Auditor Wins Battle Against NASA in $279 Million Breach of Contract Case
On March 21, 2012, the U.S. Court of Federal Claims granted a motion for partial summary judgment, ruling for the CPA firm of Horn & Associates in its $279 Million breach of contract suit against NASA. Details are sketchy, but Law360 (subscription required) reported the case as follows—
NASA contracted Horn & Associates Inc. in 2004 to look at its books and determine whether the agency had overpaid for various services over a 10-year period. After Horn began work, NASA began to dispute what exactly it had contracted the firm to do.
From what we can gather, NASA issued an RFP for firms to assist in auditing contracts for improper payments. The RFP specified that the auditors would review only firm fixed-price contract types. When Horn & Associates submitted its proposal it “recommended” that NASA review all contract types. Law360 reported—
When NASA awarded the contract to Horn & Associates, it included a clause stating ‘[t]he contractor shall perform a primary audit recovery on all contract payments for the period beginning Oct. 1, 1997 through Sept. 30, 2003, identifying overpayments and/or underpayments.’
Accordingly, the dispute between the contracting parties centered on whether NASA had, or had not, hired Horn & Associates to audit all contract types, or just firm fixed-price contract types. NASA itself was confused about what it had hired the auditors to audit. The Law360 story stated—
Evidence of NASA’s confusion about what was required under the contract was evident by emails that went back and forth with different language about it, according to the judge’s opinion. NASA eventually provided Horn & Associates with some information about contracts other than fixed ones.
Judge Horn of the COFC (no relation to the plaintiff) found that the language in the contract superseded the language in the RFP. The Judge found, further, that if there was any ambiguity, the doctrine of contra proferentum would dictate that the ambiguity be construed against the drafter (i.e., NASA).
Law360 quoted Judge Horn’s decision as follows—
‘In this case, the contracting officer, with authority to do so, issued and signed the order, with its attached statement of work to audit all contracts,’ the judge said. ‘The contracting officer personally put the order number on the upper right hand corner of each page of the order, including the statement of work identifying the scope of work as encompassing all contracts, signifying the contracting officer’s review and approval of the language of the order and the statement of work attached thereto.’
Being interested in this David vs. Goliath victory, we contacted Mr. Horn, who told us—
“We think we have a good case and we won the first of a series of battles that we are expecting. We just hope we win the war! You never know in these situations until the check clears the bank.”
It is important to remember, in the words of Mr. Horn, that this represents one battle in a long campaign. But should Horn & Associates prove victorious at the end of the war, they will cash a whopping $279 Million check. We wish them the best of luck.
Government Loses Yet Another Statute of Limitations Case
In December, 2009, we reported to our readers that McDonnell Douglas (Boeing) had won a victory in a defective pricing dispute, because the government failed to assert its claim within the Contract Dispute Act’s six-year statute of limitations. In that ASBCA case, it took DCAA more than 3 years to complete its post-award audit of McDonnell Douglas’ subcontractor and to issue its draft report to DCMA. It took another fourteen months for DCMA to send a letter to Boeing, “seeking comments” on the matter in order to finalize the audit report. (The final audit report was issued about a month later—nearly 52 months after DCAA commenced its audit.
It took another six years for the cognizant DCMA Contracting Officer to issue a final decision.
The ASBCA was quick to find for Boeing. The Judge wrote—
Because the government’s defective pricing claim upon which the COs’ decisions were based is time-barred and not cognizable under the CDA, the COs’ decisions asserting the claim were not valid. If there is no valid CDA claim, any purported CO’s decision on the matter is a nullity and we do not have jurisdiction to entertain an appeal from the purported decision.
In January, 2012, we reported to our readers that Boeing had won another victory at the ASBCA. In that dispute, which concerned a disclosed change in cost accounting practice, Boeing submitted a revised Disclosure Statement in October 2000. DCAA issued an audit report concerned the cost impact associated with the change in June 2002. In September, 2003, the cognizant ACO began negotiations with Boeing. Between December 2003 and April 2005, the parties attempted to resolve the dispute through negotiation. The parties continued to discuss the matter “intermittently” until 2010. Ultimately, negotiations proved unsuccessful and, in October, 2010, the ACO issued a Final Decision—and Boeing appealed that Final Decision to the ASBCA.
