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Court of Federal Claims Discusses Government’s “Special Plea in Fraud” Defense - 1 of 2

Nick Sanders
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Part 1 of 2

This is an article about legal stuff—namely, the Government’s “affirmative defense” called the “special plea in fraud”. (28 U.S.C. § 2514.) Let us remind readers right off the bat that we are not attorneys and we are not giving legal advice and we are not qualified to have any opinions whatsoever on such tricky topics as common-law fraud or affirmative defenses or special pleas in anything.

Yet here we are.

An “affirmative defense,” Black’s Law Dictionary (6th Edition) tells us, is “in pleading, a matter asserted by defendant which, assuming the complaint to be true, constitutes a defense to it. A response to a plaintiff’s claim which attacks the plaintiff’s legal right to bring an action, as opposed to attacking the truth of claim.”

The Government’s “special plea in fraud” defense has a long and, as we shall learn in Part 2 of this article, a mixed history in Federal jurisprudence. Our favorite example of its use was in the 2006 decision by the U.S. Court of Federal Claims in the matter of Daewoo Engineering and Construction Co., Ltd. v. USA. Here’s a link to that decision. The Judge summed up his decision thusly—

Daewoo’s case against the United States is wholly without merit; its claims are fraudulent. The Corps of Engineers has been as conscientious, patient, and fair in its administration of this contract as Daewoo has been demanding, unreasonable, and inept.

(The good stuff in the decision starts about page 34, for those interested in such things. Fair warning: we are going to be quoting extensively from the decision.)

The Judge wrote—

Plaintiff did not present a clear legal theory to support its large claim against the Government. It appeared that Daewoo did not expect to find itself in court trying to justify its case; perhaps it thought defendant would pay a negotiated amount. The purpose of the Contract Disputes Act is to prevent this sort of gamesmanship. …

[Daewoo’s witnesses] did not seem capable of providing testimony that would support a coherent legal theory, if one could have been identified. This was true despite the court’s conviction that Daewoo prepared its witnesses with unusual care. We did not have an effective understanding of plaintiff’s legal position other than its insistence on having been misled by the Weather Clause [in the contract]. …

Kim [Daewoo’s Project Manager] certified the claim for $64 million, and he testified that he expected the Government to pay the entire amount. Later the same day, he recanted that testimony, stating that the claim was for only $13 million. Plaintiff’s counsel made the remarkable argument that Kim’s testimony concerning the amount of the claim, and in fact the complaint itself, are ‘irrelevant.’ We understood him to mean that Kim’s testimony should be viewed as irrelevant because it was ‘inconclusive.’ The testimony was inconclusive because it was ‘inconsistent.’ Kim was the project manager. He was the person whom Daewoo authorized to certify claims to the United States on plaintiff’s behalf. His ‘conflicting testimony’ on an issue of paramount importance to this case does not go to relevance; it goes to credibility.

Okay, readers. Somewhere about this time you ought to be getting the sense that Daewoo was in trouble with this Judge, that its case wasn’t going as well as it initially may have hoped. This was confirmed later in the decision, as follows—

Mr. Kim’s testimony also provided examples of Daewoo’s lack of good faith. He testified that some part of the claim was intended to indicate ‘the seriousness of the situation’ and to get the Government to ‘pay attention’ so defendant would agree to Daewoo’s preferred method of compaction. This is the source of the dispute regarding plaintiff’s ‘negotiating ploy.’ Using a claim to gain leverage against the United States violates the principle on which Congress enacted the Contract Disputes Act, including its effort to prevent contractors from using the claims process to obtain higher profits. Congress called it ‘horse trading.’

Daewoo’s project manager testified that plaintiff filed at least $50 million of its certified claim as a negotiating ploy; Daewoo’s counsel essentially confirmed it: ‘Daewoo’s suggestion that the Government expedite a previously approved and validated alternative embankment placement method is a reasonable request that served the projects best interests and, therefore, is grossly mischaracterized as a ‘ploy.’’ Unfortunately, Daewoo’s ‘reasonable request’ or ‘suggestion’ that the Government ‘expedite’ approval of the cheaper compaction method took the form of a certified claim.

