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Government Contracts Update:
Vol. II, No. 3 August, 2006
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
Although government contractors should follow closely the development of the various authorization and appropriations bills through Congress (see, e.g., Title VIII of the House and Senate passed versions of H.R. 5122, cited in the attached table of weblinks), Congress has created significant issues for contractors in the recent passage of pension and tax legislation. These pieces of legislation could cause major problems for various contractors in CAS compliance and cost recovery.
On August 17, 2006, President Bush signed into law the Pension Protection Act of 2006, Pub. L. No. 109-280. Generally, with respect to defined benefit plan funding, the purpose of this legislation is to force employers to increase funding by replacing current ERISA funding rules with new rules. The new rules require the employer to make a “minimum required contribution” for each plan year. Where the value of plan assets is less than “the funding target” (the present value of all benefits accrued or earned at the beginning of the plan year), the “minimum required contribution” is the sum of “the target normal cost” (the present value of all benefits which are expected to accrue or to be earned during the plan year) and the “shortfall amortization charge,” the amount necessary to amortize any shortfall over no more than seven years. Where the value of the plan assets equals or exceeds the funding target, the minimum required contribution is the target normal cost for the plan year reduced by such excess (but not below zero).
The Pension Protection Act also contains “special rules for plans of certain government contractors,” which would exempt certain government contractor plans from the new funding rules until the Cost Accounting Standards Board reviewed and revised CAS 412 and 413 “to harmonize the minimum required contribution under [ERISA] of eligible government contractor plans and government reimbursable pension plan costs not later than January 1, 2010.” To be eligible, a plan must be maintained by a corporation (“or a member of the same affiliated group”) “whose primary source of revenue is derived from business performed under contracts … subject to [FAR and DFARS], and whose revenue derived from such business in the previous fiscal year exceeded $5,000,000,000, and whose pension plan costs that are assignable under those contracts are subject to [CAS 412 and 413]."
Those contractors with defined benefit pension plans who cannot come within the exemption potentially face significant issues arising from the inconsistency between the new law and CAS 412 and 413 requirements. The new law essentially requires full funding, while contractor current cost accounting practices may not permit recovery of all the costs of such funding on cost-type contracts. Moreover, contractors may find that their fixed price contracts are now underpriced because of the increased funding requirements.
Another recently passed statute, the “Tax Increase Prevention and Reconciliation Act of 2005,” Pub. L. No. 109-222, imposes additional burdens on government contractors at the federal, state and local levels, by imposing a three percent withholding from every payment for goods and services. Section 511 of that statute states in part:
The Government of the United States, every State, every political subdivision thereof, and every instrumentality of the foregoing … making any payment to any person providing any property or services … shall deduct and withhold from such payment a tax in an amount equal to 3 percent of such payment.
The effective date of Section 511 is December 31, 2010. On the day that President Bush signed this Act into law, Sen. Larry E. Craig introduced S. 2821 to repeal Section 511.
Although the effective date of Section 511 is December 31, 2010, contractors should recognize the effect this provision could have on cash flow. Contractors should closely monitor regulations promulgated by the Internal Revenue Service to implement Section 511.
II. Regulations
Several recent regulatory actions are noteworthy, including the promulgation of FAC 2005-10. That circular includes a final rule requiring cost or pricing data submission for noncommercial modifications of commercial items, “if the total price of all such modifications under a particular contract action exceeds the greater of $500,000 or 5 percent of the total price of the contract.” Contractors should closely monitor their use of the commercial item exemption from cost or pricing data requirements to avoid government claims of defective pricing.
The Department of Defense published an interim DFARS rule with request for comments, entitled “Contractor Personnel Authorized to Accompany U.S. Armed Forces.” This rule addresses the status of contractor personnel accompanying the armed forces and discusses contractor personnel use of deadly force. Among other requirements, the interim rule mandates that “the Contractor accepts the risks associated with required contract performance in [dangerous and austere] conditions”; and that the contractor shall ensure that its personnel are familiar with and comply with U.S law, host country law, third country national law, treaties and international agreements, U.S. regulations, directives, instructions, policies and procedures.
III. Litigation
Recent decisions have favored contractors on a variety of issues, and have underscored the importance of contract draftsmanship. In Lear Siegler Service, Inc. v. Rumsfeld, the Federal Circuit reversed the ASBCA and held that the Service Contract Act price adjustment clause required the government to compensate a contractor for increases in the costs of defined benefit health plans. The court rejected the government’s argument that the clause was triggered only by enlarged benefits rather than the enlarged costs of providing those benefits.
