Problems with the T&M Contract Type – Part 2
Okay, we promised to discuss issues associated with subcontracts under T&M prime contracts in this Part of the analysis of the T&M contract type. Instead, we want to talk about this recent decision at the Armed Services Board of Contract Appeals (ASBCA). Trust us, it will fit in to the Part 1 discussion on the Government’s problems administering and managing this contract type.
The ASBCA decision addressed an appeal by the GaN Corporation. GaN held a sole source contract (awarded pursuant to the SBA’s 8(a) program) to provide “interior design support for office and barracks furnishings” for the U.S. Army Engineering Support Center, Huntsville (USACEH). The contract called for orders to be issued on either a firm, fixed-price (FFP) basis or Labor Hour (LH) basis, based on “firm fixed price rates” established for individual labor categories.
GaN accounted for labor hours under the “total time” method. Thus, GaN employees recorded all hours worked, whether compensated or uncompensated. For salaried employees—whose hourly rate was calculated based on 2,080 labor hours in a year—this created “uncompensated overtime” (UCOT) hours, where more than 2,080 hours were recorded in a single year. In its proposal to USACEH, GaN stated—
Our accounting and timesheet procedures will require the recording of uncompensated overtime and its allocation to all charge numbers worked throughout the pay period. As such, because ofthe contract type, all hours worked, whether compensated or uncompensated, will be charged and billed to the contract.
The Contracting Officer (CO) notified GaN that its billings under the LH orders awarded to it included hours for which its employees were not being paid. This finding was based on an “internal review of the contract” performed (we assume) by auditors of the Army Audit Agency. In addition, the CO asserted that GaN’s invoices did not include required documentation to substantiate labor expenses, as required by the contract’s payment clause (52.232-7). The CO stated, “The contractor never states that it actually paid the employee for those hours [billed].”
GaN and its CO continued to correspond, with GaN asserting that it was permitted to bill the Government for all direct labor hours recorded by its employees to the order, regardless of whether or not those labor hours were compensated. The CO continued to assert that “If your firm does not incur certain costs for your employees, pursuant to FAR 52.232-7, these costs are not billable to the Government under the labor hours provisions of the contract.” Eventually, the CO issued a final decision demanding some $72,000 in alleged “overpayments,” which GaN appealed to the ASBCA.
The ASBCA Judge found for GaN, writing—
The government contends that under the plain meaning of the Payments clause and the contract billing procedures, appellant overbilled the government regarding the labor for ‘unexpensed hours’ worked by the above-mentioned GaN employees. As such, its withholding was justified. … It argues that, except for the labor rates being fixed, the contract is a variant of a Time and Materials (T&M) contract and is tantamount to a cost reimbursement contract …. The government states that the central issue is whether appellant, under a labor hour task order, is entitled to charge the government for the employees ‘unexpensed and uncompensated’ overtime when the contract in effect made them all hourly workers …. Because appellant's ‘novel and unsupportable interpretation allows the contractor to pocket undue windfall profits at taxpayer expense,’ the government avers that we ‘should not countenance such a 'weird and whimsical result'’. …
The government appears to think that the various references to actual payment and cost mean that the contractor cannot recover for hours unless the employees were paid on an hourly basis. We disagree.
Because the Government misinterpreted the contract type as “tantamount to a cost reimbursement contract,” it mistakenly thought that GaN had to incur a labor cost in order to invoice it. In fact, the contract type was closer to an FFP type, in that the price for labor hours was fixed and the contractor’s labor costs were simply irrelevant to the established price. But as we have seen, the real answer is that the contract type was Labor Hour, which (like T&M) is its own unique type and should not be analyzed by looking at the rules for other contract types.
The GaN decision did not reference what DCAA has to say about uncompensated overtime, but it well might have. Section 6-410 of the DCAA Contract Audit Manual (CAM) discusses UCOT. It starts out by stating, “The Fair Labor Standards Act (FLSA) requires employers to compensate hourly workers for hours worked in excess of 40 hours per week, but the FLSA does not require employers to pay overtime to salaried employees. Salaried or exempt employees are paid a salary to provide a service.”
