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Inflation and Your Supply Chain

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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.

Last Updated on Monday, 22 January 2024 19:53

Allowable Cost and Payment, Unilateral Decrement Factors: What We Now Know

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Here’s what we now know:

Item One: The Government cannot unilaterally impose an arbitrary decrement factor on a contractor that fails to submit its annual proposal to establish final billing rates, even if DCAA recommends that factor, unless it can support that factor. The Government has the burden of proof to show why any decrement factor is reasonably related to its risks that the contractor has overbilled its indirect cost rates.

Item Two: When dealing with Time & Materials (T&M) contract types, any DCAA-recommended decrement factor—no matter how calculated or supported—can only apply to indirect cost rates. Those indirect cost rates are applied to the reimbursable (“M”) side of the T&M contract costs. That factor simply cannot apply to the contractor’s fixed labor billings, the “T” side of contract costs. Nope. Can’t do it—those rates are fixed by contract terms and are simply not affected by any changes to allowable indirect cost rates.

Item Three: The Allowable Cost and Payment clause (52.216-7) applies to T&M contracts whether or not the clause is found in the contract at hand. Yes, readers: the clause will be read into the contract by operation of the Christian Doctrine.

Now, how do we know the foregoing?

We know about this stuff because Allard Nazarian Group, Inc., dba Granite State Manufacturing, appealed a contracting officer’s final decision to the ASBCA and Judge Stinson (writing for the Board) made those determinations in July, 2023.

A short history:

Scandia Manufacturing Company, Inc. (Scandia), had several government contracts—including three ID/IQ contracts that permitted issuance of only T&M task orders. In 2008, Allard purchased Scandia and all its contracts. A Novation Agreement was prepared and signed by an Administrative Contracting Officer. So far, so good.

In 2009, Allard was awarded a fourth contract of a similar nature: ID/IQ with T&M task orders. Unlike the other three, this contract incorporated clause 52.216-7 (“Allowable Cost and Payment”). Because T&M Task Orders were contemplated by the parties, all four contracts contained clause 52.232-7 (“Payments under Time-and-Material and Labor-Hour Contracts”). Okay so far?

Now it gets weird.

Apparently, Allard never submitted the annual proposals to establish final indirect billing rates (popularly but incorrectly called an “incurred cost submission”). Did it have to? Arguably, nothing in the three contracts it acquired from Scandia required the contractor to do so. With respect to the fourth contract—the one it entered into on its own—yes. Absolutely. 52.216-7 requires submission of a proposal to establish final billing rates.

If one contract requires submission, then that pretty much means you have to prepare a submission for the entire business entity. You’ve got to calculate final pools and bases; you’ve got claim (and certify) indirect costs. You’ve got to fill out the myriad Schedules we’ve all come to know and love. You signed the contract and so you have to submit the proposal and support it through audit.

But Allard never did.

Finally, the government lost patience.

By letter dated November 27, 2019, the Defense Contract Management Agency (DCMA) issued a contracting officer’s final decision and demand for payment of debt ‘resulting from Allard’s/Scandia’s failure to submit indirect cost rate proposals for Fiscal Years 2007-2009,’ stating that the ‘[d]ecision is applicable to all flexibly-priced contracts and subcontracts performed by Scandia/Allard during Fiscal Years 2007-2009’. According to the contracting officer ‘all reasonable efforts have been exhausted to obtain the subject matter final indirect cost rate proposals,’ and, therefore, the government had ‘unilaterally established . . . final indirect rates for Allard/Scandia fiscal years ending 31 December 2007, 31 December 2008, and 31 December 2009’.

(Internal citations omitted.)

In unilaterally establishing the Scandia/Allard final billing rates for FYs 2007, 2008, and 2009, the contracting officer applied a 20% decrement factor, as recommended by DCAA-Baltimore. With respect to the more current years (FYs 2010 through 2014), the contracting officer applied a decrement factor of 16.4%.

