Lockheed via an Act of Congress. Don’t believe us? Google it. One salient fact was the imminent insolvency of Rolls-Royce, maker of aircraft engines. One report summarized the situation thusly: “If the engine supplier for the L-1011 was bankrupt, the contract for the RB.211-22 engine would be nullified.” Now, perhaps the crisis was driven by technical challenges in fixed-price development contracts, but the salient fact is that the contracts were fixed-price, and the contractors couldn’t absorb the associated losses. If the supply chain collapsed, the prime contractor (i.e., Lockheed) was toast.

Now, I’m watching my prediction come true.

People’s Exhibit A: “Lockheed, Howmet Price Fight Over F-35 Titanium Goes Public.” (Source) As Michael Bruno wrote on 04 December 2023 in Aviation Week Online—

Lockheed’s lawsuit—filed in U.S. District Court for Northern Texas—alleges Howmet in November demanded a ‘massive price increase’ on titanium materials used in the Joint Strike Fighter (JSF) and other systems, beyond the numbers specified in their underlying contract. The Fort Worth Star-Telegram reported that when Lockheed and other subcontractors refused to meet Howmet’s request, the company stopped supplying.

There’s more.

For its part, Howmet on Dec. 1 said it has complied with its contractual and regulatory obligations to Lockheed. The cornerstone supplier painted a picture of rising prices for materials, in part due to Russia’s invasion of Ukraine in February 2022.

‘Since 2022, Howmet has been transparent with Lockheed Martin about these challenges and has acted in good faith to attempt to reach a reasonable resolution for the benefit and long-term health of the F-35 Program,’ Howmet said in a public statement. ‘While such discussions were still ongoing, Lockheed Martin unfortunately chose to file a meritless lawsuit seeking to compel Howmet to continue to supply product at prices that no longer reflect commercial reality and on terms that Howmet believes it is not contractually obligated to provide.’

It’s ironic that Lockheed must contend—once again, 50 years later—with a supply chain issue that threatens the single largest defense contract currently being performed. Alanis Morissette should add a new lyric to her song.

Anyway, the latest news on the dispute is that Lockheed Martin attempted to invoke “national security” to force Howmet to provide titanium but the Judge said no to that.

The point I tried to make six months ago is that the subcontract language may be unenforceable—or winning the lawsuit may be a Pyrrhic victory for LockMart. What do I mean? If they force Howmet into bankruptcy then it doesn’t matter what the contract says. LockMart just becomes another creditor in the bankruptcy proceeding. Meanwhile: no titanium. No F-35 production. Other companies in the F-35 supply chain—those who rely on the raw titanium to process into bulkheads and suchlike—they have no input and therefore no output. They start to go under, as well. And for LockMart, they don’t have any more planes in shape to deliver to their customers. They start to incur liquidated damages or other penalties found in the prime contract. It’s not a pretty picture. In other words, LockMart can win and still lose everything.

Second Rant: They did this to themselves, quite frankly. I ain’t got no sympathy for them. You simply cannot expect to enforce a fixed-price subcontract in a highly inflationary environment. Airbus figured that out relatively quickly when it’s A380 supply chain was threatened. What did Airbus do? Did they drag their suppliers into court? Nope. What they did was to renegotiate the contracts so that it was economically feasible for the suppliers to perform. Lockheed Martin could have done that same thing, if they’d looked around for some historical lessons learned and implemented them. Lockheed Martin could have acted like smart business people and negotiated a solution. They might have had to eat some planned profit, but at least they’d keep their program intact. Instead, they listened to their lawyers. I ain’t got no sympathy for them. None.

People’s Exhibit B: “Bankrupt Co. Asks Court To Reject Gulfstream Supply Deal” (Source: Alyssa Aquino, Law360)

Incora, a bankrupt aerospace supply chain management company, urged a Texas court to immediately end a Gulfstream supply contract that became unprofitable during the COVID-19 epidemic, contesting Gulfstream’s claims that a contract termination clause must be honored for Incora to reject that deal.

