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CONGRESS EMPHASIZES CONTRACTOR SCRUTINY;
COURT REJECTS GOVERNMENT'S IR&D DISALLOWANCE
Smith Pachter McWhorter PLC
Government Contracts Update:
Vol. I, No. 2 December, 2005By Stephen D. Knight Smith Pachter McWhorter PLC constantly tracks current events, issues, and trends in Government Contracts to keep clients on the cutting edge of legal and policy developments. This e-letter highlights the most important issues, and the attached index provides web-links to the source documents of these and many more developments. I. Legislation On November 15, 2005, the Senate passed S. 1042, "National Defense Authorization Act for Fiscal Year 2006," substituting the language of that bill for H.R. 1815. The bill will go to conference to resolve differences between the House and Senate. Title VIII of S. 1042 contains specific provisions related to procurement, which show the Senate's continued interest in compliance issues. The Senate bill would impose substantial burdens on contractors, including in certain instances a 100% withhold of amounts questioned under an audit. Contractors are well advised to become familiar with provisions such as:

  • Section 801, which would require a review by the DOD Inspector General and the inspector general of each non-defense agency that procured property in excess of $100 million on behalf of DOD during fiscal year 2005. The IGs would review procurement policies, procedures and internal controls of the non-defense agency to determine compliance with DOD procurement requirements. If the non-defense agency did not comply with DOD requirements, such agency could not procure property or services for DOD in an amount exceeding $100,000.
  • Section 804, which would prohibit the procurement of a major weapon system as a commercial item unless specifically authorized by Congress. The prohibition would not extend to a subsystem or component of a major weapon system if the subsystem or component otherwise met the commercial item requirements.
  • Section 807, which would require DOD to report on the acquisition status of each major defense acquisition program whose program acquisition unit cost has exceeded the original baseline projection by more than 50 percent.
  • Section 809, which would prohibit the commencement of any major defense acquisition program before the completion of an analysis of alternatives.
  • Section 809A, which would require DOD to report on the use of lead system integrators for acquisition of major systems, including definition of intellectual property rights, assurance that DOD obtains appropriate rights in technical data, prevention of organizational conflicts of interest by lead system integrators, use of competitive procedures to award subcontracts, and the prevention of "pass-through charges" (defined as overhead or profit on work performed by a lower-tier contractor that does not "promote significant value added with regard to such work") by lead system integrators.
  • Section 809C, which would prohibit "a tiered evaluation" for contracts or task or delivery orders, unless the contracting officer has conducted market research to determine whether a sufficient number of qualified small businesses are available to justify limiting competition.
  • Section 809F, which would prohibit the conversion of a DOD civilian function to performance by a contractor unless the conversion is based on a public-private competition in accordance with OMB Circular A-76 dated May 29, 2003. The competition would be based on a "most efficient organization" ("MEO") plan, and would require continued performance by DOD civilian employees unless contractor performance would be less costly to DOD by an amount that equals or exceeds the lesser of $10 million or 10 percent of the MEO's personnel-related costs.
  • Section 809G, which would require DOD to prescribe procedures for "ensuring that consideration is given to using Federal Government employees on a regular basis for work that is performed under [DOD] contracts and could be performed by Federal Government employees." The required procedures would give "special consideration" to contracts: performed by federal employees at any time after October 1, 1980; associated with inherently governmental functions; not awarded on a competitive basis; or determined to be poorly performed due to excessive costs or inferior quality. Similarly, this section would require DOD to "ensure that Federal Government employees are fairly considered for the performance of new requirements."
  • Section 821, which would require DOD contractors that hold any non-commercial item contract in excess of $10 million to report the names (and other specific information relating to job responsibilities) of any former DOD officers or employees who received compensation from the contractor during the preceding calendar year. The reporting requirement would be limited to former DOD officers or employees that received compensation from the contractor not more than two years after the employee left DOD service and not more than two years before the date the report is due.
  • Section 822, which would require DOD to conduct a review of ethics considerations raised by contractor performance of functions closely associated with inherently governmental functions, and contractor performance of functions historically performed by government employees. The review would consider options to address ethics issues, such as amendments to the FAR, specific contract requirements imposing ethics standards on contractor employees, requirements for contractor personnel to receive ethics training, and mitigation of ethics concerns involving contractor personnel.
  • Section 823, which would require DOD to establish a risk assessment team "to assess the vulnerability of [DOD] contracts to fraud, waste, and abuse." The team would be chaired by the DOD IG, and include representatives from DLA, DCMA, DCAA, and the services. The team would review both DOD and contractor internal control systems for fraud vulnerability. After a GAO review of the team's efforts, DOD would submit an action plan to Congress to address the areas of vulnerability identified by the team.
  • Section 824, which would require DOD to submit quarterly reports on contracts and subcontracts related to security and reconstruction activities in Iraq and Afghanistan. This section would also authorize 100 percent withholding of payments of amounts "determined by an investigative or audit component of [DOD] to be unsupported, questioned, or both".
  • Section 854, which would require DOD to maintain a website available to the public that provides information on instances in which "major contractors" (those that receive at least $100 million in federal contracts in the most recent fiscal year) "have been fined, paid penalties or restitution, settled, plead guilty to, or had judgments entered against them in connection with allegation of improper conduct." The section does not define "improper conduct."

