Legal and Settlement Costs - Cases Settled Out of Court

Government contractors, and all companies for that matter, face the risk of lawsuits filed for discrimination, anything from equal opportunity, equal opportunity for veterans, affirmative action for workers with disabilities, sexual harassment, and the list goes on and on. Contractors will expended usually significant amounts of money defending against these sometimes frivolous lawsuits. Usually they are settled before going to court with the company agreeing to pay a specified amount. When the suit is settled out of court, there is no guilty verdict and contractors often try to include settlement and legal expenses as allowable costs under their cost-reimbursable contracts.

Not so fast.

A 2009 Court of Federal Claims decision, Secretary of the Army v. Tecom, 566 F.3d 1037, establishes a standard for allowability of such costs.

Tecom addresses the allowability of contractor costs associated with defense and settlement of legal claims brought against a contractor by a third party. Tecom, Inc. was awarded a negotiated cost-reimbursement contract for military housing maintenance. The contract contained various FAR clauses, including FAR 52.222.26 (Equal Opportunity). During the contract period, a former employee sued Tecom under Title VII of the Civil Rights Act of 1964 (“Title VII”), alleging sexual harassment and retaliation for filing a harassment charge. Tecom incurred more than $96,000 in legal bills defending the case. It settled the plaintiff’s claims for $50,000. Tecom sought reimbursement from the Army for $146,000 in defense and settlement costs as a direct cost under the contract. Tecom contended that it had not violated the law; that the former employee’s allegations were false; and that taking the case to trial would have cost approximately $300,000. The Army Contracting Officer found Tecom’s defense and settlement costs unallowable, and Tecom appealed the decision to the Armed Services Board of Contract Appeals (“Board”). The Board found for Tecom, and the Army appealed to the United States Court of Appeals for the Federal Circuit.

The Federal Circuit reversed the Board and rejected Tecom’s claims that the costs were allowable. In doing so, the court made two rulings. First, the Federal Circuit held that a contractor’s costs associated with an adverse judgment involving claims under Title VII are not allowable: a trial verdict that the contractor violated Title VII means the contractor breached FAR 52.222-26’s prohibition on discrimination on the basis of race, color, religion, sex, or national origin. Because costs are allowable only when they comply with the terms of the contract, and FAR clause 52.222-26 was a term of the contract, costs associated with a Title VII violation (including defense costs and any damages awarded by the court) are unallowable.

Second, the Federal Circuit held more broadly that the rule against reimbursing contractors for discriminatory conduct goes beyond trial verdicts; under Tecom, the rule also applies to settlements in certain circumstances. The Federal Circuit was concerned that a contractor that violated Title VII might try to avoid application of the rule against allowability by simply settling the matter before a trial verdict in the plaintiff’s favor. Thus, the court held that, where a contractor settles a Title VII case before judgment, the costs of litigation are allowable only if plaintiff’s claims had “very little likelihood of success on the merits.”

Significantly, the Federal Circuit did not define "very little likelihood of success," but instead adopted the standard based on FAR's treatment of legal costs associated with contractor defense of third-party False Claims Act suits. In those cases, FAR 31.205-47(c)(2) provides that costs may be allowed where "the contracting officer, in consultation with his or her legal advisor, determines that there was very little likelihood that the third party would have been successful on the merits."

Contractors who wish to settle matters out of court and who wish to include settlement and legal expenses as allowable costs under Government contracts, should first contact their contracting officers regarding allowability. Tomorrow we will identify the data that may be required by a contracting officer to help him/her make that decision.

Time to Update Provisional Billing Rates

Its a new year and, if you haven't already done so, its time for contractors to update their provisional billing rates (PBRs) - before billings are submitted for costs incurred in January. PBRs should be based on some sort of annual budget, submitted at least annually, but more often as circumstances dictate.

Vouchers and progress payment requests can be returned if submitted without properly established billing rates. Many contractors, especially small businesses without the luxury of having in-house staff to develop and monitor indirect billing rates, know all to well the punishment meted out by the contract auditor or the contracting officer when rates are out of date - rejected payment requests disrupt the cash flow process which dominoes into other problems (like the inability to meet payroll and pay vendors).

When submitting a PBR proposal to either the auditor or the contracting officer, contractors should include a comparative analysis showing last year's actuals, current year to day actuals, and current year budget. Significant differences withing this comparative analysis should be explained in sufficient detail to provide a reviewer some insight into changes.

