In Part 1 of this analysis of the recent Raytheon victory at the ASBCA, we outlined the issues—which involved multiple appeals covering multiple issues across multiple years at both the Raytheon Corporate Home Office and its Missile Systems business unit. We also discussed the first major issue: the allowability of Raytheon’s premium class airfare. In Part 2 we discussed the treatment of two similar issues: Raytheon’s “Corporate Development” and “Government Relations” costs.

Here’s a link to the ASBCA decision, in case you want to review the 100+ page decision. (Hint: you really should.)

In Part 3, we are going to discuss the treatment of patent costs incurred at Raytheon Missile Systems (RMS).

Let’s get to it.

Patent Costs

FAR 31.205-30 (“Patent Costs”) controls the allowability. In a nutshell, the cost principle says that patent costs required by a government contract are allowable and “general counseling services relating to patent matters, such as advice on patent laws, regulations, clauses, and employee agreements,” are allowable. Pretty much all other patent-related costs are not allowable. (But read the cost principle for the details, please.)

Raytheon had a policy to tell employees how to treat any inventions that might be produced on company time. (As we are learning from writing this series of articles, Raytheon seems to have had a policy for just about everything under the sun. Given how Raytheon has a near-unbroken string of victories for appealing costs questioned by DCAA, we suggest other contractors might want to consider doing the same.) Raytheon’s policy assumed that any new inventions would be discovered during performance of a government contract, but allowed that such might not be the case. The policy contained a form that the inventor was to complete and submit it to a committee for review. Importantly, the policy did not solely address patents; it addressed any intellectual property that might be created.

The Board described Raytheon’s policy as follows:

Form 10-5876 requires the inventor to describe the invention technically and to explain how it is new. It also requires identification of the labor charge code applicable to the time the inventor spent conceiving of or reducing the invention to practice. If the invention was discovered separately from government contract work, the inventor must identify the charge code for the company-funded program or overhead. If the work was performed under a government contract, the invention disclosure reports the contract number and the applicable FAR and Defense Federal Acquisition Regulation Supplement (DFARS) patent rights clauses.

(Internal citations omitted.)

The committee evaluated the invention disclosure to determine whether Raytheon should file for a patent or treat the intellectual property as a trade secret, innovation award, or a different type of intellectual property. If the committee decided not to seek a patent, the invention was not disclosed to the public and remained confidential. If the committee decided to seek a patent, the invention disclosure was submitted to another function for handling. According to Raytheon, at the point where the committee decided to seek a patent, the associated costs become subject to the 31.205-30 cost principle. All costs incurred prior to that point where not subject to the cost principle, because nobody knew whether or not they were related to a patent. Costs incurred before a decision to submit for patent processing were just regular (allowable) overhead costs, according to Raytheon.

The Board noted that, in 2007, 149 invention disclosure forms were submitted for committee review at RMS. Of that amount, 110 (74%) were approved for patent processing. Of the 110 patents that were processed in that year, 26 (24%) were related to a government contract (i.e., allowable), and the remainder were not (i.e., unallowable).

If you’ve read the previous two articles on this appeal, you will not be surprised to learn that DCAA (and DCMA) disagreed with Raytheon’s position on cost allowability. DCAA’s position, according to a quote in the Board’s decision, was that “’all effort incurred by RMS employees to prepare, review, and approve/disapprove invention disclosures for patent applications to be patent costs’.” (Emphasis in original.) According to the Board’s Findings of Fact (#122 and #123)—

DCAA based its questioned amount of $96,701 in ‘engineering labor costs claimed in the engineering overhead pool for RMS patent activities not required by contract.’ DCAA speculated that the actual costs incurred could be ‘substantially more.’ (emphasis added) DCAA concluded that RMS had violated CAS 405 by failing to identify adequately and exclude the expressly unallowable patent costs.

DCAA replied [to Raytheon’s objections] that, unlike RMS’ practice, FAR 31.205-30 did not exclude costs of invention disclosures not submitted for patent approval, or protected as intellectual property in some other way, from its unallowable cost restrictions.

The Board also noted that, perhaps because of the long delay associated with DCAA’s audit (the audit started in 2008 and concluded in 2014), the agency’s position had changed over time. Initially, the auditors had said there was “insufficient audit evidence” to support questioning the costs, but that initial position didn’t stop the agency from overruling the auditor’s judgment in the final report. (GAGAS violation, anybody?) In the end, the audit report questioned $96,701 of claimed indirect engineering labor costs and the DACO hit RMS with a CAS 405 noncompliance because Raytheon should have known that those costs were expressly unallowable. (Notwithstanding the fact that a different group of DCAA auditors at a different Raytheon business unit had found similar costs, in similar circumstances, not to be unallowable at all.)