To be clear, the supply contract with Gulfstream did not cause Incora to go bankrupt; but it was certainly a factor. Let’s dive a bit deeper.

June 9, 2023—about seven months ago—Ben Unglesbee, writing in SupplyChainDive, said—

Incora’s bankruptcy sends a warning signal to aerospace supply chains: Over the past year, the dollar value of late shipments from Incora’s suppliers has increased by ninefold, with on-time deliveries at around 50%.... Average lead time for shipments of parts has doubled to 18 months from nine months. That caused a major problem for Incora, ‘because its role in the aerospace industry (and some of its contracts) require it to maintain substantial inventory that manufacturers and maintenance service providers can call upon at any time,’ Carney noted.

Incora has taken on added costs because of shortfalls, in part by buying alternative supply at higher costs to fill gaps, leaning on expedited freight to move goods more quickly, and because of labor costs to turn late-arriving inventory faster, according to Carney.

Moreover, the company has had to pay higher prices for inputs as inflation spiked for raw materials, costs that Incora can’t pass on to its customers because of the timing of its contracts. Carney also said that ‘many suppliers of proprietary parts have exploited their position to raise prices in excess of general inflation rates.’ …

As for Incora, the company is looking to address its debt burden — partly a legacy of its leveraged buyout by Platinum Equity. The company also aims to use the Chapter 11 process to, as Carney put it, bring ‘unprofitable customer contracts’ in line with ‘current economic and commercial reality.’

Tip of the iceberg time, gentle readers. Tip of the iceberg. Two stories about different companies, both facing the economic realities of fixed-pricing contracts in a time of high inflation. Two suppliers with inflexible prime contractors. Two prime contractors with supply chain problems.

I bet you have some of those same challenges. What are you going to do? Are you going to enforce strictly the terms of your subcontracts, even if that means destroying your suppliers? Is that the hill you are going to die on?

Or are you going to negotiate some compromise that preserves your supply chain at the cost of short-terms profits?

Well, I bet I already know your answer. Here’s what you’ll say: “I’ll do what my boss tells me to do.”

And therein lies the true root cause of the problem.

From time to time contractors attempt to limit auditor access to certain records, data, or documents. Generally, the attempted limits stem from a contract clause, or from a lack of a contract clause. Recently, the Civilian Board of Contract Appeals (CBCA) tackled another contractor attempt. In doing so, the CBCA established some interesting positions of which government accounting and compliance practitioners should be aware.

We could tell you that the July, 2023, CBCA decision in the matter of HPM Corp. v. Dept. of Energy will likely be of limited use as a precedent—but that wouldn’t be entirely accurate. While the decision was issued from the civilian BCA, it is well-written and could be persuasive to Judges of other fora. (I mean, what do I know? I’m not a lawyer. But the decision seems to me to be potentially persuasive. We’ll have to see.)

HPM was awarded a contract by DOE in 2018 “to perform occupational medical services at the Hanford Site in Washington state.” (There it is: Hanford. Again. What is it about that place, anyway?) What type of contract was it? Yes. It was all the types of contracts.

Here’s how the CBCA described HPM’s contract: “a performance-based Contract that includes Firm-Fixed-Price (FFP) Contract Transition, FFP Occupational Medical Services, Cost Reimbursement (CR) Occupational Medical Support Services, and Indefinite Delivery/Indefinite Quantity (IDIQ) Contract Line Item Numbers (CLIN).” A “hybrid contract,” in short.

Hybrid contracts are all the rage these days. It’s not really unusual at all. The question is: which contract clauses apply to which contract types within the hybrid contract? Do all clauses apply to all contract types? That cannot be the case! For example, it would be absurd to say that the Allowable Cost and Payment Clause (52.216-7)—which is a mandatory clause for all cost-type contracts—applies to the FFP portions of a contract. Similarly, we know (through judicial decisions) that, even though 52.216-7 is mandatory for T&M contract types, it really only applies to the cost-reimbursement portion and not to the FFP-per-labor-hour portion. So you can’t say that all clauses apply to everything everywhere in the contract. The question remains: which clauses apply to what?

