“Certainly the game is rigged. Don't let that stop you; if you don't bet you can't win.” – Robert A. Heinlein

This past week was Fed Pubs’ La Jolla Government Contracting Week, in which one of the most popular seminar-providers scheduled multiple courses in multiple areas of government contracting—all held in one hotel. Lots of people attended; it’s kind a big deal and there’s even a sponsored reception for students from the various classes to meet, mingle, and network. We know most of the instructors and they are, for the most part, top-notch. We have had no problem recommending these courses. That said, we were eager to get some feedback from course attendees.

One thing we heard was that some instructors were recommending use of Advance Agreements in order to proactively establish defenses against adverse DCAA audit findings. Obviously we weren’t there, but the logic seemed to be that DCAA auditors were going to have findings—often findings that were obviously meritless—but the cognizant Contracting Officer was going to be hesitant about flatly overruling those findings because of the DCMA bureaucratic rules that govern the process.

Gone are the days when a warranted Contracting Officer had the authority to use independent business judgement to adjudicate and negotiate and resolve disputes without litigation. In today’s Federal contracting environment, it’s a rare CO who wants to risk their career in order to support a contractor’s rebuttal of an adverse audit finding.

The theory, then, is that it is better to negotiate and work out a deal before things get adversarial. The contractor and CO should come to an understanding, memorialize it, and sign it. Then when DCAA shows up with problematic findings, it’s not about an auditor being wrong; instead, it’s about a pre-existing agreement that needs to be upheld by the US Government.

It’s a good theory and we have no problem seconding the recommendation. Advance Agreements are great things when you’ve got them (and have retained them to support future audits). Our only problem is that they are damn hard to get these days.

Let’s talk about Advance Agreements.

FAR Rules

Advance Agreement are discussed in FAR 31.109. FAR 31.109(a) states that “To avoid possible subsequent disallowance or dispute based on unreasonableness, unallocability or unallowability under the specific cost principles at Subparts 31.2, 31.3, 31.6, and 31.7, contracting officers and contractors should seek advance agreement on the treatment of special or unusual costs and on statistical sampling methodologies at 31.205-6(c).” So there’s the rationale for having them: they are intended to avoid cost disallowances or disputes in areas where it is “difficult to determine” cost allowability. Importantly, the FAR is clear that Advance Agreements should be negotiated “before incurrence of the costs involved” – i.e., in advance. (Duh.) According to FAR 31.109(b): “The agreements must be in writing, executed by both contracting parties, and incorporated into applicable current and future contracts. An advance agreement shall contain a statement of its applicability and duration.” In addition, “Advance agreements may be negotiated with a particular contractor for a single contract, a group of contracts, or all the contracts of a contracting office, an agency, or several agencies.” Other than that, the parties are relatively free to draft their Advance Agreement in any manner they may choose.

FAR 31.109 lists areas in which Advance Agreements may be of particular value in avoiding disputes. These areas include:

1. Compensation for personal services, including but not limited to allowances for off-site pay, incentive pay, location allowances, hardship pay, cost of living differential, and termination of defined benefit pension plans

2. Use charges for fully depreciated assets

3. Deferred maintenance costs

4. Precontract costs

5. Independent research and development and bid and proposal costs

6. Royalties and other costs for use of patents

7. Selling and distribution costs

8. Travel and relocation costs, as related to special or mass personnel movements, as related to travel via contractor-owned, -leased, or -chartered aircraft; or as related to maximum per diem rates

9. Costs of idle facilities and idle capacity

10. Severance pay to employees on support service contracts

11. Plant reconversion

12. Professional services (e.g., legal, accounting, and engineering)

13. General and administrative costs (e.g., corporate, division, or branch allocations) attributable to the general management, supervision, and conduct of the contractor’s business as a whole. These costs are particularly significant in construction, job-site, architect-engineer, facilities, and Government-owned contractor operated (GOCO) plant contracts

14. Costs of construction plant and equipment

15. Costs of public relations and advertising

16. Statistical sampling methods

In addition to the foregoing, the FAR emphasizes that construction and architect-engineer contracts are especially good candidates for use of Advance Agreements. The FAR states (at 31.105) “Because of widely varying factors such as the nature, size, duration, and location of the construction project, advance agreements … for such items as home office overhead, partners’ compensation, employment of consultants, and equipment usage costs, are particularly important in construction and architect-engineer contracts.”

The DFARS adds (at 231.205-70(d)(viii)) that the Contracting Officer should negotiate an Advance Agreement when a contractor is engaging in external restructuring (think Lockheed and Martin Marietta merging). That external restructuring Advance Agreement must set forth “at a minimum, a cumulative cost ceiling for restructuring projects and, when necessary, a cost amortization schedule.”

Finally, you need to know that Contracting Officers cannot sign an Advance Agreement that makes an unallowable cost allowable. (See 31.109(c).) Some costs are made unallowable by statute, and no CO has the authority to contravene a public law.

Sounds pretty straightforward, right? So what’s the problem?