Raytheon had attempted to create a “bright line” for cost allowability, similar to its treatment of Government Relations and Corporate Development costs. (See the Part 2 article for details.) In Raytheon’s view, it was not until it was clear that a patent would be pursued that the costs became subject to the 31.205-30 cost principle. In contrast, the DCAA/DCMA view was that all costs associated with a patent, including preparation of invention disclosures (and the Raytheon disclosure form) were expressly unallowable unless required by a government contract.

The Board disagreed with both positions.

According to the Board—

The government misreads FAR 31.205-30 to apply more broadly than it does, and it adds language to the regulation that is not there. The regulation certainly does not specifically define ‘preparation’ of ‘invention disclosures’ ‘as an initial but essential step in the [p]atent application process’ (whether or not a patent is ultimately submitted, rejected, or obtained). Moreover, it does not state that all invention disclosures are patent costs, regardless of whether patents are involved. Indeed, some of RMS’ invention disclosures are associated with forms of intellectual property other than patents, or with RMS’ recognition of invention efforts that did not lead to patent applications. It is not clear whether such costs are among the costs at issue.

On the other hand, Raytheon also misreads FAR 31.205-30. RMS does not consider the costs to discover new inventions, of preparing and submitting invention disclosures, of a manager’s review of invention disclosure forms, or of [the committee’s] review to be patent costs, on the ground that there is not yet any patent and RMS does not know whether there will be one. RMS defines patent costs to be those occurring after the [committee] decides to pursue a patent. …

Raytheon’s interpretation of FAR 31.205-30 is unreasonable. Under its interpretation, patent-related invention disclosure costs would never be unallowable, even if no government contract requirement were involved, and the FAR’s reference to allowable patent invention disclosure costs would be superfluous.

(Internal citations omitted.)

The Board interpreted the cost allowability provisions of 31.205-30 as follows:

The reasonable interpretation of FAR 31.205-30 is that, when patents are involved, the costs of the associated invention disclosure and review are patent costs. They are allowable if incurred due to government contract requirements. Otherwise, they are not allowable. There is no exception for costs incurred during the invention disclosure preparation and review process prior to the decision to pursue a patent. If patents are not involved, the invention disclosure and related costs are allowable.

Even though Raytheon’s interpretation was rejected, it still won. The Board found that the DACO had questioned costs that were likely to be allowable. The Board wrote:

It appears that the $96,701 disallowed amount at issue improperly includes costs for subject inventions and might include costs for non-patent invention disclosures and review that are allowable. The Board cannot determine from the record what the proper amount of unallowable costs should be. This is a failure of proof by the government leading us to sustain the appeal.

In a final footnote the Board added this nugget:

In any case, if the government could have established the proper amount of unallowable costs, its various treatments of FAR 31.205-30, including its overly broad interpretation in this appeal, would have undermined its contention that the invention disclosure and review costs at issue were ‘expressly unallowable’ under FAR 42.709-1(a)(1). The government’s demand for a level one penalty was unwarranted.

(Internal citations omitted.)

So how should Raytheon enhance its policies and controls to address the Board’s finding that it has misinterpreted the cost principle?

If we were advising RMS and Raytheon—which, to be clear, we are not nor do they need any outside expertise in this area—we would suggest that all costs related to invention disclosures be treated as being unallowable. Perhaps the costs of preparing and reviewing the invention disclosure forms could be segregated in a separate Statistical Order. As the committee decides which inventions will be processed for patents (which is about 74% of them), the costs associated with the remaining 26% could be subsequently transferred to and allowable indirect account. Then, for the patentable inventions, since about 24% of those were required by a government contract, then those costs could also be identified and transferred to an allowable account (whether direct or indirect as circumstances dictate). Whatever would be left over would have been properly classified as being unallowable.

Alternately, RMS and Raytheon could record all costs as being allowable but perform a year-end analysis as above, and self-disallow or “withdraw” costs related to patents that were not required by a government contract. Either way would seem to work.

But we are not done yet. The ASBCA decision also dealt with outside patent costs.

External Patent (Legal) Costs

According to the Board: “Raytheon withdraws the ‘vast majority’ of patent costs it pays to its external counsel to prepare and submit patent applications, but it charges the government the costs associated with the preparation of its patent application if it considers the patent to be a ‘subject invention’ conceived of as a requirement of a government contract under FAR 31.205-30. These costs are charged to the government as indirect costs and are not charged directly to the contract.”

