Improving Cash Flow by Reducing Fee Withholds

DCAA's failure to audit incurred costs in a timely manner imposes serious financial ramifications for contractors.Contractor (and small business contractors to a higher degree) are especially hurt by untimely audits for several reasons. First, the fee withhold provisions on cost-type contracts diminish cash flows. The Government has been sitting on fee withholds sometimes up to eight years (perhaps longer) without paying interest. Secondly, costs incurred in very old years, some going back to 2004 (perhaps longer) is very difficult to support. Records get moved, misplaced or destroyed according to record retention policies.
The record retention requirements for many of these records have long since lapsed. Employee turnover is a factor as well. Finally, small businesses often do not have in-house support and require costly outside support.

Yesterday we discussed the quick-closeout provisions available to close out some contracts ahead of the final audit.This will help in some cases. Another way to minimize the impact of the Government's holding onto money that is not theirs is to ensure that you have received as much of your fee as possible. There are three withhold levels.

Level 1 - In accordance with FAR 52.216-8, Fixed Fee under CPFF contracts, after payment of 85 percent of the fixed fee, the ACO may withhold further payment of fee until a reserve is set aside in an amount that the Government considers necessary to protect the Government's interest. This reserve may not exceed 15 percent of the total fixed fee or $100 thousand, whichever is less.

Level 2 - This same FAR provision requires the ACO to release 75 percent of all fee withholds after receipt of the certified final indirect cost rate proposal covering the year of physical completion of the contract, provided the contractor has satisfied all other contract terms and conditions, including the submission of final patent and royalty reports, and is not delinquent in submitting completion/final vouchers on prior years' settlements.

Level 3 - Finally, the ACO may release up to 90 percent of the fee withholds based on the contractor's past performance related to the submission and settlement of final indirect cost rate proposals.

Example: A $500 thousand contract with a fixed fee of 8 percent (or $40 thousand). Level 1, the ACO withholds 15 percent of $40 thousand or $6,000. Level 2, the ACO releases 75 percent of the $6,000 or $4,500. Remaining withhold at this point is $1,500. Level 3, the ACO releases 90 percent of the $6,000 or $5,400. Remaining withhold after Level 3 is $600. After Level 3, the contractor has received $39,400 of the total $40,000 fee.

If you have contracts that have not been closed and you haven't received 90 percent of the original fee withhold, you need to contact your ACO and have him/her release the maximum amount of fee withhold permissible. Its your cash flow.

DoD Changes "Award Fee" Payout Provisions

DoD issued a final rule today affecting award-fee contracts. Specifically, (i) 40 percent of the award fee pool must now be reserved until the final award fee determination period and (ii) the Government can no longer make "provisional award-fee payments. Contractors entering into award-fee type contracts need to be aware of these measures because of the likely impact on their cash flows.

According to DoD, the purpose of making 40 percent of the award-fee pool available under the final evaluation period is to set aside a sufficient amount to protect the taxpayer's interest in the event a contractor fails to meet contractual obligations.

Contractors will continue to be paid incurred costs on cost-type contracts, completed work under fixed-price contracts with progress payments, or milestones achieved under fixed-price contracts with performance-based payments. However 40 percent of the anticipated fee could be significant and contractors should factor this into their cash flow projections.

The new rule also prohibits the prepayment of award fee prior to the end of an award-fee period. DoD believes that prepayments are inappropriate since the contractor's performance has not been evaluated and the contractor may not earn that paid award fee during that period.

The new clause does contain a provision to reduce the amount of fee reserved for the final award fee determination period from 40 to 20 percent when approved by the head of a contracting activity. Don't count on that happening.

Potential Award Fee Reductions

There are a lot of ways for the Government to reduce award fees - many of them subjective. Now comes another. DoD just issued an interim rule, amending the DoD FAR Supplement (DFARS) to require contracting officers to consider reduction or denial of award fee if contractor (or subcontractor) actions jeopardize the health or safety of Government personnel (both military and civilian personnel).

The basic requirement reads as follows:

If, in the performance of this contract, the Contractor's or its subcontractor's actions cause serious bodily injury or death of civilian or military Government personnel, the Government may reduce or deny the award fee for the relevant award fee period in which the covered incident occurred, including the recovery of all or part of any award fees paid for any previous period during which the covered incident occurred.