The CAM lists three UCOT accounting methods that are considered “acceptable” for use. These three methods include:
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Compute a separate average labor rate for each labor period, based on the salary paid divided by the total hours worked during the period, and distribute the salary cost to all cost objectives worked on during the period based on this rate.
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Determine a pro rata allocation of total hours worked during the period and distribute the salary cost using the pro rata allocation. For example, if an employee was paid on a weekly basis and worked 25 hours on one cost objective and 25 hours on another cost objective, each cost objective would be charged with one-half of the employee's weekly salary.
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Compute an estimated hourly rate for each employee for the entire year based on the total hours the employee is expected to work during the year and distribute salary costs to all cost objectives worked on at the estimated hourly rate. Any variance between actual salary costs and the amount distributed is charged/credited to overhead.
In addition, the CAM discussed two other methods that “require further evaluation” in order to determine whether or not the method use is acceptable. The two additional methods are:
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Distribute the salary cost to all cost objectives based on a labor rate predicated on an 8-hour day/40-hour week and credit the excess amount distributed to overhead.
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Determine a pro rata allocation of hours worked each day and distribute the daily salary cost using the pro rata allocation …
So it is clear that—contrary to the Government’s argument that GaN’s position was “novel and unsupportable,” and resulted in an “undue windfall”—the fact of the matter is that GaN had several UCOT cost accounting methodologies from which to choose, and not all of them required salaried employees to receive actual payment for hours worked in excess of 40 per week or 2,080 per year. It’s too bad that the USACE Contracting Officer allowed him/herself to be intimidated by internal auditors into creating this dispute with the USACE’s 8(a) contractor, since the Government’s position contrary to the plain reading of the appropriate regulatory framework.
In the next article in this series, we’ll take the promised look at subcontracting under T&M contracts.
Sequestration in the News
We are not going to breathlessly issue alert bulletins about the progress—or lack thereof—of the looming doomsday scenario known as “sequestration”. (We have the Aerospace Industries Association to do that for us.) We are, however, going to publish interesting pieces that seem to have implications for Government contractors.
But make no mistake, sequestration is looming and events leading up to its cataclysmic impacts are unfolding like scenes in a slow-motion multi-car collision. You know: you can see one car hit another, who then hits another, and so on—all in slow motion so that you can tell your car inevitably will be smashed … and there’s not a damn thing you can do about it. Sequestration is like that. We can all see the events unfolding with inevitability and there’s not a damn thing we can do about it, except hope that sanity breaks out in Congress before the collision chain starts.
So we’re not going to report on the events leading up to sequestration, which either will or will not happen. If sequestration is avoided, then great. But if not, then expect doomsday.
The Defense Department is reportedly “not planning” for four possible scenarios:
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Congress inserts language into a continuing resolution that delays sequestration another year or two when there is a less-heated political environment, but the government implements the first and perhaps second year of cuts, which some refer to as the ‘mini-sequester.’
Lockheed Martin and some other defense contractors have warned the Obama Administration that they might be forced—by the requirements of the WARN Act—to issue potential lay-off notices to their workforces 60 days in advance of sequestration—i.e., just before the November elections. (Real subtle, right?)
Echoing that line, the DefCon Hill blog reported that a Defense Department official testified before the House Armed Services Committee that anywhere from 89,000 to 200,000 civilian DOD employees would be laid-off under sequestration—and that they would receive their lay-off notices in early November. Congress critters complained that the Pentagon has failed to plan for sequestration, and passed a law “that would require the Obama Administration to explain how the sequestration would take effect.”
Hey, we can explain how sequestration would take effect! How about: “Like dropping a nuclear bomb on the Pentagon.” Does that draw a sufficient picture for our Congress men and women who created this disaster by failing to reach a compromise in this election year?
Finally, the Department of Labor has weighed into the fray, issuing its opinion that the WARN Act will not—repeat, not—require advance lay-off notices to be issued in November.
The Ares Blog over at Aviation Week & Space Technology has some choice words about the on-going sequestration “battles”. The authors wrote—
The ‘uncertainty’ about sequester that has so bothered the defense industry is being turned back on it by the Obama administration, which argues, hey, how are you going to know what people to warn you’ll lay off if you don’t know what your business will look like after the dust settles? (To which House lawmakers have said: This is why we need the Pentagon to do a comprehensive study of the after-effects! And the vortex continues to spin.)
