Settling Disputes Part 1 of 2
This is a topic that’s been much on the mind lately. We’ve alluded to the issue—almost as a throw-away—in several recent blog articles. It’s a complex topic so bear with us if we maunder a bit.
It’s come to our attention that Contracting Officers don’t resolve very many disputes these days. Instead, what we’ve seen is a rash of shoot-from-the-hip Contracting Officer Final Decisions (COFDs)—creating what is essentially a dare to the contractor to litigate the issue, if it thinks it can afford the time and expense to prevail in court.
We can argue about the cause of the situation. Perhaps it’s that the average CO is intimidated by DCAA and knows that if s/he ignores any audit findings, an auditor might get upset and call the DOD Inspector General. Maybe the situation is caused by the well-publicized decline of the necessary skill sets at DCMA, coupled with a decade of agency mismanagement and ineffective organizational structures. Perhaps issues are being given short shrift because the number of COs is well below the level it should be, and the resulting workload is simply too overwhelming to handle. Maybe there’s been a loss of individual CO accountability. Perhaps the issue stems from direction from Fort Lee to quickly “disposition” complex issues so that the reporting metrics look pretty. Maybe the cause is perceived pressure from the looming six-year Statute of Limitations of the Contracts Disputes Act (CDA), leading to a situation where issuing any decision—no matter how dubious the position taken—is better than missing the filing deadline and seeing the Government’s claim thrown out of court without a hearing.
Perhaps the situation we’ve experienced is caused by all of the above reasons, plus more causative factors we can’t even guess at. Hey, it’s all speculation on our part; we don’t work for DCMA.
But whatever the cause, we think the result is undeniable. COs don’t resolve complex issues any more. They don’t negotiate DCAA audit findings (such as cost disallowances or CAS noncompliances). They don’t look to “split the baby” because getting an assured half a loaf now is no longer better than litigating for an entire loaf (plus interest), even when the probability of getting that entire loaf in a judicial award approaches zero.
No, it seems that the prevailing DCMA logic these days is to issue a COFD and let the lawyers handle the rest. In our view, too many DCMA Contracting Officers are ignoring the contractor’s side of the story, and essentially rubber-stamping DCAA audit reports. Aside from the obvious drawbacks with that approach, the problem with that lack of use of “independent business judgment” is leading inexorably to a tsunami of litigation over at the Armed Services Board of Contract Appeals (ASBCA) and the Court of Federal Claims (COFC). Those government lawyers are going to get spread awfully thin trying to handle all the looming contract-related litigation, in our opinion. And while it’s undeniably good news for external counsel, the shareholders of government contractors are going to be seeing some large legal expenses and some large balance sheet reserves in the near future, and they are going to be much less happy than the lawyers. (The contractors’ legal expenses, we should note, will almost certainly be unallowable and come out of company profits.)
Want an example of what we’re talking about? See our article(s) on the Boeing EELV controversy. Boeing and the United Launch Alliance are suing the U.S. Government for some $385 Million (plus interest), simply because the issue had dragged on so long without resolution and the companies needed to file their claim(s) in order to “preserve the ability to recover the money” (according to a Boeing spokesperson quoted in the article to which we linked). We know of other, less public, litigation battles that are being waged at the ASBCA and at the COFC as we write this. Readers, you ain’t seen nothing yet.
This situation should not be happening, according to regulation, agency guidance, and legal precedent. Yet here we are.
As we’ve mentioned before, the FAR requires COs to attempt to settle issues before they ripen into disputes. FAR 33.204 clearly establishes the policy of the U.S. Government thusly—
The Government’s policy is to try to resolve all contractual issues in controversy by mutual agreement at the contracting officer’s level. Reasonable efforts should be made to resolve controversies prior to the submission of a claim. Agencies are encouraged to use ADR procedures to the maximum extent practicable.
Clearly, too many DCMA Contracting Officers are violating this policy and nobody is holding them accountable as individuals. Clearly, DCMA as an agency is not enforcing this policy and nobody is being taken out to the woodshed. Mr. Williams ought to be ashamed that his organization is so ineffectual at resolving “contractual issues in controversy” by “mutual agreement at the contracting officer’s level,” but if nobody is making it into an issue at his level, then why should he worry about it?
