“Arising Under or Relating to” a Contract
From time to time we pretend to be lawyers and we try to interpret a recent judicial decision. We’re not lawyers, though. We’re really not. Much of the legal jurisprudence that comes our way baffles us. So keep that in mind. If you want good legal advice, hire an attorney. If you want our layperson’s thoughts on legal stuff that impinges upon government contract cost accounting, administration, and compliance, then please keep reading this blog article.
Today’s discussion concerns the Contract Disputes Act (CDA) and what claims can be adjudicated by a court. The CDA confers jurisdiction to one of two types of fora: either the Court of Federal Claims or an appellate Board such as the Armed Services Board of Contract Appeals or the Civilian Board of Contract Appeals.
But what is a claim?
The FAR defines a “claim” at 2.101; the definition states –
‘Claim’ means a written demand or written assertion by one of the contracting parties seeking, as a matter of right, the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to the contract. However, a written demand or written assertion by the contractor seeking the payment of money exceeding $100,000 is not a claim under 41 U.S.C. chapter 71, Contract Disputes, until certified as required by the statute. A voucher, invoice, or other routine request for payment that is not in dispute when submitted is not a claim. The submission may be converted to a claim, by written notice to the contracting officer as provided in 33.206(a), if it is disputed either as to liability or amount or is not acted upon in a reasonable time.
Based on the FAR definition, a claim can be a demand for one of three things:
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The payment of money in a sum certain
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The adjustment or interpretation of contract terms
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Other relief
But whatever a claim may be, it must also arise “under” or “relating to” a government contract.
And therein lies the question we will explore today. What does it mean to arise under or relating to a contract?
This question was tackled by the Armed Services Board of Contract Appeals (ASBCA) in its recent opinion on a government motion to dismiss a contractor’s appeal of its contracting officer’s final decision, based on an asserted lack of jurisdiction by the ASBCA. The decision, captioned “ABB Enterprise Software, Inc., f/k/a Ventyx" (ASBCA No. 60314), concerned allegations by a contractor that the Navy had violated its software agreement by using multiple copies of the contractor’s software. Eventually the contractor filed a claim with the contracting officer, who denied it because it was not a dispute covered by the CDA, in that it did not arise under and/or was not related to the contract. The contractor appealed that COFD and, during the appeal process, the government filed a motion to dismiss for lack of jurisdiction, essentially repeating that same argument the contracting officer had used to deny the contractor’s original claim.
According to Judge Prouty’s recital of the facts, ABB Enterprise Software, Inc., which was formerly known as Ventyx, which was formerly known as Tech-Assist, Inc., held two contracts with the Navy. Each contract was awarded to acquire “a number of Electronic Shift Operations Management Systems (eSOMS) clearance and database software modules.” The contracts “also expressly required Tech-Assist to provide to the Navy licenses to use the software.”
Separately, the Navy and Tech-Assist executed a software license agreement for 268 copies of the eSOMS software. The dispute arose because Ventyx (Tech-Assist’s successor-in-interest) complained that the Navy had violated the software agreement. For its part, the Navy denied (in writing) that it had violated the agreement, but also stated that any disputes would need to be resolved pursuant to the requirements of the Contract Disputes Act. There was extensive correspondence over a period of at least 18 months, “culminating in a 28 June 2013 letter from a Navy attorney to Ventyx’s general counsel, suggesting that Ventyx file a CDA claim if it wished to pursue the matter further.” Apparently Ventyx was surprised when the contracting officer rejected its claim, using the rationale that a license agreement violation was not a CDA dispute.
In its motion to dismiss, the Navy argued that the “arising under or relating to” a contract requirement was not met, since the software agreement did not expressly reference any government contract. The Navy further argued that the language must be read narrowly, such that “only direct breaches of a contract” would qualify as meeting the test. Judge Prouty quickly dismissed the Navy’s arguments, writing that “the first argument is not consistent with binding precedent; the second is belied by the uncontroverted facts.”
In making his decision, Judge Prouty cited to a 2011 Federal Circuit decision, Todd Construction, L.P., in which the Federal Circuit “instructed that this phrase is to be read ‘broadly’ in the context of CDA jurisdiction.” As Judge Prouty wrote—
Put yet another way, to be related to a contract, a claim ‘must have some relationship to the terms or performance of [the] government contract.’” Accordingly, “we reject the Navy’s proposed construction of the CDA, which would limit our jurisdiction to only those claims involving breaches in the terms of the contract or matters encompassed in the disputes clause.
