Labor Qualifications for Time and Material Contracts

A couple of years ago, we reported an incident where auditors had questioned costs on a Time and Materials Contract (T&M) because the skills of the employees performing the work did not match the minimum skill set of the position contracted for. You can read it here. At the time, the issue remained unresolved so we never heard the end of the story. We still don't know what happened in that specific instance but DCAA (Defense Contract Audit Agency) recently issued guidance that speaks to the issue.

Fundamentally, the guidance requires that auditors coordinate with the contracting officer prior to questioning costs in circumstances where actual skills do not match contracted skills. The action to be taken by the auditor depends upon what the contracting officer tells them: authorization to use a lower skill set has been given, authorization to use a lower skill set will be given, or authorization to use a lower skill set is not given.

In our experience, contracting officer authorization to use a lower skill mix is not a given. Some contracting officers become incensed and demand a refund. Some are more matter-of-fact and simply ask for a price adjustment or other compensation. Others are more pragmatic and look at the overall performance rather than skills of the person performing the job. Regardless of contracting officer (CO) responses, contractors still have a responsibility and obligation to notify the CO whenever there is a difference between contracted skills and the skills of the person performing the work.

FAR 52.232-7(a)(3) states:

Labor hours incurred to perform tasks for which labor qualifications were specified in the contract will not be paid to the extent the work is performed by employees that do not meet the qualifications specified in the contract, unless specifically authorized by the Contracting Officer.

While FAR requires specific authorization, it does not require the contracting officer to provide that authorization prior to the delivery of the work. Sometimes, usually when brought to their attention, contracting officers will approve the use of lower skill employees after the fact.

Even when the contracting officer is not prone to approve the use of lower skill workers, he/she will rarely disallow all of the costs. After all, services were rendered. Instead, the contracting officer will seek a rate adjustment or sometimes add a new line item for the lower skilled category.

You can view the guidance on DCAA's website by clicking here.

Time and Material Contracts and Uncompensated Overtime

From time to time, we are asked about how uncompensated overtime should be billed under T&M or labor-hour contracts. This is not really an easy question to answer - it depends upon the particular clauses in the contract. But we can offer a "general" (non-legal) opinion.

Under T&M or labor-hour contracts, the Government and contractor negotiate fixed hourly rates for particular skill sets. Cost for particular task orders are calculated by multiplying the number of agreed-to hours by the negotiated rates. As the contractor works the hours, it can get reimbursed at the agreed-to hourly rates. Whether the employee was paid for those hours, is irrelevant to the contract (though a contractor could face other issues if these employees were not exempt under the Fair Labor Standards Act). If the employee performed the work, the contractor should get paid at the agreed-to rate.

A 2012 ASBCA (Armed Services Board of Contract Appeals) affirms this position. In this particular case, an Army contracting officer, based on a review by contract auditors, disallowed about $50 thousand in billings from GaN Corporation because the company had billed the Army for hours that they actually worked but did not compensate its employees who had performed the work. Those employees were exempt employees and were working uncompensated overtime.

The Board found the Government's interpretation of the contract and its arguments "unpersuasive and without merit.

The contract is clear: "Firm fixed price rates will be established [in] Section B of the contract. Task orders will be Labor Hour (LH) and/or Firm Fixed Price (FFP) and will be priced in accordance with the pricing schedule in Section B." ... The pricing schedule is cross referenced with Sections (a)(2) and (3) of the Payments clause, which controls: "the amounts shall be computed by multiplying the appropriate hourly rates prescribed in the Schedule by the number of direct labor hours performed." Further, "[t]he hourly rates shall be paid for all labor performed on the contract that meets the labor qualifications specified in the contract. ... " There is no question that the labor was performed and the employees paid their regular salaries .... The government's argument that the other provisions of the clause that refer to costs (Sections (d) Total Cost and (e) Ceiling Price) "make all employees hourly workers for purposes of reimbursing the contractor" ... is not a reasonable interpretation of the entire clause. First, these sections are not germane to the issue at hand as they merely reference "costs" in conjunction with the ceiling price of the contract and the procedures to ensure that the contractor does not exceed such limit. Secondly, and most importantly, these sections do not specifically prohibit the contractor from collecting its hourly rates for work performed by salaried employees (subject to the ceiling price). Thus, to "read out" or ignore portions of Sections (a)(2) and (3) of the Payments clause is not legally defensible.

When we were auditors and assessing proposed rates for T&M or LH contracts, we would try to reflect the impact of uncompensated overtime, if any, into the hourly rate buildup. If a contractors experienced a significant amount of overtime historically, there was a reasonable assumption that it would continue to do so. By adding uncompensated overtime hours in the denominator when calculating average hourly rates, the impact of uncompensated overtime is addressed. Sometimes negotiators accepted the position, sometimes not.

You can read the entire ASBCA case by clicking here.

