Penalties on Unallowable Costs - Part II

We began a short series yesterday on penalties imposed on contractors who claim costs that are unallowable under FAR cost principles (and also under Agency supplements like the DoD FAR Supplement or NASA FAR Supplement). If you missed that segment, you can read it here. These penalties have a statutory basis meaning Congress passed a law and the President signed it.

As discussed yesterday, there are two different penalties, one for specifically unallowable costs and a double penalty for costs that were determined to be unallowable before the incurred cost claim was submitted. Although not specifically mentioned in the Regulations as such, these two penalties are commonly referred to as Level 1 and Level 2 penalties respectively.

Only the contracting officer has the authority to assess penalties (see FAR 42.709-3). Usually however the contracting officer is relying on someone else (e.g. DCAA) to make the recommendation. To assess a Level 2 penalty, the contracting officer must have some evidence that the costs were determined unallowable prior to submission. The kinds of evidence listed in the Regulations include;

1. A DCAA Form 1, Notice of Contract Costs Suspended and/or Disapproved (or similar notice) that was not appealed and was not withdrawn.
2. A contracting officer final decision which was not appealed
3. A prior executive agency Board of Contract Appeals or court decision involving the contractor, which upheld the cost disallowance; or
4. A determination or agreement of unallowability under 31.201-6 (Accounting for Unallowable Costs).

After making the assessment, the contracting officer must issue a final decision which includes a demand for payment of any penalty. The demand shall state that the determination is a final decision under the Disputes clause of the contract. This demand is separate from demanding repayment of any paid portion of the disallowed cost.

Interest

In addition to the penalties, there is also the interest component. The contracting office will compute interest on the paid portion of the disallowed cost from the midpoint of the contractors' fiscal year to the date of the demand letter. The regulations do provide some flexibility on the duration if the costs were not paid evenly during the year. The interest rate to be used is the Treasury Rate, currently set at 1.75 percent.

The contracting officer wouldn't normally have the information necessary to ascertain the paid portion of unallowable costs so he/she would need to request assistance from the contract auditor.


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Read our complete series on penalties for unallowable costs by following these links.
Part I - Regulatory Authority
Part II - Levels I and II Penalties, and interest
Part III - Waivers
Part IV - Calculating
Part V - Audit Guidance