Terminations for Convenience - Settlement Expenses

The Government can terminate a contract at any time. Government contracts contain one of the several "termination" clauses depending upon type of contract. For example fixed price contracts (non-commercial) include FAR 52.249-2, Termination for Convenience of the Government. Contractors have very little recourse when the Government terminates their contract other than ensuring that whatever was spent prior to the termination, is somehow reimbursed. We don't know of any cases where a contractor successfully lobbied a Government agency to withdraw their termination notice.

Once the termination notice is delivered, the contractor is obligated to cease work. Those costs become part of a contractor's settlement proposal. There's a second category of costs - cost continuing after termination. These are costs that can't be avoided such as a cancellation fee on an unexpired lease. Contractors have an affirmative duty to minimize or mitigate these costs. A third category of costs related to terminations are "settlement expenses".

The FAR coverage of settlement expenses is found in FAR 31.205-42(g). That section reads as follows:

1. Settlement expense, including the following, are generally allowable:
    (i) Accounting, legal, clerical, and similar costs reasonably necessary for
        (A) The preparation and presentation, including supporting data, of settlement claims to the contracting officer
        (B) The termination and settlement of subcontracts.
    (ii) Reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract
    (iii) Indirect costs related to salary and wages incurred as settlement expenses , normally limited to payroll taxes, fringe benefits, occupancy costs and immediate supervision costs.

So, settlement expenses are somewhat unique in that contractors are allowed to pull out costs that are normally indirect in nature, and charge them direct to settlement expenses. Contractors however must ensure that these costs are also removed from the indirect expense pool(s) from whence they came.

Also, the labor portion of settlement costs must be burdened with applicable fringe costs. For contractors with fringe rates and perhaps an occupancy pool, this is an easy task. For other contractors, a special analysis is required to calculate and claim applicable fringes.

Many contractors underestimate settlement expenses. At the time of negotiations, there is usually a portion of settlement expenses that are still estimates and these will require a thoughtful projection of how much time it will take to reach a settlement. Other contractors fail to include all settlement costs to which they are entitled. Some forget to add fringe. Some forget to post hours.

One last thing about settlement expenses. These costs are fully reimbursable as direct costs and do not need to be charged to an indirect expense pool and allocated to all the work of the contractor. For this reason, many contractors engage professional help (such as firms like ours) to assist in preparing settlement proposals.

Contractor Admits to Falsifying it Annual Incurred Cost Submission

Well, I guess that it sometimes pays to do an audit. Just when we think that nothing scintillating, or at least interesting, is ever discovered during an incurred cost audit, the Justice Department comes out with a press release proclaiming otherwise.  Vector Planning out of San Diego just plead guilty to criminal charges that it cooked its books and overcharged the Government on some DoD contracts. Vector has to pay about $6.5 million in restitution and gets a deferred prosecution out of the deal. Needless to say, its days as a Government contractor are in jeopardy as well. Accolades to DCAA for uncovering this fraud.

Under cost reimbursement contracts, contractors are allowed to bill for its direct costs and a pro-rata share of indirect expenses. At year end, contractors are required to submit annual incurred cost proposals for audit, review, reconciliation and approval. Contractors certify these costs. In this case, Vector admitted that after claiming and being paid for direct costs in connection with other, firm-fixed-price and time-and-materials contracts, it systematically reclassified the same costs in its accounting system to make it appear as if the costs were indirect costs. This inflated the indirect rates which were, in turn, charged to the Government. This allowed Vector to get paid twice for the same costs; once as direct and again as indirect.

This practice was going on for some time. Vector admitted to the false submissions in 2005 through 2009. When the auditors started their audit in 2011, Vector falsified its electronic accounting entries, and prepared and backdated fake invoices in order to support those falsified accounting entries. Vector blamed it on the dead guy - said that the entire scheme was orchestrated by its former CEO who is now deceased.

Although the fraud tallied $3.6 million, Vector agreed to pay $6.5 million to settle up the civil side of things. Vector also has to set up and maintain an ethics and compliance program. If Vector says clean for three years, the Justice Department will drop its criminal case.

"Purchased Labor" is Not "Consulting Costs"

Yesterday we highlighted new guidance to DCAA auditors that essentially told them to be reasonable and use common sense when evaluating whether professional and consultant services costs are adequately supported (if you missed that blog posting, you can read it here).

