Presidential Executive Order on Contractor Salaries

By now most of you, even if you didn't watch the President's State of the Union address, know that the President plans, through Executive Order, to set the minimum wage on Government contracts to $10.10 per hour. This will apply prospectively to new contracts - existing contracts are unaffected. No one really knows how many workers will be impacted. A couple of accounts have set this number at about 500,000. But there are already rumors that there will be exceptions and waivers granted under the Executive Order so that number could be significantly lower.

It's always interesting to find out PSC's (Professional Services Council) take on these kinds of issues. In this case, PSC expressed concerns about the implications of its impact. PSC denied any implication that federal contractors are paying substandard wages. "The requirements of the federal prevailing wage laws and the government's central role in determining the definition of a fair and reasonable wage are clear and long-standing. Moreover, there is a natural concern that, amid a national debate over the minimum wage, government contractors are being uniquely singled out."

There could be a lot of implications to this new minimum wage for Government contracts.

1. What about contractor employees who spend part of their time on Government contracts and part on commercial contracts? Will contractors need to bifurcate their workforce? Will employees have different wage rates depending upon where they work?
2. Consider the HR (Human Relations) impact. Who decides which employees get to work on the Federal contract and who gets stuck on the lower paid commercial work?
3. Commercial contractors seeking to compete with Government contractors for the same skills, could find themselves either scraping the bottom of the labor pool barrel, or have to raise employee wages to compete. Thus, in some markets, the entire wage structure could be impacted by this one Executive Order.
4. Will contractors cut other benefits in order to meet the new minimum wage? It would be a simple matter to cut medical/dental benefits, contributions to 401K plans, cafeteria plans, or incentive compensation so that the bottom line is unaffected. How does anyone benefit if wages are raised but benefits are cut?

Hold on, this is going to be a wild ride.

GAO To Start Charging Filing Fees for Bid Protests

Tucked within the omnibus budget bill signed by the President earlier this month was a provision authorizing the GAO to begin charging a filing fee for companies filing bid protests. This filing fee is to pay for a new online docketing system as well as the cost of operating the new system. The new system will replace the manual process now in place for reviewing thousands of protest-related e-mails.

Although the legislation does not specify the amount of the filing fee, the GAO's managing associate general counsel for procurement law estimated that the fee will be in the neighborhood of $250 but warned that the figure might change depending upon the price of the system and the features that GAO ultimately adds to the system.  A couple of years ago, the GAO, based on market research, estimated an electronic system would cost about $450 thousand per year to operate and a $250 filing fee would cover that cost. The math doesn't work however. $450 thousand divided by 2,500 cases works out to $180 per case. Perhaps the GAO is expecting that with the filing fee, the number of cases filed will drop.

This new filing fee is not likely to deter companies from filing bid protests. In the scheme of things, especially when one considers the cost of attorney fees, this fee is not significant. It might deter those companies who know their chances of prevailing are slim but choose to protest anyway on the off-chance that things will go their way.
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In a related matter, the GAO announced that it has cleared its backlog of bid protests caused by last Fall's Government shutdown. That furlough, affecting the majority of GAO's staff, caused the Agency to miss its 100 day deadline for deciding protests.

DoD Proposal Adequacy Checklist - New Revision

Last October, we reviewed the newly issued DoD Proposal Adequacy Checklist in some detail along. There was a lot of confusion on one question in particular, Question No. 19. You can read all about it by following this link.

The DoD has changed its mind concerning Question No. 19 and has now deleted it through a Federal Register Notice posted today.

Question No. 19 required price analysis for all commercial items offered that are not available to the general public. After further research, DoD determined that Item No. 19 is duplicative in nature. DoD concluded that items proposed with a commercial basis under subcontracts in the proposal require price analysis by the offeror. Furthermore, DoD also concluded that questions 14 and 17 currently address the requirement for price analysis of the proposed commercial item that is produced or performed by others.

Its going to take awhile before the revised checklists (i.e. checklists with Question No. 19 deleted) become readily available. Contractors and prospective contractors can expect to see old versions sent out with solicitations and through other means. That is unfortunate because companies might spend a lot of unnecessary time trying to understand exactly what the now-deleted Question No. 19 really requires and whether it is applicable to them.

The online versions of the checklist have not yet been updated, even though this changed is effective immediately.

Small Business Ombudsman

The Department of Defense (DoD) Office of Small Business Programs (OSBP) recently announced the appointment of small business ombudsmen in the Defense Contract Management Agency (DCMA) and the Defense Contract Audit Agency (DCAA).

According to the plan, these DCAA and DCMA Agency Small Business focal points, will

• advise their respective Directors on policy issues related to small business concerns, and
• serve as the agencies' primary point of contract and source of information.

The DCAA small business ombudsman has also been tasked to collect and monitor relevant data regarding the defense audit agency's conduct of audits. We don't know from where the ombudsman will collect this data - perhaps from angry callers.