Congress is also considering a slew of bills in the wake of Hurricanes Katrina and Rita that would subject contractors to added scrutiny. Those bills would:

  • Set up a select committee comprised of Congressional members to investigate contract awards, payments, audits, penalties, and subcontracting policies. The select committee would have the power to subpoena both witnesses and documents.
  • Establish a Special Inspectors General Council for Hurricane Katrina, comprised of IGs from at least nine agencies, to monitor recovery efforts.
  • Establish a Special Inspector General for Hurricane Katrina Recovery to be appointed by the Secretary of Homeland Security, charged to conduct, supervise, and coordinate audits and investigations of expenditures for recovery.
  • Set up an Independent Commission to Prevent Fraud and Abuse in the Response to Hurricane Katrina, comprised of personnel appointed by the president, and Senate and House members. The commission's duties would include scrutiny of contract and subcontract awards, and audits of contracts, with particular emphasis on competition, conflicts of interest, and revolving door issues.
  • Expand the responsibilities of the Special Inspector General for Iraq Reconstruction to include audits and investigations relating to federal programs for Hurricane Katrina recovery.

One bill, S. 1765, contains a surprising provision that would treat all direct and indirect costs on federal contracts and subcontracts associated with employees displaced by Hurricane Katrina, and delays, disruption and loss of efficiency, as "allowable and compensable, and the pricing of such contracts and subcontracts shall be equitably adjusted accordingly." This provision would act as a legislatively mandated equitable adjustment on all hurricane-affected contracts and subcontracts.Another bill, S. 1761, would limit the liability of contractors performing rescue, recovery, repair or reconstruction work to private lawsuits. The bill would create a federal cause of action precluding punitive damages and pre-judgment interest, and would limit "non-economic damages" (emotional pain, suffering, inconvenience, physical impairment, mental anguish, disfigurement, loss of enjoyment of life or consortium, injury to reputation "and any other non-pecuniary losses"). The bill would also extend the benefit of the government contractor defense to the contractor.Additional proposed legislation of concern to contractors is listed in the attached index with web-links to the source documents.II. Regulations and Policies In Federal Acquisition Circular 2005-06, the government implemented several final rules that should interest government contractors. One final rule amends FAR 31.201-6, Accounting for Unallowable Costs, to provide criteria for the use of statistical sampling to identify unallowable costs. The criteria include use of an unbiased sample, and separate review of "any large dollar value or high risk transaction [which is] excluded from the sampling process." The final rule also states: "For any indirect cost in the selected sample that is subject to the penalty provisions at 42.709, the amount projected to the sampling universe from that sampled cost is also subject to the same penalty provisions." Thus, contractors subjected to penalties for unallowable costs could find penalty increases due to the use of statistical sampling. Another final rule amended FAR 31.205-35, Relocation Costs, to permit limited use of a $5,000 lump-sum reimbursement. However, that rule also states that lump-sum reimbursement for costs of finding a new home, travel to the new location, and temporary lodging "may be allowed … when adequately supported by data on the individual elements (e.g., transportation, lodging, and meals) comprising the build-up of the lump-sum amount to be paid …" This requirement appears at odds with the rationale underlying lump-sum reimbursement. Contractors with Time-and-Material and Labor-Hour contracts should pay close attention to the proposed revision to FAR 52.232-7. That proposed rule would preclude prime contractor profit or fee on subcontracted effort, and would permit the government to refuse any payment for subcontracted effort prior to the date the contractor obtains required government consent to enter into a subcontract. Contractors should also pay attention to the proposed change to FAR Part 45, Government Property. The proposed regulation would rewrite FAR Part 45 and would, among other provisions, apparently require government authorization for the contractor to dispose of any contractor inventory, not just "government property." Those CAS-covered contractors performing contracts overseas should take note that the CAS Board has invited comments on a staff discussion paper relating to the CAS exemption for contracts executed and performed entirely outside the United States and its possessions. Additional final and proposed regulation, as well as DCAA and OSD guidance, may be found in the attached index with web-links to the source documents.