Annual Incurred Cost Submissions and Time and Material Contracts

This is a followup to our discussion in Monday's post describing the need for contractors to include T&M (Time and Material) contracts in their incurred cost claims. If you missed it, you can read it here. There is some good news for contractors that have T&M contracts but no flexibly-priced contracts (e.g. CPFF, CPAF, CPIF, etc). The annual incurred cost submission becomes very simple.

FAR 52.216-7, Allowable Cost and Payment, contains requirements in section (d)(2)(iii) and (iv) for contractors to submit adequate indirect cost rate proposal withing six months following the end of the fiscal year. Most contractors are familiar with the requirement - it contains required schedules 'A through 'O as well as optional schedules 'A through 'O (not too many contractors submit the optional schedules).

Required schedules 'A through 'H, 'L, 'M, 'N, do not apply to T&M contracts. Those are the schedules where contractors identify their indirect cost pools and corresponding allocation bases, calculate indirect rates, reconcile those costs to the General Ledger and accumulate claimed costs at the calculated indirect rates, among other things that do not apply to T&M contracts. That leaves only Schedules 'I, 'J, 'K, and 'O as applicable or potentially applicable.

Schedule 'K, Summary of each time-and-materials and labor-hour contract information, including labor categories, labor rates, hours, and amounts is the primary schedule for detailing hours and costs charged to T&M contracts. This information is rolled up into Schedule I, Schedule of cumulative direct and indirect costs claimed and billed by contract and subcontract. Its largely redundant and doesn't serve a useful purpose but if a contractor fails to provide it, the auditor will most certainly reject the submission on that technicality.

Schedule 'J lists subcontractors and subcontracts. This may or may not be applicable depending upon whether there are subcontractors under a contractors' T&M contracts.

Schedule 'O simply indicates whether particular contracts are ready to close.

So there you have it. Contractors with T&M (and labor-hour) contracts but no flexibly-priced contracts, don't have much to do when it comes to completing their annual incurred cost submissions.

Time and Material Contracts - Incurred Cost Audits

One question we are frequently asked concerns the need to include T&M (Time and Material) contracts in an annual incurred cost submission. Contractors sometimes reason that the since rates are fixed, what is there to audit? The rates are already fully burdened and with indirect costs and profit. That's true, there will be no audit of the fixed rates. However, the contract auditor is concerned primarily with two things, the number of hours claimed or billed and the whether the the people working the job had the requisite skills and qualifications.

Hours claimed under T&M contracts must be supported by evidence of work performed - timesheets. Timesheets must be part of an overall timekeeping system that satisfies the basic requirements for Government contracting; recording all hours worked no less than daily, reviewed and approved by supervision, documented changes, etc. Hours that cannot be traced back to timesheets will be questioned and referred to the contracting officer for resolution. Normally, that doesn't end well for the contractor.

Auditors are also interested in the qualifications of the employees billed under the various skill codes specified in the contract. For example, a T&M contract might spell out rates for Senior Engineer, Junior Engineer, and Technician. The auditor will want to ensure that the contractor is not billing a Junior Engineer at a Senior Engineer rate. That is why auditors sometimes request HR information related to employees charging T&M contracts. It doesn't matter nor will the contractor be able to assert that the Junior Engineer was better qualified than the Senior Engineer for the job. If the Government called for a Senior Engineer and paid the rate for a Senior Engineer, it should get the services of a Senior Engineer. Any evidence that the contractor is using lower priced employees will get referred to the contracting officer.

Auditors will also examine the extent, if any, to which billed hours duplicate costs in the indirect portion of the T&M labor rate. The time of partners, officers, or supervisors is not generally acceptable as direct labor unless specifically authorized in the contract. Cost for this type of labor is generally part of the indirect expense rate that was calculated and included in the original negotiation.

Finally, we should mention overtime. Overtime hours cannot be converted to a larger number of regular hours to compensate for any overtime premium payments, nor will the rates charged for overtime be increased unless the contract so provides. Ideally, if any overtime is contemplated, it is already factored into the negotiated fixed hourly rates.

Time and Material Contracts - Actual Skills Must Match Billings

Time and Materials contracts are agreements to provide specific labor skill levels at fixed negotiated rates (and materials at actual costs). The Government pays a fixed rate for each hour of labor provided by the contractor. Historically, auditors have limited their reviews to ascertaining whether the hours billed under the contract are traceable to timekeeping records.

Recently we were alerted to an instance where the auditors took their analysis deeper and checked to see if the contractor employees who actually worked on the project, had the requisite skills and qualifications for the position being billed the Government. Where the qualifications did not meet the standards for the position, the auditor questioned the entire cost.

It will be interesting to see how this issue is resolved. Although by all accounts the Government was pleased with the work performed by the under-qualified individuals, the Government was nevertheless overcharged for the level of skills delivered.

Contractors with Time and Material contracts should self-assess any vulnerabilities in this area.