The procedure is laid out in FAR 42.801. Briefly, it goes like this:
At any time during the performance of a contract (typically a cost-reimbursable contract), the contracting officer responsible for administering the contract may issue the contractor a written notice of intent to disallow specified costs incurred or planned for incurrence. However, before issuing the notice, the contracting officer shall make every reasonable effort to reach a satisfactory settlement through discussions with the contractor (FAR 42.801(s)).
A notice of intent to disallow such costs usually results from monitoring contractor costs. The purpose of the notice is to notify the contractor as early as practicable during contract performance that the cost is considered unallowable under the contract terms and to provide for timely resolution of any resulting disagreement. In the event of a disagreement, the contractor may submit to the contracting officer a written response. Any such response shall be answered by withdrawal of the notice or by making a written decision within 60 days (FAR 42.801(b)). A notice of intent to disallow can also be the result of a report by the contract auditor.
At a minimum, the notice shall
- Refer to the contract's Notice of Intent to Disallow Costs clause
- State the contractor's name and list the numbers of the affected contracts
- Describe the costs to be disallowed, including estimated dollar value by item and applicable time periods, and state the reasons for the intended disallowance
- Describe the potential impact on billing rates and forward pricing rate agreements
- State the notice's effective date and the date by which written response must be received
- List the recipients of copies of the notice, and
- Request the contractor to acknowledge receipt of the notice
Recently, the U.S. Court of Federal Claims took the Department of Energy to task for not following these procedures. DOE withheld costs from a contractor who had given employees a pay raise. DOE requested the contractor to provide information necessary for it to determine whether the pay raises were justified and if the information was not provided, DOE planned to take appropriate action to protect the Government's interests. The contractor did not provide the requested data so DOE withheld two percent of billed direct labor costs.
The contractor argued that DOE had not complied with the FAR criteria for disallowing costs. It had not issued a notice of intent to disallow costs nor had it afforded the contractor the opportunity to responded to the notice.
The Federal Claims court agreed with the contractor and ordered DOE to repay the $1.1 million withheld plus any additional amounts that may have been withheld in the interim.
The full decision can be read here.