As some-time expert witnesses we were interested in how Daewoo’s experts fared in the Judge’s scathing decision. Answer: they did not fare well. Here’s a longish snippet—

The testimony of plaintiff’s expert witnesses was obtuse. It was not always clear what they were attempting to accomplish or avoid by their use of such careful semantics, however. They jostled with government counsel about whether the firm was hired to ‘update’ plaintiff’s certified claim or to ‘reprice’ it. … Presumably, they preferred the word ‘reprice’ because [the experts] wanted it known that they had nothing to do with the certified claim, which they reduced by more than $20 million from $64 million (or increased by approximately $30 million from $13 million). ‘Update’ would suggest that they started with numbers used in the certified claim and refined them, accounted for passage of time for example, but that was not the case. Each expert deferred to the other for responses to questions that both should have known but could not or would not address.

The experts emphasized that they had not read the certified claim they were to update or reprice. They wished to distance themselves from any numbers or supporting data that had been a part of that claim. The issue became more cloudy later in their testimony. Mr. Allen reported that he may have ‘looked it over. That’s all.’ Mr. Freas ‘did not go in and look at Daewoo’s bid in its entirety, check every single number, every single quantity. That I did not do.’ So either they merely scanned the certified claim or they did not read it at all.

There are literally pages and pages of the Judge’s review of Daewoo’s witnesses and scathing dismissal of their arguments. (You may be gleaning the reason why this is one of our favorite cases….) But now we’ll skip to the Government’s counterarguments—which included counterclaims for fraud.

The evidence of fraud arose from and during the testimony of plaintiff’s own witnesses, during its case-in-chief. … The Government showed primarily through cross-examination that it was not liable on plaintiff’s claims, and that Daewoo’s claims were fraudulent. Defendant used its own case to establish additional evidence supporting findings of fraud and quantifying them. Defendant did not hire new experts to pursue its fraud counterclaims or call new witnesses. Its accountants expanded their testimony somewhat to include additional examples of plaintiff’s efforts to inflate its claims. We offered plaintiff’s counsel the opportunity to depose defendant’s expert witnesses on the expanded testimony, but they declined.

Despite the magnitude and importance of this case, plaintiff did not present a coherent legal theory for recovery other than its insistence on having been misled by the Weather Clause. Every witness seemingly was instructed to emphasize that the Weather Clause was misleading. …

The Government is entitled to judgment on all its counterclaims for reasons discussed throughout this Opinion. Plaintiff made obvious mistakes and overly-optimistic assumptions in its bid proposal, but its claims against the Government go well beyond mere error or oversight.

The Judge went into some detail regarding the Contracts Disputes Act (CDA) and the role of claim certification in the disputes process. He wrote—

The Contract Disputes Act requires that an authorized corporate official certify that the contractor’s claims are ‘made in good faith.’ See 41 U.S.C. § 605(c)(1). ‘The supporting data must be accurate and complete to the best of [the official’s] knowledge and belief, [and] the amount requested [must] accurately reflect[] the contract adjustment for which the contractor believes the government is liable. . . .’ Id.

Congress provided that claims against the United States must be certified by an authorized corporate official, to ‘discourag[e] the submission of unwarranted contractor claims.’ … Plaintiff’s Project Manager, Mr. Kim, certified Daewoo’s claim. He testified repeatedly that the claim totaled $64 million. He expected the Government to pay the entire amount. …

Daewoo’s experts could have performed an important service by checking plaintiff’s books and records concerning operating costs and acquisition costs of equipment. They could have found the duplicated and scrapped equipment in the claim …. See United States v. TDC Mgmt Corp., 24 F.3d at 292, 298 (D.C. Cir. 1994) (‘[E]very party filing a claim before the contracting officer and this court has a duty to examine its records to determine what amounts the Government already has paid or whether payments are actually owed to subcontractors or vendors. . . . [A] failure to make a minimal examination of records constitutes deliberate ignorance or reckless disregard, and a contractor that deliberately ignored false information submitted as part of a claim is liable under the False Claims Act.’).

The Government filed counterclaims pursuant to the False Claims Act, the Special Plea in Fraud, and the Contract Disputes Act. Defendant also claimed fraud in the inducement, or ‘bait and switch,’ an unusual counterclaim in this context.

According to the Judge in the Daewoo case, the Government’s “special plea in fraud” defense is summarized by this quote from the United States Code:

A claim against the United States shall be forfeited to the United States by any person who corruptly practices or attempts to practice any fraud against the United States in the proof, statement, establishment, or allowance thereof.