DCAA has to be real careful with this position so as not to impact the independence of the auditor. To this end, the duties of the ombudsman well be segregated from ongoing audits in the field. The ombudsman will not be allowed to engage in any activities with regard to particular audits that could compromise the independence of the Agency or undermine compliance with applicable audit standards. So, if you're a small business and have complaints about an on-going audit, don't complain to the ombudsman, you will not get any sympathy. And that makes us wonder whether the ombudsman is a true ombudsman or just another flack compiling data.

We'll just have to wait and see how this program works out and whether there's any tangible benefits to the small business. You can reach the DCAA small business ombudsman at 937-255-7789 (curiously, an Ohio area code).

The DCMA small business ombudsman will not have the same constraints as DCAA however the tasking given it by DoD's Office of Small Business Programs does not sound like it will be someone who investigates small businesses' complaints against the government or its functionaries. According to DoD OSBP, the ombudsman will be evaluating and analyzing how well prime contractors ensure small businesses receive maximum practicable opportunity" to participate in prime contractors' subcontractors. DCMA already does this to a certain extent by monitoring prime contractor progress in meeting small business subcontracting goals so we're not sure what this adds to the program. Whatever is going on there, DCMA has not made a contract phone number public like DCAA has.

The DoD OSBP Director stated, "These appointments are another example of DoD working to reduce barriers for small businesses and will strengthen the partnership between DCAA, DCMA and industry." Pardon our skepticism but its going to take more than a press release to convince us that anything is operating differently.

Annual Ethics Training

Government contractors with a contract greater than $5 million and lasting more than four months are required to have a Business Ethics and Compliance program. One of the key features of most, if not all ethics programs is a need and requirement to provide periodic ethics training to employees. This is a reminder to those companies that have allowed their training efforts to languish to dust it off and get back on the program.

We've seen many cases over the years where contractors have spent a lot of time, money, and effort to develop robust ethics programs, only to allow the training aspect of their ethics programs to lapse. After a few years, the excitement wears off (right, ethics training is exciting?), the emphasis wains and other priorities take over. What was once a vibrant ethics program becomes just another policy and procedure manual that no one ever reads. If the contractor is lucky, someone within the company will be able to dredge up a copy if an auditor happens to ask for it.

And, invariably, an auditor will come looking for it. Auditors use the information to perform risk assessments. A viable ethics program will allow, in theory, auditors to reduce the amount of transaction testing necessary to formulate an opinion on whatever it is they're auditing. This is good for the contractor and good for the auditor. But woe to the company that has a training program as part of its ethics program but does not fullfull it. Its almost worse to have an ethics program and not follow it to not having one at all. Its a slam-dunk finding for an auditor to report failure to follow existing policies and procedures.

The Department of Defense requires annual ethics training for members of its acquisition workforce. To them, ethical values-based decision making is the foundation for successfully supporting the Department and protecting the taxpayer. Annual training provides awareness of ethical obligations and responsibilities. Training is not going to guarantee that nothing will go awry. Peruse (or subscribe) to the Department of Justice press releases and you'll find some kind of procurement fraud every week, sometimes more frequently. But, the hope is that by providing training, everyone's awareness is raised and contractors can minimize the risk to themselves.

Evaluation of Final Vouchers

Once upon a time, DCAA (Defense Contract Audit Agency) performed audits, or least they called them audits, of final vouchers. Final vouchers are those documents submitted by contractors after contract completion and after the pertinent annual incurred cost audits have been completed. 

Back in 2009, the DoD Inspector General came along and decided that the procedures that DCAA was applying to reviews of final vouchers did not rise to the level of an "audit". Most notably, DCAA rarely tested any transactions during these reviews. Most of the activity involved reconciling the final voucher to incurred cost claims.

DCAA agreed and changed the name of the activity from Contract Audit Closing Statements (CACS) - whose name implied that an audit was performed, to "Evaluation of Final Voucher". Gone now is the wording found in the CACS that an audit was performed in accordance with Generally Accepted Government Auditing Standards (GAGAS). In its place, the scope more generally describes the tasks and comparisons performed.  

Those detailed steps, now called "non-audit" steps are basically comprised of reconciliations and comparisons. For most types of flexibly priced contracts, these steps include:

1. Reconcile claimed direct costs by year to annual audit files
2. Verify subcontract amounts agree with assist audits
3. Verify that the final rates are those agreed upon
4. Perform a math check
5. Verify period of performance
6. Determine whether fee is calculated correctly
7. Verify that the total amount claimed does not exceed the lesser of the allowable costs or funding limitation.

If your final vouchers reconcile to your annual incurred cost submissions (as negotiated), the final voucher process should flow very smoothly. If they don't reconcile, be prepared to identify the reasons and rational for any differences. You're going to get asked anyway so you might as well be prepared.

When Bidding, Pay Close Attention to All Evaluation Factors

The U.S. Army Corps of Engineers issued a solicitation to renovate a barracks at Fort Benning. The award was to be made on a best-value basis considering the following four factors

1. designer specialized experience
2. contract duration and schedule
3. design and construction teaming approach, and
4. price

Concerning price the solicitation contained a $30 million cap for both design and construction. Offers exceeding the cap were to be ineligible for the award.

For purposes of award, factor 1 was the most important, followed by 3 and then 2. These three factors when combined, were equal in importance to price (factor 4).