Let’s propose right here and now that DCMA get its attorneys together and start tracking (if they do not already do it) the number of cases filed at the ASBCA and COFC that relate to contractual issues in controversy, as well as the number that get mutually resolved at the contracting officer’s level. Further, let’s propose that the claims that make it to the courts, and their ultimate disposition, are tracked so that the number of losers can be reported. Finally, let’s propose that the DCMA attorneys offer feedback to DCMA leadership, identifying the court cases that should never have been litigated, because they should have been mutually resolved at the contracting officer’s level, in accordance with the FAR. (We admit that last one would be more than a little subjective, but you’ve got to start somewhere.)
We think the foregoing metrics would help Mr. Williams (as well as Mr. Kendall and SECDEF Panetta and Congress) assess how well the COs are doing their jobs. If they care about such things.
It’s not as if DCMA hasn’t issued sufficient guidance to its Contracting Officers. It certainly has. They just seem to be able to ignore their guidance with impunity.
The DCMA guidance to its COs (link above) clearly states that “DCMA ACOs [Administrative Contracting Officers] and TCOs [Termination Contracting Officers] have the responsibility and authority to resolve disputes, including through the use of ADR [Alternate Dispute Resolution] methods.” Clearly, DCMA has told its contracting officers that they not only have the authority to settle issues before they end up in court, but that they also have the responsibility to do so.
So why don’t they?
And the DCMA COs aren’t failing in executing just that one particular FAR policy section; indeed, by failing to make a serious attempt to negotiate and resolve issues in controversy, they are also failing to execute that little piece of the FAR that states—
An essential consideration in every aspect of the System is maintaining the public’s trust. Not only must the System have integrity, but the actions of each member of the Team must reflect integrity, fairness, and openness. The foundation of integrity within the System is a competent, experienced, and well-trained, professional workforce. Accordingly, each member of the Team is responsible and accountable for the wise use of public resources as well as acting in a manner which maintains the public’s trust. Fairness and openness require open communication among team members, internal and external customers, and the public.
(See FAR 1.102-1(b)(1).)
If the FAR requires that “each member of the Team is responsible and accountable” for its actions, then why don’t we read about disciplinary actions being taken against those COs who fail to execute their job responsibilities in the proper manner?
Let’s also not forget this bit from FAR 1.602-2(b):”Contracting officers are responsible for ensuring … that contractors receive impartial, fair, and equitable treatment ….” When COs don’t give contractors a fair chance to tell their side of the story, and don’t even make a token attempt to negotiate audit findings, then how is that treatment either fair or equitable? If the CO’s simply rubber-stamp a DCAA audit report and attach it to a COFD, how is that action treating contractors impartially?
Answer: it’s not. And nobody in DCMA or DOD leadership seems to care. They don’t seem to care that the Federal Acquisition Regulations, as well as agency guidance, are being flouted on a routine basis.
The DCMA guidance to its COs also reinforces the need for the COs to use independent business judgment. The guidance states—
A Final Decision must represent the independent decision and determination of the ACO or TCO issuing the decision. While it may be necessary to obtain assistance from legal and other advisors (e.g., Defense Contract Audit Agency auditors, technical specialists, etc.), ACOs or TCOs are responsible for the ultimate decision and must make that decision after thoroughly reviewing all facts and recommendations.
Yes, that’s the standard. And our recent experience has been that it’s only rarely met by DCMA Contracting Officers.
In Part 2 of this topic, we’ll review some ancient ASBCA cases that discuss what happens when a Contracting Officer doesn’t do his/her job properly.
(Hat-tip to Bob Dourandish of Quimba Software for the FAR references.)
DCAA Gets Serious About Access to Contractor Records and Ignoring Legal Principles
Here’s the thing, dear readers. DCAA is getting serious about forcing contractors to turn over records and other information that its auditors believe they need to perform their audits.
If you’ve been reading this blog for any length of time, you ought to have several problems with the declarative sentence above. Let’s elaborate, shall we?
First, you might take issue with the assertion that DCAA auditors actually perform audits. Indeed, it has been our experience, and the finding of other knowledgeable sources, that the average DCAA auditor spends more time “on the administrative aspects of the audit rather than on conducting the audit.” As a result, DCAA is decades behind in performing audits of contractors’ incurred costs. The only way the audit agency will ever catch up is to “risk waive” the lower dollar audits from the smaller contractors. We predict that practice will last until POGO documents the amount of costs that are not being audited, and then DCAA will try another tack.