As the Judge found—

The forfeiture counterclaim carries no monetary penalties other than the forfeiture itself. We found no liability against the Government on plaintiff’s claim, so Daewoo has nothing to forfeit. Defendant made the necessary showings of intent and otherwise met the elements and the burden called for by this section, however. For example, defendant showed by clear and convincing evidence that the contractor knowingly presented a false claim with the intention of being paid for it. Once these standards and burdens are established, this court must forfeit plaintiff’s entire claim. ‘In such cases, the United States Court of Federal Claims shall specifically find such fraud or attempt and render judgment of forfeiture.’ 28 U.S.C. § 2514 (emphasis added).

Thus, regardless of the merits of Daewoo’s claim against the Government, its claim was forfeit and it received nothing as a matter of law.

If the foregoing wasn’t a sufficient penalty, the Judge also invoked the fraud provisions of the Contract Disputes Act. (41 U.S.C. § 604.) He quoted the statute as follows—

If a contractor is unable to support any part of his claim and it is determined that such inability is attributable to misrepresentation of fact or fraud on the part of the contractor, he shall be liable to the Government for an amount equal to such unsupported part of the claim in addition to all costs to the Government attributable to the cost of reviewing said part of his claim.

As you may well suspect by this point in the story, the Judge found that Daewoo had violated the fraud provisions of the CDA. He wrote—

The Government proved by any standard that Daewoo’s $64 million claim was fraudulent. Plaintiff made the claim for purposes other than a good faith belief that the Government owed Daewoo that amount. Plaintiff in fact did not believe that the Government owed it $64 million as a matter of right. … Daewoo submitted a certified claim as a negotiating ploy; that is, for a reason other than an attempt to recover money for which Daewoo believed the Government is liable. … Daewoo’s entire $64 million claim was an attempt to defraud the United States.

So let’s recap Daewoo’s situation at this point. It had filed a $64 million claim against the U.S. Government which had been forfeited by the special plea in fraud. In addition, the company was looking at roughly $50 million in civil penalties related to its filing of a fraudulent claim under the CDA. But that’s not all. There was still more to come for this inept contractor.

In addition to its other arguments, the Government alleged that Daewoo also violated the False Claims Act by submitting its fraudulent claim. As the Judge explained—

Daewoo presented a false claim for payment and knowingly used false records or statements to support the claim. The penalty is $10,000 plus three times the amount of damages. 31 U.S.C. § 3729(a)(3). ‘Claim’ is defined broadly by the statute to include ‘any request or demand . . . for money or property’ from the Government. See § 3729(c). …

The certified claim itself was false or fraudulent and plaintiff knew that it was false or fraudulent. Whether the United States suffered damages as a result, however, is a matter that we could not establish.

Because the Court couldn’t determine any damages actually suffered by the Government, it could only assess a simple $10,000 penalty. Had damages been able to have been assessed, the Judge opined that Daewoo might have been liable for an additional $7.6 million. He concluded his decision as follows—

Daewoo violated the False Claims Act by knowingly submitting false or fraudulent claims; it violated the Contract Disputes Act through its submission of false or fraudulent claims with an intent to deceive or mislead the government; and it attempted to practice fraud against the United States ‘in the proof, statement, establishment, or allowance’ of its claims. … These findings are supported by testimony of plaintiff’s witnesses and other evidence produced by plaintiff and defendant. Plaintiff’s claim to the contracting officer and its complaint in this court sought a ‘total monetary damage claim’ of $64 million, an amount that Daewoo’s own witnesses, experts, and attorneys abandoned before the trial was over. …

Daewoo obtained this contract under false pretenses, though we have not attempted to assign damages to the Government’s claim of fraud in the inducement. It submitted false records and made false statements in preparing, certifying, and pursuing its claim and subsequent “updates.” Defendant lists a number of instances in which plaintiff made false statements to the Government to further its ambitions or to obtain money or property ultimately. …

We enter judgment for defendant on its counterclaims pursuant to the Contract Disputes Act, the Special Plea in Fraud, and the False Claims Act as follows:

Contract Disputes Act – $50,629,855.88.
False Claims Act – $10,000.
Special Plea in Fraud – No monetary judgement.

Daewoo appealed the decision. It did not fare well in the appellate decision either. We quote some of the interesting bits below.