Four offers were submitted. A three-member technical evaluation board evaluated the non-price evaluation factors. IAP-Leopardo Construction (IAP) put up a very impressive bid. It scored equal to or higher then the winning bidder on the three non-price evaluation factors. However, IAP was subsequently removed from further consideration because its bid exceeded the $30 million cap. IAP appealed to the Comptroller General's office.

IAP claimed that discussions with the Corps on non-price evaluation factors obligated the agency to inform IAP that its proposal was ineligible for award because its price exceeded the cost limitation. Specifically, IAP claimed the Corps engaged in inadequate discussions.

The Comptroller disagreed and denied the protest. Whatever discussions ensued, were not significant enough so as to require IAP to modify its proposal nor was the agency obligated to inform or remind IAP that its proposal exceeded the cap.

You can read the entire case here.

Cost/Price Might Become the Most Important Evaluation Factor

Representative Grayson (Florida) introduced legislation earlier this month that, if passed, would reduce the flexibility that Government procurement authorities have in structuring the importance of evaluation criteria for awarding competitive proposals. This legislation, by the way, would only affect DoD contracts.

This proposed legislation would make cost or price to the Government the most significant evaluation factor in evaluating contractor proposals. No longer would a contracting officer be able to make the combination of all evaluation factors other than cost or price, more significant than cost or price.

The existing regulation reads:

"... shall include cost or price to the Federal Government as an evaluation factor that must be considered in the evaluation of proposals and shall disclose to offerors whether all evaluation factors other than cost or price, when combined are
     significantly more important than cost or price
     approximately equal in importance to cost or price, or
     significantly less important than cost or price."

The proposed regulation would read:

"...shall include cost or price to the Federal government as an evaluation factor that must be considered in the evaluation of proposals and that must be assigned importance at least equal to all evaluation factors other than cost or price when combined."

The proposed legislation also provides for waivers to the rule if the head of the contracting activity wants to grant a waiver and put the justification in writing. Those waivers would also be reported to Congress annually. We wouldn't expect to see much enthusiasm by the contracting community to pursue waivers.

One bill tracking website gives this proposed legislation a two percent chance of becoming law as stand-alone legislation but a much higher chance if tacked on to some other legislation, such as next year's NDAA (National Defense Authorization Act).

"Responsibility" Determinations - Not All Negative Information is Relevant

Prior to awarding contracts, the Government performs responsibility determinations in order to ensure that the winning bidder has integrity, a proven track record, financial footing, and other factors. There are several sources of information available to contracting officers to help in those determinations from the self-certifications made thought the SAM (System for Award Management), to past performance information to excluded party database.

The Government can't know everything and sometimes relevant information slips through the cracks and does not get to the person making the responsibility determination. Sometimes however, this so-called relevant information is not so relevant, as demonstrated in the appeal of RQ Construction of the Navy's award to a competitor.

RQ Construction and Stronghold Engineering, both of California, were competitors bidding on some repair work for the Navy. Stronghold won the bid after which RQ appealed the Navy's responsibility determination on Stronghold. According to RQ, a former employee of Stronghold filed a wrongful termination complaint against the company that was (and still is) working its way through the California Judicial System. RQ contends that if those allegations proved to be true, then Stronghold would not be a "responsible" contractor and therefore should not have been awarded the contract.

According to the record, the Navy was not aware of any court actions or allegations making up the complaint. Even though RQ asserted that it was public knowledge at the time of award, RQ was unable to show any reason why the Navy should have had knowledge of a complaint filed in a California state court
nor show any legal obligation on the contracting officer's part to conduct the type of search that might have produced this information (the Navy is not omniscient). Moreover, the Comptroller General stated that RQ's argument is based upon unproven allegations in a complaint that is the subject of litigation, and not upon facts establishing that Stronghold has been convicted of any federal, state, or local crime, or subject to administrative penalties.

RQ also alleged that Stronghold's failure to inform the Navy of the wrongful termination suit, and the allegations contained therein, is a material misrepresentation. RQ contends that Stronghold was required to inform the Navy of the lawsuit as required by the Code of Business Ethics and Conduct clause (FAR 52.203-13). That particular clause requires contractors to disclose "credible evidence that a principal, employee, agent, or subcontractor has committed violations of federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations, or violations of the False Claims Act.

The Comptroller General rejected this argument. It did not agree with RQ that the unsupported allegations contained in a state civil complaint constitute "credible evidence" of the aforementioned violations

Terminations for Convenience - Settlement Expenses

The Government can terminate a contract at any time. Government contracts contain one of the several "termination" clauses depending upon type of contract. For example fixed price contracts (non-commercial) include FAR 52.249-2, Termination for Convenience of the Government. Contractors have very little recourse when the Government terminates their contract other than ensuring that whatever was spent prior to the termination, is somehow reimbursed. We don't know of any cases where a contractor successfully lobbied a Government agency to withdraw their termination notice.

Once the termination notice is delivered, the contractor is obligated to cease work. Those costs become part of a contractor's settlement proposal. There's a second category of costs - cost continuing after termination. These are costs that can't be avoided such as a cancellation fee on an unexpired lease. Contractors have an affirmative duty to minimize or mitigate these costs. A third category of costs related to terminations are "settlement expenses".

