Penalties for Unallowable Costs

Let's talk about penalties for unallowable costs. It's pretty well known that if an auditor finds unallowable costs in your annual incurred cost submission, they'll recommend that the Contracting Officer slap you with a penalty. There are provisions to waive the penalty; e.g where the unallowable costs total less than $10 thousand or you can do a bang-up job of convincing the Contracting Officer that you've really got it together now and it'll never happen again. But it seems to us that the Government is less inclined these days to be so forgiving.

There are two kinds of penalties. There are the penalties that apply to unallowable costs defined in FAR Part 31 or the corresponding Agency FAR Supplements. The other penalty applies where the Contracting Officer determines that a cost submitted by the Contractor in its proposal includes a cost previously determined to be unallowable for that Contractor. This latter penalty could get costly as it is double the amount of unallowable costs charged to the contract(s).

A recent settlement (announced this month) between Northrop Grumman and the Government nicely illustrates the application of the second penalty. Northrop Grumman paid $11.4 million to settle a Government claim based on its failure to abide by a 2002 settlement agreement with DCMA (Defense Contract Management Agency). Northrop charged costs related to deferred compensation to key employees to Government contracts even though it had promised not to do so as part of the 2002 settlement.

The Contracting Officer found that Northrop had failed to honor its commitment and assessed a penalty equal to twice the amount of the unallowable costs. Northrop appealed to the U.S. Court of Federal Claims in Washington, D.C. Ultimately, Northrop decided to settle for the $11.4 million.

So, if you've reached agreement with the Contracting Officer over the allowability of certain costs, be careful to exclude the same or similar costs from any billings or incurred cost submissions.