The Court of Federal Claims did not find that Daewoo’s theories of the government’s breach of the contract—based on alleged defective specifications, failure to disclose superior knowledge, and impossibility—were fraudulent (though it ultimately found these theories to be without merit). Rather, the Court of Federal Claims found that Daewoo’s $50.6 million projected cost calculation was fraudulent. That calculation assumed that the government was responsible for each day of additional performance beyond the original 1080-day contract period, without even considering whether there was any contractor-caused delay or delay for which the government was not responsible. The calculation then simply assumed that Daewoo’s current daily expenditures represented costs for which the government was responsible.6 Daewoo apparently used no outside experts to make its certified claim calculation, and at trial made no real effort to justify the accuracy of the claim for future costs or even to explain how it was prepared. … Indeed, Daewoo’s damages experts at trial treated the certified claim computation as essentially worthless, did not utilize it, and did not even bother to understand it. … The Court of Federal Claims pointed out that Daewoo’s claim preparation witnesses inconsistently referred to and interchanged actual, future, estimated, calculated and planned costs. … The court found that J.W. Kim, who certified the claim, gave false testimony. … The court also found that the testimony of Daewoo’s witness Mr. Richardson regarding the calculation of Daewoo’s certified claim ‘left no doubt that [Daewoo’s] case was unsupportable and was pursued by Daewoo with fraudulent intent.’ …

Daewoo appears to argue that a claim can be fraudulent only if it rests upon false facts rather than on a baseless calculation. We disagree. Here Daewoo certified, as required by 41 U.S.C. § 605(c)(1), that ‘the claim is made in good faith; that the supporting data are accurate and complete to the best of my knowledge and belief; that the amount requested accurately reflects the contract adjustment for which the Contractor believes the Government is liable.’ … By certifying a claim for damages in the amount of $64 million, Daewoo represented that the claim was made ‘in good faith.’ It is well established that a baseless certified claim is a fraudulent claim.

Going a bit into the Government’s special plea in fraud defense, the Appellate Court wrote—

Unlike the antifraud provision of the Contract Disputes Act, 41 U.S.C. § 604, under which a contractor may incur liability only for the unsupported part of a claim, forfeiture under 28 U.S.C. § 2514 requires only part of the claim to be fraudulent. For instance, in Young-Montenay, Inc. v. United States, we held that because a contractor had submitted a claim to the government for $153,000 when the contractor knew the government was liable only for $104,000, such a knowingly false claim forfeited the contractor’s later damages claim against the government under the contract. 15 F.3d 1040, 1042-43 (Fed. Cir. 1994).

Needless to say, the original Court of Federal Claims decision was affirmed.

Think this was a long article? It was just prelude. In the next installment, we will discuss a recent Court of Federal Claims decision in which the Government’s special plea in fraud defense was rebuffed by the Judge.


 

Cost Problems Already for Boeing’s KC-46 Tanker

Nick Sanders
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When last we checked-in, Russia had submitted a late proposal, leaving the U.S. Air Force with a clear choice between EADS/Airbus and Boeing. Then there was that little procurement integrity kerfuffle, when the Air Force sent sensitive ratings to the wrong bidders. But everybody got through that and by now it should be old news that Boeing won, beating out EADS.

At the time, the Washington Post (link above) reported—

‘… in the end, Boeing won on price,’ said Loren B. Thompson, a defense policy analyst for the Arlington-based Lexington Institute. ‘Price consists of the cost of producing the plane, plus the cost of operating it over 30 years. The Airbus plane is so much bigger and burned over a ton more fuel per flight hour. Multiply that by 179 planes, times 30 years of service life and it becomes very big.’

 

‘These are fixed-price contracts,’ [U.S. Air Force Secretary] Donley said. The decision ‘reflects our efforts to deliver better value to the warfighter . . . in a budget process that we realize is not going to give us more money every year.’

And that seemed to be the end of that. Boeing won on price and was awarded a $35 billion fixed-price-incentive-fee (FPIF) contract for a boatload of aerial tankers. Moreover, according to this Bloomberg report, USAF Secretary Donley promised that, “The U.S. Air Force won’t allow changes to Boeing Co.’s air refueling tanker contract of more than $30 billion without ‘high-level’ review from Pentagon leadership.” The Bloomberg article reported—

Donley said today that he is drafting a memorandum that will spell out Pentagon leaders’ involvement in reviewing any changes to the contract. He also said the Air Force has discussed the issue with Boeing.

Altering the program may increase manufacturing costs, so Boeing has ‘the same interest’ as the Air Force in avoiding changes, Donley told reporters at a roundtable in Washington.