Therein lies the gravamen of the dispute.

The CBCA noted that HPM’s contract included the FAR clause 52.215-2 (“Audits and Records–Negotiation,” Oct 2010). The contract also included the FAR clause 52.216-7 (“Allowable Cost and Payment,” Jun 2013) ”… but with a limiting notation (added in bold lettering) that states as follows: ‘Applies to Cost-Reimbursement.’”

The dispute started during DCAA’s audit of HPM’s FY2019 proposal to establish final billing rates. HPM was reluctant to provide DCAA with all requested supporting documents. The documents it did provide to the auditors were marked to prevent DCAA from providing them to others—i.e., to the DOE contracting officer. Apparently, HPM’s rationale was based on the fact that “because HPMC did not submit any cost or pricing data for the FFP portion of the hybrid contract, it should not need to provide proprietary information to DOE regarding fixed-price costs.”

Hmmm. Interesting position.

It is true and correct that certain cost data associated with FFP contracts awarded without submission of any cost or pricing data are exempt from audit. For example, FAR Part 14 sealed bid contracts are generally thought to be audit-exempt. Similarly, FAR Part 12 commercial product or services would likely be found to be exempt, as well. But it’s a large step to go from there to “my FFP CLINs are exempt from audit.” I mean … that’s some kind of chutzpah right there, isn’t it?

The dispute continued into the FY2020 proposal to establish final billing rates. As related by the CBCA—

For the FY 2020 incurred-cost audit, DOE designated Cohn Reznick (CRZ) as its auditor. On January 19, 2022, the DOE contracting officer, relying on the requirements of FAR 52.216-7 (clause I.36) and DEAR 970.5204-3 (clause I.173), directed HPMC to provide both CRZ and DOE with a final indirect-cost-rate proposal accompanied by ‘adequate supporting data’ that included ‘any firm fixed price data needed to evaluate the indirect cost pool and base costs used to calculate indirect cost rates.’ Counsel for HPMC responded on January 22, 2022, that the disputed information was proprietary and that DOE was not entitled to it. He argued that clause I.173 was intended to provide DOE with access only to materials related to environmental, safety, and health work plans to protect against ionizing radiation and radioactive materials. He indicated that HPMC would provide information necessary to the audit to CRZ but not to DOE.

(Internal citations omitted.)

Let’s stop right here. If your legal counsel is already involved before the audit has really gotten started … well, you can be pretty sure your audit is not going to go well. As a very experienced government audit liaison (some would say too experienced), I have to opine that some battles just ain’t worth fighting. When your counsel tells your auditor that they can’t have access to information they want to see (or that whatever they see can’t be shared with their customer, in this case DOE) the first thought that is going to pop into the auditor’s head is “those guys are hiding something they don’t want me or my DOE customer to see.”

Why would you want to create that thought in your auditor’s head? Yeah, don’t do that.

In fact, my advice (after 40 years of doing this shit) is to keep your legal counsel far, far, away from ongoing audits unless they must be involved because a huge issue has been alleged (or has been found-out). There is a place for attorneys in protecting the company; of course there is! But there is an unfortunate tendency for attorneys to polarize the parties while they’re carving-out their legal positions. They start preparing for litigation right away. Which is fine if you’re excited to litigate. But as for me? My job as audit liaison is, generally, to avoid litigation. Litigation is expensive; it is time-consuming. It takes a long time and, while you’re waiting for the judge’s decision, you’re stuck in limbo. Litigation is not something I enjoy; nor should you if your job is to make the audits run smoothly.

The attorneys were involved here and, fairly quickly, a nonmonetary claim was filed with the contracting officer. After rejection, an appeal was docketed at the CBCA.

