Tuesday, October 2, 2012

Compensation - Part 3 - Reasonableness

This section of the FAR compensation cost principle deals with the concept of reasonableness and is divided into two subsections, one for compensation pursuant to labor-management agreements and the other for situations where no labor-management agreement exists.

Labor-Management Agreement Exists: Compensation set by arm's length labor-management agreements are generally considered reasonable. We could not find any cases where reasonableness was challenged when a labor-management agreement was in place. However, the cost principle does identify exceptions to this general rule. These exceptions include:

  • costs are unwarranted by the character and circumstances of the work
  • costs are discriminatory to the Government

For example, the application of the provisions of a labor-management agreement designed to apply to a given set of circumstances and conditions of employment (e.g. work involving extremely hazardous activities) would be unreasonable if the Government contract involved less-hazardous duties.

It would also be discriminatory  against the Government if the labor-management agreement results in employee compensation in excess of that being paid for similar non-Government work under comparable circumstances.

Labor-Management Agreement Does Not Exist: Where there is no labor-management agreement, the presumption of reasonableness does not exist. Contractors must prove that compensation paid to individuals (or job class of employees) is reasonable. Even in situations where contractors have gone to great lengths to demonstrate reasonableness, the Government often conducts is own analysis by benchmarking contractor salaries against one or more salary surveys. This has become a very contentious are where the Government has recently lost two key cases. We blogged about them earlier this year and you can read about them here. In both of these cases, the contractors performed their own analysis to demonstrate reasonableness. The Government came along and performed their own "benchmarking" (which unsurprisingly resulted in lower compensation levels) and questioned the difference, without adequately explaining or demonstrating any deficiencies in the contractor's analysis. In one case, the ASBCA (Armed-Services Board of Contract Appeals) even termed the Government's analysis to be "fatally flawed".

The basic requirement in this subsection is that compensation for each employee or job class of employees must be reasonable for the work performed. This subsection further states that Compensation is reasonable if the aggregate of each measurable and allowable element sums to a reasonable total. When auditors test the reasonableness of compensation, they must consider factors determined to be relevant by the contracting officer. Many auditors fail to query the contracting officer about factors he or she determine to be relevant. This subsection identifies some of those factors that may be relevant. They include conformity with compensation practices of other firms -

  1. of the same size
  2. in the same industry
  3. in the same geographic area; and
  4. engaged in similar non-Government work under comparable circumstances.

Contractors that are being challenged by DCAA on their compensation levels need to keep in mind that the Agency has made up a lot of its own rules for assessing reasonableness levels (e.g. you cannot use a "free" compensation survey as a basis for comparison). None of those rules however have any statutory or regulatory basis behind them. Contractors should be able to defend their compensation levels but the method for determining reasonableness does not necessarily have to follow DCAA's script.

Next: Section (d) - Form of Payment

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