Boeing agreed to perform in accordance with its winning bid. Bloomberg reported—

‘Our commitment is to perform to schedule and on cost and that is what we intend to do,’ William Barksdale, a spokesman for Boeing’s tanker program, said in an e-mailed statement.

Issues are sure to arise, he said, ‘and as they arise, we will work closely with the Air Force to resolve them. We expect minimal contract change activity on this program.’

It looked to all observers that the relationship between Boeing and the USAF was on to a great start.

Hold on. Not so fast there, folks.

In late June, 2011, reports began to emerge that Boeing may have “bought-in” to the competition, intentionally submitting a price that it knew to be lower than its projected costs. Which is perfectly legal and fine—so long as the bidder stays “bought-in” to its prices. DODBuzz (link above) reported, “Boeing believes it could encounter as much as a $300 million cost overrun on its KC-46A tankers, but everyone involved — the company and the Air Force — understand the company will bear that and any other extra costs.”

In mid-July, 2011, articles such as this one reported that, “Boeing has bumped up costs for its $4.4 billion Air Force tanker deal up to the ceiling price of $4.9 billion. The company has to fund 40 percent of the increased costs, and be responsible for 100 percent of any further expenses.”

Another article reported—

Boeing Co's winning bid for the U.S. Air Force's fiercely contested tanker development deal means it likely will show no profit in the program's first phase and shift $600 million in development costs to taxpayers, new government figures showed.

Boeing could be on the hook for $700 million in development costs of its own, according to a compilation of figures provided by the government and a congressional source.

Boeing's below-cost bid for the contract was part of a carefully crafted strategy to deny the deal to Europe's EADS, parent of rival commercial jet builder Airbus SA. …

The Air Force, in a written reply to queries from Reuters, said on Monday that Boeing's target cost had been $3.9 billion to develop the aerial-refueling plane … ‘For every dollar the program costs above target cost of $3.9B, the government pays $0.60 and the contractor pays $0.40, until the total amount paid to Boeing reaches $4.9 billion,’ at which point Boeing assumes all further costs, the service said. Under this formula, taxpayers would pick up $600 million up to the $4.9 billion ceiling. Boeing would cover the other $400 million plus any ceiling overrun. …

Boeing told the Air Force on April 25 that it projected that it would spend more than the ceiling price for the development phase of the contract, Miller said. The ceiling is set at 125 percent of the target cost. Boeing's potential profit under the deal likewise was built in and would have totaled 12.5 percent, or about $500 million, if the target were hit. The company would break even if the development phase is completed at the ceiling.

The Air Force said it was neither improper nor uncommon for a company to bid a development price that is below actual cost in a competition.

The Air Force and Department of Defense ‘will now tightly control’ the program's execution to make sure Boeing delivers on its promises within negotiated cost, schedule and performance baselines, said Miller, the Air Force spokesman.

Yeah, about that “tight control” which is what the Air Force promised Congress and the taxpayers back in April and now promises Congress and the taxpayers yet again, three months later….

Senator McCain thinks the current situation is “completely unacceptable,” according to this report. The Arizona Senator sent Dr. Ashton Carter, Under Secretary of Defense (A,T&L), a letter in which he also stated, “This is gravely wrong and creates an incentive, particularly on very large programs, for contractors to low-ball a contract knowing that the taxpayers will subsidize at least some of the overruns that will be needed to actually complete the work.”

The article reported—

McCain wrote … ‘I can assure you that Congress and taxpayers will find a $600 million subsidy of a low-ball bid by Boeing is something they feel they should not have to pay. Boeing fully understood that up to 60 percent of any cost overrun up to $1 billion over the target cost’ of $3.9 billion ‘would be borne by the taxpayer. On a program that you found to be low-to-moderate risk, the extent of exposure to the taxpayer here appears excessive.’

Dr. Carter, for his part, dismissed concerns about unacceptable cost growth on the nascent aircraft program. According to this Reuters report—

The Pentagon's top weapons buyer dismissed concerns on Friday that Boeing is projecting huge cost overruns in developing a new Air Force refueling tanker, saying it was a fixed-price contract and company losses were ‘not our problem.’

Defense Undersecretary Ashton Carter said Boeing had made a commercial decision to offer a below-cost bid for development of the aircraft in hopes of making up its losses during production of 179 of the aircraft through the 2020s. …

Carter, answering questions about defense procurement at the Brookings Institution think tank on Friday, dismissed reports of Boeing's cost overruns, saying, ‘It's not our problem because it's a fixed-price contract and it was written with ... protections for the taxpayers.’