The Judge wrote—
Because the government's 25 October 2010 final decision claiming the accounting revision costs was untimely, it is not valid. Given that it is invalid, it is a nullity and we lack jurisdiction to entertain an appeal from it. Accordingly, we dismiss the appeal for lack of jurisdiction.
The maxim, “Insanity is doing the same thing over and over again, and expecting different results,” is generally attributed to Albert Einstein. A more reasonable litigant (or perhaps one who was spending his own money instead of the taxpayer’s money) might give up on the issue and stop litigating disputes that were over six years old. But not the U.S. Government. No, indeed. Instead, they keep litigating the same CDA statute of limitations issue over and over again, expecting different results.
In the latest defeat for the Government, the U.S. Court of Federal Claims threw out the case against Raytheon Company. The matter concerned an Advance Agreement between Raytheon and the Department of Defense, covering some retirement obligations the company had inherited in its acquisition of certain parts of Hughes Aircraft Company. The Advance Agreement was executed in 1999, and included a provision that made the allowability of retirement costs subject to DCAA audit. Raytheon claimed $106 million pursuant to that agreement, but in 2003 DCAA asserted that $4.75 million of that amount was unallowable. Raytheon shrugged and credited the Government for the allegedly unallowable amount. And that’s where the parties stood until 2007.
In 2007, the DOD Inspector General issued a report that criticized the 2003 DCAA audit. In response, DCAA issued a “supplemental report” in August 2008—asserting in that second report that $25 million of Raytheon’s costs were unallowable. In December 2008, the cognizant DCMA Contracting Officer issued a Final Decision. Raytheon filed suit.
Raytheon sued for a “declaratory judgment” that the Contracting Officer’s Final Decision was “void and of no effect.” The COFC decision was quite short, as these things go. It was eight pages long. Although the Court discussed a number of Government theories, they were not persuasive. The Judges wrote—
Defendant had been aware of all the information on which it based the $25 million government claim for nine years before the contracting officer issued his decision in 2008. The decision conflicted dramatically with results of the first audit, issued in 2004, which used information identical to that employed by the second set of auditors in 2007. The only event occurring after defendant signed the Advance Agreement in 1999, and before the 2008 contracting officer’s final decision, was the Inspector General’s report criticizing DCAA’s $5 million first audit.
The $25 million government claim in this proceeding is barred by the Contract Disputes Act’s six-year statute of limitations. Plaintiff’s motion for judgment declaring that the contracting officer issued his final decision beyond the statute of limitations of the Contract Disputes Act is GRANTED. All other pending motions are moot and therefore DENIED.
Boeing has won twice at the ASBCA; now Raytheon has won at the Court of Federal Claims. When will the Government get the message that the CDA’s statute of limitations will be strictly enforced by the Courts?
Or, perhaps, they will keep litigating the same issue over and over, expecting different results.
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DCAA Issues Audit Guidance Concerning Proper Charging of B&P and IR&D Costs
On March 22, 2012, the Defense Contract Audit Agency (DCAA) issued audit guidance concerning the proper charging of Bids & Proposals (B&P) and Independent Research & Development (IR&D) costs. This topic is not new to readers of this blog. Indeed, in December, 2011, we told you about the policy memo from Shay Assad (Director, Defense Pricing) that addressed this very topic. In fact, the bulk of this particular DCAA Memorandum for Regional Directors (MRD) is essentially a letter of transmittal of that Assad policy memo. (Why it took DCAA four months to pass the memo to its auditors remains a mystery.)
We already reported on the Assad memo (link above) but DCAA has added some additional pointers to assist its auditors. (When do they not?) The MRD states—
Auditors should examine disclosed practices and report a noncompliance with CAS 402 and CAS 420 if disclosed practices allow the contractor to charge proposal costs directly, absent a specific contractual provision for the effort. Auditors should be alert for vague and misleading wording in the disclosure statement that could lead to direct charging proposal costs that are not specifically required by an existing contract. If the examination is not within the scope of a current assignment, a focused audit of the specific cost accounting practice should be initiated under the 19100 activity code. Identified noncompliances should be reported immediately under the 19200 activity code. In addition, auditors should test proposal preparation costs identified in forward pricing and incurred cost audits for compliance with CAS 402 and 420.
Why do we take issue with the foregoing audit guidance?