The FAR coverage of settlement expenses is found in FAR 31.205-42(g). That section reads as follows:

1. Settlement expense, including the following, are generally allowable:
    (i) Accounting, legal, clerical, and similar costs reasonably necessary for
        (A) The preparation and presentation, including supporting data, of settlement claims to the contracting officer
        (B) The termination and settlement of subcontracts.
    (ii) Reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract
    (iii) Indirect costs related to salary and wages incurred as settlement expenses , normally limited to payroll taxes, fringe benefits, occupancy costs and immediate supervision costs.

So, settlement expenses are somewhat unique in that contractors are allowed to pull out costs that are normally indirect in nature, and charge them direct to settlement expenses. Contractors however must ensure that these costs are also removed from the indirect expense pool(s) from whence they came.

Also, the labor portion of settlement costs must be burdened with applicable fringe costs. For contractors with fringe rates and perhaps an occupancy pool, this is an easy task. For other contractors, a special analysis is required to calculate and claim applicable fringes.

Many contractors underestimate settlement expenses. At the time of negotiations, there is usually a portion of settlement expenses that are still estimates and these will require a thoughtful projection of how much time it will take to reach a settlement. Other contractors fail to include all settlement costs to which they are entitled. Some forget to add fringe. Some forget to post hours.

One last thing about settlement expenses. These costs are fully reimbursable as direct costs and do not need to be charged to an indirect expense pool and allocated to all the work of the contractor. For this reason, many contractors engage professional help (such as firms like ours) to assist in preparing settlement proposals.

Contractor Admits to Falsifying it Annual Incurred Cost Submission

Well, I guess that it sometimes pays to do an audit. Just when we think that nothing scintillating, or at least interesting, is ever discovered during an incurred cost audit, the Justice Department comes out with a press release proclaiming otherwise.  Vector Planning out of San Diego just plead guilty to criminal charges that it cooked its books and overcharged the Government on some DoD contracts. Vector has to pay about $6.5 million in restitution and gets a deferred prosecution out of the deal. Needless to say, its days as a Government contractor are in jeopardy as well. Accolades to DCAA for uncovering this fraud.

Under cost reimbursement contracts, contractors are allowed to bill for its direct costs and a pro-rata share of indirect expenses. At year end, contractors are required to submit annual incurred cost proposals for audit, review, reconciliation and approval. Contractors certify these costs. In this case, Vector admitted that after claiming and being paid for direct costs in connection with other, firm-fixed-price and time-and-materials contracts, it systematically reclassified the same costs in its accounting system to make it appear as if the costs were indirect costs. This inflated the indirect rates which were, in turn, charged to the Government. This allowed Vector to get paid twice for the same costs; once as direct and again as indirect.

This practice was going on for some time. Vector admitted to the false submissions in 2005 through 2009. When the auditors started their audit in 2011, Vector falsified its electronic accounting entries, and prepared and backdated fake invoices in order to support those falsified accounting entries. Vector blamed it on the dead guy - said that the entire scheme was orchestrated by its former CEO who is now deceased.

Although the fraud tallied $3.6 million, Vector agreed to pay $6.5 million to settle up the civil side of things. Vector also has to set up and maintain an ethics and compliance program. If Vector says clean for three years, the Justice Department will drop its criminal case.

"Purchased Labor" is Not "Consulting Costs"

Yesterday we highlighted new guidance to DCAA auditors that essentially told them to be reasonable and use common sense when evaluating whether professional and consultant services costs are adequately supported (if you missed that blog posting, you can read it here).

There is a related issue in that sometimes, auditors (and contracting officials) use the documentation criteria required in FAR 31.205-33 to evaluate costs that do not meet the definition of "professional and consulting services".

The definition of professional and consultant services, as defined in FAR 31.205-33 means those services rendered by persons who are members of a particular profession or possess a special skill. Examples include those services acquired by contractors (or subcontractors) in order to enhance their legal, economic, financial, or technical positions. Professional and consultant services are generally acquired to obtain information, advice, opinions, alternatives, conclusions, recommendations, training, or direct assistance, such as studies, analyses, evaluations, liaison with Government officials, or other forms of representation.

If the costs being evaluated do not meet this definition, we just quoted out of FAR, they are not "professional and consultant" costs and should not be evaluated using the criteria of FAR 31.205-33.

Here are some examples of costs that are not professional and consulting costs (according to DCAA's newly issued guidance):

1. Temporary accounting services to perform bookkeeping activities.
2. Program management activities for a contract (the individual works directly with contractor employees and contractor management to track and monitor progress on contract performance
3. Outside writers to augment their in-house staff in preparing technical publications.

Each of the foregoing examples represent purchased services or purchased labor. Allowability should be governed by the reasonableness criteria found in FAR 31.201-3, not by the consultant and professional services criteria.

