Fines and Penalties - Part II

This is our second and final part in discussing FAR 31.205-15, Fines, Penalties and Mischarging Costs. Yesterday we discussed the "fines and penalties" section and today we will discuss the "mischarging costs" section.

Actually, this cost principle covers a whole lot more than just "msicharging". The entire section reads:

Costs incurred in connection with, or related to, the mischarging of costs on Government contracts are unallowable when the costs are caused by, or result from, alteration or destruction of records, or other false or improper charging or recording of costs. Such costs include those incurred to measure or otherwise determine the magnitude of the improper charging, and costs incurred to remedy or correct the mischarging, such as costs to re-screen and reconstruct records.

This section has caused a fair amount of confusion over the years. For one, the term "mischarging" is not defined in FAR. Second, is the question as to whether the mischarging is deliberate or inadvertent. The Government says both, contractors like to limit the applicability to "deliberate". This question has not been tested through the appeal process that we know of.

But the phrase that has caused a lot of ruckus over the years is "costs to re-screen and reconstruct records". A number of years back when the requirement to "certify" incurred cost submissions was instituted, many contractors withdrew their incurred cost claims and "scrubbed" them to ensure that all unallowable costs were identified and excluded. The Government took exception to these scrubbing costs. The Government reasoned that it had already paid for that service so why should they pay a second time. Additionally, contractors should have adequate systems in place to identify and exclude unallowable costs from their books and records used to support pricing and billings. Having to scrub those records a second time was tantamount to admitting that the accounting system was not adequate.

The auditors got aggressive and began to question "scrubbing" costs and any directly associated costs they could think of. Some contracting officers went along with the auditors but some did not. In order to ensure consistency, the Government added this provision in 1989.

These potentially unallowable activities still go on today but not nearly to the degree that they did back in the 1980s. Also, auditors have moved on to new hot-button issue and don't have time for this one. Thirdly, its difficult to compute a defensible cost impact as scrubbing activities are typically performed by indirect personnel who most likely, don't keep track of their time at this level of detail. Finally, contractors have made significant improvements in their systems for identifying and excluding unallowable costs from Government contracts.

Fines and Penalties - Part I

There is a FAR cost principle that addresses fines, penalties, and mischarging costs (see FAR 31.205-15). The "fines and penalties" part of this cost principle goes way back to 1940 and the "mischarging costs" portion was added in 1989.

The "fines and penalties" section of this cost principle provides that cost of fines and penalties resulting from violations of, or failure of the contractor to comply with Federal, State, local, or foreign laws and regulations, are unallowable except

• when incurred as a result of compliance with specific terms and conditions of the contract or 
• written instructions from the contracting officer. 

One would think that is fairly straight-forward however there have been a number of appeals over the years. Often times, the Government takes a position that any costs resulting from a contractor's violation of a law or regulation are in the nature of a fine or penalty. Is a payment made to an employee to settle an EEO claim a fine or penalty, or something else? The Government will usually argue that it is in the nature of a fine or penalty. But not necessarily.

There was a board case back in 1968 that illustrates this distinction. McDonnell Douglas had to pay additional workers compensation to the family of a worker killed on the job. California levied the additional workers compensation payments in order to penalize the employer for serious and willful misconduct.

The Board of Contract Appeals decided that the payments were awarded as the result of the serious and willful misconduct of the employer but not because of the violation of any law or regulation. Therefore, this cost principle was not applicable and the Government lost.

In another case, the Government used this cost principle to question payments that a contractor made to two job applicants who the EEOC (Equal Employee Opportunity Commission) found reasonable cause to believe that they had been discriminated against. The ASBCA found the cost allowable because the Government had not proved that the contractor had, in fact, discriminated against the applicants or otherwise violated any laws.

Tomorrow we will look at the "mischarging" element of this cost principle.