Second, you might take issue with the concept that DCAA is just now “getting serious” about access to contractor records and information. On December 18, 2008, the audit agency reemphasized its focus on contractor responsiveness and handling “denial of access to records” situations by issuing MRD 08-PAS-042(R). So DCAA has been “serious” about this issue for at least three years—what’s changed?
Finally, you might have a problem, as we do, with DCAA’s plans to put pressure on contractors to turn over records that have been protected from audit either by judicial decision and precedent, or by the time-honored concept of attorney-client privilege. Which is what the good folks at DCAA HQ are directing the auditors to do.
We are talking about MRD 12-PPS-018(R), dated July 25, 2012. The MRD provided audit guidance for situations where the auditors are asserting a “denial of access to records” situation, solely because the contractor asserts attorney-client privilege. This is not the first time that DCAA has asserted a right to examine protected documents. We’ve discussed the issue right here, and also here, and we noted that DCAA was going to insist on auditing confidential employee hotline allegations and the resulting investigations (many performed under privilege)—and that was going to cause problems. (NOTE: the second link leads to our published article on DCAA audits of contractor codes of ethics and business conduct. You can’t access the article unless you’re a member. Sorry about that.)
The MRD stated—
… if a contractor denies access to the requested information and does not provide alternative, non-privileged information, the FAO should pursue access to records until such time as a high-level executive from the company asserts the privilege, in writing. Upon receipt of the written assertion, the issue should be elevated to the Regional office for coordination with top-level contractor management. …
If the efforts outlined in CAM 1-504.4g prove unsuccessful for obtaining the data needed to establish allowability, allocability or reasonableness, coordinate with
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
so that Policy may review the access to records issue with DCAA counsel.
So, essentially, DCAA is throwing down the gauntlet with respect to the lawful assertion of attorney-client privilege. We predict this is going to be barrels of fun for audit liaison and in-house counsel alike.
But that’s not all. We were privileged to receive an advance copy of MRD 12-PPS-019(R), dated August 14, 2012. Here’s a link to the new MRD. (Sorry, you have to be a member to access the MRD. Membership has privileges, after all.) The new MRD discusses obtaining access to contractor internal audit reports.
Look, we all knew this was coming. We wrote about a GAO report that recommended that DCAA work harder to obtain contractors’ internal audit reports. (We also noted that DCAA auditors interviewed by GAO asserted that “they did not believe that access to contractor internal audit information is critical to their own audit work and that the internal audit reports do not have enough detail to be helpful.”) We also noted that DCAA has been trying to obtain expanded subpoena power for some time.
With that in mind, let’s not be overly surprised that the new MRD had this to say—
… DCAA Contract Audit Coordinator (CAC) offices and Field Audit Offices (FAOs) at major contractor locations must establish a process and a central point of contact to obtain and monitor DCAA’s access to and use of internal audits. This process will include a method for tracking requests for internal audit reports and working papers, when needed, and the contractor’s disposition of these requests. …
When access to internal audit reports is denied by the contractor, the CAC or FAO manager will implement Access to Records procedures per DCAA Instruction 7640.17, dated December 19, 2008. If the efforts of the FAO, Administrative Contracting Officer and regional office prove unsuccessful, the Regional Director should review the matter and determine if a subpoena should be requested in accordance with DCAA Regulations No. 5500.5, Subpoenas of Contractor Records, dated October 10, 2006.
While we don’t believe that contractor internal audit reports are going to be helpful to DCAA auditors at all, we also think that contractors need to think long and hard about whether or not they provide those internal audit reports to DCAA—especially those prepared under attorney-client privilege. (See how the two MRDs link together?)
As we told readers just over a year ago, contractors disclose internal audit reports at their own risk. In that article, we quoted distinguished attorney Karen Manos, who had written—
A U.S. Magistrate Judge ruled from the bench that Oracle’s disclosure of a privileged report in response to a General Services Administration Inspector General subpoena resulted in a broad subject matter waiver of all communications related to the report. … Oracle provided the IG a copy of the report of its outside counsel’s compliance review [related to compliance with the GSA Price Reductions clause]. … The Judge [found that] 'Defendants attorney-client privilege is waived with respect to all communications between defendants and [outside law firm] relating in any way to the contract in issue and/or the review performed.' ..
So this is a serious issue. DCAA is getting serious about it, and we think you should, too.