Importantly, the contracting officer’s unilateral rate determination did not limit application of the decrement to just appellant’s indirect costs, but rather applied the decrement factor against all invoiced amounts, including appellant’s direct, fixed rate labor costs.

Yeah, that’s gonna hurt.

Allard appealed. The company didn’t try to claim that it had actually submitted the required proposals; instead, it argued that the application of the unilateral decrement factor was flawed. That was the case in front of the Board, the case on which it ruled in a Partial Summary Judgment.

As part of pre-trial motion practice, the parties agreed to drop FYs 2007 and 2008 from the appeal. We’re thinking that was done because, to be honest, nothing in any Scandia/Allard contract required submission of a proposal to establish final billing rates. Whatever the parties intended, you couldn’t find it in the contract terms. So, at the end, the Board’s decision only covered FYs 2009 through 2014.

What did the Board rule?

  • When a government contracting officer unilaterally establishes a contractor’s final indirect billing rates (which, to be clear, is a thing that can be done), then those rate determinations are considered to be a government claim. Because they are a government claim against the contractor, the government has the burden of proof—and it must show its decrement factor is reasonable. “FAR 42.703-2 allows the government to set a unilateral rate aimed at ensuring the government does not reimburse a contractor for unallowable costs. Specifically, FAR 42.703-2(c) provides that any unilateral rate ‘should be - (i) [b]ased on audited historical data or other available data as long as unallowable costs are excluded; and (ii) [s]et low enough to ensure that unallowable costs will not be reimbursed.’ FAR 42.703-2(c)(2).

  • “… the government applied a decrement to appellant’s direct labor rate costs based upon appellant’s alleged failure to submit auditable indirect cost rate proposals. FAR 52.216-7(g) does not provide a proper justification, or regulatory authority, for the government’s actions taken here.” (Emphasis in original.) “The government’s imposition of an indirect cost rate decrement upon appellant’s fixed labor costs is unreasonable as not supported by the regulatory authorities cited by the government and contrary to the traditional demarcation between direct and indirect costs and the separate treatment of those costs.”

  • “… pursuant to the Christian doctrine, FAR 52.216-7 - as a mandatory time and materials contract clause specified in FAR 16.307(a) - is considered inserted into the contract by operation of law.”

  • “The express language of FAR 16.307(a)(1) dictates that FAR 52.216-7 applies ‘only to the portion of the contract that provides for reimbursement of materials (as defined in the clause at 52.232-7) at actual cost’.”

The Board also noted that submission of a proposal to establish final billing rates was not needed to evaluate the propriety of Allard’s direct labor billings. The contract clause 52.232-7 already gave the government audit rights in that area. It did not appear that the government availed itself of its contractual rights before deciding to apply its decrement factors.

So, readers, that’s how we know what we know.


Excessive Pension Plan Contributions?

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I used to joke that, at many aerospace/defense contractors, employees are not actually the most important priority. Instead, the supplement executive retirement plan is the most important priority. It was a joke, folks.

But then Northrop Grumman started to litigate government disallowances of its pension plan contributions.

The [Northrop Grumman Supplemental Executive Retirement] Pension Plans are designed to provide supplemental retirement benefits, paid after retirement, to a select group of Northrop Grumman’s executives and other key employees or highly compensated employees whose retirement benefits exceed those permitted under Northrop Grumman’s qualified pension plans, to encourage these employees to continue providing services to Northrop Grumman until their retirement.

(Internal citations and footnotes omitted.)

How does Northrop Grumman calculate the executives’ supplemental retirement plan benefits? Well, it varies (because there are a number of plans)—but one factor that crosses all plans is the participants’ Final Average Earnings (FAE). The plan calculates the FAE for each individual, then applies a percentage factor to that FAE to calculate the pension plan contribution amount. The number of years of service is also factored-in, but that’s not especially relevant to this discussion.