The Board noted that the DCMA DACO was concerned about the looming statute of limitations deadline, and therefore he and DCAA did not review the documentation that RMS provided when DCAA questioned 100% of its outside legal costs associated with patent processing. (Another GAGAS violation, anybody?)

The Board described the parties’ arguments as follows—

… DCMA contends that FAR 31.205-30(a) requires that, in order to qualify as direct costs of government contracts, Raytheon must prove that they are ‘literal line item requirements’ of the contracts. Additionally, even if Raytheon were able to demonstrate that the outside patent legal costs were required by government contracts, the costs should have been charged directly to the government contract involved, in accordance with FAR 31.201-2(a)(2), FAR 31. 201-4, and CAS 402. They were not and are therefore unallowable.

Raytheon alleges that the costs at issue are expressly allowable because each of the disallowed invoices was associated with a subject invention developed under a government contract. Raytheon asserts that RMS met its obligation under FAR 31.201-2(d) to maintain documentation supporting the allowability of its patent legal costs but the government chose to ignore the submitted documentation due to its statute of limitation concerns. Raytheon further asserts that DCMA has not met its burden to show that the costs are unallowable under FAR 31.205-30, which does not limit its allowability provisions to direct costs. It adds that, under the government’s ‘line item’ contention, ‘other than contracts for the purpose of acquiring patent application filing services, it is difficult to fathom what costs would be allowable . . . .’ Regarding allocability, Raytheon urges, and we have found, that, in accordance with CAS 402, RMS has consistently classified all of its legal costs as indirect expenses. This includes the legal costs for subject inventions, which benefit not just the government contract under which they were discovered but benefit Raytheon as a whole because it owns the patent. Therefore, the outside legal patent costs in question are properly allocable as indirect costs.

(Internal citations omitted; emphasis added.)

The Board agreed with Raytheon, finding that the costs in dispute were allowable because they were required by a government contract. The Board also disposed of the government’s allocability argument (as it should have) writing—

We conclude that Raytheon and RMS’ regular disclosed practice of charging outside legal costs as indirect costs meets CAS 402’s consistency requirements and was proper under the circumstances of this appeal. All of the outside legal patent costs at issue are allowable and allocable as indirect costs.

That wraps up the patent cost allowability (and allocability) portions of the decision. In the next (and final) article, we’ll talk about the remaining issues, including costs associated with recruiting and costs associated with variable compensation.

We’ve been holding off writing about Raytheon’s near-total victory at the ASBCA, but now it’s time to get into that 100+ page decision that covers multiple appeals and multiple issues and multiple years. It’s a must-read if you are dealing with cost allowability or CAS 405 noncompliance allegations. It sets things straight in a number of areas that have long vexed the contracting parties. On the other hand, we understand the government is going to appeal the Board’s decision, so it’s possible that many of the things that were set straight will be made crooked again in the near future.

Here is a link to the massive (and massively complex) decision. We spent hours trying to sort the various appeals and issues. (Remember, we are not attorneys.) The decision is so massive, we will need multiple blog articles to tackle it all. In today’s article, we’ll attempt to sort out the decision and tackle one of the many issues: airfare allowability.

Here’s what we sorted:

1. 2007 and 2008 indirect rates at Raytheon Missile Systems (RMS) included allocations from Raytheon’s Corporate Home Office. DCAA asserted that some Corporate Home Office costs were unallowable and others were expressly unallowable. Because Raytheon allegedly had included expressly unallowable costs, DCAA also asserted non-compliance with CAS 405 requirements for those two years.

2. The CACO issued a Final Decision (COFD)--$10,468,740 related to 2007 for unallowable costs, interest, and penalties. Raytheon appealed (ASBCA No. 59435)

3. The CACO issued a COFD related to 2007 noncompliance with CAS 405—$7,469,506; but Raytheon only appealed $1,870,428+$307,776=$2,178,204 of that amount. (ASBCA No. 59436)

4. The CACO issued a COFD--$1,154,383 related to 2008 for unallowable costs, interest, and penalties. Raytheon appealed (ASBCA No. 60056)

5. The CACO issued a COFD related to 2008 noncompliance with CAS 405—$2,030,636. Raytheon appealed. (ASBCA No. 60058)

6. The CACO issued a COFD related to claimed 2008 Corporate airfare--$760,861. Raytheon appealed and settled most of the disputed amount; the amount remaining was $76,556. (ASBCA No. 60057) The Board noted that “numerous appeals from government claims relating to corporate airfare costs have been stayed pending the outcome of the instant appeals.”

