DCAA Independence Hits New Low, with Auditors Opining on Legal Entitlement
On November 11, 2009 the Court of Appeals for the Federal Circuit took the somewhat unusual step of affirming a prior decision by the Armed Services Board of Contract Appeals (ASBCA) in a nonprecedential decision without comment, pursuant to its Rule 36. Curious about the case that was so clearly correct that the Appellate Judges did not believe comment was warranted, we researched the original ASBCA case, and were taken aback by what we found.
But first, some background. Readers of this site are well aware of concerns raised by the Government Accountability Office (GAO) regarding the Defense Contract Audit Agency’s (DCAA) alleged failure to maintain “independence” from those it audits. In addition to the original July 2008 GAO audit report that first raised this issue, we have reported on this issue in August, in September, and several times in October. It’s fair to say that auditor independence has played a large role in Senate and House hearings on the quality and effectiveness of DCAA’s audits, and likely led to former Director April Stephenson’s reassignment in November of 2009.
Auditor independence is a big deal—or so we thought, until we read the original ASBCA decision in the matter of Beyley Construction Group Corporation (found here).
BCG’s Contract Dispute and Appeal to the ASBCA
Beyley Construction Group (BCG) was awarded a grounds maintenance contract by the US Army, to be performed at Fort Buchanan, Puerto Rico. BCG, an 8(a) business (which is a small business which is owned and controlled by one or more socially and economically disadvantaged individuals), received the contract, which included a base year and two option years. The contract included the clauses 52.212-4 and 52.212-5 (which indicated that it was a contract for a commercial item acquired pursuant to FAR Part 12)—but it also included the clause 52.222-41, incorporating the Service Contract Act. The inclusion of the Service Contract Act clause is interesting, because acquisitions of commercial services should have been exempted from the Service Contract Act (SCA) pursuant to the requirements of the Federal Acquisition Streamlining Act Of 1994 (FASA), as this letter from the American Bar Association, Public Contract Law Section, makes clear.
In fact, research tells us that the SCA was on the list of public laws which were exempted from application to commercial item acquisitions, until it was removed from the list of exemptions in July 2000. Subsequently there was a somewhat confusing parade of DOD class deviations, interim rules and final rules, which ended with the SCA being applicable to some (but not all) prime contracts for commercial services, and to some (but not all) subcontracts for commercial services. At the end of the day, it appears that BCG’s contract was, indeed subject to the SCA, even though it was a Part 12 “commercial item” acquisition. (But even this conclusion is subject to some doubt, as we will discuss later in this article.)
The gist of the SCA requirements was discussed by the judge in BCG’s case, and is as follows—
Each service employee employed in the performance of this contract … shall be paid not less than the minimum monetary wages and shall be furnished fringe benefits in accordance with the wages and fringe benefits … as specified in any wage determination attached to this contract. … In the absence of a minimum wage attachment for this contract, neither the Contractor nor any subcontractor under this contract shall pay any person performing work under this contract … less than the minimum wage specified by … the Fair Labor Standards Act of 1938. [Emphasis added.]
As the judge noted, “The contract did not attach any wage determination and, accordingly, the minimum wage—$5.15—was applicable. Had it been made a part of the contract, the proper wage determination (WD) would have established a wage of $6.13 plus $2.02 in health and welfare benefits.”
BCG was the low bidder and, after confirmation by the Government of its price, it was awarded a contract in September 2001. (Note the timing. It is possible that the SCA was not applicable to the acquisition during formulation of the government’s requirements and request for proposal, but became applicable by the time the contract was awarded. Interestingly, there was no discussion of the acquisition time line and/or SCA applicability in the ASBCA decision.)
It became clear during the first six months of performance that BCG had “forgotten” to include an estimate for health and welfare benefits in its bid. The judge found that “BCG included a wage rate of $6.13 plus 40% for [fringe benefits]. … Beyley testified that had BCG included health and welfare benefits, the fringe benefit portion of its service employees’ pay ‘would have been like around 72 percent instead of 40 percent’.” It became clear that not only had BCG not included the full amount of prevailing wages pursuant to the SCA, neither had the government’s Independent Government Estimate (IGE). It began to look like there had been a mutual mistake in contract formation, as opposed to a unilateral mistake by the bidder, discovered after contract award. Nonetheless, failing to get a favorable decision from the Contracting Officer (using the FAR language at 14.407-4(a) as support for its position), BCG filed a certified claim pursuant to the Contracts Dispute Act. (We note for the record that it is unlikely BCG’s interpretation of that FAR Part 14 language would have been upheld by the Court.)
