Termination Settlement Expenses Disallowed Because They Were Not Reasonable

Sometimes the Government finds it  necessary to terminate contracts for convenience. When they do, contractors are entitled to reimbursement for certain costs related to the terminated contract including a special category called 'settlement expenses'. Settlement expenses (see FAR 31.205-42(g)) include accounting legal, clerical and similar costs reasonably necessary for the preparation and presentation, including supporting data, of settlement claims to the contracting officer and the termination and settlement of subcontracts. Settlement expenses also include reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract as well as indirect costs related to salary and wages incurred as settlement expenses (e.g. payroll taxes, fringe benefits, occupancy costs, and immediate supervision costs).

Historically, the section on settlement expenses in a termination settlement proposal has been a fertile field for questioned cost by Government oversight. Contractors seem to have a propensity to load up this area of costs with scant supporting evidence. Sometimes contractors forget about the overarching cost principle of reasonableness. In addition to allowability criteria, as settlement expenses explicitly are, the costs must also be reasonable (see FAR 31.201-3). ALKAI Consultants LLc (ALKAI) was one of those contractors who learned the hard way.

ALKAI had a contract that was terminated for convenience. In its settlement proposal, it claimed $126 thousand in settlement expenses. The Government only wanted to pay ALKAI $27 thousand so ALKAI filed a claim with the ASBCA (Armed Services Board of Contract Appeals) for the difference (as well as for other cost elements).

Claimed settlement expenses included third party consultant and legal expenses, ALKAI employee wages, and estimated future costs. No one had an issue with the third part consultant and legal expenses. Concerning employee wages, the Board ruled that incurring costs to prepare a narrative requeisted by the contracting officer was reasonable in principle. It also found that claiming $77 thousand for this work was unreasonable. The Board allowed just $6 thousand. The Board also found that ALKAI had provided no back-up for future estimated cost being incurred subsequent to submission at any time. Therefore it disallowed another $10,500.

In this case, the ASBCA applied a reasonableness criteria based on what they believed was the intrinsic value of the services being performed. The full text of the ASBCA case can be read or downloaded here.

New Checklists for Termination Settlement Proposals

DCAA (Defense Contract Audit Agency) recently posted several  adequacy checklists for termination settlement proposals for cost and fixed priced contracts.

• Cost type contracts
• Fixed price -inventory basis
• Fixed price - total cost basis (most common form of submission)

Checklists are useful tools for ensuring that proposals conform to the Government's basic expectations submissions. Some checklists are mandatory such as the DFARS (DoD FAR Supplement) Proposal Adequacy Checklist found at DFARS 252.215-7009. Most, including the termination settlement proposal adequacy checklists linked above and others such as the incurred cost adequacy checklists, are voluntary.

Whether voluntary or mandatory, it seems wise to us for contractors to utilize these checklists during the preparation of whatever submission will be presented to the Government. These checklists inform as to what the Government will be looking at and should reduce the change that submissions will be returned as inadequate.

Wouldn't Contractors Love to Have This Contracting Officer Overseeing Its Government Contracts

Is DCAA (Defense Contract Audit Agency) irrelevant? DCMA (Defense Contract Management Agency) must think so. Here's a case that represents an egregious waste of taxpayer funds.

Back in 2009, the Air Force partially terminated a contract for convenience. The part that was terminated involved the purchase of titanium for F-22 aircraft fuselages from one of the contractor's subcontractors.

In 2012, the Air Force Termination Contracting Officer (TCO) requested that DCAA (Defense Contract Audit Agency) conduct an audit of the subcontractor's termination settlement proposal.

In 2014, DCAA finally issued its audit report on the subcontractor's termination settlement proposal. DCAA identified $826 thousand of the $1.9 million claimed as questionable for not complying with FAR (Federal Acquisition Regulations). $354 thousand of the questioned amount were costs incurred after the notice of termination and therefore unallowable. The remaining $472 thousand were unallowable according to other FAR provisions.

DCMA (Defense Contract Management Agency) - the Contracting Officer - was responsible for negotiating the termination settlement proposal and for addressing the $826 thousand questioned by DCAA.

In 2016, The DCMA contracting officer, without considering any of DCAA's questioned costs, authorized the full $1.9 million termination settlement proposal.

Later in 2016, a Hotline Complaint was filed with the DoD Office of Inspector General (DoD-IG) alleging that the DCMA contracting officer's settlement was improper because it did not consider the DCAA audit findings (wonder who might have filed this hotline complaint). After receiving the hotline complaint, the DoD-IG initiated an investigation.

The DoD-IG found that the DCMA contracting officer and her supervisor were negligent in negotiating proposed termination costs. For her part, the contracting officer,

• did not have any experience in negotiating DCAA-questioned costs and prior to this termination settlement proposal, she performed only contract administrative tasks, such as maintaining spreadsheets of invoices billed by the contractor
• did not have any experience with contracting actions greater than $750 thousand, which did not require negotiations involving DCAA audits and
• was not aware of the requirements for appropriately considering and documenting her actions on DCAA-questioned costs.

That should not have happened with adequate supervision, correct? Didn't happen. The DoD-IG also found that the supervisor (since retired) was negligent as well: The supervisor did not

• document why he approved the action
• document whether he advised the contracting officer to sonsult with or engage DCAA during negotiations
• document whether he advised the contracting officer to seek legal counsel given her decision not to uphold the DCAA audit
• require the contracting officer to prepare a price negotiation memorandum documenting the reasons for not upholding the DCAA questioned costs.

DCMA, as part of corrective action, rescinded the contracting officer's warrant, sent her to more training, and reviewed all of her past actions. DCMA also asked for some money back but the subcontractor refused claiming that it had a signed contract modification.

If you want to read the full investigative report, click here.

Audit Threshold for Terminations to Increase from $100 Thousand to $750 Thousand

Termination settlement proposals have always had a low threshold for audit. It currently sits at $100,000 meaning that contracting officers are required by regulation to request an audit of any termination settlement proposal that exceeds $100,000. That is about to change.

A new regulation published today that becomes effective on May 31, 2018, raises that dollar threshold from $100,000 to whatever the threshold for obtaining certified cost or pricing data. Right now, that threshold sits at $750,000 but on July 1, 2018, raises to $2 million (for DoD contracts).

The FAR (Federal Acquisition Regulations) Council believes that contractors will save costs associated with the preparation and support for termination settlement audits and will enable faster final settlement and improve contractor cash flow. No doubt, doing away with audits will do all of those things but it may come at the cost of reimbursing contractors for costs that should not be included in settlement proposals. Evidently the Government is willing to take that risk.

The Council was quick to point out that this new threshold does not violate the President's freeze on new regulations as it is administrative in nature - it simply raises an already prescribed threshold. The rule imposes no reporting, record keeping, or other information collection requirements.

One final note. The new rule does not preclude the TCO (Terminating Contracting Officer) from requesting audits of settlement proposals below that threshold. If the TCO deems it warranted, the TCO can refer the proposal to the audit agency along with any specific information or data that the TCO considers relevant along with any other facts and circumstances that will assist the audit agency in performing its function. In other words, if for any reason the TCO thinks an audit needs to be performed, it has the authority to request one.