Consultant Costs - Revisited

We have frequently written concerning consultant costs on these pages (see for example this posting from last August). Historically, auditors have loved consulting costs because the language written into FAR 31.205-33 make it easy for them to question costs. That FAR cost principle is one of the few where allowability is predicated upon specific documentation requirements; an agreement, invoices, and work product. Failure to provide any one or more of those, renders the costs unallowable - at least that's the way it typically works. Until, that is, the contracting officer has to make a decision on the contract auditors recommendations. Contracting officers are usually a lot more lenient than auditors as to what level of documentation will satisfy the requirements.

DCAA issued new guidance last month which effectively tells auditors to lighten up a bit. Instead of insisting upon a strict interpretation of "work product" being some formal report that evidences work performed, DCAA is now acknowledging that there are many ways for contractors to satisfy FAR 31.205-33 documentation requirements. DCAA states:

The type of evidence satisfying the documentation requirements will vary significantly based on the type of consulting effort and from contractor to contractor. Therefore, it is important for the audit team to understand that the evidence required from the contractor is essentially the following:

• An agreement that explains what the consultant will be doing for the contractor;
• A copy of the bill for the actual services rendered, including sufficient evidence as to the time expended and nature of the services provided to determine what was done in exchange for the payment requested, and that the terms of the agreement were met. This documentation does not need to be included on the actual invoice and can be supported by other evidence provided by the contractor;
• Explanation of what the consultant accomplished for the fees paid – this could be information on the invoice, a drawing, a power point presentation, or some other evidence of the service provided.
 

DCAA will even accept retroactively prepared evidence:

The contractor may provide evidence created when the contractor incurred the cost as well as evidence from a later period. Audit teams should consider evidence from a later period provided by the contractor, taking care to assess the quality of the evidence (generally, evidence prepared after the fact is less persuasive) and will likely need to obtain additional corroborative evidence. As an example of evidence from a later period, the contractor may facilitate a meeting between the consultant and the audit team to obtain documentation (oral/written) from the consultant regarding what effort they performed (i.e., third party confirmation). The audit team should consider the evidence provided by the consultant, along with other evidence obtained, to determine if the total evidence gathered is sufficient to satisfy the documentation requirements. 

  And consider this statement from the same guidance:

The purpose of the work product requirement is for the contractor to be able to demonstrate what work the consultant actually performed (in contrast to what work is planned to be performed). Although a work product usually satisfies this requirement, other evidence also may suffice. Therefore, if the audit team has sufficient evidence demonstrating the nature and scope of the consultant work actually performed, the contractor has met the FAR 31.205-33(f)(3) requirements even if the actual work product (e.g., an attorney’s advice to the contractor) is not provided. The audit team should not insist on a work product if other evidence provided is sufficient to determine the nature and scope of the actual work performed by the consultant.  

This new guidance should ease the burden of justifying the allowability of consulting costs - it tells auditors to quit being so strident in their interpretations and use some judgment and common sense.

Operations Audits

Back in the 1980s and 1990s, when there were many more major contractors with predominantly cost-reimbursable contracts then there are today, the Government performed a significant number of  "operations" audits. Operations audits, sometimes called functional audits, focus on efficiency, effectiveness, and economy of operations (the three "Es"). Its not such a significant program area these days for a couple of reasons. First, the contract environment has changed over the years. We recall a contractor with $5 billion in annual revenues, 99 percent of which came from cost-type contracts. Under that environment, there was little incentive to be lean and mean and the Government found a lot of low-hanging fruit. Today, its rare to see that kind of contract mix (except for Department of Energy) and contractors have a strong incentive to be as productive as possible. The second reason for operations audits becoming a lesser or lower priority is that rarely would the Government and contractor come to an agreement on how to implement recommendations so little, if anything, ever came of audit recommendations. For example, in one real live case, the auditor noted that the supervisor to worker ratio at a particular contractor was significantly higher than the norm for that industry and size of company. The contractor argued that their higher than average ratio was justified due to quality control, increased oversight, and other unique Government requirements. The poor contracting officer who had to decide who was right, could decide, threw in the towel and nothing ever came of the recommendation. As that happened over and over, the Government began to realize that there wasn't sufficient payback to justify the expenditure of resources. (There is a third reason if you talk to contractors - the operations audit recommendations were often not well developed and failed to take into account some key factors. One recent audit recommended cost savings by retrofitting plant lighting to more energy efficient lighting. Problem was, the contractor had already done that a couple months before the audit report was issued.)

That being said, the Government still dedicates a small amount of audit resources to operations audits. Contractors likely to be considered for operations audits are those where the Government has a significant interest, i.e., a significant amount of cost-reimbursable effort. Audit plans focus on cost areas that have managerial significance and will contribute to a more economical and efficient operation.

Besides saving money as a result of more efficient, effective, and economical operations, another tangible benefit is the prognosis of reduce Government oversight. In theory (in DCAA's theory anyway), oversight agency's can reduce coverage where there is

1. evidence of prudent management policies and decisions
2. an efficient organization reflecting effective management control over operations, and
3. a sound and reliable system of accumulating accounting and financial data

Operations audits can benefit contractors. If the audit findings are well developed, applicable to the situation, cost-effective, and feasible, why not implement them. It would be a "win" for both you and the Government.