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In Memoriam: Phil Treccagnoli
The death notice for Phil Treccagnoli is short and contained all the salient facts one might expect. It told us that Philip D. Treccagnoli, of Setauket, New York, had passed away on August 14, 2012. It said that Phil was 54 years old, and that he left behind a wife (Kathleen) as well as two children and two step-children. He had three siblings. And that was pretty much that.
But that is very much not that for me, not about Phil. I want to acknowledge that Phil was one of the better people whom I’ve met in this business, and 54 was far too young for him to be taken from his family and from our small Government Accounting/Compliance community.
Did you know Phil? If not, here’s a link to a summary of his professional qualifications. Note that the summary comes from the “Practicing Law Institute,” where Phil was a member of the faculty. The summary shows that Phil had a MBA (Accounting) from Adelphi University, and that he was a member of the American Bar Association’s Section on Public Contract Law, the National Contract Management Association, and the National Defense Industrial Association. It says Phil was a Green Belt in Six Sigma. Phil was also a Partner at PwC, a member of the firm’s Forensic Services/Government Contract Services practice, and specialized in Government contracting matters. It says of Phil—
Phil's primary responsibilities at PwC include executive and Board of Director level client-facing activities, and delivering solutions to clients on complex business matters covering a variety of areas. These areas include public contract accounting, cost accounting, asset management, program and contract management, regulatory compliance, and litigation support. Phil is also a subject matter expert in government contracts, and serves clients in multiple industries including aerospace and defense, construction, industrial products, healthcare and pharmaceutical, automotive, and energy.
From reading the summary, one can see that Phil had roughly 30 years of experience—16 years in industry and 14 years in the world of “public accounting”. While in industry, Phil worked at Fairchild Republic, GEC Marconi, CAE Electronics, and Telephonics. As far as I know, those companies are all located on Long Island, where Phil spent most of his life. During his 16 years in industry, Phil held a variety of Finance and Contracts positions, which gave him a solid experience base to draw from when he joined Ernst & Young.
He worked at both EY and PwC during his tenure in the “Big 4”. Although we both worked for both firms, Phil had left EY (for PwC) before I joined their Government Contract Services practice, and so it was when I subsequently joined PwC myself (in 2005) that we first met.
Let me tell you about Phil. Like many New Yorkers, he was loud and opinionated. But his heart was the biggest thing about him. He had a constant smile and always seemed happy, despite the daily stress of the job. And more importantly, Phil was a “people person.” Now, that’s more rare than you might think, unless you’ve actually spent some time in the dog-eat-dog world of the “professional accounting” firms. Despite the constant pressures, Phil remained in good spirits and was devoted to his people. He was a fanatic about developing people and was a willing mentor to those who sought him out. And for the others, he still cared about them and had a long-term development plan for them in his back pocket, which he was going to use to nudge them in the right direction (whether they knew it or not).
When Phil made Partner at PwC, after years of grinding out client engagements and waiting for the “soundings” to percolate up to leadership, the first thing he did was call me and tell me that the next thing on his agenda was on getting me into the Partnership, so I could join him. That’s the kind of guy that Phil was. He was as generous and big-hearted as I’ve met in this business. (That I ended-up leaving PwC had nothing to do with Phil, and everything to do with my family situation.)
Phil’s other project was to get his “rising star”—Phil Koos—elevated into the Partnership. He was successful in that endeavor. I asked Mr. Koos if he’d like to say anything on this website about Mr. Treccagnoli, and this is what he sent me—
Phil Treccagnoli was a consummate professional whose experience and knowledge with government contracts was extensive. He helped so many clients over the years across various areas of government contracting making it difficult to define just one area to describe Phil's expertise. However, I think most would agree that across all the experience, knowledge and advice that Phil provided to his clients, co-workers and peers, he was considered an industry leader with regard to termination proposals. Phil constantly brought innovative ideas and strategies to his clients with regard to termination proposals which often resulted in significant recovery. Whenever a termination proposal project arose, Phil's effervescent smile always seemed to get a little bigger as he savoured the challenge of these proposals and the ability to strategize and develop methods for enhancing recovery for his clients. Where others saw the black and white of the FAR requirements associated with terminations, Phil always saw the grey and challenged it to bring new and innovative positions. I know some of Phil's greatest professional achievements were positive reactions and decisions by TCOs with regard to the proposals that Phil prepared, led and advised on throughout his career. To that end, one of the greatest moments of many in his career was when an arbitrator, a leader in the government contracting community, stated that the termination proposal Phil prepared for a subcontractor was the best he had seen in his many years of practice.