In its pleading before the ASBCA, the government said, “With respect to the claim for omitted DOL wage rates, the contracting officer will issue a modification that compensates Appellant for the difference between the amount Appellant received from the Army and the prevailing DOL wage rate for health and welfare benefits plus interest in accordance with the Prompt Payment Act.…” In other words, the government conceded during its arguments the merits of BCG’s claim and notified the Court that it would make BCG whole.
Then DCAA got involved.
DCAA’s Audit of BCG’s Claim
The judge found that “DCAA issued its audit report (No. 1271-2008F17200001) on 29 February 2008. Even though it found that BCG actually incurred $343,020 in health and welfare payments, more than the $322,085 originally claimed, DCAA questioned the entire amount claimed. It found that ‘[t]he contractor failed to include these costs,’ in its bid, and that it signed the contract, ‘either knowingly or unknowingly, omitting the costs.’” Based on the DCAA audit report, the government reversed its previous position and now asserted “that it has no obligation to pay said amount and intends to litigate this issue before the Board.” The government’s change of position was warranted, in its view, “because its concession on the health and welfare costs was ‘based upon a then incomplete understanding of Appellant’s claim’ since clarified by the [DCAA] audit [opinion].”
Unsurprisingly BCG opposed the government’s change of position, arguing that since “the audit cannot express any opinion on the contractor’s [legal] entitlement,” the audit report could only be used to determine quantum but not legal entitlement. The judge was not persuaded by BCG’s argument, and permitted the government to change its position. In other words, DCAA’s opinion of the legal issues involved was allowed to affect the litigation.
Generally, Government claims are divided into two basic parts: "entitlement" and “quantum”. Entitlement is the legal determination of whether the claim has merit, while quantum is the determination of how much money (or time) is involved. As a general rule, if entitlement is not established, there is no need to address quantum. Almost universally, accountants involved in litigation support roles are focused exclusively on the quantum and do not express any opinion on the legal entitlement or merits of the case, because doing so is essentially practicing law without a license. Not so DCAA, who apparently feel free to advise the government attorney on the legal merits of the contractor’s entitlement to the quantum involved.
A review of the June 2009 edition of the DCAA Contract Audit Manual (CAM) finds the following audit guidance—
Entitlement is a legal question; however, the auditor should provide the requestor with any meaningful observations regarding the question of the contractor's entitlement to recover delay damages …. These observations may be provided in the audit report explanatory notes or in an appendix on other matters to be reported. (CAM 12-802.1a. Emphasis added.)
The CAM also contains the following guidance –
Report any meaningful observations regarding the question of the contractor’s entitlement to recover unabsorbed overhead damages to assist Government officials in determining entitlement issues. Facts or circumstances that could assist the contracting officer in determining entitlement, may include:
· Evidence that the asserted Government delay/suspension did not cause any extension in the actual time of performance beyond the original or previously revised contract performance date.
· Evidence that the contractor was or was not able to begin work on the next new contract in the extension period because of continuing work on the delayed/suspended contract.
· Evidence that the contractor did or did not secure a replacement contract(s) or other substituted work between the start of the delay/suspension period and the end of the period of extension beyond the original or previously revised contract performance date.
· Evidence of contractor-caused delays that were concurrent with the alleged Government delay or suspension.
· Evidence that the contractor was aware of differing site conditions or other causes of the asserted Government-caused delay prior to the original bid submission.
· Evidence that the contractor was unable to obtain replacement work because its bonding capacity was limited due to circumstances unrelated to the Government-caused delay/suspension.
Provide observations on any evidence as discussed above in the audit report explanatory notes or in an appendix on other matters to be reported.
[Emphasis added.]