As for the Navy’s second argument, Judge Prouty wrote “execution of the license agreement was part and parcel with the performance of the contract. The contract was for acquisition of software along with the associated license agreement. … Thus, the license agreement … was required by the contract and related to performance of that contract.”
It is axiomatic that our system of justice is an adversarial one. We think, however, that the Navy’s arguments were a bit too adversarial, and verged on frivolity—wasting the Board’s resources and delaying a just decision.
But what do we know about such things?
DynCorp on Hook for Subcontractor’s False Claims
Recently we took umbrage at the phrase “the prime is responsible for managing the subcontractor” – asserting that it had been taken out of context and inflated by DCAA and GAO into a meaning the rule drafters had never intended. Despite our strong reservations with what government folks had done with the language, we were careful to distinguish certain things with which we agreed. We wrote about an official DCAA presentation –
It states: The prime contractor is primarily responsible for subcontract award, technical and financial performance, monitoring, and payment to the subcontractor for the work accomplished under subcontract terms. That’s quite true and unobjectionable ….
Indeed, there is nothing unobjectionable about the idea that the prime contractor (or higher tier subcontractor) is responsible for managing its subcontractor. If you know anything about Apogee Consulting, Inc., you should know that we have long been vociferous advocates of subcontractor management.
Let’s list those prime contractor duties found above in the DCAA presentation:
One sticks out a bit: “monitoring” the subcontractor. What does it mean to monitor the subcontractor? What efforts are sufficient in that regard?
Well, obviously the efforts deployed to monitor a subcontractor depend on the risks. If the contract is firm, fixed-price, then cost risks are minimal, since (except for contract changes) the price to be paid to the subcontractor is fixed and won’t change based on costs incurred. That means that cost allowability issues largely disappear after subcontract award (but need to be addressed when negotiating the contract price). If the contract is FFP, then the subcontractor may not need much in the way of an adequate accounting system; and thus the prime may not have to worry overmuch about monitoring what comes out of that system.
But the converse is also true. If the subcontract type is other than FFP – if, for example, it is T&M or cost-type – then the prime contractor (or higher tier subcontractor) must monitor costs being billed. The prime contractor must review each invoice submitted and exercise due diligence to ensure that only appropriate costs – that is to say, reasonable, allowable, and allocable costs – are being billed and reimbursed. The subcontractor needs to have appropriate infrastructure in place so that the prime can rely on its controls; or, failing that, the prime needs to deploy additional controls to make up for its subcontractor’s lack. It would not be unheard-of for the prime contractor to have a team of “auditors” – its own employees – review each monthly invoice and approve that invoice for payment, just to make sure unallowable costs didn’t inadvertently get reimbursed and then passed on to the government customer through the prime contractor’s own invoices.
The effort expended by the prime (or higher tier subcontractor) depends on a risk analysis. The risk analysis needs to be performed and then appropriate action taken. That’s what we think “monitoring” means.
If the prime (or higher tier subcontractor) doesn’t fulfill its responsibility for monitoring its subcontractors, then it ends up like DynCorp.
DynCorp was the subject of a False Claims Act suit brought by the Department of Justice. According to the DoJ press release—
The United States filed a False Claims Act complaint against DynCorp International Inc. (DynCorp) alleging that it knowingly submitted inflated claims in connection with a State Department contract to train Iraqi police forces (CIVPOL contract) … in its complaint, the United States alleges that DynCorp knowingly allowed one of its main CIVPOL subcontractors to charge excessive and unsubstantiated rates for hotel lodging, translator, security guard and driving services and overhead expenses, and included these charges in the claims it submitted under the CIVPOL contract to the State Department. The complaint also alleges that DynCorp added its own markup to its subcontractor’s excessive charges, thereby further inflating the claims it submitted to the government.
What the allegations seem to say is that DynCorp failed at monitoring its subcontractor. It allegedly allowed the subcontractor to submit invoices, and receive reimbursement, for “excessive and unsubstantiated” costs. DynCorp paid the invoices and included them in its own contract costs (as one does) and then “marked-up” the costs (with some kind of indirect cost rate), which we assume included an element of fee as well. Now DynCorp is facing serious allegations and will have to hire some serious attorneys to defend it and (perhaps) negotiate a serious settlement.