DCMA Boards of Review

The first problem—as we alluded to earlier—is that DCMA doesn’t give its Contracting Officers much independent discretion these days. For example, depending on the scope and/or estimated value of the contracts covered by a proposed Advance Agreement, that agreement may have to be reviewed by two separate Boards of Review (one at the Division level and one at the DCMA HQ level). If annual costs on contracts covered by the agreement are estimated to be less than $25 million, then the CO can execute it. But if annual costs on covered contracts are greater than $25 million then a Division-level Board of Review must be convened. And if annual costs on covered contracts are greater than $50 million, or if more than one contractor segment is affected, or if the Advance Agreement covers pension and/or insurance costs, then an HQ-level Board of Review must be convened.

DCMA has a Policy Instruction (“134—Boards of Review”) but it’s not available to the public. Consequently we can’t tell you with certainty how they work. But we do know this: Each time a DCMA Board of Review is convened, the CO must prepare a review package. The package takes a lot of work and its quality (or lack thereof) is a direct reflection back on the CO who prepared it. Obviously, many Contracting Officers will be reluctant to invest the necessary time and effort to prepare a package that they won’t mind being reviewed by their peers, superiors and/or the brass at Ft. Lee. You are going to have a lot of convincing to do.

Even if the CO decides to submit a review package in order to obtain approval to enter into an Advance Agreement, there is no guarantee that the Board (or Boards) of Review will go along with the plan. It’s not unheard of for a CO to hear a resounding NO back from the Board (or Boards) of Review. What happens then? Well, the CO can resubmit the package and hope for a different answer—knowing that may upset some people, who may be under the impression that the CO is dense because they didn’t get the message the first time. Or the CO can simply tell the contractor “sorry” and then get back to business.

Even if the Board (or Boards) of Review reach a favorable consensus and endorse the proposed Advance Agreement, that process is not going to happen overnight. It’s going to take weeks or months. It’s going to take time to prepare the review package and it’s going to take time to convene the Board (or Boards) of review, and it’s going to take time for the Board (or Boards) to deliberate and get back to the CO. Meanwhile, the contractor is not supposed to incur any costs covered by the proposed Advance Agreement until it’s been executed.

Good luck with that.

DCAA’s Role

At noted above, the objective of having an Advance Agreement is to proactively agree on the treatment of certain costs so that they do not become subsequently disallowed or become the subject of a dispute between contractor and customer. DCAA believes it has a role in the process of negotiating and executing an Advance Agreement, at least in certain areas. One of those areas is compliance with the unique requirements of contractor executive compensation. Without going into too much detail, DCMA and the contractor may enter into an Advance Agreement regarding use of “blended rates” to comply with the myriad statutory limits on executive compensation. DCMA and DCAA seem to have agreed that “prior to signing an advance agreement or accepting a methodology” (with respect to blended rates) “the ACO … must invite DCAA to review the computation of the compensation cap, and participate in prenegotiation discussions and/or subsequent negotiations.” (See MRD 16-PSP-005, dated 2/19/2016.) Thus, if a contractor is proposing an Advance Agreement to address use of blended rates to comply with the executive compensation ceilings, not only will all of the DCMA process steps discussed above need to be followed, but your friendly local DCAA auditor will be part of the process as well.

As somewhat of a side note, we were piqued by the notion that DCAA would be participating in prenegotiation discussions and/or subsequent negotiations, as if DCAA somehow had co-equal authority as the warranted Contracting Officer. That seems … odd—and would seem to defeat at least a part of the objective for having an Advance Agreement in the first place. But what do we know?

More generally, the DCAA Contract Audit Manual (at 6-710) clearly states that “The auditor shall abide by properly executed advance agreements that are in effect for the fiscal year when determining final rates.” However, the CAM notes that “Should the auditor find that an advance agreement is not in the best interest of the Government, he/she will follow established procedures for recommending to the contracting officer, in writing, that the advance agreement be rescinded.” We have some experience with rescinded Advance Agreements and, let us tell you, the rescission leaves a very bad taste in the contractor’s mouth. Rescission of an Advance Agreement—after a cost has been incurred—is very much akin to breach of contract, in our view.

Where does this leave us with respect to the advice offered by the Fed Pubs instructors?

Well, we agree with it. It’s good advice.

In theory.

But in the real world of today’s somewhat adversarial defense acquisition environment, we believe that it’s going to be a difficult challenge to get an executed Advance Agreement prior to incurrence of the costs at issue. Is it impossible? No. Not at all. But it is a challenge and it will take a long time, and the odds are stacked against a favorable outcome.

But don’t let that stop you. If you don’t bet you can’t win.

Well calm down, temper, temper
You shouldn't get so annoyed
You're acting like a silly little boy
And they wanted to be men
And do some fighting in the street
(They said) no surrender
No chance of retreat …

Drunken plot's hatched to jump it
Ask around are you sure?
Went for it but the red light was showing
And the red light indicates doors are secured

“Red Light Indicates Doors are Secured,” The Arctic Monkeys

According to its website—

The National Ecological Observatory Network (NEON) is an NSF-funded large facility project. NEON comprises terrestrial, aquatic, atmospheric, and remote sensing measurement infrastructure and cyberinfrastructure that deliver standardized, calibrated data to the scientific community through a single, openly accessible data portal. NEON infrastructure is geographically-distributed across the United States, including Alaska, Hawaii and Puerto Rico, and will generate data for ecological research over a 30 year period.