Contractors need to ensure that their PBRs do not include unallowable costs. Of course, if the rates are based on budgeted information, there will most likely not be sufficient detail to identify potentially unallowable costs. Some contractors take small decrements off the G&A rate to provide for the potential that it will incur unallowable costs. Usually this is an acceptable practice but there are no guarantees the auditors will like it. There are 4,000 contract auditors scattered across 120 offices and while they try to achieve uniformity, it does not always happen.

Monitoring is also a key element to PBR development. Someone in the company must monitor approved billing rates against actual experience to ensure their continued viability. Indirect rates are impacted when business volume changes and contractors have the duty to revise PBRs whenever there are significant changes. Rates can swing up or down. If rates increase, the contractor is hurting itself by not adjusting PBRs upward. When rates fall, the Government is harmed if the PBRs are not adjusted. If the latter happens, you've just signed up for some increased audit oversight.

A Bid Too Low Might Mean You Don't Understand Requirements

A DoD Agency issued a solicitation for cost-reimbursable contract to renovate a building in Afghanistan. Two bids were submitted, one for $12 million and the other for $10 million. Award was to be made on a best-value basis considering, management/technical approach, past performance, technical understanding and cost realism. Vendors were also informed that the agency would evaluate vendors' understanding of requirements.

One of the bidders, B&V, submitted a bid that was $2 million under that of the higher bidder. The Government looked at that from a cost realism point of view and bumped B&V's cost by about $1.1 million representing what it believed would be B&V's "probable cost". More to the point however, is that in doing so, the Government also determined that B&V didn't really understand the requirements and knocked their rating down on technical merits.

B&V appealed the source selection on the basis that the solicitation did not advise vendors that the results of the cost realism evaluation could be used in this fashion. The GAO disagreed. The GAO ruled that the agency could use the cost realism analysis to assess the firm's understanding of the requirements - "Such a consideration ... is reasonably encompassed by the evaluation criteria that provided ... for assessing the vendors' understanding and cost realism."

GAO noted that FAR defines cost realism as a process of independently reviewing and evaluating specific elements of each offeror's cost estimate to determine

1. whether the estimated proposed cost elements are realistic for the work to be performed, 
2. reflect a clear understanding of the requirements, and 
3. are consistent with the unique methods of performance and materials described in the offeror's proposal.

In this regard, the agency's assessment was well within the bounds of a cost-realism review.

You can read the entire case by clicking here.

GAO Releases 2013 Report on Bid Protest Activities

The GAO issued its fiscal year 2013 annual report on bid protests last week. You can read the entire report here. Some of the highlights from that report follows:

Overall, the number of cases filed to 2,429, a two percent drop from fiscal year 2012. The GAO made no attribution as to the reason for the drop. It could be because fewer contracts were awarded or because the Government is doing better at awarding contracts. Any reduction is progress but that number is still 72 percent higher than the number of filings just six years ago.

Of the decisions issued by GAO, 17 percent sustained appeals and 83 percent denied appeals. The most prevalent reasons for sustaining protests were:

1. failure to follow the solicitation evaluation criteria
2. inadequate documentation of the record
3. unequal treatment of offerors
4. unreasonable price or cost evaluation

It would have been interesting to know the primary reasons for not sustaining an appeal but unfortunately, this report did not provide that information.

A significant number of protest filed with the GAO do not reach a decision on the merits because agencies voluntarily take corrective action in response to the protest rather than defend the protest on the merits. Agencies need not, and do not, report any of the myriad reasons they decide to take voluntary corrective action.

The report discusses the "effectiveness rate". The effectiveness rate is a percentage of all protests closed during the fiscal year where the protestor obtained some form of relief from the agency, either as a result of voluntary agency corrective action or GAO sustaining the protest. In 2013, the effectiveness rate was 43 percent and this percentage has held fairly constant for the past five years.

Finally, the report includes data on the use of ADR (Alternative Disputes Resolution). Of the protests filed with the GAO, the parties agreed to utilize ADR processes for 145 of those cases. The percentage of cases resolved in that process totaled 86 percent. The GAO report did not provide any details as to how those cases were resolved but its likely that both parties got something.

Subcontract Administration - Part 5 - Common Deficiencies

Today we will finish up this series on subcontract administration. This series has been a high level overview of Government expectations for contractors with subcontractors - especially cost-reimbursable subcontractors. Anyone that has gone through a purchasing system review (commonly referred to as CPSR or Contractor Purchasing System Review) know full well the excruciating level of detail that DCMA (Defense Contract Management Agency) request and expects. Its no fun. Fortunately, unless you're in that top 100 Government contractors (or so) its unlikely that you will ever have to go through it. However, that doesn't mean the expectations are diminished. Contract administration and audit can still assess the adequacy of contractor policies and procedures over subcontract administration when reviewing price proposals or auditing incurred costs.