While Lear Siegler concerned a standard clause, other cases considered language drafted by the parties. In Wesleyan Co. v. Harvey the Federal Circuit also found that the ASBCA had jurisdiction to consider the breach of a confidentiality agreement if such an agreement was incorporated into purchase orders. That case concerned the Army’s purchase of prototype hydration systems for testing, and the allegation that the Army had disclosed the contractor’s proprietary information to competitors. The court sent the case back to the ASBCA to determine whether the purchase orders contained a confidentiality agreement and, if so, to take jurisdiction of the contractor’s claim under the Contract Disputes Act.
The GSBCA rejected the government’s refusal to pay for a third year of a storage area network lease under an unexercised option in Northrop Grumman Computing Systems, Inc. v. GSA. The contract restricted the government’s right to exercise the option by requiring the government to “use its very best efforts to effect an extension of each lease …” The GSBCA stated that “very best efforts” required “the party put its muscles to work to perform with full energy and fairness the relevant express promises and reasonable implications therefrom.” The board found that the government had not used its very best efforts when it decided not to fight for funds necessary to continue the lease.
Contractors should note the government’s increased aggressiveness in defective pricing claims. In Lord Corporation, the ASBCA denied the contractor’s motion for summary judgment based on a government claim apparently involving overstatement of cost estimates. Settled law establishes that the government may not maintain a defective pricing case against the contractor when the alleged overstatement is an estimate, because an estimate does not fall within the definition of “cost or pricing data.” Notwithstanding this case precedent, government auditors have been aggressive in attempting to characterize estimates as “facts” that would support a government claim. In Lord, the ASBCA decided that a fully developed record was necessary to properly adjudicate the government’s claim.
In United Technologies Corporation, Pratt & Whitney, the ASBCA considered the Federal Circuit’s instructions on remand to address the contractor’s need to show “affirmative misconduct on the part of the government” to support an estoppel defense against a government CAS claim. The ASBCA rejected the contractor’s estoppel defense based on the lack of facts to support a finding of the government’s affirmative misconduct. The decision is significant to contractors for a number of reasons. First, a close reading of the facts shows that, in order for the contractor to argue that the government had knowledge of certain cost accounting practices, the contractor must show in some detail the government’s consideration of those practices. In the future, if a contractor intends to argue that the government was aware of contractor practices, the contractor is well advised to “spell it out” to the government so no doubt will exist of the government’s awareness.
Second, no doubt the government will argue that the “retroactive cost disallowance doctrine,” an estoppel defense discussed in Litton Systems, Inc. v. United States, 449 F. 2d 392 (Ct. Cl. 1971), is all but dead, but such a government position would be premature. The ASBCA went to some length to distinguish the United Technologies decision from Litton and its progeny. Contractors should realize, however, that the United Technologies decision is not entirely clear on when contractors must show government affirmative misconduct to support an estoppel defense.
The above two observations lead to the third: resolution of cost accounting issues just became more difficult for contractors. Contractors must increase their efforts to make facts plain through detailed documentation, and must assume an increased burden to defend against government cost accounting claims.
Finally, in United States v. Stein, a federal court determined that the Department of Justice violated defendants’ rights to effective assistance of counsel and to a fair trial under the Constitution, by pressuring their employer, KPMG, not to advance legal defense costs to those defendants. KPMG had long paid for legal defense costs of its personnel, regardless of the cost and whether the personnel were charged with crimes. In this case, however, DOJ followed an internal memorandum (the Thompson Memorandum), binding on all federal prosecutors, which obliged prosecutors to consider advancement of legal fees by companies as indicative of an attempt to protect culpable employees, and as a factor in favor of indicting the company. The court stated:
And the only question now before the Court is whether a criminal defendant has a right to obtain and use in order to prepare a defense resources lawfully available to him or her, free of knowing or reckless government interference. Given all that has been said above, this Court concludes that such a right is basic to our concepts of justice and fair play. It is fundamental.
The court’s decision is, without a doubt, correct. The Thompson Memorandum pitted companies against their employees and operated with especial unfairness on government contractors. This is so because companies that do business with the government are subject to suspension and debarment – often a corporate death sentence – on no more than an indictment. Prosecutors know that contractors will go to great lengths to avoid suspension and debarment, and they seek to take advantage of that fact.