Critically, when calculating the FAE, “The FAE does not exclude compensation that was in excess of the FAR 31.205-6(p) compensation limitation in effect at the time the plan participant earned the compensation (bonus and salary).” Thus, the FAE includes compensation made unallowable by 31.205-6(p).

The amount of the participants’ supplement executive retirement plan benefits is based, at least in part, on unallowable compensation.

Is this a concern? Northrop Grumman didn’t think so. The company argued that—

… the pension costs here are allowable pursuant to FAR 31.205-6(j)(1) as they meet both CAS 412 and 413, which are referenced in that FAR provision, and that ‘the cost limitations and exclusions set forth in paragraph (j)(1)(i) and in paragraphs (j)(2) through (j)(6)’ do not apply to the pension costs at issue here. According to appellant, the compensation cap set forth in FAR 31.205-6(p) has no application because (1) it does not expressly state that it applies to defined benefit pension plans, and (2) FAR 31.205-6(p)(2)(ii) states the cap represents ‘the ‘sole statutory limitation’ on allowable senior executive . . . compensation’. Appellant also argues that the pension costs are not directly associated costs under FAR 31.201-6(a) because the pension costs were not ‘generated solely’ as a result of unallowable compensation (salary and bonus) and the government cannot establish that the pension costs would not have been incurred but for the incurrence of the participant’s compensation.

(Internal citations omitted.)

The government, for its part, begged to differ with Northrop Grumman, which is why the matter wound up before the ASBCA.

As summarized by the Board, the government’s position was—

… although the Pension Costs themselves may not be subject to the FAR 31.205-6(p) compensation cap, the cap nonetheless applies to the underlying bonus and salary utilized in the Retirement Benefit Formulas’ compensation factor. The government notes that FAR 31.205-6(p)(2)(ii) expressly disallowed senior executive compensation in excess of the benchmark compensation amount determined applicable for the contractor fiscal year by the Administrator of the Office of Federal Procurement Policy (OFPP). According to the government, the pension costs here are unallowable as directly associated costs of unallowable compensation pursuant to FAR 31.201-6 and are unreasonable because they are derived from unallowable compensation. The linchpin connecting both arguments is the proposition that the Retirement Benefit Formulas utilized to determine pension costs include as one factor a plan participant’s FAE computed utilizing compensation that exceeded the FAR 31.205-6(p) limitation in effect at the time the plan participant earned the compensation.

(Internal quotations and citations omitted.)

Northrop’s arguments were unavailing. The Board ruled that pension contributions that were based on unallowable compensation were, themselves, unallowable. The Board wrote:

Northrop Grumman drafted its pension plan such that a portion of it (the portion the government seeks to disallow) is paid based upon executive salary that exceeds the statutory cap. To put it another way, if Northrop Grumman were not paying a salary above the statutory cap, it would not have paid the challenged portions of the pensions at issue. …

At bottom, it is the amount of the pension cost - determined in part by compensation that exceeds the cap - that would not have been incurred but for incurrence of the participant’s compensation exceeding the cap. In that manner, the challenged pension costs were generated by Northrop Grumman’s inclusion in its pension formula of amounts that exceeded the cap. As the government notes, it was Northrop Grumman that created the Retirement Benefit Formula for determining pension benefits. Northrop Grumman was free to structure it in such a way that its formula did not include amounts above the applicable compensation cap. The fact that Northrop Grumman chose to include costs above the cap does not justify its now seeking reimbursement from the government for pension costs that were determined based upon the excess costs. Clearly, the additional pension cost for which appellant requests reimbursement would not have been incurred had appellant not paid its pensioners compensation that exceeded the cap.

At the end of the day, the Board cited to its previous 2020 DynCorp decision, which also disallowed certain severance costs when they were based on compensation that exceeded the FAR ceilings. We didn’t care for that decision—and we explained why in our article. However, this decision seems far less tortuous to us.

Any other compensation that is based on unallowable compensation is, itself, unallowable. That’s the rule—whether you like it or not.