NEON is designed to enable the research community to ask and address their own questions on a regional to continental scale around the environmental challenges identified as relevant to understanding the effects of climate change, land-use change and invasive species patterns on the biosphere.

It’s a government project, a government IT project. We all know without looking that it’s going to be a troubled project, with cost overruns and schedules slips That’s the way most government IT projects go these days.

But we didn’t expect controversial audit findings, auditors being whistleblowers on their own management, and Congressional hearings.

We wrote about the NEON controversy before. That was in 2014. Much has happened since then, but if not for a couple of gently persistent folks who kept pointing us to the Wikipedia article on DCAA (in which the controversy is prominently featured), we would have missed it.

Our original article did not express much sympathy towards the DCAA whistleblower or towards the Senators who wrote nasty letters or towards the Congresspersons who held hearings on the topic in December, 2014. Additional hearings were held in February, 2015. Records are sketchy but it appears to us that NEON justified the use of “management fees” charged to the subsidiary performing the NSF grant.

The NEON, Inc. Chairman testified that-

It is our understanding that OMB has long held that fees in the case of a non-profit like NEON or profit in the case of a private business are not considered appropriated funds and are outside the scope of OMB Circular A-122 and the Byrd Anti-Lobbying Amendment. Moreover, NSF has consistently indicated to NEON that management fees constitute discretionary or unrestricted funds and can be used to pay for business costs that are considered unallowable. … NEON has used management fees to cover a variety of costs, including those associated with contract terminations, late fees, and other normal business expenses. NEON also has used management fees to cover costs associated with government outreach activities, providing amenities, including coffee, for its employees, and meals and social functions that included the purchase of alcohol.

We noted a letter from the law firm of Gibson Dunn (found on the website, link in the previous sentence) that stated—

OMB Circular No. A-122 provides principles for determining the costs of work performed by non-profit organizations under cooperative agreements. The Circular explicitly states that ‘[p]rovision for profit or other increment above cost is outside the scope of this Circular.’ While the Circular notes that the costs of alcoholic beverages and lobbying are unallowable, the Circular’s cost principles do not apply to any management fee or profit earned by an organization through a cooperative agreement. Accordingly, Circular No. A-122 does not prohibit a non-profit organization from using funds earned through management fees on a cooperative agreement for such costs. Nor does any other statute, rule or guidance of which we are aware.

Likewise, according to NSF regulations, as clarified by OMB guidance, management profit and fees earned under a cooperative agreement are excluded from the definition of ‘appropriated funds’ for purposes of the prohibition on use of such funds for lobbying. Accordingly, it appears there is no prohibition on the use of management fees or profit for the purposes of lobbying, so long as proper disclosure is made in accordance with 45 C.F.R. § 604.100(c).

According to NEON and its attorneys, NEON, Inc. charged a management fee to the subsidiary, which was akin to profit and could be used to pay for business-related costs, including costs that would otherwise be considered to be unallowable costs under applicable rules. Seems like a total victory.

But it may have perhaps been a Pyrrhic victory because, while the parent company was successfully surviving Congressional hearings into its use of the management fees, the performing subsidiary was looking at an $80 million project overrun and 2 year schedule slip, which did NOT make the NSF happy. As a result, the management contract was terminated and NSF picked Battelle Memorial to try to wrangle the troubled project.

Now, back to the DCAA Wikipedia article that discusses the audit allegations and results. According to that article, NEON, Inc. was “fired from the project” and that action “represents one of the largest Federal agreement terminations for cause in history.” We are not convinced that’s the proper way to view this. While it is indisputable that the NEON management contract was terminated, it is not at all clear that it was terminated for cause. There was no need for NSF to take such a drastic step—a step that could be litigated and converted to a T4C—when the easier step was to simply terminate the contract for convenience and let the parties walk away. We strongly suspect that is the proper way to view the termination and replacement of the management contractor.

Similarly, the Wikipedia claims that the whistleblower’s claims “directly led” to the termination of the NEON management contract is suspect. While we are quite sure that the controversy and hearings did the contractor no good whatsoever, we strongly suspect it was the large cost overrun and significant schedule slip that were more directly linked to the termination. If the contractor had been performing well, it might have survived its audit problems. This is, in our view, an important illustration of the importance of effective project management—a topic that’s gotten lots of attention on this website in the past 7 years.

Some people who send us email would like to make the NEON controversy into a back-room management conspiracy. In particular, they’d like to link it to the sudden departure of former Director Fitzgerald from DCAA. We don’t see it that way. Occam’s Razor suggests the simplest explanations are more likely to be true. In that sense, the auditor was overruled by DCAA management, and it seems there was good rationale for the position they took. We don’t know why Director Fitzgerald left DCAA, but it is more likely to be linked to the pile of unaudited Incurred Cost Submissions (which led to Draconian action by Congress in the 2016 NDAA) than it is to audit problems with a non-profit entity under a non-DOD grant/contract.