I was interested in how the DOE contracting officer dealt with the issue. According to the CBCA,

The contracting officer found that, pursuant to the contract’s inspection and audit clauses, DOE is permitted access to what HPMC views as proprietary material during an incurred-cost audit, even if some of the material relates to the FFP portion of the hybrid contract. The contracting officer then indicated that ‘DOE will proceed with the remedy to remove all unsupported costs associated with the FY 2020 indirect rates and FY 2022 provisional billing rates.’

(Internal citations omitted. Emphasis added.)

Yeah, that’s gonna hurt.

There’s a lot of stuff in the CBCA decision about whether the Board could even hear HPM’s claim. Here’s a summary:

HPMC is asking the Board to interpret its contract in a manner that would relieve HPMC from having to provide DOE with the audit support documents that DOE is demanding. Although HPMC presumably could continue to decline DOE’s production demand (as it now seems to be doing), wait for DOE to effectuate the indirect cost reductions that DOE has indicated it intends to impose, and then submit a monetary claim to recover that money, HPMC is not obligated to wait until DOE takes such action in order to seek a decision interpreting its audit production obligations under the contract.

Anyway, the CBCA Judges disagreed with HPM’s position. We’re going to quote extensively and you should read the quoted material, even though you probably won’t.

With regard to HPMC’s argument that these clauses only authorize DOE and its auditors to access information regarding the cost-reimbursement CLINs in its contract and that information associated with the FFP CLINs are completely off-limits, we disagree. HPMC’s contract expressly identifies one of the FAR clauses identified above (FAR 52.216-7) as being tied to the cost-reimbursement portions of HPMC’s contract, but the other FAR clause (FAR 52.215-2) provides generally for audits of ‘cost-reimbursement’ contracts. Although HPMC asks that we decide whether FAR 52.215-2 applies only to the cost reimbursement CLINs in its hybrid contract or to the contract as a whole, it is unnecessary to do so because, as far as we can tell, DOE’s auditors have not requested documents that would fall outside the context of a normal incurred-cost audit. Contractors’ incurred-cost submissions under cost-reimbursement contracts ‘are audited . . . to establish allowable direct costs and indirect cost rates for each fiscal year.’ Donald P. Arnavas, James J. Gildea & Normal E. Duquette, “DCAA Audits,” 94-09 Briefing Papers 1, 4 (Aug. 1994). DOE represents that ‘[a] well-known audit risk is misallocation and/or cost shifting between fixed price, cost reimbursable, and indirect work/costs’ and that ‘HPMC has had a history of misallocating costs between FFP and [cost-reimbursement] portions of the Contract.’ The audit in question is being undertaken to ensure that indirect costs being charged to the cost-reimbursement CLINs are appropriately allocated to those CLINs and have not been, through some type of accounting mechanism, moved away from FFP CLINs. …

The Board is in no position to impose some type of myopic limitation on the scope of documentation that auditors need to support an audit of the cost-reimbursement aspects of this contract or of HPMC’s indirect cost rates. … HPMC has identified no basis upon which we would step into the shoes of the auditors and micromanage what documents they may, or may not, need to support their review or bar them from accessing certain categories of documents.

The Court of Claims made clear more than forty years ago that a contractor cannot complain during contract performance about the Government’s reliance upon audit access rights, including the right to access what the contractor views as proprietary information, created by contract clauses to which the contractor, prior to award, did not object [quoting SCM Corp. v. United States, 645 F.2d 893, 902 (Ct. Cl. 1981)] ….

HPMC tells us that the documents which the auditors are seeking are far beyond what should be needed to evaluate HPMC’s costs. Certainly, the Government’s audit rights under these clauses are not limitless and do not provide a basis for wide-ranging document requests for corporate records unrelated to the verification of actual costs. But the contractor does not get to stop an audit simply because it thinks that what it has produced is good enough.

(Internal citations omitted. Emphasis added.)

So, at the end of the day, HPM managed to delay some audit procedures, coax from the DOE contracting officer a threat to unilaterally establish both final rates and provisional billing rates by removing “unsupported” costs, and to upset the working relationship with its auditors and with its government customer.

Not the greatest job of audit liaison, in my view.

I hope you will do better.