First of all, our experience with this issue (and we have lots of experience with this issue) tells us that the “specific contractual provision” is not a clear as the audit guidance would presuppose. By way of explanation, let’s discuss a hypothetical example. Suppose you have a contract and the contract is silent regarding submission of a follow-on proposal. Then one day you receive a phone call from your authorized Contracting Officer, telling you to prepare a follow-on proposal and charge proposal preparation costs to the existing contract. What do you do?
In our view, if you have explicit direction from a Government representative with authority to direct you, then you follow that direction. (Unless, of course, if following the direction would lead you into a cost accounting practice that would be inconsistent with your disclosed or established cost accounting practices. Contracting Officers do not have authority to direct a contractor to violate a statute.) In this case, the CO’s direction essentially added the follow-on proposal to the list of contract deliverables (CDRLs). Since the proposal was a contract deliverable, the costs of preparing that proposal should be treated as direct costs of the benefiting contract.
So that’s what the DCAA audit guidance missed.
Second, we are apprehensive that DCAA auditors will have little if any idea exactly what “vague and misleading wording in the disclosure statement” might look like. In our experience, Disclosure Statement language is, by necessity, general and somewhat vague regarding specifics, since the language has to cover all situations. So we think that bit of direction will lead nowhere good.
Finally, readers of this blog may have familiarity with our views on DCAA audit quality and timeliness. (How could you not? We cram it down your throat every week.) This guidance directs auditor to “test proposal preparation costs” in contractors’ new business cost proposals, as well as in Final Incurred Cost Proposals (FICP) for compliance with CAS 402 and 420. (Add to that also testing within Forward Pricing Rate Agreements.) It’s not that we object to CAS compliance testing within those assignments—we have no problem with that, assuming that DCAA can perform its work timely. But the problem is that the audit agency cannot perform its work timely right now. Adding to the workload will only add to the duration of the audits. And that serves nobody.
If DCAA wants to evaluate contractors’ compliance with the Cost Accounting Standards, then have at it. But don’t try to cram in yet another tasking within the already high priority and high stress forward pricing and FICP audits.
Lockheed Martin Agrees to $15.8 Million FCA Settlement
On March 23, 2012, Lockheed Martin agreed to pay $15.8 million to settle allegations that the company mischarged the U.S. government for “perishable tools” used on major aircraft programs, including the F-22 and the F-35. What caught our eye was not necessarily the size of the settlement (it’s rather small as such things go) but, instead, it was the fact that it was LockMart’s subcontractor (Tools & Metals, Inc., or TMI), that did the actual mischarging. LockMart just added burden and fee to the subcontractor’s costs, and invoiced the government. Normally, it’s rather difficult to establish liability under the civil False Claims Act (FCA) for (presumably unknowingly) passing on improper costs to the government.
As many readers are likely aware, the civil False Claims Act was amended in 1986 to establish defendant liability for “deliberate ignorance” and for “reckless disregard” of the truth. So to prove that LockMart was liable, the government needed to show that it acted in deliberate ignorance or with reckless disregard for the accuracy of TMI’s invoices. That is not as difficult as showing scienter (i.e., knowing intent), but it’s not especially easy to do either.
Readers also need to understand that the government typically holds the Prime accountable for the actions of its subcontractors. Accordingly, if the subcontractor commits “defective pricing” then the government’s remedy is to assess the pricing impact at the Prime level, and leave it up to the Prime to recover the price adjustment through legal action against the subcontractor. That’s called “privity of contract” and it basically means that the contract is between the Prime and the government, so the government has no means of reaching the subcontractor.
Now, privity of contract is not always in play. For example, many times the cost impact(s) of CAS noncompliances will be assessed against the subcontractor and not the Prime—particularly if the subcontractor is a large company. (We note legal precedents that say this should not be the case, but in our experience it is the case, regardless of legal opinions to the contrary.)
In this particular instance, it seems that the government went after the subcontractor (TMI) first, then came after the Prime (Lockheed Martin) separately. (We caution readers that our interpretation of the situation may be wrong; we have no inside information and have only the tidbits in published news stories to guide us in our analysis. So caveat emptor.)
The news story (link in first sentence, above) reported—
In March 2006, Todd B. Loftis, a former TMI president, was sentenced in federal court in Fort Worth, Texas, to 87 months in prison and ordered to pay $20 million in restitution after his December 2005 guilty plea in connection with his role in the scheme.