There is a related issue in that sometimes, auditors (and contracting officials) use the documentation criteria required in FAR 31.205-33 to evaluate costs that do not meet the definition of "professional and consulting services".

The definition of professional and consultant services, as defined in FAR 31.205-33 means those services rendered by persons who are members of a particular profession or possess a special skill. Examples include those services acquired by contractors (or subcontractors) in order to enhance their legal, economic, financial, or technical positions. Professional and consultant services are generally acquired to obtain information, advice, opinions, alternatives, conclusions, recommendations, training, or direct assistance, such as studies, analyses, evaluations, liaison with Government officials, or other forms of representation.

If the costs being evaluated do not meet this definition, we just quoted out of FAR, they are not "professional and consultant" costs and should not be evaluated using the criteria of FAR 31.205-33.

Here are some examples of costs that are not professional and consulting costs (according to DCAA's newly issued guidance):

1. Temporary accounting services to perform bookkeeping activities.
2. Program management activities for a contract (the individual works directly with contractor employees and contractor management to track and monitor progress on contract performance
3. Outside writers to augment their in-house staff in preparing technical publications.

Each of the foregoing examples represent purchased services or purchased labor. Allowability should be governed by the reasonableness criteria found in FAR 31.201-3, not by the consultant and professional services criteria.

Consultant Costs - Revisited

We have frequently written concerning consultant costs on these pages (see for example this posting from last August). Historically, auditors have loved consulting costs because the language written into FAR 31.205-33 make it easy for them to question costs. That FAR cost principle is one of the few where allowability is predicated upon specific documentation requirements; an agreement, invoices, and work product. Failure to provide any one or more of those, renders the costs unallowable - at least that's the way it typically works. Until, that is, the contracting officer has to make a decision on the contract auditors recommendations. Contracting officers are usually a lot more lenient than auditors as to what level of documentation will satisfy the requirements.

DCAA issued new guidance last month which effectively tells auditors to lighten up a bit. Instead of insisting upon a strict interpretation of "work product" being some formal report that evidences work performed, DCAA is now acknowledging that there are many ways for contractors to satisfy FAR 31.205-33 documentation requirements. DCAA states:

The type of evidence satisfying the documentation requirements will vary significantly based on the type of consulting effort and from contractor to contractor. Therefore, it is important for the audit team to understand that the evidence required from the contractor is essentially the following:

• An agreement that explains what the consultant will be doing for the contractor;
• A copy of the bill for the actual services rendered, including sufficient evidence as to the time expended and nature of the services provided to determine what was done in exchange for the payment requested, and that the terms of the agreement were met. This documentation does not need to be included on the actual invoice and can be supported by other evidence provided by the contractor;
• Explanation of what the consultant accomplished for the fees paid – this could be information on the invoice, a drawing, a power point presentation, or some other evidence of the service provided.
 

DCAA will even accept retroactively prepared evidence:

The contractor may provide evidence created when the contractor incurred the cost as well as evidence from a later period. Audit teams should consider evidence from a later period provided by the contractor, taking care to assess the quality of the evidence (generally, evidence prepared after the fact is less persuasive) and will likely need to obtain additional corroborative evidence. As an example of evidence from a later period, the contractor may facilitate a meeting between the consultant and the audit team to obtain documentation (oral/written) from the consultant regarding what effort they performed (i.e., third party confirmation). The audit team should consider the evidence provided by the consultant, along with other evidence obtained, to determine if the total evidence gathered is sufficient to satisfy the documentation requirements. 

  And consider this statement from the same guidance:

The purpose of the work product requirement is for the contractor to be able to demonstrate what work the consultant actually performed (in contrast to what work is planned to be performed). Although a work product usually satisfies this requirement, other evidence also may suffice. Therefore, if the audit team has sufficient evidence demonstrating the nature and scope of the consultant work actually performed, the contractor has met the FAR 31.205-33(f)(3) requirements even if the actual work product (e.g., an attorney’s advice to the contractor) is not provided. The audit team should not insist on a work product if other evidence provided is sufficient to determine the nature and scope of the actual work performed by the consultant.  

This new guidance should ease the burden of justifying the allowability of consulting costs - it tells auditors to quit being so strident in their interpretations and use some judgment and common sense.