III. Litigation On November 30, 2005, the U.S. Court of Federal Claims issued a decision in ATK Thiokol, Inc. v. United States, No. 99-440C, upholding the contractor's classification of certain costs as IR&D, and rejecting the government's position that costs implicitly required in contract performance must be accounted for as direct contract costs. The court set forth a detailed discussion of CAS 402, 420, and FAR 31.205-18, and the related case precedent, and stated:[T]he court has determined that whether IR&D costs are "required in the performance of a contract," within the meaning of CAS 420, is determined by the contracting parties' intent. Accordingly, the court declines to interpret "required in the performance of a contract" in the manner advocated by the Government, because doing so would undermine CAS 402, eliminating the primacy that the CAS Board intended the contracting parties intent to serve in the allocation of "Sometimes direct/Sometimes indirect" costs. Nor will the court interpret "required in the performance of a contract" in that manner for IR&D alone, because doing so would conflict with the identical phrase in the definition of B&P costs, required by the CAS Board's retention of CAS 402 and Interpretation No. 1, when CAS 420 was promulgated.The court's opinion is significant in putting to rest government attempts to disallow contractor IR&D costs as direct contract effort. Moreover, the court's opinion should provide support to contractors faced with claims under the civil False Claims Act such as United States v. Newport News Shipbuilding, Inc., 276 F. Supp. 2d 539 (E.D. Va. 2003). In response to a request by the court, Steve Knight of the firm submitted an amicus curiae brief on behalf of ATK, in his capacity as an Adjunct Professor with the George Washington University School of Law, LL.M. Government Procurement Program. Other noteworthy cases include Lockheed Martin Corp. v. England, No. 04-1461 (Fed. Cir. Sept. 21, 2005), in which the court ruled that FAR 49.202 does not allow a higher-tier contractor to recover fee for subcontractor effort under a CPFF contract termination. In MPR Associates, Inc., ASBCA No. 54689 (Oct. 27, 2005), the board decided that the ACO had entered into an oral settlement of allegedly unallowable lease costs, and denied the government's cost disallowance based on the "common control" provision of FAR 31.205-36(b)(3). The government argued that the ACO lacked authority to enter into an oral agreement that provided for cost allowability over the "common control" limitation, but the board disagreed. The board stated: "This is not a case where the ACO violated a plain requirement of a statute or regulation … There is no plain illegality here. The ACO was authorized to exercise his judgment in interpreting the regulations to resolve the rent issue under the cost principles."MPR is important because it demonstrates that oral agreements with the government may be binding under the right circumstances, and contracting officers have authority to exercise discretion to interpret regulatory requirements.

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For a complete list of Recent Developments in Government Contracts, please see the attached index with weblinks to the source documents. If you wish to discuss these or any other government contract issues, please contact the following individuals or view our website at www.smithpachter.com to view additional attorney biographical information:

John S. Pachter
703 847 6260
jpachter@smithpachter.com 		Stephen D. Knight
703 847 6284
sknight@smithpachter.com
Richard C. Johnson
703 847 6266
rjohnson@smithpachter.com		 Jonathan D. Shaffer
703 847 6280
jshaffer@smithpachter.com
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Edmund M. Amorosi
703 847 6268
eamorosi@smithpachter.com 		Erin R. Karsman
703 847 6316
ekarsman@smithpachter.com
Tamara F. Dunlap
703 847 6261
tdunlap@smithpachter.com		 David S. Stern
703 847 6264
dstern@smithpachter.com

LINKS TO RECENT DEVELOPMENTS IN GOVERNMENT CONTRACTS  

I. LEGISLATION

II. REGULATIONS AND POLICIES

III. CASES

IV. REPORTS

The information in this newsletter is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.