Cases Settled Out of Court - How to Support Allowability of Costs

As we reported yesterday, there is a significant risk to settling legal matters before trial in that the legal costs and whatever is paid the plaintiff as settlement costs, may be unallowable. In a 2009 CFC decision, Army v. Tecom, the court set a new standard for allowability - the cost of litigation are allowable only if plaintiff's claims had very little likelihood of success on the merits. Who decides whether the claim has very little likelihood of success? The contracting officer does. And where does the contracting officer get the information necessary to make that decision? From the contractor. And how does the contracting officer convey his decision? In writing. So you see, the contractor has the opportunity to persuade the contracting officer that a plaintiff's case was fallacious, unworthy, without merit, and unlikely to succeed. That is really a tall order as the contracting officer will be naturally skeptical. A lot of contracting officers adhere to that old adage "where's there's smoke, there's fire".

So here's what contractors should do.

1. The contractor must provide a written rationale for asserting that the plaintiff had very little likelihood of success on the merits, including specific supporting information.
2. The rationale should include 
• a description of all claims and procedural actions in the case
• a copy of the Complaint and Answers
• title and docket numbers, 
• any pre- or post-Complaint demand letters from plaintiff's counsel
• the settlement agreement or proposed settlement agreement, and 
• any other information that the contracting officer should consider.

Beyond these items, contractors must be prepared to ensure that it submits, in a timely manner, all information that the Contracting Officer requests.

The Federal Circuit in Tecom was concerned about the government reimbursing contractors for conduct
where there was significant proof of discriminatory conduct; in other words, the court was focused on
the actual, objective conduct of the contractor. Some settlements are appropriate and prudent because,
as a matter of fact, it is unlikely that the plaintiff’s allegations are true but, for reasons other than the
actual, factual merits of the case, there is a risk that a jury might reach a verdict in the plaintiff’s favor.
While exogenous circumstances not related to the actual facts of a claim or the actual conduct of the
contractor may support a decision to settle a claim, such circumstances are not relevant to determining
whether the contractor engaged in discriminatory conduct and should not be considered in the objective
review of the merits of a claim under this guidance.

Legal and Settlement Costs - Cases Settled Out of Court

Government contractors, and all companies for that matter, face the risk of lawsuits filed for discrimination, anything from equal opportunity, equal opportunity for veterans, affirmative action for workers with disabilities, sexual harassment, and the list goes on and on. Contractors will expended usually significant amounts of money defending against these sometimes frivolous lawsuits. Usually they are settled before going to court with the company agreeing to pay a specified amount. When the suit is settled out of court, there is no guilty verdict and contractors often try to include settlement and legal expenses as allowable costs under their cost-reimbursable contracts.

Not so fast.

A 2009 Court of Federal Claims decision, Secretary of the Army v. Tecom, 566 F.3d 1037, establishes a standard for allowability of such costs.

Tecom addresses the allowability of contractor costs associated with defense and settlement of legal claims brought against a contractor by a third party. Tecom, Inc. was awarded a negotiated cost-reimbursement contract for military housing maintenance. The contract contained various FAR clauses, including FAR 52.222.26 (Equal Opportunity). During the contract period, a former employee sued Tecom under Title VII of the Civil Rights Act of 1964 (“Title VII”), alleging sexual harassment and retaliation for filing a harassment charge. Tecom incurred more than $96,000 in legal bills defending the case. It settled the plaintiff’s claims for $50,000. Tecom sought reimbursement from the Army for $146,000 in defense and settlement costs as a direct cost under the contract. Tecom contended that it had not violated the law; that the former employee’s allegations were false; and that taking the case to trial would have cost approximately $300,000. The Army Contracting Officer found Tecom’s defense and settlement costs unallowable, and Tecom appealed the decision to the Armed Services Board of Contract Appeals (“Board”). The Board found for Tecom, and the Army appealed to the United States Court of Appeals for the Federal Circuit.

The Federal Circuit reversed the Board and rejected Tecom’s claims that the costs were allowable. In doing so, the court made two rulings. First, the Federal Circuit held that a contractor’s costs associated with an adverse judgment involving claims under Title VII are not allowable: a trial verdict that the contractor violated Title VII means the contractor breached FAR 52.222-26’s prohibition on discrimination on the basis of race, color, religion, sex, or national origin. Because costs are allowable only when they comply with the terms of the contract, and FAR clause 52.222-26 was a term of the contract, costs associated with a Title VII violation (including defense costs and any damages awarded by the court) are unallowable.

Second, the Federal Circuit held more broadly that the rule against reimbursing contractors for discriminatory conduct goes beyond trial verdicts; under Tecom, the rule also applies to settlements in certain circumstances. The Federal Circuit was concerned that a contractor that violated Title VII might try to avoid application of the rule against allowability by simply settling the matter before a trial verdict in the plaintiff’s favor. Thus, the court held that, where a contractor settles a Title VII case before judgment, the costs of litigation are allowable only if plaintiff’s claims had “very little likelihood of success on the merits.”