This would seem to be a great illustration of the importance of monitoring subcontractors, which is an element of overall subcontractor management. Effective subcontractor management may be expensive, but we believe that ineffective subcontractor management is even more expensive.
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Apogee Consulting, Inc. to be at Navy’s Gold Coast Conference
This is a semi-official announcement that Apogee Consulting, Inc. – your humble correspondent and blog writer – will be hosting a booth at the upcoming Navy’s San Diego Gold Coast conference, an annual conference aimed at small businesses.
Hosted by the Navy and the San Diego chapter of the National Defense Industrial Association (NDIA), “Gold Coast provides a forum to educate, guide, and assist businesses, especially small businesses, in working with the government, primarily the Department of Defense.”
Allegedly. We’ve never attended before, so we’re not sure what to expect.
The Conference will be held August 23rd and 24th, at the San Diego Convention Center. (We expect most of the trash from the San Diego Comic Con will have been cleaned up by then.)
In keeping with the Conference’s theme of educating, guiding, and assisting businesses, Apogee Consulting, Inc. will be hanging around, looking to engage in discussions regarding government contracting and cost accounting and other related administrative issues.
Yes, that’s right. We are going to be offering free advice.
Okay. It will not be free. We lied about that. The advice will cost 5 cents.
But we will have nickels on hand to cover those who no longer carry cash.
So it will be kinda free.
We guarantee that the advice will be worth every penny and/or nickel paid!
If you should find yourself in the area, please come visit us at booth #217.
More on Blended Rates
Executive compensation, the gift that keeps on giving.
 Congress has no trouble with the free market, until and unless that same free market dictates that corporate executives should earn as much as movie stars. Then legislation is drafted and becomes law, and the FAR Councils draft regulatory revisions and they become final rules … and then contractors have to figure out how to comply. At which point, everybody realizes how flawed the original statutory language was, which led to a flawed regulatory regime, which led to a compliance conundrum—wherein it costs contractors more to comply with the flawed requirements than the Federal government saves in price reductions.
What are we talking about?
For background, please start with this article, published more than two years ago, in January, 2014. Or maybe start with this one, an article written about six months prior to the other one. They are but two of several articles we’ve devoted to the topic of calculating allowable executive compensation in accordance with the complex – and flawed – rules.
Those articles formed the backdrop for our November 2014 article on use of “blended rates” to calculate allowable executive compensation. As we wrote in that article—
At this point, the average contractor must handle three separate rules that each establish separate limits on allowable compensation. Some contracts are subject to the “old” executive compensation ceiling of $952,308, as applied to the Top 5 most highly compensated individuals in each segment. Other contracts are subject to the “old” ceiling as applied to all contractor employees (not just the Top 5). Still other (newer) contracts are subject to a lower compensation ceiling of $487,000, as applied to all contractor employees. The ceiling on allowable compensation depends on when the contract was issued and its effective date, because it is the FAR Part 31 cost principle language in effect on that effective date that establishes the applicable ceiling.
The solution to that problem, as we discussed, was the use of “blended rates” to calculate a weighted average allowable executive compensation amount.
But as we noted, at that time DCAA was not on board with the use of blended rates, even though DOD as an agency approved of that methodology. DCAA was going to question the resulting indirect cost rates and questioned costs were going to be found to be expressly unallowable. Thus, the need for an Advance Agreement to create the situation where the contractor and the cognizant ACO agreed in advance that the resulting rates were going to be allowable. The Advance Agreement acted to protect the contractor; any DCAA questioned compensation costs stemming from use of blended rates would not be sustained by the ACO.
(Never mind that Advance Agreements are extremely difficult to obtain these days, as we discussed in yet another article.)
So, anyway. That’s where things stood until recently.
What changed?
Well, one thing that changed was that the OFPP published another executive compensation benchmark and ceiling in March, 2016. The new ceiling, which applies to compensation costs incurred after January 1, 2014 is $1,144,888. We think that ceiling applies to compensation costs incurred by non-DOD contractors (and to compensation costs incurred by DOD contractors prior to June 24, 2014) but, quite honestly, at this point we’re not sure of anything regarding executive compensation. It’s a big confusing mess. The OFPP has a webpage that tries to help people make sense of it all, but we got lost trying to figure it all out.