Importantly, the foregoing guidance (found at CAM 12-804c and d) permits the DCAA auditor to “report … observations” with respect to the contractor’s entitlement—but only to the contracting officer and only with respect to audits of claims for unabsorbed overhead in claims for government delays and/or disruptions. Thus, it is doubtful that the DCAA audit report discussing BCG’s SCA costs could be said to have been prepared in full compliance with applicable audit guidance. In our view, the questioning of the contractor’s entire claim by the DCAA auditor, based on the auditor’s opinion of the contractor’s legal entitlement to its additional costs, is more than a lack of independence; it brings into question whether the auditor followed applicable professional standards.
The Court’s Decision
The ASBCA judge permitted the Government to change its position with respect to BCG’s claim for the additional health and welfare costs it failed to include in its bid. Characterizing the situation as a “unilateral mistake in bid,” it found there was “insufficient proof” that the Government knew (or should have known) that BCG”s bid was too low. Accordingly, the Court found that BCG was not entitled to a reformation of its contract to cover the omitted health and welfare costs. There were other claim elements, each of which was addressed and denied seriatim.
As we noted at the beginning of this article, the ASBCA decision was appealed and adjudicated by the Court of Appeals (Federal Circuit) without comment, pursuant to Rule 36. The Federal Circuit’s Rule 36 permits an Entry of Judgment without Opinion when “an opinion would have no precedential value” and when one of several conditions are determined to exist. Among those decisions are “findings that are not clearly erroneous,” and where there was no error of law in the original judgment.
Based on our reading of the ASBCA case, we beg to differ with the Appellate Court’s opinion. We hope this article has raised a number of questions in the readers’ minds—among them whether this was a case of a unilateral or mutual mistake, and whether or not the SCA should have been incorporated into BCG’s commercial item contract. Additionally, we trust we have raised awareness and concern regarding a DCAA report that (apparently) offered a legal opinion on the contractor’s entitlement, and which significantly influenced the outcome of the litigation.
DISCLAIMER: Nobody at Apogee Consulting, Inc. is an attorney and (unlike DCAA) we are not offering any opinions of law. We are simply reporting the personal opinion of the author, which may not reflect the views of Raytheon Company or any client of Apogee Consulting, Inc. In fact, as laypersons, we probably got the whole legal analysis wrong. If we were you, we wouldn’t rely on it. Except the part about DCAA issuing opinions on legal entitlement—that’s the issue we think you should be prepared for when you file a claim pursuant to the Contract Disputes Act.
UPDATE: Latest KC-X Tanker RFP Illegal?
We previously wrote about the troubled history of the KC-X aerial tanker program, calling it a “poster child for what’s wrong with the modern Defense acquisition system.” We noted continued problems with the RFP and noted that any significant revisions to the current draft RFP might lead to further delays, but that if any bidder believed that the playing field wasn’t level, it might pull out of the competition altogether.
Now from InsideDefense.com comes word that a former Bush administration “Top Procurement Official” questions whether the Air Force's proposed evaluation methodology complies with a recently enacted statute governing Defense acquisition of major weapon systems. Enjoying wide bipartisan support, the Weapon Systems Acquisition Reform Act of 2009 (Public Law 111-23) was passed quickly by both Houses of Congress and signed into law by President Obama in June 2009. An analysis of the statute can be found here. Among other things, the statute requires that “mechanisms to ensure that trade-offs among cost, schedule and performance objectives are made as a part of the process for developing program requirements.” In the words of one commenter, “The Act targets acquisition programs at the point of concept refinement, technology development and requirements definition, rather than when programs reach the system development phase. The conscious effort to force trade-offs between cost, schedule and performance is a clear reaction to the perception in Congress that the budget, acquisition and requirements processes are not now rationally connected.”
So when Robert Burton, former (and longtime) Deputy Administrator of the Office of Federal Procurement Policy (OFPP) whispers that there may be a problem with the current KC-X RFP, one must take the allegation quite seriously, even if he made the allegation as a legal consultant for hire by one of the bidders. InsideDefense.com quotes Burton as saying, “Clearly the KC-X draft request for proposals goes against the spirit of the … Act and I think you could make an argument that it might even be in violation of the law.”