For me, Phil's technical capabilities were incredible and he taught me much throughout our time working together. However, the one thing that I believe Phil may have been even greater at than government contracting was people. Phil had a core belief in people and their capabilities. He allowed those who worked with him to expand themselves, to challenge their abilities and to achieve success unconditionally while always being there to support, guide, and advise. Phil's belief in the human spirit allowed those around him to excel and achieve both personally and professionally. Phil also believed the team was always more powerful than the individual and worked each day to build the strength, cohesiveness and collaboration of his team. He allowed each of us to understand that, through the team, we could drive value and quality, augment our strengths, grow through the strengths of others and progress in our careers. Personally, this went a step further to a friendship that I will always cherish. Phil was one of those few people that you cross paths and count as a close and true friend for life. His unwavering support, steadfast commitment, and positive attitude and smile was so infectious that you could not help but smile when he was present, even on your worst day. Although Phil is no longer here, I know that for his entire team and me, his professional and life advice, leadership, knowledge and people skills will forever be present with each of us and continue to shape our lives, both professionally and personally, forever.
Yes, this is the Phil that I worked with—and counted as a friend—as well.
Another PwC Partner, Glenn Brady, also had some words about Phil that he graciously sent to me. If you don’t know Glenn, then you should know that he also has a big heart and is the epitome of a professional business advisor. Working with Glenn was one of the pleasures of my PwC tenure. Glenn offered these observations about Phil—
I worked of course with Phil from time to time, but not closely, and not for several years. … As a partner Phil was always there for me when I needed him. One specific example was when I had a significant client issue on one client that resulted in [an unplanned] continuation of an engagement, which resulted in needing a partner to step in and kick off and essentially run an engagement for another client. Phil did so without batting an eye. He had to do a fair amount of ramp up in a short amount of time and he threw himself into the project with energy and focus and creativity and the like. I believe this was fueled by his passion for client service and for the values of our partnership in how we work together and how we support our staff. I will miss Phil and his regular check ins on how my beloved Cardinals are doing as well. I only wish his beloved Yankees and my Cardinals made it to the fall classic just one time over the past 10 years or so we worked together. I am sure we would have traded tickets and seen some games together.
That two busy Partners—one of whom had not worked with Phil for several years—would take the time to write and send me the foregoing indicates just how special Phil was to many of us who worked with him.
My heart goes out to Phil’s family, who lost a husband and father too soon. And my heart goes out to Phil’s Partners, co-workers, and employees, who lost a valuable member of their team. We need more like Phil, and not less.
Small Business Must Pay Penalties and Interest on Expressly Unallowable Costs
Astute readers may have noticed that we’ve focused this week on the “challenges” associated with small businesses that seek to sell goods and services to the Department of Defense. If you are a small business and win your first “flexibly priced” contract, the resulting euphoria may blind you to the downside risks. For example, there’s this whole accounting system “adequacy” thingee (which includes an evaluation of your indirect cost allocation structure and your calculation of indirect cost rates). And there’s a requirement to submit an annual proposal for “final billing rates” using an “Incurred Cost Electronically” format that you probably haven’t heard of before winning that golden cost-plus contract. These two areas are among the many landmines that await your business as it tries to collect the promised funds from the DOD.
So here’s the bottom-line for small businesses entering the defense marketplace: If you focus on contract execution and don’t pay attention to the back-office administrative requirements, your story will not end happily. You could easily end up paying the U.S. Government far more than it paid you (as our friends at Quimba Software learned, to their chagrin.)
Yet another potential landmine that you could trigger would be failing to deal with this “unallowable cost” thingee that’s addressed in FAR Part 31. (That’s where Quimba tripped-up.) If you are a small business, you may only have a vague idea as to what the FAR is—let alone have sufficient expertise in navigating the identification and segregation of unallowable costs (and the calculation of acceptable indirect cost rates). We suggest you had better learn more about this area—and quickly. The ability to properly account for unallowable cost implicates not only the adequacy of your accounting system, but also the adequacy (and accuracy) of your annual proposal for final billing rates. If you blow the proper accounting for unallowable costs, you are going to make DCAA very happy—because they will get to issue an audit report with lots and lots of questioned costs in it.