Another thing that changed was that DCAA issued MRD 16-PSP-005 on February 19, 2016. That MRD transmitted a guidance memo from OUSD (AT&L) signed by Shay Assad, Director of Pricing. The DOD memo noted that the FAR had been revised (via interim rule) to implement some of the legislative interference in the free market we noted above. The DOD memo acknowledges that DOD contractors “may elect, but are not required, to use the blended rate approach.” The DOD memo states –
If a contactor proposes to use the blended rate method to cost and propose, the contractor will initially calculate and use a blended rate for interim billing. Subsequently, for the purpose of establishing final overhead rates, contractors will calculate blended rates reflecting actual proportion of contract costs for the current year for contractors prior to and after June 24, 2014. The contractors’ final overhead submission for the completed fiscal year must include auditable substantiation of the calculation of the actual blended rates.
The DOD memo also stated –
Contract administration office contracting officers and contractors will execute an advance agreement … with each contractor that chooses to employ the blended rate method. The advance agreement will outline the agree-to process, auditable data submission and expiration for the application of the blended rates. Additionally, DCMA will issue implementation guidance in coordination with DCAA on this subject.
The implementing guidance noted in the preceding quoted paragraph was issued January 29, 2016; it was also included in the DCAA MRD. It started by reciting some of the history of the compensation ceiling and how that ceiling applies to contractors. (I.e., it is a summary of the hairball of compliance rules with which contractors must comply.) The implementing guidance memo made it crystal clear that DCAA was to audit the contractor’s calculation of the blended rate ceiling. In other words, DCAA was not to question compensation costs solely from the use of a weighted average compensation ceiling. (Thus the prior DCAA audit guidance was changed by executive fiat.)
There is lots of good guidance in the memo regarding exactly how a contractor is to calculate its weighted average compensation ceilings. If you have questions in this area, please see the memo.
But that’s not all that changed.
On June 30, 2016, DCAA published MRD 16-PSP-007, which was an “audit alert” regarding treatment of proposals to establish final billing rates (aka “incurred cost proposals”) when a contractor used blended rates to determine allowable executive compensation. It establishes the novel and utterly unsupportable position that a final billing rate proposal shall not be considered to be adequate for audit until and unless the contractor and government have executed an Advance Agreement.
Now, we’ve already written that such Advance Agreements are good things to have, and we agree that one should be in place. On the other hand, we’ve also written that it’s very difficult to actually obtain an Advance Agreement these days. It may be the case that the contractor and the government cannot come to a meeting of the minds regarding how the contractor will implement the blended rate methodology. It may be the case that the Contracting Officer is waiting for legal review, or the results of a Review Board, or maybe everybody is really busy. The point is, an Advance Agreement may not be in place.
The DCAA audit guidance states: “When the proposal is determined adequate and there is no executed advance agreement, the audit team should return the proposal and require the contractor to resubmit the proposal only after executing an advance agreement with the ACO.” That is insane.
Contract clause 52.216-7 establishes the format of a contractor’s proposal to establish final indirect rates. DCAA rammed through its ICE model approach into the FAR a couple of years ago, and right now that’s what the FAR requires. Nowhere does the language of 52.216-7 require an Advance Agreement to be in place in order for the contractor’s proposal to be audited.
Nowhere in the FAR language of 31.109 does it condition cost allowability on the existence of an Advance Agreement. In fact, the word “should” is found in the regulatory language, which is a far cry form the word “shall” (which denotes the imperative).
In our admittedly biased view, if DCAA refuses to audit a contractor’s incurred cost proposal simply because an Advance Agreement is missing, that decision would be tantamount to a contract breach. If the conditions established in 52.216-7 have been met, then the government must meet its duty of performing an audit and entering into negotiations to establish final billing rates.
We hope somebody, somewhere, takes DCAA to task for this bizarre and unsupportable position.
So there you have it. Executive compensation. Cost allowability. Blended rates. Legislative interference and DCAA interference. A hairball of regulatory complexity that may actually cost more to comply with than any savings generated thereby.
Your government at work.
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