LINKS TO RECENT DEVELOPMENTS IN
GOVERNMENT CONTRACTS
I. LEGISLATION
- H.R. 5122, “John Warner National Defense Authorization Act for Fiscal Year 2007” (passed by Senate, June 22, 2006)
- H.R. 5122, “G.V. ‘Sonny’ Montgomery National Defense Authorization Act for Fiscal Year 2007” (passed by House, May 11, 2006)
- H.R. 5441, “Making Appropriations for the Department of Homeland Security for the Fiscal Year Ending September 30, 2007” (passed by Senate, July 13, 2006)
- H.R. 5699, “Patriot Corporations of America Act of 2006” (June 28, 2006)
- H.R. 4356, “Emergency and Disaster Assistance Fraud Penalty Enhancement Act of 2005” (June 21, 2006)
- Pub. L. No. 109-222, “Tax Increase Prevention and Reconciliation Act of 2005;” S. 2821, “Withholding Tax Relief Act of 2006” (May 17, 2006)
- S. 2794/H.R. 5362, “Department of Energy Contractor Employee Equitable Treatment Act of 2006” (May 11, 2006)
- H.R. 5505, “Federal Contract Accountability Act” (May 25, 2006)
II. REGULATIONS & POLICIES
- Final Rule, FAC 2005-11, 71 Fed. Reg. 38238 (July 5, 2006)
- Notice, “Renegotiation Board Interest Rate; Prompt Payment Interest Rate; Contract Disputes Act,” 71 Fed. Reg. 37638 (June 30, 2006)
- Final Rule, FAC 2005-10, 71 Fed. Reg. 36922 (June 28, 2006)
- Interim Rule, “DFARS: Contractor Personnel Authorized to Accompany U.S. Armed Forces,” 71 Fed. Reg. 34826 (June 16, 2006)
- Proposed Rule, “FAR: Contractor Personnel in a Theater of Operations or at a Diplomatic or Consular Mission,” 71 Fed. Reg. 40681 (July 18, 2006)
- Proposed Rule, “FAR: Contract Terms and Conditions Required to Implement Statute or Executive Orders – Commercial Items,” 71 Fed. Reg. 42344 (July 26, 2006)
- DCAA Memorandum, “Audit Guidance on Revisions to FAR Subpart 31.201-6 Allowing Contractors to Use Statistical Sampling to Identify Unallowable Costs” (April 14, 2006)
III. CASES
- Lear Siegler Services, Inc. v. Rumsfeld, No. 06-1080 (Fed. Cir. July 28, 2006) (reversing ASBCA and holding that SCA Price Adjustment Clause required government to compensate contractor for increases in defined-benefit health plan costs)
- Wesleyan Co. v. Harvey, No. 05-1522 (Fed. Cir. July 17, 2006) (ASBCA had jurisdiction to consider breach of confidentiality agreement if such agreement was incorporated into purchase orders)
- Applied Companies v. Harvey, No. 05-1511 (Fed. Cir. July 14, 2006) (contractor not entitled to share in future savings under VECP clause)
- City Crescent Limited Partnership v. United States, No. 05-580C (COFC July 10, 2006) (government liable under Tax Adjustment clause of building lease for Baltimore supplemental annual property tax)
- Viacom, Inc. v. United States, No. 01-79C (COFC May 8, 2006) (application of original and revised CAS 413.50(c)(12) pension adjustments for segment closings)
- Spacehab, Inc., ASBCA No. 54880 (July 12, 2006) (ASBCA denies NASA summary judgment motion on contractor claim for hardware lost in space shuttle accident)
- Northrop Grumman Computing Systems, Inc. v. GSA, GSBCA No. 16367 (June 26, 2006) (“very best efforts” language required agency to fight for funds to exercise option)
- Lord Corporation, ASBCA No. 54940 (June 7, 2006) (denying contractor’s summary judgment motion in defective pricing case where government claim based on error)
- L-3 Communications Link Simulation and Training, ASBCA No. 54798 (May 23, 2006) (final pricing required by CLIN under terms of FPI contract)
- United Technologies Corp., ASBCA Nos. 47416 et al. (May 12, 2006) (rejecting contractor’s estoppel defense to government CAS claim)
- United States v. Stein, No. S1 05 Crim. 0888(LAK) (SDNY June 26, 2006) (DOJ’s Thompson Memorandum violated defendants’ Sixth Amendment right to counsel)
- United States v. Dynamics Research Corp., Civ. No. 03-11965-NG (D. Mass. July 17, 2006) (denial of contribution and indemnification claims in FCA and AKA proceeding)
- Fleming Steel Co. v. W.M. Schlosser Co., Civil Action No. 02-828 (WD Pa. July 10, 2006) (FAR supercedes subcontract provisions)
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.
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