By Stephen D. Knight
Smith Pachter McWhorter 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 weblinks to the source documents of these
and many more developments.
I. Legislation
Three statutes directly relevant to government contractors
became law recently. Those statutes continue familiar policies
favorable to government employees in the public/private competition
arena, but they also contain provisions that should worry
contractors: Congress is actively examining the possibility
of “contracting in” work now under contract,
for performance by federal employees.
In Section
343 of
the FY 06 DOD Authorization Act, Congress ordered DOD to “prescribe
guidelines and procedures for ensuring that consideration
is given to using Federal Government employees for work that
is currently performed or would otherwise be performed under
[DOD] contracts.” Congress instructed DOD to give “special
consideration” to contracts that: “(A) have been
performed by Federal Government employees at any time on
or after October 1, 1980; (B) are associated with the performance
of inherently governmental functions; (C) were not awarded
on a competitive basis; or (D) have been determined by a
contracting officer to be poorly performed due to excessive
costs or inferior quality.” Congress passed a similar
provision in Section
842(b) of
the FY 06 Transportation, Treasury and HUD Appropriations
Act. There, Congress ordered that OMB Circular A-76 “shall
provide procedures and policies for these [public-private]
competitions [to convert work from contract to federal employee
performance] that are similar to those applied to competitions
that may result in the conversion of work from performance
by Federal employees to performance by a contractor.”
The language in these provisions is problematic because
it is so broad. For example, under the criteria in the DOD
Authorization Act, any work that federal employees
performed at any time in the last quarter century,
that contractors now perform, must be given “special
consideration” for conversion to federal employee performance.
Similarly, contract work that is “associated” with
inherently governmental functions must be given such special
consideration, along with any contract “not awarded
on a competitive basis,” or determined by a contracting
officer to have excessive costs or inferior quality. Congress
provided no measures to indicate how “excessive” or “inferior” costs
and quality must be to qualify for “contracting-in.”
Title
VIII of
the DOD Authorization Act contains a number of acquisition
polices to expand congressional oversight of increased costs
in major defense acquisition programs (Sec.
801-802,
804),
and control over the treatment of a major weapon system as
a “commercial item.” In Section 805,
Congress sought to gain visibility into the role of “lead
system integrators” in major systems, focusing on organizational
conflicts of interest and the use of “pass-through
charges” by such integrators. Congress defined these
charges as “a charge for overhead or profit on work
performed by a lower-tier contractor (other than charges
for the direct costs of managing lower-tier contracts and
overhead and profit based on such direct costs) that does
not, as determined by the Secretary [of DOD] for purposes
this section, promote significant value added with regard
to such work.” This provision continues the attack
on prime contractor recovery of indirect costs and profit
on subcontractor effort. It is especially troubling because
DOD appears to have the discretion to determine what “does
not promote significant value added with regard to” subcontracted
work.
Section 841 of
the DOD Authorization Act orders GAO to “conduct a
review of efforts by [DOD] to identify and assess the areas
of vulnerability of [DOD] contracts to fraud, waste, and
abuse.” GAO must submit a report to Congress within
six months, including findings and recommendations. Section
847 establishes a consolidated Civilian Board of Contract
Appeals, in place of the numerous agency boards that previously
existed.
The FY 06 DOD Appropriations Act contains familiar provisions,
including Sections 8014 (“Limitation
on Conversion to Contractor Performance”), 8029 (public/private
competition for depot maintenance work), and 8030 (rescission
of blanket waiver of Buy American Act for products produced
in a foreign country). The DOD Appropriations Act also contains
Title
X ,
prohibiting “cruel, inhuman, or degrading treatment
or punishment” for any individual “in the custody
or under the physical control of the United States Government,
regardless of nationality or physical location.” This
provision defines cruel, inhuman, or degrading treatment
as that prohibited by the U.S. Constitution and other sources.
Contractors, especially contractors performing security functions,
must be alert to the fact that they may be considered “agents” of
the U.S. Government and open to liability for mistreatment
of any individual “in the custody or under the physical
control” of the government. Section 1004 provides
for a limited defense in any civil action or criminal prosecution
if the person charged “did not know that the practices
were unlawful and a person of ordinary sense and understanding
would not know the practices were unlawful.”
II. Regulations and Policies
Important regulatory proposals include several relating
to Cost Accounting Standards (CAS). On January 26, 2006 ,
the CAS Board invited comments on the staff discussion paper
regarding CAS 416, “Accounting for Insurance Costs.” 71
Fed. Reg. 4335 .
The focus of the paper is the use of the term “catastrophic
losses” in CAS 416 as opposed to the use of that term
in FAR 31.205-19. The concern is that the lack of a definition
in CAS 416 may lead to a requirement to allocate “catastrophic
losses” beyond the segment experiencing the loss, to
the segment’s home office, while FAR 31.205-19 will
render such allocated cost unallowable. The CAS Board staff
paper questions whether “catastrophic losses” in
CAS 416 should be changed to “significant” or “very
large.”
Another proposed CAS change is an exemption from CAS for
time-and-materials (T&M) and labor-hour (LH) contracts
for the acquisition of commercial items. 71
Fed. Reg. 313.
The proposed language would exempt from CAS “Firm fixed-priced,
fixed-priced with economic price adjustment (provided that
price adjustment is not based on actual costs incurred),
time-and-materials, and labor-hour contracts and subcontracts
for the acquisition of commercial items.” The CAS Board
noted that under the provisions of legislation and a proposed
FAR rule on T&M and LH contracts, “T&M and
LH contracts for commercial items must be awarded on a competitive
basis. In addition, the contracting officer is precluded
from obtaining cost or pricing data … Therefore, the
application of CAS, from a pricing standpoint, is similar
to a firm fixed-price contract awarded on the basis of competition
without submission of certified cost or pricing data.”