But even though Oates wrote it would be ‘inconsistent’ with the law for a Lockheed Martin to issue tens of thousands of layoff warnings, the note doesn’t seem to indicate whether that is actually illegal. Lockheed and the other brand-name firms could well send anything they want to their employees, up to and including potential layoff warnings, just to try to goose voters into goosing politicians to resolve the sequester. …
Not to be outdone, the Defense Industry Daily wrote—
[The Labor Department] argue that while ‘it is currently known that sequestration may occur, it is also known that efforts are being made to avoid sequestration.’ It is a bizarre line of reasoning given that executing sequestration next January is currently signed law. Perhaps knowing this, the Dept of Labor also argues that because DoD hasn’t announced which contracts would be affected, potential layoffs are speculative.
One doesn’t need a crystal ball, nor detailed planning, to foresee that sequestration will have a devastating impact on the Federal government and its contractors. Civilian employees of the Defense Department—as well as employees of all major prime contractors—should expect to receive WARN Act lay-off notices in November. That doesn’t mean people will be laid-off, of course. But it does mean that the stakes will become very, very clear for voters and politicians alike.
Readers should also note that Apogee Consulting, Inc. does termination settlement proposals pretty damn well. You might want to keep our e-mail address and telephone number handy, come January, 2013.
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Problems with the T&M Contract Type – Part 1
The Time and Materials (T&M) contract type is the “least preferred” type of contract awarded by the Federal government. To emphasize how few T&M contract awards the Federal government wants to see, before making any T&M contract award the Contracting Officer must make a determination and finding (D&F) that no other contract type (including cost-plus) is suitable for the contract award. (See FAR 16.601(d).) T&M contracts are tough to work with (and tough to write about) because applicable requirements differ by the award circumstances. For example, whether the award is made for a commercial item or a noncommercial item, or whether or not the award is made pursuant to competition, affect the applicable FAR/DFARS provisions and clauses—and thus also dictate the contract payment terms.
The T&M contract type is the least preferred because it is the hardest to manage for both Government and contractor. That assertion may be counter-intuitive for some readers. How can something so simple that’s used every day (i.e., number of hours x fixed billing rate = amount billed) be so hard to manage? But indeed, readers, such is the case. We will be exploring some of the problems with the T&M contract type in this article.
The first question to be addressed is, “What is a T&M contract type?” Many individuals can’t accurately answer that question. In fact, the FAR has different answers to that question, depending on which Part you’re looking at.
Some individuals (including DCAA auditors) categorize T&M contracts under “flexibly priced” contract types, along with cost-reimbursement types, because the final price isn’t known until all hours have been billed and any indirect costs allocated to the Materials portion have been finalized. Other individuals lean more toward categorizing T&M contracts under “fixed-price” arrangements, because the cost per billed labor hour is fixed and not subject to change if the contractor’s labor or labor overhead costs change.
FAR Part 16 states that T&M contract types are neither cost-plus nor fixed-price. Instead, they are a third category of contract types called “Time-and-Materials,” and they have their own FAR section at 16.6. Yet, FAR 30.6 (and the related 52.230-6 CAS Administration contract clause) requires that, when a T&M contract is included in a cost impact proposal, it must be broken into its constituent components, such that the “T” portion is included in the fixed-price section of the analysis while the “M” portion is included in the flexibly priced section.
The fact of the matter is that a T&M contract type is neither flexibly priced nor is it firm-priced. It’s not a hybrid type, either. Instead, it is its own type. The folks who feel compelled to look at the world in terms of black and white have a problem with this; but they are clearly wrong. While in some cases it may be helpful to think of the contract in terms of a fixed-price per labor hour plus cost-reimbursable non-labor costs, that’s about as far as it should go. Knowing management of fixed-price contracts won’t get you where you need to go on T&M types, nor will knowing management of cost-plus types. Instead, you need to develop an expertise in managing T&M contracts—and subcontracts, too.
