Cost Incurred in Defending Against Third Party Lawsuits are Probably Unallowable

For 47 years between 1943 and 1990, the Government produced plutonium for nuclear weapons at the Hanford site in Washington State, leaving behind about 56 million gallons of nuclear waste stored in underground tanks. If all of that sludge were put in tanker trucks, the line of trucks would extend from Philadelphia to New York.

In 2000, Bechtel was awarded a cost-plus-incentive fee contract by the Energy Department for the design, construction, and operation of a nuclear waste treatment plant to process the waste. Now, 19 years later, the construction phase is yet to be completed.

During contract performance, two former Bechtel employees at the Hanford site sued Bechtel alleging sexual and racial discrimination and subsequent retaliation for raising their complaints. Bechtel settled these lawsuits out of court and then sought $500 thousand in reimbursement from the Energy Department for costs it incurred in defending against the two suits. Bechtel did not seek reimbursement for the settlement payments, presumably because those were covered by insurance.

In 2016, DOE (Department of Energy) disallowed the $500 thousand based on the standards set forth in a prior Federal Court of Appeals decision (the 'Tecom decision'). Bechtel then brought a suit in the Federal Claims Court challenging the contracting officer's decision. The Claims Court sided with DOE, concluding that Tecom was the proper standard for determining whether defense costs were allowable. Bechtel then appealed the Claims Court decision to the Federal Court of Appeals. The Appeals Court affirmed the Claims Court decision.

So what is the 'Tecom Standard'?

The Tecom case involved a similar dispute over whether costs associated with settling an employment discrimination lawsuit were allowable costs under a Government contract. A former employee had sued Tecom under Title VII, alleging sexual harassment and firing in retaliation for filing a sexual harassment charge. The allege conduct, if proven, would have violated Title VII. After settling the suit, Tecom sought reimbursement from the Government for (i) defense costs and (ii) settlement payments associated with the lawsuit.

One of the allowability criteria for costs on Government contracts is that they comply with the terms of the contract (see FAR 31.201-2). The Tecom contract included a clause that prohibited the contractor from discriminating against any employee or applicant for employment because ro race, color, religion, sex, or national origin (see FAR 52.222-26).

In the Tecom case, the Court articulated a standard for determining when costs incurred by a contractor in defending and settling third party claims are allowable under a Government contract. First, "... we ask whether, if an adverse judgment had been reached, the damages, costs, and attorney's fees would be allowable and second, if not, we ask whether the costs of settlement would be allowable". In the Tecom case, the Court found that a violation of Title VII would not be allowable under the contract because sexual harassment is a form of sex discrimination and the alleged discrimination would have clearly violated the contract. As for the second step, where damages or penalties paid in the even of an adverse judgment are disallowed, settlement costs are also unallowable unless the contractor can establish that the plaintiff in the discrimination suit had very little likelihood of success on the merits.

Since Bechtel did not provide evidence that the plaintiffs in its case had very little likelihood of success, the Court affirmed the contracting officer's decision and the Claims Court's ruling.

You can read the full Federal Appeals Court's decision here.