Significantly, the Federal Circuit did not define "very little likelihood of success," but instead adopted the standard based on FAR's treatment of legal costs associated with contractor defense of third-party False Claims Act suits. In those cases, FAR 31.205-47(c)(2) provides that costs may be allowed where "the contracting officer, in consultation with his or her legal advisor, determines that there was very little likelihood that the third party would have been successful on the merits."

Contractors who wish to settle matters out of court and who wish to include settlement and legal expenses as allowable costs under Government contracts, should first contact their contracting officers regarding allowability. Tomorrow we will identify the data that may be required by a contracting officer to help him/her make that decision.

Time to Update Provisional Billing Rates

Its a new year and, if you haven't already done so, its time for contractors to update their provisional billing rates (PBRs) - before billings are submitted for costs incurred in January. PBRs should be based on some sort of annual budget, submitted at least annually, but more often as circumstances dictate.

Vouchers and progress payment requests can be returned if submitted without properly established billing rates. Many contractors, especially small businesses without the luxury of having in-house staff to develop and monitor indirect billing rates, know all to well the punishment meted out by the contract auditor or the contracting officer when rates are out of date - rejected payment requests disrupt the cash flow process which dominoes into other problems (like the inability to meet payroll and pay vendors).

When submitting a PBR proposal to either the auditor or the contracting officer, contractors should include a comparative analysis showing last year's actuals, current year to day actuals, and current year budget. Significant differences withing this comparative analysis should be explained in sufficient detail to provide a reviewer some insight into changes.

Contractors need to ensure that their PBRs do not include unallowable costs. Of course, if the rates are based on budgeted information, there will most likely not be sufficient detail to identify potentially unallowable costs. Some contractors take small decrements off the G&A rate to provide for the potential that it will incur unallowable costs. Usually this is an acceptable practice but there are no guarantees the auditors will like it. There are 4,000 contract auditors scattered across 120 offices and while they try to achieve uniformity, it does not always happen.

Monitoring is also a key element to PBR development. Someone in the company must monitor approved billing rates against actual experience to ensure their continued viability. Indirect rates are impacted when business volume changes and contractors have the duty to revise PBRs whenever there are significant changes. Rates can swing up or down. If rates increase, the contractor is hurting itself by not adjusting PBRs upward. When rates fall, the Government is harmed if the PBRs are not adjusted. If the latter happens, you've just signed up for some increased audit oversight.

A Bid Too Low Might Mean You Don't Understand Requirements

A DoD Agency issued a solicitation for cost-reimbursable contract to renovate a building in Afghanistan. Two bids were submitted, one for $12 million and the other for $10 million. Award was to be made on a best-value basis considering, management/technical approach, past performance, technical understanding and cost realism. Vendors were also informed that the agency would evaluate vendors' understanding of requirements.

One of the bidders, B&V, submitted a bid that was $2 million under that of the higher bidder. The Government looked at that from a cost realism point of view and bumped B&V's cost by about $1.1 million representing what it believed would be B&V's "probable cost". More to the point however, is that in doing so, the Government also determined that B&V didn't really understand the requirements and knocked their rating down on technical merits.

B&V appealed the source selection on the basis that the solicitation did not advise vendors that the results of the cost realism evaluation could be used in this fashion. The GAO disagreed. The GAO ruled that the agency could use the cost realism analysis to assess the firm's understanding of the requirements - "Such a consideration ... is reasonably encompassed by the evaluation criteria that provided ... for assessing the vendors' understanding and cost realism."

GAO noted that FAR defines cost realism as a process of independently reviewing and evaluating specific elements of each offeror's cost estimate to determine

1. whether the estimated proposed cost elements are realistic for the work to be performed, 
2. reflect a clear understanding of the requirements, and 
3. are consistent with the unique methods of performance and materials described in the offeror's proposal.

In this regard, the agency's assessment was well within the bounds of a cost-realism review.

You can read the entire case by clicking here.

GAO Releases 2013 Report on Bid Protest Activities

The GAO issued its fiscal year 2013 annual report on bid protests last week. You can read the entire report here. Some of the highlights from that report follows:

Overall, the number of cases filed to 2,429, a two percent drop from fiscal year 2012. The GAO made no attribution as to the reason for the drop. It could be because fewer contracts were awarded or because the Government is doing better at awarding contracts. Any reduction is progress but that number is still 72 percent higher than the number of filings just six years ago.

Of the decisions issued by GAO, 17 percent sustained appeals and 83 percent denied appeals. The most prevalent reasons for sustaining protests were:

1. failure to follow the solicitation evaluation criteria
2. inadequate documentation of the record
3. unequal treatment of offerors
4. unreasonable price or cost evaluation

It would have been interesting to know the primary reasons for not sustaining an appeal but unfortunately, this report did not provide that information.

A significant number of protest filed with the GAO do not reach a decision on the merits because agencies voluntarily take corrective action in response to the protest rather than defend the protest on the merits. Agencies need not, and do not, report any of the myriad reasons they decide to take voluntary corrective action.

The report discusses the "effectiveness rate". The effectiveness rate is a percentage of all protests closed during the fiscal year where the protestor obtained some form of relief from the agency, either as a result of voluntary agency corrective action or GAO sustaining the protest. In 2013, the effectiveness rate was 43 percent and this percentage has held fairly constant for the past five years.