The confusion over T&M contract type has been exacerbated by regulatory revisions. Historically, T&M contracts have been treated as delivery contracts, with the deliverable being labor hours. In other words, the contractor was required to deliver labor hours (and ancillary material) and there was no specified contractual outcome associated with those hours. Accordingly, payments of T&M contract billings were delivery payments, not interim payments. A payment meant that the Government had inspected and accepted the hours billed, and had no recourse when it turned out that not all billed hours were of equal productivity. This situation led to problems (particularly in the IT system implementation realm) where contractors had delivered 100% of the specified labor hours without completing the contemplated work. That was a problem for the Government, since it didn’t obtain what it wanted, but need to pay the contractor regardless. Consequently, the FAR was revised in the mid-2000’s to clarify that T&M payments were interim payments, not payments for partial deliveries. That revision was ill-advised, because it required revisions to a host of other provisions and clauses
For a good example of what we mean, take a look at this recent final FAR revision (issued July 26, 2012). It attempted to “harmonize” differing requirements for submitting final invoices with respect to T&M contract types. As the FAR Councils wrote—
FAR clause 52.232-7 provides for monthly invoicing and submission of the completion voucher no later than one year from the date of work completion. These provisions are in conflict with the corresponding provisions of FAR clause 52.216-7, which is invoked under a time-and-materials contract. FAR clause 52.216-7 provides for invoicing on a bi-weekly basis for large businesses, and more frequent invoicing for small businesses, and the submission of the completion voucher no later than 120 days after completion of work.
Thus, the final rule clarifies that the invoicing requirements of 52.232-7 apply to the fixed-price-per-hour “T” portion of the contract, but not to the reimbursable “M” portion, which is covered by the requirements of 52.216-7. (Readers should recall that, among other things, 52.216-7 requires submission of a final annual indirect cost rate proposal for audit and subsequent negotiation of final indirect rates. If you are a smaller business and only have one or two T&M contracts—with all others being FFP—then it seems absurd to go through this process. It seems even more absurd to be subject to the requirements of 52.216-7 if the amount of reimbursable “M” costs is immaterial in comparison to the “T” amounts.)
The foregoing example is just one of the myriad issues and inconsistencies created by the rule-makers, when they decided to make T&M contract payments interim payments, instead of payments for partial deliveries.
Another problem with the T&M contract type is increasing the hours being acquired, when it turns out the original amount ordered was insufficient to meet the Government’s needs. This is a problem because FAR 16.601(d)(2) requires that every T&M contract must include “a ceiling price that the contractor exceeds at its own risk”—and the CO must “document the contract file to justify the reasons for and amount of any subsequent change.” In contrast, while a cost-reimbursement type contract contains an estimated cost and fee, the estimated cost amount can (and frequently is) increased for changes that are within the originally contemplated contract scope of work.
On July 26, 2012, a proposed rule was published for public comment that would make it harder for COs to justify any increases to the original amount of ordered labor hours. If implemented as drafted, then any increase to ordered hours would need to be justified (by the CO) as “non-competitive new work.” In other words, instead of increasing the contract price to permit the contractor to deliver (and bill) additional labor hours, the correct approach is to recompete the additional work.
In another admission that their previous rule-making was ill-advised, the FAR Councils wrote—
FAR 16.601(d) has also been amended to make it clear that a D&F is required for T&M orders. This FAR change will clarify that a T&M D&F is required for each non-commercial item T&M order under a part 16 indefinite-delivery indefinite-quantity (IDIQ) contract. This change is necessary both to keep part 16 parallel with part 8 (which requires a D&F for each part 8 T&M order) and to clarify an unintended lack of clarity in the 2006 FAR changes that rewrote much of the T&M policies in the FAR (see FAC 2005-15, published in the Federal Register at 71 FR 74656 on December 12, 2006). Currently, only part 12 includes a direct requirement for T&M orders to be authorized by a T&M D&F, but this applies only to commercial items. This FAR case is adding a clarification to part 8 to repeat that policy to ensure that part 8 T&M orders are also each authorized by a T&M D&F. With this case, part 16 is also being changed to explicitly require T&M D&Fs for orders.