It may sound self-serving, but we honestly believe that if you are clueless regarding government contract cost accounting, then it would be a very good idea to hire a subject matter expert to assist you in that area. That’s not to say that hiring an outside SME is a guarantee of a successful outcome. Indeed, Quimba learned the hard way that not all government contract cost accounting advisors are cut from the same cloth. Quimba’s problems with DOD need not typify that of every small business, but if you don’t at least come close to getting the contract accounting and billing correct, you are going to have similar problems.
It is not going to be pretty.
Today’s article is about another small business, one (like Quimba) focused on innovative technology and R&D (and performer of SBIR and STTR contracts) that fell afoul of DCAA and DCMA. But before we discuss the problems of Inframat Corporation, we want to bring you up to speed about expressly unallowable costs and why they can cost your company more than mere garden-variety “unallowable” costs.
We’ve discussed the “flavors” of unallowable costs before on this blog, notably in this article. We wrote that the FAR contract clause 52-242-3 states—
If the Contracting Officer determines that a cost submitted by the Contractor in its proposal is expressly unallowable under a cost principle in the FAR, or an executive agency supplement to the FAR, that defines the allowability of specific selected costs, the Contractor shall be assessed a penalty equal to—
(1) The amount of the disallowed cost allocated to this contract; plus
(2) Simple interest, to be computed—
(i) On the amount the Contractor was paid (whether as a progress or billing payment) in excess of the amount to which the Contractor was entitled; and
(ii) Using the applicable rate effective for each six-month interval prescribed by the Secretary of the Treasury pursuant to Pub. L. 92-41 (85 Stat. 97).
If the Contracting Officer determines that a cost submitted by the Contractor in its proposal includes a cost previously determined to be unallowable for that Contractor, then the Contractor will be assessed a penalty in an amount equal to two times the amount of the disallowed cost allocated to this contract.
That contract clause is not the only place that contractors are put on notice regarding the potential imposition of penalties and interest for including expressly unallowable costs in their final indirect rate proposals. For example, FAR 31.110 states—
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Certain contracts require certification of the indirect cost rates proposed for final payment purposes. See 42.703-2 for administrative procedures regarding the certification provisions and the related contract clause prescription.
- If unallowable costs are included in final indirect cost settlement proposals, penalties may be assessed. See 42.709 for administrative procedures regarding the penalty assessment provisions and the related contract clause prescription.
So let’s just take it as a given that when any contractor receives a “flexibly priced” contract, it is put on clear notice that inclusion of expressly unallowable costs, billed as either direct or indirect costs, may lead to imposition of penalties and interest by the U.S. Government.
Inframat apparently knew that risk, but thought its “sob story” would convince a DCMA Administrative Contracting Officer (ACO)—and later, an ASBCA Judge—that it wasn’t deserving of such a fate. Inframat’s story convinced neither the ACO nor the Judge. Here’s the Judge’s decision on the matter.
The first thing we noticed about the ASBCA decision was that Inframat was represented by Mr. Nicholas Vlahos, Inframat’s “General Manager/Controller”. Apparently, Inframat did not think it worthwhile to hire an attorney to represent its interests. In fairness, the quantum in dispute was only $26,016 plus “simple interest.” We can see Inframat’s management making the decision to forego attorney’s fees for such a small amount. On the other hand, we’ve opined before that “your choice of attorney matters one hecuva lot.” We don’t know if Inframat’s decision to forego representation affected the ultimate outcome, but we are very sure it didn’t help them any.
Inframat submitted its “certified final incurred cost rate proposal” for its Fiscal Year 2004 in August 2006. (The Judge did not discuss why Inframat’s submission was fourteen months late.) DCAA issued an audit report in November 2007, and asserted that Inframat had included expressly unallowable costs in its submission. The Judge noted that DCAA questioned “pensions, legal fees, interest, convention/ seminar, travel, consultant, audit, entertainment and advertising costs and expenses as expressly unallowable.” (We’re fairly confident that a strong attorney would have argued that not all of those items were expressly unallowable, but that’s not the point of this article.) DCAA recommended that $21,238 in “level one penalties” be assessed.