Finally, the report includes data on the use of ADR (Alternative Disputes Resolution). Of the protests filed with the GAO, the parties agreed to utilize ADR processes for 145 of those cases. The percentage of cases resolved in that process totaled 86 percent. The GAO report did not provide any details as to how those cases were resolved but its likely that both parties got something.

Subcontract Administration - Part 5 - Common Deficiencies

Today we will finish up this series on subcontract administration. This series has been a high level overview of Government expectations for contractors with subcontractors - especially cost-reimbursable subcontractors. Anyone that has gone through a purchasing system review (commonly referred to as CPSR or Contractor Purchasing System Review) know full well the excruciating level of detail that DCMA (Defense Contract Management Agency) request and expects. Its no fun. Fortunately, unless you're in that top 100 Government contractors (or so) its unlikely that you will ever have to go through it. However, that doesn't mean the expectations are diminished. Contract administration and audit can still assess the adequacy of contractor policies and procedures over subcontract administration when reviewing price proposals or auditing incurred costs.

The easiest way to ensure adequate subcontract oversight is to assume that whatever the Government does to you, you need to do the same to your subcontractors (assuming the subcontract is the same type as the prime contract). If the Government is assessing your accounting system, you probably need to assess whether your subcontractors have accounting systems that are adequate for the type of subcontract contemplated. If the Government demands an annual incurred cost proposal, you should probably figure that your subcontractors need to submit one as well.

Following is a listing of some common subcontractor oversight deficiencies published by DCAA (Defense Contract Audit Agency). We can't tell you anything about the frequency of occurrences - only that DCAA calls them "common".

1. Failure to verify the subcontractor has an adequate accounting system. See our previous post on what it takes to have an adequate accounting system.
2. Failure to appropriately monitor subcontract effort. There are plenty of activities throughout the life of the subcontract.
3. Failure to request a denial of access and notify the ACO when the subcontractor refuses access. There are situations where the subcontractor refuses to provide access to prime contractors. Often times its because the prime and sub are sometimes competitors and the historical data is proprietary. The Government understands this and will call in its own auditors to provide the necessary  oversight. Sometimes, the threat of Government auditors is enough incentive for subcontractor to have a change of heart.
4. Failure to notify the ACO and obtain approval, to subcontract
5. Failure to include the appropriate contract clauses in the agreement with the subcontractor. One of the toughest jobs for contractors is to ensure that the proper Prime Contract clauses are also included in subcontracts. Many times, the Government doesn't even include the right ones or omits some. 
6. Failure to ensure subcontract billings are accurate and compliant with subcontract terms. Its not sufficient to merely pay subcontractor invoices. There needs to be some level of review (e.g. ensure the subcontractor is using the correct billing rates).
7. Failure to obtain an adequate incurred cost submission from subcontractor.

Subcontract Administration - Part 4 - Ensuring the Propriety of Incurred/Claimed Costs

Happy New Year everyone. We're back and we're continuing our series on subcontract administration. So far, we've looked at the contractual requirements for prime contractors to monitor their subs (Part 1), the consent to contract requirement for contractors that do not have approved purchasing systems (Part 2) and what it means to "monitor" subcontracts (Part 3). Today we're going to examine a particular reporting requirement that pertains to prime contractors with cost-reimbursable subcontracts.

Most every Government contractor is familiar with the requirement to submit annual incurred cost proposals whenever flexibly-priced contracts (CPFF, CPIF, CPAF, FPI, T&M, etc.) exist. Those requirements and the structure required are spelled out in FAR 52.216-7. One of the required schedules, Schedule J, requires the following:

(J) Subcontract information. Listing of subcontracts awarded to companies for which the contractor is the prime or upper-tier contractor (include prime and subcontract numbers, subcontract value and award type, amount claimed during the fiscal year, and the subcontractor name, address, and point of contact information).

Sometimes there is a bit of controversy over whether this requirements includes all subcontracts or just flexibly-priced subcontracts. Logically, it pertains only to cost-reimbursable subcontracts because those will need to be "settled" before the prime contract can be closed out. Also, the auditor will need to determine whether the prime contractor can and will audit the subcontractor or will need to request an assist audit. We've seen auditors go both ways on this requirement.

The DCAA Information for Contractors Pamphlet however make is clear that the schedule pertains only to cost reimbursable subcontracts. See Enclosure 6, Page 87 of the Information for Contractors. This example also requires data that is not listed in the FAR, specifically the subcontract period of performance. We always recommend contractors include the period of performance information even though not required by FAR. It is easily obtainable and will facilitate the eventual audit.

Once the auditor establishes that a contractor has flexibly-priced subcontracts, he/she will inquire  as to the status of the prime contractors' audit of incurred costs. The requirement to submit annual incurred cost submissions is a flow-down provision meaning that subcontractors must also submit annual incurred cost claims. If the subcontractor is also a prime contractor, it is likely that the Government, through its own contract auditors or an outside organization, will audit incurred costs. If the subcontractor has no prime contracts, the prime contractor will have to determine how it will go about ensuring that claimed costs are allocable, allowable, and reasonable and otherwise proper.