Interest Expense

The ASBCA (Armed Services Board of Contract Appeals) recently passed down a decision involving financing costs. FAR 31.205-20 states the interest on borrowings (however represented), bond discounts, costs of financing and refinancing capital (net worth plus long-term liabilities), legal and professional fees paid in connection with preparing prospectuses, and costs of preparing and issuing stock rights are unallowable. This cost principle has been broadly applied by the Government to question or disallow all costs associated with financing including, not only interest, but also fees and other related expenses. The ASBCA recently added a bit of a twist to this long-standing position in the Appeal of SRI International, ASBCA No. 56353, February 18, 2011

By way of background, the contractor (SRI) sought to recover costs incurred to maintain a standby Letter of Credit (LOC) issued by a bank to guarantee its ability to repay long-term debt. The Government argued that the costs were unallowable under FAR 31.205-20 (Interest and Financing Costs) as long term financing. SRI argued that the costs are allowable because they are similar to bonding costs allowable under FAR 31.205-4, and alternatively, as administrative costs of short-term borrowings for working capital allowable under FAR 31.205-27(a)(3).

The ASBCA sided with SRI. The Board concluded that the LOC costs are allowable for three reasons:

1. FAR 31.205-20 is inapplicable to disallow the LOC costs because SRI treated the full amount of its long-term bond debt as part of its "current liabilities", not as "long-term" liabilities and the Government failed to show this treatment is inappropriate.
2. Paying an annual fee (the LOC costs) for a one-year bank LOC for the purpose of collateralizing or guaranteeing its ability to repay the full amount of its long-term debt in the short-term (one year) qualifies as administrative costs for short-term borrowing for working capital allowable under FAR 31.205-27(a)(3).
3. The LOC costs in dispute are not fixed and upfront costs and are therefore different in kind from the typical costs of financing.

No word yet on whether the Government will appeal this decision.