The easiest way to ensure adequate subcontract oversight is to assume that whatever the Government does to you, you need to do the same to your subcontractors (assuming the subcontract is the same type as the prime contract). If the Government is assessing your accounting system, you probably need to assess whether your subcontractors have accounting systems that are adequate for the type of subcontract contemplated. If the Government demands an annual incurred cost proposal, you should probably figure that your subcontractors need to submit one as well.

Following is a listing of some common subcontractor oversight deficiencies published by DCAA (Defense Contract Audit Agency). We can't tell you anything about the frequency of occurrences - only that DCAA calls them "common".

1. Failure to verify the subcontractor has an adequate accounting system. See our previous post on what it takes to have an adequate accounting system.
2. Failure to appropriately monitor subcontract effort. There are plenty of activities throughout the life of the subcontract.
3. Failure to request a denial of access and notify the ACO when the subcontractor refuses access. There are situations where the subcontractor refuses to provide access to prime contractors. Often times its because the prime and sub are sometimes competitors and the historical data is proprietary. The Government understands this and will call in its own auditors to provide the necessary  oversight. Sometimes, the threat of Government auditors is enough incentive for subcontractor to have a change of heart.
4. Failure to notify the ACO and obtain approval, to subcontract
5. Failure to include the appropriate contract clauses in the agreement with the subcontractor. One of the toughest jobs for contractors is to ensure that the proper Prime Contract clauses are also included in subcontracts. Many times, the Government doesn't even include the right ones or omits some. 
6. Failure to ensure subcontract billings are accurate and compliant with subcontract terms. Its not sufficient to merely pay subcontractor invoices. There needs to be some level of review (e.g. ensure the subcontractor is using the correct billing rates).
7. Failure to obtain an adequate incurred cost submission from subcontractor.

Subcontract Administration - Part 4 - Ensuring the Propriety of Incurred/Claimed Costs

Happy New Year everyone. We're back and we're continuing our series on subcontract administration. So far, we've looked at the contractual requirements for prime contractors to monitor their subs (Part 1), the consent to contract requirement for contractors that do not have approved purchasing systems (Part 2) and what it means to "monitor" subcontracts (Part 3). Today we're going to examine a particular reporting requirement that pertains to prime contractors with cost-reimbursable subcontracts.

Most every Government contractor is familiar with the requirement to submit annual incurred cost proposals whenever flexibly-priced contracts (CPFF, CPIF, CPAF, FPI, T&M, etc.) exist. Those requirements and the structure required are spelled out in FAR 52.216-7. One of the required schedules, Schedule J, requires the following:

(J) Subcontract information. Listing of subcontracts awarded to companies for which the contractor is the prime or upper-tier contractor (include prime and subcontract numbers, subcontract value and award type, amount claimed during the fiscal year, and the subcontractor name, address, and point of contact information).

Sometimes there is a bit of controversy over whether this requirements includes all subcontracts or just flexibly-priced subcontracts. Logically, it pertains only to cost-reimbursable subcontracts because those will need to be "settled" before the prime contract can be closed out. Also, the auditor will need to determine whether the prime contractor can and will audit the subcontractor or will need to request an assist audit. We've seen auditors go both ways on this requirement.

The DCAA Information for Contractors Pamphlet however make is clear that the schedule pertains only to cost reimbursable subcontracts. See Enclosure 6, Page 87 of the Information for Contractors. This example also requires data that is not listed in the FAR, specifically the subcontract period of performance. We always recommend contractors include the period of performance information even though not required by FAR. It is easily obtainable and will facilitate the eventual audit.

Once the auditor establishes that a contractor has flexibly-priced subcontracts, he/she will inquire  as to the status of the prime contractors' audit of incurred costs. The requirement to submit annual incurred cost submissions is a flow-down provision meaning that subcontractors must also submit annual incurred cost claims. If the subcontractor is also a prime contractor, it is likely that the Government, through its own contract auditors or an outside organization, will audit incurred costs. If the subcontractor has no prime contracts, the prime contractor will have to determine how it will go about ensuring that claimed costs are allocable, allowable, and reasonable and otherwise proper.