In February 2011, the cognizant DCMA ACO issued a letter to Inframat transmitting the DCAA audit report and notifying the company that he intended to impose penalties. (The Judge did not discuss why it took DCMA more than three years to send the letter, or whether DCMA had a duty to mitigate the interest damages it claimed, which had increased over those three years.)
Inframat responded to the ACO and did not dispute DCAA’s findings; instead, Inframat asked for mercy. Inframat asked the ACO to waive the penalties (as was within his authority to do) because the company felt it had taken appropriate corrective actions so as to ensure that the errors in accounting for unallowable costs would not recur. Inframat told the ACO—
During 2003 the company was using an accounting software package called DELTEK after a recommendation from DCMA. After the Deltek system was installed the company failed to make yearly maintenance payments and thus, support for the system broke down. The accounting staff was unable to use certain modules of the accounting system. The certified public accountants who reviewed their financial statements typically only used the general ledger that the controller provided them. The general ledger did not match the balance sheet and income statements. The bookkeeper was unable to make timely entries into the system because the software would close each period after each month. This compounded the problem as entries were not being made and amounts that were paid were left on the accounts payable ledgers. The Deltek system crashed during 2004. The company was able to recapture some of the lost information but [not] to recreate other information that was missing. Starting in 2006 we switched to Quickbooks accounting software to fix the problems.... The new accounting system worked better at being able to separate.. .allowable and unallowable costs by using the class tracking system. The 2004 incurred cost submissions were submitted by the former controller, Hank Taylor. He was inexperienced in the submissions required. Mr. Taylor also felt that he could submit everything and just be told by DCAA what was not acceptable, which demonstrates his lack of understanding of the FAR.
Readers, Inframat’s story is a classic attempt to appeal to the “better angels” of the ACO. Unfortunately, it was never going to work. Indeed, in only exacerbated Inframat’s problem—since it clearly demonstrated that Inframat did not deserve a waiver.
FAR 42.709-5 discusses when a contracting officer should consider waiving the penalties. It says—
(c) The contractor demonstrates, to the cognizant contracting officer’s satisfaction, that—
(1) It has established policies and personnel training and an internal control and review system that provide assurance that unallowable costs subject to penalties are precluded from being included in the contractor’s final indirect cost rate proposals (e.g., the types of controls required for satisfactory participation in the Department of Defense sponsored self-governance programs, specific accounting controls over indirect costs, compliance tests which demonstrate that the controls are effective, and Government audits which have not disclosed recurring instances of expressly unallowable costs); and <
(2) The unallowable costs subject to the penalty were inadvertently incorporated into the proposal; i.e., their inclusion resulted from an unintentional error, notwithstanding the exercise of due care.
As you can see, Inframat admitted that it failed to properly maintain its Deltek accounting system and that the former Controller was intentionally negligent in preparing the company’s certified final indirect rate submission. Unsurprisingly, the ACO declined to waive the imposition of penalties and interest.
Inframat appealed the ACO’s decision to the ASBCA. As previously noted, the company did not invest in the cost of an experienced government contracts attorney. Instead, the company essentially reiterated its “sob story” to the Judge, writing—
While penalties such as the one imposed may act as incentives for ‘bad’ companies to take appropriate action to correct their behavior, in this situation, as corrective action had already taken place well before Mr. Galvagni's decision, we question the need for the Government to implement a significant (for us) financial penalty.
Like the ACO, the Judge was not moved by Inframat’s plea. Judge James wrote—
Inframat failed to raise a genuine issue of material fact, however, that it met the requirements of FAR 42.709-5(c)(2). On 31 August 2006 it submitted its 2004 final incurred indirect cost rate proposal …. Prior thereto, it failed to exercise due care because its system support broke down for failure to make yearly maintenance payments, its Deltek system crashed, it lost cost information, its bookkeeper could not make timely cost entries, and its inexperienced controller included expressly unallowable costs in its 2004 final indirect cost rate proposal on the misunderstanding that DCAA later would tell him what costs were not acceptable …. Therefore, ACO Galvagni properly determined that Inframat failed to exercise due care in preparing its 2004 indirect cost rate proposal and properly denied its request to waive the penalties.
The Government’s motion for summary judgment was granted as a matter of law, and Inframat’s appeal was denied.
As we wrap-up this week of articles, the majority of which focused on the challenges of small business contracting, we need to remind contractors (large and small) that they ignore the administrative and accounting requirements of their flexibly priced contracts at their peril.
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