The problem with the RFP, according to Burton, is that it reportedly contains 373 equally weighted pass-or-fail attributes. As we previously reported, “water flow in the sink and toilet were just as important as fuel offload rate.” Because the Air Force is seeking to award a fixed-price development contract for the next generation aerial tanker, and because there is no apparent mechanism to evaluate the risk associated with each bidder’s approach, Burton asserts that the “best value” solicitation approach has been converted into a “low-price, technically acceptable” approach, which significantly increases the Government’s risk of cost overruns, quality issues, and schedule delays.
Burton is not alone in expressing criticism of the draft RFP. Senator John McCain (R-AZ), who sponsored the Weapon Systems Acquisition Reform Act, reportedly wrote a letter to SecDef Gates in late October 2009 stating his concerns with the Air Force’s approach to selecting the KC-X contractor. InsideDefense.com reports that McCain was concerned that Systems Engineering and Technology Maturing evaluation sub-factors were not weighted more heavily than other evaluation sub-factors, since doing so would help the Pentagon evaluate “relative developmental and integration risk” (according to Senator McCain). Burton agreed, asserting that “the failure of the draft RFP to provide for trade-offs between cost, schedule and performance is clearly inconsistent with the intent of the law and Congress’ desire to maximize competition and minimize risk.”
As always, the political ramifications of a contract of this magnitude ($40 billion) have to be understood as background noise to the actual proposal process that is underway. That being said, the history of this troubled acquisition fails to inspire confidence that the Air Force finally got it right, this time.
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DOD Issues Latest Iraq Status Report Citing Positive Trends and Continued Challenges
DOD recently issued to the public its latest quarterly status report on conditions in Iraq. The report, mandated by Public Law, provides an in-depth look into the present and future of the war-torn region. The latest report (current through 30 August 2009) discusses implementation of the Security Agreement (SA) and Strategic Framework Agreement (SFA), and notes that Iraqi Security Forces (ISF) are now responsible for providing urban security, with the US forces acting in an advisory role. Multi-national forces (e.g., UK, Australia, Romania) have largely departed the theater and the drawdown of US forces has begun; the report envisions a complete withdrawal of US forces by 31 December 2011. (We reported on allegations that support contractors are not reducing their staffs in a commensurate manner to the troop drawdowns here.)
The report states that the upcoming January 2010 elections will be “a pivotal event” for the Government of Iraq (GoI); the election includes a national referendum on the SA that, if voted down, could “force an earlier than anticipated redeployment of U.S. forces.”
Territorial issues between Kurds and Arabs continue to breed internal tensions. In addition, the report states “targeted operations against insurgent and extremist groups continue to disrupt their activities, but gains in the security environment are not yet enduring.” Shi’a and Sunni nationalist groups are slowly integrating into the Government, but much work remains to be done. The report includes the statement that—
Malign Iranian influence continues to pose a significant challenge to Iraq’s long-term stability and political independence. The GoI, through reciprocal visits with Iran at the Head-of-State and Foreign Minister levels, has sent strong messages warning Iran against its continued support to Shi’a militants, while still encouraging improved bilateral relations, economic cooperation, and cultural and religious exchanges.
Significantly, the Iraq military and civilian budgets and overall fiscal situation have been impacted by low oil prices and the diversion of export oil to its own infrastructure.
The report (which can be found here) concludes as follows—
… political, security, economic, diplomatic, and rule of law trends in Iraq remain generally positive, but significant challenges remain. … In spite of the continued progress, these gains remain uneven throughout the country and marred by infrequent but high-profile attacks. Additional progress is required to produce sustainable stability. Iraq remains fragile, primarily because many underlying sources of instability have yet to be resolved, putting security gains at risk. To ensure long-term stability, the GoI must continue to build its legitimacy through the provision of basic services and improved security for the Iraqi people, as well as the continued resolution of lingering political, ethnic, and sectarian disputes.
PICTURE CREDIT: An Iraqi soldier exits a Marine helicopter during joint air assault training between Iraqi commandos and scouts, and U.S. Army paratroopers on Camp Ramadi, Iraq, Nov. 15, 2009. The goal of the training was to learn the standard procedures of each side for future joint missions. The U.S. soldiers are assigned to the 82nd Airborne Division's 2nd Battalion, 504th Parachute Infantry Regiment, which is serving as an Advise and Assist Brigade. /U.S. Army photo by Spc. Michael J. MacLeod
Allowability and Allocability of Costs in the War Zone
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.
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