He said the issue was the value of the contract at its ceiling price.

‘The fact that Boeing decided that it would lose money in the development phase, presumably in the hopes of making money in the production phase, was a decision that they made, and that's not a problem from the Defense Department's point of view,’ Carter added.

Well, we readers know that, in fact, Boeing did not sign a firm, fixed-price contract, as Dr. Carter stated. A FPIP contract is significantly different from a FFP contract, and we would expect Dr. Carter to understand that difference—given his position in DOD’s procurement policy-making hierarchy.

The thing is—and there’s really no way to get away from it—is that Boeing has taken just about everything (monetarily speaking) from the Air Force that it can and, absent requirements changes, is stuck at the FPIF ceiling and now has to perform to that amount. In essence, the company has announced that it’s going to overrun the development phase and will hope to make up the loss during production. Whether or not the Pentagon will permit Boeing to “get well” on the prices of production aircraft remains to be seen.


What is clear, however, is that the company is now (along with Lockheed Martin’s JSF program) now centered in the cross-hairs of Congressional critics and taxpayer advocates. Boeing’s credibility has been undercut and the only way out is to perform on schedule, on budget, and meet technical specifications. We can’t see much incentive for the Air Force to let Boeing slide any further ….


 

Former U.S. Army Sergeant Pleads Guilty to Theft of Equipment in Iraq

Nick Sanders
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On June 28, 2011, the U.S. Department of Justice announced that Robert A. Nelson, age 46, of San Antonio, Texas, had pleaded guilty “to conspiring to steal U.S. Army equipment related to his work as a non-commissioned officer helping to train Iraqi army personnel in Mosul, Iraq, in 2008.” According to the DOJ, Nelson pled to one count of “conspiracy to steal public property”. The DOJ reported that—

Nelson was deployed to Forward Operating Base Diamondback, Iraq, as the non-commissioned officer-in-charge of the Ninewa Operations Command Military Transition Team. This transition team helped train the Iraqi Army units stationed nearby.

While serving in Iraq, Nelson agreed with a U.S. Army translator to steal eight generators from a lot on base that held various pieces of used equipment. Once the generators were taken off the base, the translator arranged for them to be sold on the black market in Iraq. Nelson admitted that he received half of the proceeds of the sales of stolen equipment, with approximately $35,000 of the money being wired to Nelson’s account by the translator’s brother. In total, Nelson admitted receiving approximately $44,830 from this scheme.

One thing we noticed in the foregoing is that this case continues the apparent trend of cutting military folks a break. From the DOJ report, it seems pretty clear that Nelson did quite a bit more than “conspire to steal public property.” In fact, he did participate in the actual theft of military equipment from an Army F.O.B. Regardless, he was allowed to plead to what seems to be a lesser offense.

We first noticed—and complained about—this sort of prosecutorial beneficence in this article about “Captain Mike”—who was convicted of “theft of government property” for stealing nearly $700,000 in “uncirculated bundles of $100 bills”. In contrast, we offer this tale of Kellogg, Brown & Root (KBR) who was sued under the False Claims Act “because it was unable to account for materials paid for” under a subcontract with a Turkish company named Yuksel-Reysas. It seems to us like too many (former) military service people are allowed to plead to lesser charges while contractors get the book thrown at them. But perhaps that’s just our bias showing ….

Former Army Sergeant Nelson faces up to five years in prison plus a fine of up to $250,000. In addition (DOJ reported), Nelson agreed to pay the U.S. Government $44,830—the amount of his unlawful gain.

Finally, DOJ reported that, “The investigation into this conspiracy continues.” So stay tuned for future related news stories

 

DCAA Questions Northrop Grumman’s Math

Nick Sanders
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A full year ago, in July 2010, we reported that Northrop Grumman had issued a press release in which in announced that it planned to “winddown” shipbuilding at its Avondale, Louisiana shipyard, close two other Louisiana shipyards, and “consolidate” shipbuilding operations between its Louisiana and Mississippi shipyards. We reported Northrop Grumman’s statement that—

The consolidation will reduce future costs, increase efficiency, and address shipbuilding overcapacity. … The company also anticipates that it will incur substantial restructuring and facilities shutdown-related costs including, but not limited to, severance, relocation expense, and asset write-downs. These costs are expected to be allowable expenses under government accounting standards and recoverable in future years under the company's contracts. The company estimates that these restructuring costs will be more than offset by future savings expected to be generated by the consolidation.