It should be clear that the T&M contract type is a difficult one for both the Government and the Prime Contractor. In the next Part of this analysis, we’ll take a look at subcontracts under T&M prime contracts. Readers, you ain’t seen nothin’ yet.
Reporting Executive Compensation and First-Tier Subcontract Awards
In July, 2010, FAC 2005-44 implemented FAR Case 2008-039 on an interim basis. We told you about the interim rule in this pithy blog article. As we told you, the interim rule had two fundamental requirements:
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Prime contractors will need to report “executive compensation” (see 31.205-6(p) for limitations on the allowability of executive compensation) for its five most highly compensated executives. In addition, the prime will need to report the compensation for the top five most highly compensated executives of its first-tier subcontractors.
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Prime contractors will need to report all first-tier subcontract awards valued in excess of $25,000.
Contractors that were required to comply with the new rule included those that—
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Received 80 percent or more of its annual gross revenues from Federal contracts (and subcontracts), loans, grants (and subgrants) and cooperative agreements in the preceding fiscal year; and
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Received $25,000,000 or more in annual gross revenues from Federal contracts (and subcontracts), loans, grants (and subgrants) and cooperative agreements in the preceding fiscal year; and
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The public does not have access to information about the compensation of the executives through periodic reports filed under section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a), 78o(d)) or section 6104 of the Internal Revenue Code of 1986.
We opined on the interim rule as follows—
First, most of the larger contractors will be exempted from the compensation reporting requirements because they already publish executive compensation information to the Securities & Exchange Commission. Second, some of the commercial contractors will be exempted from the compensation reporting requirements because they don’t receive more than 80 percent of their revenue from the Federal government. Finally, the very smallest contractors will be exempted from the compensation reporting requirements because they receive less than $25 million in annual Federal revenue. Those exemptions are going to reduce significantly the number of entities for whom exemption compensation information will need to be reported. That will leave the requirement to report first-tier subcontract awards, which will be borne by the prime contractors. And they should be able to handle the additional reporting requirements. We hope.
Well, FAC 2005-60, just published on July 26, 2012, implemented the final rule on this topic. The final rule contains some changes from the interim rule. Readers should note that any contract that contains the interim (July 2010) 52.204-10 contract clause language is supposed to be modified (“on a bilateral basis”) to update the clause to this July 2012 revision.
The rule-makers had to deal with a number of negative public comments, most of which complained about things over which the rule-makers had little discretion. Readers, when there is a statute requirement, the FAR Councils pretty much have to implement it. That said, the rule-makers seemed to relish using what discretion they had to implement the statutory requirement on commercial item contracts and classified contracts. We’re just sayin’.
The final rule applies to all contracts valued at $25,000 or more. Period.
The first-tier subcontract reporting requirement applies to “first-tier subcontracts,” as defined by the provision/clause language at 52.204-10 (July 2012 version). The definition of “first-tier subcontract,” for purposes of complying with this rule, is—
First-tier subcontract means a subcontract awarded directly by the Contractor for the purpose of acquiring supplies or services (including construction) for performance of a prime contract. It does not include the Contractor's supplier agreements with vendors, such as long-term arrangements for materials or supplies that benefit multiple contracts and/or the costs of which are normally applied to a Contractor's general and administrative expenses or indirect costs.
The executive compensation reporting requirement is the same as for the interim rule. No changes there.
Prime contractors have one month after award to report their first-tier subcontract awards. They must report the same data items as were listed in the interim rule. No changes there.
As with the interim rule, prime contractors must also report executive compensation of their first-tier subcontractors. No changes there. However, the final rule provides that—
The [Prime] Contractor is required to report information on a first-tier subcontract covered by paragraph (d) when the subcontract is awarded. Continued reporting on the same subcontract is not required unless one of the reported data elements changes during the performance of the subcontract. The Contractor is not required to make further reports after the first-tier subcontract expires.
So our opinion of this reporting requirement hasn’t really changed. This is going to add a little bit of work to the Supply Chain Management personnel in the Prime Contractors. There will be some rough patches during implementation, because some smaller companies won’t easily accept that they need to provide the required compensation data. But there’s a statute and a FAR provision/clause that supports the requirement.
So kvetch all you want, you still have to comply. And so do your first-tier subcontractors.
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