Tuesday, May 25, 2010

Compensation "Reasonableness"

We do not have scientific evidence to support it, but it seems to us that contractors are being challenged to demonstrate the reasonableness of their employee compensation levels with increased frequency. If you are being challenged, the first thing you need to do is take a look at how FAR defines reasonableness in compensation. FAR 31.205-6(b) distinguishes between compensation pursuant to labor-management agreements and compensation not covered by labor-management agreements. For compensation pursuant to labor-management agreements, provided everything is done on the up-and-up, there is a presumption of reasonableness. The only exception is when it appears that the agreement is discriminatory against the Government. For compensation not covered by labor-management agreements, reasonableness is a little more complicated to demonstrate.

There are two reasonableness criteria for compensation. First, compensation for each employee or job class of employees must be reasonable for the work performed. This standard has been successfully used by the Government to challenge situations where employees were being compensated for performing little or now work. A notable case involved a small company who's owner placed his entire family on the payroll with no evidence that they were performing any work at all.

The second reasonableness criteria requires that the aggregate of each measurable and allowable element must sum to a reasonable total. In determining the reasonableness of total compensation, the Government will consider only allowable individual elements of compensation. Factors that may be relevant include, but are not limited to, conformity with compensation practices of other firms
  • of the same size
  • in the same industry
  • in the same geographic area
  • engaged in similar non-government work under comparable circumstances.
Obviously, the only way to determine whether your compensation practices comport to those of other firms of the same size, in the same industry, in the same geographic area, engaged in similar work under comparable circumstances, is to find out the compensation practices of those "other" firms. There are commercial benchmark surveys available for that purpose but they tend to be expensive and not cost-effective for small firms. Tomorrow we will take a look at how the Government assesses reasonableness. On Thursday, we will offer some guidance on how to demonstrate compensation reasonableness without spending unreasonable time and money.

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