At the time, we openly questioned whether the Pentagon would go along with NGC’s plan to pass back its restructuring costs as “allowable expenses”.

A few months later, we noted that NGC had dropped its plans to sell the shipbuilding business, and would instead “spin-off” its maritime business into a new company with separate management. Indeed, that’s what happened and Huntington Ingalls Industries, Inc.—located in Newport News, Virginia—was born.

Recently, Bloomberg reported that DCAA was having trouble buying NGC’s math.

It reported that—

The Pentagon’s audit agency has concluded it can’t verify Northrop Grumman Corp. (NOC)’s assertion that divesting its shipbuilding business and shutting one of its three yards will save the U.S. as much as $600 million.


The Defense Contract Audit Agency in a Feb. 1 audit also concluded that Northrop’s claim for $310 million in federal reimbursement to close the Avondale, Louisiana shipyard is ‘unsupported,’ according to a summary.

In what summary did the Bloomberg journalists find this fascinating tidbit of information? According to the article, it was located in an Appendix of the DOD Inspector General’s recently published Semi-Annual Report to Congress. With that hint, we headed over to Appendix G of the SAR and found a brief recap of DCAA Audit Report No. 01751-2010G17900010, in which the DOD IG reported, “The audit of the contractor’s internal restructuring proposal resulted in $23.5 million of questioned costs relating to proposed labor, severance pay, incentive bonuses, and relocation expenses. Another $284.5 million of proposed costs and the entire $600 million proposed gross savings are considered unsupported.”

Bloomberg followed-up with the U.S. Navy and reported—

‘Ninety-two percent of the claimed shutdown costs were unsupported because the contractor could not provide sufficient evidence of its underlying assumptions,’ said Navy Commander Kathleen Kesler, an agency spokeswoman, in an e-mail. ‘Because these assumptions are integral to the savings computations, the resulting savings calculation could not be adequately evaluated.’ … Huntington and the Navy have not reached agreement on the ‘allowability of proposed restructure costs,’ Navy spokeswoman Captain Catherine Mueller said in an e-mail.

Readers may remember that, in the early 1990’s (during Clinton-era defense industry consolidation), the Pentagon announced that it would pay for “restructuring costs” in order to encourage contractors (notably Lockheed and Martin Marietta) to merge with each other. In order to make the otherwise unallowable restructuring costs allowable, a DOD Contracting Officer had to determine that the business combination would result in overall reduced cost to DOD—or that the combination would preserve a critical defense capability.

In 1994, Congress passed a law that required additional hurdles to be jumped in order to make contractor restructuring costs allowable. These Congressionally mandated hurdles included:

  • The projections of restructuring savings had to be based on “audited cost data”.

  • A senior DOD official had to certify that the projected savings would result in overall reduced costs to DOD.

More hurdles were added by Congress in 1996, including requiring that projected savings had to be at least twice the amount of allowed restructuring costs (unless a critical defense capability was being persevered, in which case savings simply had to exceed costs). All the foregoing requirements were made permanent in 1997.

GAO has issued several audit reports related to claimed DOD savings from contractor combinations. However, its results have not been as quantitatively precise as it would have liked. In one report, GAO stated—

Determining the precise impact of restructuring on specific contract prices requires isolating the impact of these activities from nonrestructuring-related factors, such as changes in business volume, quantities purchased, and accounting practices. DOD, selected business segments, and we were generally not able to isolate the effects of restructuring from those of other factors.

Moreover, GAO noted that, “The regulations do not require contractors to propose or demonstrate savings on individual contracts or use any particular method or approach in estimating restructuring savings.” Because of the varied approaches in estimating restructuring savings taken by the contractors it reviewed, GAO recommended that DCAA tighten its audit guidance related to contractor proposals. GAO reported that DOD nonconcurred with that recommendation.

Quite obviously, we have not seen the NGC proposal(s) related to its business restructuring. That said, we have little doubt that such a murky area as projecting shutdown costs and future contract savings would fare poorly in a DCAA audit that was conducted in the current—shall we say?—difficult environment. We expect that it would be difficult for NGC to submit an “adequate” proposal, and we expect that it would be difficult for DCAA to reach a GAGAS-compliant conclusion regardless of how NGC supported its costs.