Loftis had waived an indictment and pleaded guilty to a one-count information charging conspiracy to defraud the government with false and fraudulent claims. He admitted that from 1998 through 2004, as president and chief operating officer at TMI, he, along with others, conspired to defraud the Defense Department and Lockheed Martin Aeronautics by obtaining payments from both through false and fraudulent billings. …
In order to cover up this activity, the government said, Loftis and others under his direction created false invoices using a computer scanner to remove actual pricing data and substitute fictitious data to give the appearance of legitimate pricing. Loftis was able to control the audit sample of invoices as well so as to limit the possibility that a fraudulently priced part would be found. After the audits, Loftis ordered the fraudulently created documents and computer files to be destroyed.
TMI and Loftis realized approximately $20 million in profits on these fraudulent sales to the government, prosecutors said.
The foregoing provides details regarding how TMI perpetrated its fraud, but it doesn’t address LockMart’s culpability. Where was the deliberate ignorance or reckless disregard?
The first thing we noticed in the story was the following sentences—
In 1998, TMI … obtained a sole-source integrated supply contract with Lockheed Martin Aeronautics to supply all of Lockheed’s perishable tools for the manufacture of airplanes including the Defense Department’s F-16, F-22 and other military needs in Fort Worth, San Diego and Marietta, Ga. Perishable tools are the drill bits, router bits and other small tools that are used in the manufacturing process.
We wonder why TMI was able to win the subcontract award. Now, perhaps TMI had some kind of proprietary technology that made its “drill bits, router bits and other small tools” the only ones that met LockMart’s requirements. That kind of technology certainly would justify a sole-source subcontract award. But we are skeptical that would have been the case. In fact, we bet that more than one company in the USA offered such perishable tools, and would have been willing to submit bids on the subcontract, had LockMart opened up the opportunity to competition.
The story reported that the government was “accusing the firm of contributing to the inflated amounts paid by the government by failing to adequately oversee TMI’s charging practices and by mishandling information revealing these practices.” Thus, according to the story, it was not so much a matter of inappropriately awarding the subcontract, as it was a matter of failing to ensure that TMI was submitting accurate invoices. We have reported on DCAA’s concerns with similar matters before. In that article, we quoted DCAA Director Pat Fitzgerald as follows—
During our review of prime contractor billings and incurred cost audits, DCAA has identified situations where the prime contractor has not awarded its fixed-price subcontracts based on fair and reasonable prices leading to unreasonable or unallowable costs being paid by the Government. … in those cases where the subcontract is sole source, it is often difficult to obtain cost data to ascertain the reasonable costs without access to the subcontractor’s books and records. DCAA access to subcontractor books and records is generally limited and dependent on the flow down by prime contractor to the subcontractor of the appropriate FAR clauses, and in instances of fixed price subcontracts, virtually nonexistent. … Since DCAA does not have access to the subcontractor’s books and records, we were unable to determine through other processes the reasonableness of the prices being paid to the subcontractor and subsequently passed on to the Government for reimbursement. … The FAR audit access clause does not provide for Government access to the subcontractor’s costs records when the subcontract is firm-fixed-price.
Because DCAA was not able to verify the “reasonableness” of the subcontractors’ prices, they questioned the entire amount paid to the subcontractor as being “unreasonable.”
Now, we are not saying that LockMart’s situation with TMI is the same as the one that Mr. Fitzgerald reported to the Commission on Wartime Contracting back in July 2010, but we don’t think it’s too dissimilar either. In both cases, the Prime contractor was held responsible for proving adequate oversight of its subcontractors. That oversight responsibility was considered to encompass more than just technical performance; it was also considered to encompass monitoring the accuracy and appropriateness of the original negotiated prices as well as the accuracy and appropriateness of invoices.
Lockheed Martin settled and it’s unclear why the company chose to do so. Clearly, there’s more to the story than was reported in the media.
The lesson here, if one can be taken from such scanty information, is that Primes need to focus on subcontractor management. (Long-time readers may recall that this is a familiar theme on this blog.) More importantly, Primes need to perform sufficient due diligence to ensure the appropriateness of the initial subcontract award pricing, and to perform some limited audits/reviews of subcontractor invoices. In this particular case, we would start with trying to gain an understanding as to why a sole-source subcontract award was thought to be justified and how pricing reasonableness was established.
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