Audit Access

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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.


Flawed Audits and Disallowed Temp Labor Costs: Another Dispute at Hanford

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Washington River Protection Solutions LLC (WRPS) was awarded a Tank Operations Contract (TOC) by the Department of Energy for performance at the Hanford Site. You know about the Hanford Site, right? We’ve written about the Site before—we’ve written a surprising number of articles about compliance issues there, involving many different contractors.

WRPS is “an Amentum-led” company. Which means (we think) that WRPS is managed by Amentum, even though many other companies may be involved in performance of TOC work. Amentum is the name of a company that used to be called AECOM. During its history, AECOM acquired URS, which had acquired EG&G, Westinghouse Government Services, Lear Siegler, Washington Group International (formerly known as Morrison Kundsen), and Apptis. AECOM also acquired DynCorp International and Pacific Architects and Engineers (PAE) at various points in time. So, basically, Amentum is a massive conglomerate with multiple subsidiaries and business that have very long government contracting pedigrees.

In other words, WRPS knows the ins and outs of government contracting. Thus, when DOE demanded it repay costs found to be unallowable, WRPS hired itself some attorneys and appealed the decision to the Civilian Board of Contract Appeals (CBCA).

WRPS started performing the TOC in 2008. During its performance, WRPS used a practice of augmenting staff by hiring “contracted labor resources (CLRs).” “CLRs are individuals hired through staff augmentation subcontractors to perform a specific scope of work or to fill in for missing personnel on a temporary basis under the direct supervision of a WRPS employee.”

From the Board’s findings of fact:

WRPS competes different labor categories among staff augmentation contractors and enters into blanket master agreements (BMAs) that contain labor categories and rates. Once BMAs are established, CLRs can be hired quickly, and WRPS does not incur the training or separation costs that it would for a full-time employee, costs estimated to be between $28,000 and $38,000. CLRs also allow WRPS to accomplish tasks when budget funds are available and to downsize quickly without additional cost when budget funds are not available. It also allowed WRPS to obtain the services of contractors who would not take a full-time position. WRPS hired 1224 CLRs in the first ten years of the contract, as compared to the average 4300 full-time WRPS employees. Very few of these CLRs worked full-time during any given year, and few worked more than five years as a CLR. WRPS spent nine percent of its staffing dollars paying for CLRs.

(Internal citations omitted, as will be the case in all block quotes used.)

In February, 2020—nearly eight years after WRPS had started contract performance—the DOE issued a Notice of Intent to Disallow Costs to the company. DOE intended to disallow more than $6 Million for a variety of reasons. To our way of thinking, DOE threw a bunch of spaghetti at a wall to see which issue would stick. The disallowance was based on an audit report prepared by the DOE Richland Finance Office.

As the Board wrote—

In the audit, DOE Finance examined the compensation records for forty-one individuals hired as CLRs by WRPS that it had ‘judgmentally selected, seeking CLRs that had worked for WRPS for three or more years consecutively. DOE Finance identified numerous concerns with the employment and compensation for thirteen of these individuals, including concerns that WRPS did not have effective controls to ensure that CLRs met minimum qualifications and that several CLRs were paid rates higher than the rates agreed to on the subcontract through which they were hired. DOE Finance was also concerned that none of the forty-one CLRs had been subject to a ‘make versus buy’ analysis to determine whether it was less expensive to hire a new WRPS employee rather than filling the requirement with a CLR. DOE Finance did not provide a dollar figure that matched the $6 million amount in the notice of disallowance; instead, DOE Finance recommended a settlement range between $5.75 million and $8 million.

In August 2020, WRPS provided a response to both the audit report and an explanation of the reasonableness of the dollars expended for the thirteen individuals that were the focus of the DOE audit.

Okay. Let’s stop right there. Notice the lack of specificity of the purported audit findings. Notice the lack of a sum certain. What kind of audit recommends a “settlement range” rather than express a sum certain finding? Answer: no audit we ever heard of. At least no audit that complies with GAGAS.