Operations Audits

Back in the 1980s and 1990s, when there were many more major contractors with predominantly cost-reimbursable contracts then there are today, the Government performed a significant number of  "operations" audits. Operations audits, sometimes called functional audits, focus on efficiency, effectiveness, and economy of operations (the three "Es"). Its not such a significant program area these days for a couple of reasons. First, the contract environment has changed over the years. We recall a contractor with $5 billion in annual revenues, 99 percent of which came from cost-type contracts. Under that environment, there was little incentive to be lean and mean and the Government found a lot of low-hanging fruit. Today, its rare to see that kind of contract mix (except for Department of Energy) and contractors have a strong incentive to be as productive as possible. The second reason for operations audits becoming a lesser or lower priority is that rarely would the Government and contractor come to an agreement on how to implement recommendations so little, if anything, ever came of audit recommendations. For example, in one real live case, the auditor noted that the supervisor to worker ratio at a particular contractor was significantly higher than the norm for that industry and size of company. The contractor argued that their higher than average ratio was justified due to quality control, increased oversight, and other unique Government requirements. The poor contracting officer who had to decide who was right, could decide, threw in the towel and nothing ever came of the recommendation. As that happened over and over, the Government began to realize that there wasn't sufficient payback to justify the expenditure of resources. (There is a third reason if you talk to contractors - the operations audit recommendations were often not well developed and failed to take into account some key factors. One recent audit recommended cost savings by retrofitting plant lighting to more energy efficient lighting. Problem was, the contractor had already done that a couple months before the audit report was issued.)

That being said, the Government still dedicates a small amount of audit resources to operations audits. Contractors likely to be considered for operations audits are those where the Government has a significant interest, i.e., a significant amount of cost-reimbursable effort. Audit plans focus on cost areas that have managerial significance and will contribute to a more economical and efficient operation.

Besides saving money as a result of more efficient, effective, and economical operations, another tangible benefit is the prognosis of reduce Government oversight. In theory (in DCAA's theory anyway), oversight agency's can reduce coverage where there is

1. evidence of prudent management policies and decisions
2. an efficient organization reflecting effective management control over operations, and
3. a sound and reliable system of accumulating accounting and financial data

Operations audits can benefit contractors. If the audit findings are well developed, applicable to the situation, cost-effective, and feasible, why not implement them. It would be a "win" for both you and the Government.

Cases Settled Out of Court - How to Support Allowability of Costs

As we reported yesterday, there is a significant risk to settling legal matters before trial in that the legal costs and whatever is paid the plaintiff as settlement costs, may be unallowable. In a 2009 CFC decision, Army v. Tecom, the court set a new standard for allowability - the cost of litigation are allowable only if plaintiff's claims had very little likelihood of success on the merits. Who decides whether the claim has very little likelihood of success? The contracting officer does. And where does the contracting officer get the information necessary to make that decision? From the contractor. And how does the contracting officer convey his decision? In writing. So you see, the contractor has the opportunity to persuade the contracting officer that a plaintiff's case was fallacious, unworthy, without merit, and unlikely to succeed. That is really a tall order as the contracting officer will be naturally skeptical. A lot of contracting officers adhere to that old adage "where's there's smoke, there's fire".

So here's what contractors should do.

1. The contractor must provide a written rationale for asserting that the plaintiff had very little likelihood of success on the merits, including specific supporting information.
2. The rationale should include 
• a description of all claims and procedural actions in the case
• a copy of the Complaint and Answers
• title and docket numbers, 
• any pre- or post-Complaint demand letters from plaintiff's counsel
• the settlement agreement or proposed settlement agreement, and 
• any other information that the contracting officer should consider.

Beyond these items, contractors must be prepared to ensure that it submits, in a timely manner, all information that the Contracting Officer requests.

The Federal Circuit in Tecom was concerned about the government reimbursing contractors for conduct
where there was significant proof of discriminatory conduct; in other words, the court was focused on
the actual, objective conduct of the contractor. Some settlements are appropriate and prudent because,
as a matter of fact, it is unlikely that the plaintiff’s allegations are true but, for reasons other than the
actual, factual merits of the case, there is a risk that a jury might reach a verdict in the plaintiff’s favor.
While exogenous circumstances not related to the actual facts of a claim or the actual conduct of the
contractor may support a decision to settle a claim, such circumstances are not relevant to determining
whether the contractor engaged in discriminatory conduct and should not be considered in the objective
review of the merits of a claim under this guidance.