7. The RMS DACO issued a COFD related to 2007 claimed airfare, outside legal costs related to patents, and employee recruiting costs. Raytheon appealed. (ASBCA No. 59437)

8. The RMS DACO issued a COFD for penalties and interest, related to Raytheon’s inclusion of allegedly expressly unallowable costs in 2007. Raytheon appealed. (ASBCA No. 59438)

9. The RMS DACO issued a COFD, disallowing RMS’ indirect airfare costs claimed in 2008; but he did not make a payment demand because the amount of costs claimed to be unallowable, plus an amount Raytheon had agreed to remove from its claim for other indirect costs, was less than the amount being withheld from current approved billing rates for 2008. Raytheon appealed. (ASBCA No. 60059)

10. The RMS DACO issued two COFDs, disallowing RMS’ direct airfare costs that had been included in its billings under two named contracts and demanding payment of $167,427 and $17,274. Raytheon appealed. (ASBCA Nos. 60060 and 60061)

The parties prepared the following table explaining the amounts in dispute and the reasons for disallowable. Where the parties disagreed on the amounts, both amounts are shown.

Airfare Costs

Long-time readers of this blog will know that the FAR travel cost principle was revised in 2010, muddying what had, up to that point, been a relatively well-understood cost principle—at least with respect to how to determine the allowability of airfare. Prior to the 2010 regulatory revision, the cost principle read:

Airfare costs in excess of the lowest customary standard, coach, or equivalent airfare offered during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements.

After the 2010 revision, the cost principle read:

Airfare costs in excess of the lowest priced airfare available to the contractor during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements.

Notice that change? It turns out the change was driven by DCAA’s fanatical belief that Raytheon had taken advantage of the government by negotiating volume-based discounts with certain air carriers. Those discounts permitted Raytheon, in certain circumstances, to claim premium class airfare as fully allowable because the premium airfare was actually lower than the “lowest customary standard, coach, or equivalent airfare offered during normal business hours.” DCAA really didn’t like that. DCAA didn’t like that so much that when DCMA and the Office of the Secretary of Defense and the DAR Council all told DCAA that its interpretation of the cost principle was wrong, and that “the words in the FAR [ ] would support the company’s position,” DCAA did an end-run by issuing an MRD in November, 2002, that told auditors to question Raytheon’s airfare costs based on their insistence that everybody else was wrong. Fortunately for Raytheon, the DCMA Defense Corporate Executive—what we would now call the CACO—told DCAA to stuff it, writing “DCMA Headquarters disagrees with the guidance in the attached DCAA memorandum. … There is nothing in the record to indicate defense contractors are to negotiate airfare rates with carriers and that the negotiated rates are the customary rates to be used for determining the unallowable amount. Accordingly, I can't support or sustain DCAA’s audit position.”

Several years later (2006) DCAA sponsored a new DAR Case to “clarify” the cost principle to match their interpretation. Despite the fact that the majority recommended that the Case be closed “with no further action,” it turns out that DCAA didn’t want to accept that answer. Instead, “DCAA persisted and brought the travel cost principle issue to the Office of Defense Procurement and Acquisition Policy (DPAP).” What did DPAP think? “While DPAP does not concur with our interpretation of the existing language, (nor do they wish to take a position regarding the proper interpretation of the current language), they have conceded that the language is ambiguous.” Thus, the FAR Case was opened and the rest was history.

Well, except for the fact that DCAA applied the revised cost principle retroactively, because it was only a clarification of the ambiguity of which DCAA had always understood the correct interpretation—at least with respect to Raytheon. And then DCMA decided to go along with the DCAA’s retroactive interpretation, and issue a COFD using the revised cost principle to address the allowability of airfare incurred five or six years before the regulatory revision. Which required Raytheon to appeal…

In addition, DCAA questioned Raytheon’s use of a “10-hour rule” to justify an upgrade from coach to a premium fare. After much back and forth, DCMA and Raytheon had agreed that an upgrade would be an allowable cost if three conditions were met: (1) Travel primarily took place during non-customary business hours; (2) Raytheon employees reported directly to their TDY or permanent duly station (PDS) after arrival at their destination airport; and (3) Actual flight time (not an employee’s departure from their residence and travel time to a TDY site, and the reverse when returning home), must exceed 10 hours in duration. When all three factors were met, the cost of premium airfare was allowable. The agreement was memorialized and Raytheon revised its travel policy accordingly. Naturally, DCAA—who was not a signatory to the agreement—had a problem with that it.