The CAS Board also published a proposed rule on adjustment
of dollar thresholds for CAS applicability, waiver authority,
and CAS Disclosure Statement requirements. 70
Fed. Reg. 73423.
FAR and DFARS regulators also published proposed changes
to dollar thresholds for applicability of various requirements.
70
Fed. Reg. 73415,
71
Fed. Reg. 3446.
DOD contractors should note the proposed DFARS change to
Earned Value Management Systems (EVMS) regulations. 71
Fed. Reg. 3449.
That proposal would apply various EVMS requirements to cost
or incentive contracts and subcontracts valued at thresholds
of $20 million and $50 million. Currently, EVMS requirements
apply to RDT&E contracts over $73 million, and procurement
or O&M contracts over $315 million.
Finally, on December 22, 2005 , DOD published proposed
rules on “Criminal Jurisdiction Over Civilians Employed
by or Accompanying the Armed Forces Outside the United States,
Service Members, and Former Service Members.” 70
Fed. Reg. 75998.
DOD followed this proposed rule with a related final rule
on February 22, 2006 . 71
Fed. Reg. 8946.
The final rule implements the Military Extraterritorial Jurisdiction
Act of 2000 which establishes federal criminal jurisdiction
over whomever engages in conduct outside the United States
constituting a felony “while employed by or accompanying
the Armed Forces outside the United States .” The final
rule corresponds to DOD Instruction 5525.11. Significantly,
the rule’s effective date is retroactive to March 3,
2005 , which could raise issues for contractors deployed
with the armed forces overseas.
III. Litigation
Contractors should pay attention to several recent cases
decided by the courts and boards recently. Some of the decisions
show the continuing difficulty contractors face in cost allowability
and cost allocability cases, especially at the Federal Circuit.
For example, in Information
Systems & Networks Corporation
v. United States,
the Federal Circuit reversed a Court of Federal Claims decision
in favor of the contractor on the allowability of tax payments
made by that S Corporation’s sole shareholder. The
court rejected the lower court’s examination of the
state code provisions establishing the purpose, structure,
and tax liabilities of an S Corporation. The lower court
had found that “the obligations of an S corporation
and its shareholders to pay state income taxes are therefore
closely intertwined, and an S corporation is very much required
to ensure the payment of its state income taxes. The rigid
argument that the tax liabilities of plaintiff and [the shareholder]
are completely separate does not suffice to prohibit reimbursement” under
FAR 31.205-41. The Federal Circuit reversed, stating: “The
plain language of [FAR 31.205-41(b)] states that taxes from
which the contracting entity is exempt are not allowable
costs. This is the case here. ISN is free from taxation on
[the shareholder’s] income derived from ISN’s
corporate dividends.” The Federal Circuit, contrary
to the detailed discussion by the Court of Federal Claims,
took an overly simplistic approach to FAR 31.205-41 and found
that ISN was “exempt” from state taxes.
In Richlin
Security Service Company v. Chertoff,
the Federal Circuit decided that a contractor cannot obtain
interest under the Contract Disputes Act “for amounts
found due” unless the contractor was out-of-pocket
on the underlying claim.
The Armed Services Board of Contract Appeals issued a decision
interpreting CAS 418 in AM
General LLC,
ASBCA Nos. 53610 , 54741 (February 2, 2006). That decision
upheld a DCAA challenge to the contractor’s single
manufacturing overhead pool as not in compliance with CAS
418’s homogeneity requirement. There, the undisputed
facts showed that declining government requirements for HMMWV
vehicles would have made the government’s price per
vehicle prohibitive. AM General, with the government’s
encouragement, launched a commercial version of the HMMWV,
known as the HUMMER, in order to subsidize the government’s
diminished requirements so that the company could continue
to produce HMMWV’s at an affordable price. The parties
incorporated AM General’s commercial program into their
negotiations.
At about the same time, the company changed its cost accounting
practice for accumulation and allocation of manufacturing
overhead to a single pool allocated over a units of production
base. The pool included costs of several sites, including “the
Armour building” which only housed commercial production.
DCAA objected to the single pool because of the inclusion
of the Armour building for allocation to all units. The ASBCA
agreed with the government in what appears to be an analysis
based solely on geography rather than the analysis of the
causal-beneficial relationship between the pooled costs and
cost objectives through the allocation base. The ASBCA stated: “[I]t
is undisputed that AM General’s indirect manufacturing
overhead cost pool included the indirect costs from the Armour
building. It is also undisputed that the military HMMWV derived
no benefit from the costs incurred in the Armour building
because none of the military HMMWVs were manufactured in
that building. Consequently, we agree with the government
that the indirect manufacturing overhead cost pool was
not homogeneous because the costs included therein did not
have the same or bear a similar beneficial or causal relationship
to all activities whose costs were included in the cost pool.”
The ASBCA decision jumps the track in comparing pooled
activities to other pooled activities, and its refusal to
analyze the functions of the activities in the single overhead
pool as related to the allocation base. CAS 418-50(b)(1)
states that an indirect cost pool is homogeneous “if
each significant activity whose costs are included therein
has the same or a similar beneficial or causal relationship to
cost objectives as the other activities whose costs
are included in the cost pool.” The proper analysis
is to examine the pooled activities vis-à-vis the
cost objectives; the expression of that relationship is the
allocation base. CAS 418-40(b)(c). Here, the ASBCA assumed
the government production units “received no benefit” because
the Armour building housed only commercial production. Yet,
the facts more than suggest that AM General’s commercial
production saved the military program from ending, because
the undisputed facts showed that the absence of the commercial
program would have meant that the military vehicles would
become cost prohibitive. The ASBCA did not perform the analysis
called for by CAS 418.