The question then is, what is a "covered incident". The new DFARS defines that term as well. A covered incident is any incident in which the Contractor, through a criminal, civil, or administrative proceeding has been determined in the performance of this contract to have caused serious bodily injury or death of any civilian or military personnel. The term "death" is obvious but what is a "serious bodily injury"? DFARS defines that term also. Serious bodily injury means a grievous physical harm that results in a permanent disability.

DoD didn't think this one up on its own. It was required as part of the National Defense Authorization Act for Fiscal Year 2010.

More on Fee Withholds

Last week we alerted you to a few cases where DCAA had rejected billings under CPFF contracts because contractors had included amounts for fee that exceeded 85 percent of the negotiated fixed fee. DCAA erroneously cited FAR 52.216-8 that merely allows the Government to withhold fee where it was deemed in the best interests of the Government (the example used to justify fee withhold was a contractor who was consistently late in submitting its annual incurred cost claims). The clause does not require fee withhold. According to the Defense Contract Management Agency, in order to invoke that provision, the contracting officer would need to issue a contract modification to that effect. In the cases we are aware of, there were no contract modifications. We do not know how widespread the DCAA practice but we recommended that if you are having fee withheld on your contract(s), or you are voluntarily withholding fee based on some long established practice, you check your contract to verify that such a withhold is appropriate.

While the fee withhold provision is currently discretionary, there is a proposal on the table to make it mandatory. The FAR Councils proposed a rule last August to do just that. In May, the Director of Defense Procurement and Acquisition Policy (DPAP) completed an assessment of public input on systemic issues related to contract closeout. As a result, certain changes were proposed to the FAR to improve contract closeout. One of those proposed changes was to make fee withholding mandatory to

protect the Government's interest and to encourage the timely submission of an adequate final indirect cost rate proposal

The comment period on this proposed regulation closed last October. Sixteen commentators weighed in but only about half commented on this particular provision. All who did, were opposed to it, believing that it lumped the timely contractors with the recalcitrant ones, that it would have a major impact on contractors' cash flow, and the current regulations already provide for fee withhold when necessary.

This is still an active case. The report by the Implementation Team tasked with reviewing public comments and drafting the final FAR rule was expected in late January. We were unable to determine current status. If implemented as proposed, it will certainly have a significant financial impact on many Government contractors.

The Government May Be Illegally Withholding Some of Your Contract Fee

Most, but not all, cost-reimbursable contracts contain the FAR Clause 52.216-8, -9, or -10 (depending on whether the contract is fixed fee, construction, or incentive fee). These clauses states that after the Government pays out 85 percent of the fixed fee, the Contracting Officer may withhold further payment of fee until a reserve is set aside in an amount that the Contracting Officer considers necessary to protect the Government’s interest. This reserve shall not exceed 15 percent of the total fixed fee or $100,000, whichever is less. Notice the term "may withhold". The contracting officer may withhold fee, a fee withhold is not automatic.

According to Defense Contract Management Agency (DCMA) Information Memorandum No. 03-121 dated January 14, 2002,

there should normally be no need to exercise the option of withholding fee for a contractor with a record of timely submission of final cost vouchers and certified final indirect cost proposals, and that complies with other contract terms and conditions.

DCMA goes on to state that if the ACO determines that it is necessary to withhold fee to protect the Government's interests, written direction should be issued to the contractor by modification of the contract. The following paragraph provides suggesting wording for the modification:

This modification is issued to incorporate fee withholding in accordance with FAR Clause 52.216-8 (or -9 or -10, as appropriate). In order to protect the Government's interest, (contractor) is hereby directed to begin withholding fee from billings under this contract until a reserve is set aside in the amount of ....etc

DCMA also acknowledged in its Information Notice that some contractors are automatically withholding fee from billings, although not directed by the contracting officer and that DCMA has been advising contractors to stop withholding unless directed by the contracting officer.

Therefore, while the contract clause allows contracting officers to withhold fee when necessary to protect the Government's interest, in order to do so, the contracting officer must amend the contract.

Recently, we encountered a few situations where contractors had their billings rejected because they had billed in excess of 85 percent of fee. These rejections were inappropriate becuase the contracting officer had not amended the contract to require withhold. In one case, the clause was not even part of the contract. These rejections financially harmed the contractors because they disrupted their cash flows.

If you have a similar situation where the Government is withholding fee, you need to read your contract. If the withhold provision is not explicitly spelled out, you are entitled to your full fee. You should meet with DCMA and DCAA and straighten things out.