On December 10, 2020, DOE issued a contracting officer’s decision in which DOE disallowed $6,025,069 because the costs were unreasonable.


Okay. But notice that WRPS had, in its view, already supported the reasonableness of the disputed costs. And notice that the Contracting Officer’s Final Decision was a specific sum certain, rather than a range.

How did anybody get from a “settlement range” to $6,025,069? The Board answered that question as follows:

DOE calculated this amount by identifying specific costs to be disallowed for thirteen individuals for four different reasons. For five individuals, DOE identified a ‘high’ and ‘low’ amount that were disallowed and averaged the figures. The sum of the amounts calculated for the thirteen individuals was $3,012,534. DOE multiplied this figure by two to derive the final amount disallowed. DOE applied this so-called ‘2x’ factor because DOE, in its review, found other instances of the same issues identified for the thirteen individuals, and the factor would account for what DOE believed was ‘excessive pass-through’ of subcontracting costs related to CLRs.

Do we even have to articulate how we feel about that so-called “methodology”?

Averages. A 2x “factor” to address an issue not even found in the COFD. Are you kidding us? This is audit malpractice, as clear as the sun in the sky or the radioactive waste in the ground at Hanford. Auditors who participated in this debacle, and their supervisors who approved it, should be—at the very minimum—educated in how to conduct audits and reach conclusions based on evidence.


According to the Board—

DOE brought challenges to specific costs that can be grouped into four categories:

1. The hourly rates paid to seven individuals exceeded the hourly rates that they would have received purportedly as WRPS full-time equivalents (FTE).

2. The hourly rates paid to three individuals exceeded the rates set forth in the BMAs competed among the staff augmentation subcontractors.

3. Seven individuals purportedly did not meet the qualification requirements set forth in the BMA for their positions.

4. The hourly rate paid to two individuals was increased ‘overnight’ with purportedly no reason for the increase.

The Board discussed each of the four issues within its decision. For the most part, the Board dismissed the DOE’s non-specific concerns and, instead, accepted WRPS’s analysis as sufficient evidence to support a finding that the CLR costs were, indeed, reasonable. For example, the Board wrote—

We find no merit in DOE’s challenge based upon what the individuals would have been paid if hired as full-time WRPS employees. The problems with DOE’s analysis on this point are myriad—the analysis fails to account for the hours these individuals worked, is based upon an analysis of 2018 rates, but applied across all years of the contract, and fails to account for the years of experience that many of these individuals possessed.

You can and should read the analyses within the decision; the link is provided above.

With respect to the “2x factor” the Board wrote:

The specific amounts that DOE challenged for the thirteen individuals totaled $3 million. Because DOE had identified other individuals with qualifications or other issues, DOE doubled the amount sought to capture them. DOE sought to be conservative in applying this 2x factor. As the DOE auditor explained, it was not proper to extrapolate because DOE had selected the original forty-one individuals to be audited based upon tenure rather than sampling the entire pool. DOE sought to capture other issues, like excessive pass-through, which the DOE auditor acknowledged had not been quantified.

(Emphasis added.)

The foregoing describes gamesmanship, not auditing.

The Board did not castigate DOE for its approach. Instead, the Board wrote:

While we appreciate that DOE was attempting to approximate the costs of other problems it identified with its application of the ‘2x factor,’ this approach does not comport with the FAR requirement that the contracting officer identify a ‘specific cost’ that was challenged on reasonableness. FAR 31.201-3.

At the end of the day, the $6 Million sought by DOE was not upheld. Instead, WRPS was required to pay $80,275 (plus interest).

Why sanctions weren’t sought—and imposed—on the DOE for its methodology, a methodology that smacks of a lack of good faith and fair dealing, remains a mystery to this blog author.

Last Updated on Tuesday, 15 August 2023 08:51

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Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.