The successor DCE rescinded the MOU. Upon the recission, Raytheon revised its travel policy again, this time by relaxing the requirement that employees must report for work upon arrival. DCAA countered by questioning premium class airfare incurred in accordance with the revised policy, and then citing Raytheon for a significant deficiency in its accounting system because it failed to properly account for the allegedly unallowable airfare. “After a five-year audit of Raytheon’s accounting system, on January 29, 2015, DCAA issued an audit report questioning how Raytheon accounted for allowable and unallowable costs. DCAA found a significant deficiency in Raytheon’s accounting system due to its treatment of premium class airfare.”

Seriously: a five-year accounting system audit? Are you kidding us? The Board did not express an opinion on why in the world it would take DCAA five years to complete an audit, so we will just leave that little factoid there.

Then DCAA issued another audit report that found the Missile Systems’ business unit estimating system had deficient controls because the business unit estimated premium class airfare in accordance with the Corporate travel policy. This caused Raytheon to revise its travel policy for the third time (in order to not have its estimating system determined to be inadequate). In the third iteration of the travel policy, in order to make the premium airfare allowable, the employee must perform “meaningful work upon arrival.”

If you are getting the impression that DCAA was “out to get” Raytheon in this matter, welcome to the club. So much for independence and objectivity….

Back to allowability, DCAA not only retroactively applied the 2010 cost principle “clarification” to costs incurred prior to 2010, but they questioned all premium airfares regardless of whether there was a justification that would have made the costs allowable under the exceptions found in the cost principle itself. Further, there were some errors or, shall we say, questionable assumptions made by DCAA when quantifying the allegedly unallowable premium airfare costs.

Under oath, the DCAA auditor defended the methodology used thusly:

Because we were just trying to determine -- when we were doing the audit, we were just trying to determine a reasonable amount. We understand these are negotiations, so we were just trying to give the government some kind of platform to, kind of, base where they should start at.

Accordingly, it seems that DCAA made no real attempt to be accurate when quantifying costs that were allegedly unallowable, notwithstanding that the agency would also allege that Raytheon’s failure to properly account for those allegedly unallowable airfare costs represented a significant deficiency in the accounting system as well as the estimating system; and notwithstanding that at the Missile Systems business unit, DCAA and the DCMA DACO were also making similar allegations based on similarly flawed audit methodologies.

How this was all not a massive GAGAS violation remains a mystery to us.

Anyway, at the end of the day the Board sided with Raytheon, finding that “the government has failed to prove its contention that the policy did not comply with the regulation.” Along the way, the Board made some statements that have important implications for government contractors seeking to comply with the 31.205-46 rules on airfare allowability. Let us quote them for you.

1. “While Raytheon’s interpretation of the pre-2010 version of FAR 31.205-46(b) as referring to a standard coach fare available to the general public is reasonable, the government’s interpretation is not reasonable. As noted, the governing statute makes commercial aircraft travel costs that exceed the ‘standard commercial fare’ unallowable. It does not refer to any negotiated airfare available to a particular contractor. Similarly, the pre-2010 implementing regulation, FAR 31.205-46(b), refers to the ‘lowest customary standard, coach, or equivalent airfare.’ … Contrary to the government’s stance, its revision of the regulation in 2010 was not a mere clarification, it was a change. If that change were made to apply to the 2007 and 2008 costs in question, it would be an impermissible retroactive change.”

2. “Under FAR 31.205-46 ‘[c]osts incurred by contractor personnel on official company business are allowable,’ subject to certain limitations, including those in FAR 31.205-46(b) regarding premium airfare. However, we agree with Raytheon that, by its plain language, the pre-2010 version of FAR 31.205-46(b) does not make premium class travel unallowable per se. Rather, it imposes an allowability limitation upon airfare costs that exceed the ‘lowest customary standard, coach, or equivalent airfare offered during normal business hours,’ which Raytheon reasonably interprets as a baseline of standard coach fare available to the general public. Therefore, as long as airfare costs do not exceed that limitation, they are not unallowable under FAR 31.205-46.”

3. Importantly, the Board let stand Raytheon’s policy that permitted premium airfare costs to be claimed as being allowable when the circumstances met criteria established by the Federal Travel Regulations and Joint Travel Regulations. (See FTR §301-10.123 and §301-10.125.) Often, DCAA auditors will point to the exception circumstances found in 31.205-46(b) as the sole determinants of premium airfare allowability (e.g., circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements.) However, it is clear that the additional FTR exception criteria may be used, or at least used to justify the reasonableness of the additional airfare costs.

Okay, that’s it for today. Part 1 complete. We still have many aspects of this important ASBCA decision to discuss. Stay tuned.