Normally, we would expect DCMA to move ahead in negotiating with NGC even with an adverse DCAA audit report—and, apparently, NGC expected the same thing. The Bloomberg article reported—

‘We are working with the Navy and DCAA on the specifics of the restructuring proposal,’ William Glenn, a spokesman for Huntington, said in an e-mail. ‘The cost estimates submitted as well as the savings projections will be further supported through the negotiation process.’

 

The Navy’s Mueller and Huntington’s Glenn said the company is following Pentagon’s acquisition rules in applying for reimbursement of the shutdown costs.

Unfortunately for DCMA, Huntington Ingalls, and NGC, Congress mandated that the costs have to be audited by DCAA. That requirement is going to throw a monkey-wrench into the works—or so it seems to us.


 

Armor Group Dodges Brothel Bullet, Agrees to Quick FCA Settlement

Nick Sanders
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Brothel

We have had concerns with the FAR contract clause 52.222-50 since its initial promulgation. The clause prohibits trafficking in persons—i.e., it prohibits contractors from using, benefitting from, or participating in the use of slave labor. Period. Which is fine, if that’s all the clause did.

But the clause also prohibits “the procurement of commercial sex acts”.  Further, it defines “commercial sex acts” as “any sex act on account of which anything of value is given or received by any person”. Let’s note that such activities are legal and regulated by the Government in many places, including parts of Nevada as well as parts of Europe.  But you can’t engage in such lawful activities when you are performing on a contract that contains the clause. Moreover, the definition is so loose that simply taking your date out for a dinner might well be construed to be giving or receiving a thing of value.  If one “gets lucky” one might be violating the contract prohibition.

The clause carries with it its own remedies for noncompliance. Those remedies include:

  • Requiring the contractor to remove a contractor employee or employees from the performance of a contract.

  • Requiring the contractor to terminate a subcontract.

  • Suspension of contract payments.

  • Loss of award fee.

  • Termination of the contract for default or cause.

  • Suspension or debarment of the contractor.

Recently, a contractor performing work in Afghanistan ran afoul of this issue. Armor Group North America (AGNA) found itself the defendant in a False Claim Action filed by a qui tam relator (whistleblower) named James Gordon, who was a former employee of AGNA who claimed that he had been retaliated against for bringing concerns about wrongdoing and ethical breaches to the attention of his management. According to this internet report, Mr. Gordon alleged the following—

  • AGNA did not properly staff the Kabul embassy in order to provide the level of security outlined in the company’s contract with the Department of State.

  • AGNA employees were allowed to visit local brothels that were well-known for using trafficked women as employees, in violation of the Trafficking Victims Protection Act.

  • AGNA cut costs by substituting refurbished Iraqi vehicles in place of armored vehicles for transporting goods to and from the Kabul Embassy.

AGNA settled the FCA suit for $7.5 million. According to this Department of Justice press release—

The settlement resolves U.S. claims that in 2007 and 2008, AGNA guards violated the Trafficking Victims Protection Act (TVPA) by visiting brothels in Kabul, and that AGNA’s management knew about the guards’ activities. The settlement also resolves allegations that AGNA misrepresented the prior work experience of 38 third country national guards it had hired to guard the Embassy, and that AGNA failed to comply with certain Foreign Ownership, Control and Influence mitigation requirements on the embassy contract, and on a separate contract to provide guard services at a Naval Support Facility in Bahrain.

Previously, we have gone on record warning contractors performing international work—especially work in Southwest Asia—regarding the FAR “morals clause” that has been included in many of their contracts. The remedies available to the Government are both severe and wide-ranging. In our view, AGNA “dodged a bullet” by agreeing to a quick settlement with the DOJ. Not only did the company avoid much more severe consequences, but it also removed this salacious story from the insatiable modern news cycle.

Contractors performing international work need to guard against their employees violating the prohibitions of 52.222-50. Contractors need to listen to allegations of wrongdoing and be prepared to show Government investigators that they took those allegations seriously. Although $7.5 million may not seem like a lot of money, we’re sure of at least two things: (1) the company paid more than that amount when attorney fees are included, and (2) that amount could have paid for quite a bit of self-governance processes.

If your company performs international work, you may want to ask yourself how prepared you are to survive similar charges of wrongdoing.

According to the DOJ, Mr. Gordon will receive $1.35 million as his share of the settlement. There was no report as to how much of that amount his attorneys will receive.


 
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Newsflash

Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.