Smith Pachter McWhorter PLC
Government Contracts Update
Vol. II, No. 4 December, 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

Less than fifteen years after the high water mark of Acquisition Reform and just over twenty years after the then Democratically-controlled Congress passed the FY 1986 DOD Authorization Act placing significant burdens on contractors, Democrats have again assumed control of Congress with promises of increased scrutiny of contractors and the procurement process. The recently enacted FY 2007 DOD Authorization and Appropriation Acts, which became law before the mid-term elections, contain significant oversight provisions, but contractors can expect far more scrutiny from leading Democrats such as Rep. Henry Waxman.

The John Warner National Defense Authorization Act for Fiscal Year 2007, Pub. L. No. 109-364 (October 17, 2006), contains several items of significance to contractors. Section 802 requires DOD to assess long-term technical data needs for major weapons systems and subsystems, and to establish strategies for obtaining technical data. Section 802(b) also modifies the presumption of “development exclusively at private expense” by imposing on contractors and subcontractors the burden to provide information that “demonstrates that the item was developed exclusively at private expense.” This provision underscores the importance of a contractor’s record retention system that shows the funding of intellectual property development by the contractor.

Section 807 imposes limitations on lead systems integrators to respond to perceived organizational conflicts of interest problems. Section 813 requires DOD to establish a “Panel on Contracting Integrity” whose purpose is to conduct reviews of DOD progress “to eliminate areas of vulnerability of the defense contracting system that allow fraud, waste, and abuse to occur,” and to “recommend changes in law, regulations, and policy … necessary to eliminate such areas of vulnerability.” The panel will consist of representatives from DOD, the service acquisition executive of each military department, the DOD Inspector General, the Inspector General of each military department, and “each Defense Agency involved with contracting, as determined appropriate by the Secretary of Defense.”

Section 814 requires DOD to issue guidance “with detailed implementation instructions (including definitions)” on the appropriate use of award and incentive fees. The guidance shall link such fees to acquisition outcomes, establish standards for identifying the appropriate level of officials authorized to approve the use of award and incentive fees, provide guidance on circumstances in which contractor performance may be judged to be “excellent” or “superior,” establish standards for determining the percentage of fee available for “acceptable,” “average,” “expected,” “good” or “satisfactory” performance, and provide specific direction on the circumstances for “rolling over” award fees from one period to another.

In a provision somewhat reminiscent of a prominent issue from the 1980s – fixed price development contracts, Section 818 requires DOD to modify regulations regarding the determination of contract type for development programs. This provision authorizes the selection of either a fixed-price type contract or a cost type contract, but then, for use of a cost-type contract, imposes the requirement for a written determination that “the program is so complex and technically challenging” that a fixed-price type contract would not be practicable, given the level of program risk.

Section 842 addresses the “specialty metals” issue and, unless an exception applies, prohibits the use of appropriated funds for procurement of end items or components thereof “containing a specialty metal not melted or produced in the United States,” relating to aircraft, missile and space systems, ships, tank and automotive items, weapon systems, or ammunition. Section 842 imposes a similar prohibition on procurement of “a specialty metal that is not melted or produced in the United States and that is to be purchased directly” by DOD or a prime contractor. The prohibitions do not apply: (1) to the extent that the Secretary of Defense or the Secretary of the military department concerned determines that “compliant” specialty material cannot be procured as and when needed; (2) to procurements outside the United States in support of combat operations or contingency operations; (3) to procurements under the “unusual and compelling urgency of need” exception to competition; (4) to certain procurements necessary to comply with offset agreements with foreign governments; (5) to purchases not greater than the simplified acquisition threshold; and (6) to procurements of commercially available electronic components whose specialty metal content is “de minimis in value compared to the overall value of the lowest level electronic component produced that contains such specialty metal.” Significantly, Section 842 states that the prohibition “applies to procurements of commercial items.”

Section 842 permits DOD to accept noncompliant specialty metals incorporated into items before the date of the statute upon the contracting officer’s written determination that: “(i) it would not be practical or economical to remove or replace the specialty metals … or to substitute items containing compliant materials; (ii) the prime contractor and subcontractor responsible … have in place an effective plan to ensure compliance … and (iii) the non-compliance is not knowing or willful; and” the service acquisition executive approves the contracting officer’s determination.

Congress also instructed the GAO to submit a report by December 1, 2007, on employment of former DOD officials by major defense contractors, and to “assess the extent to which former officials of the [DOD] who served in acquisition-related positions were provided compensation by major defense contractors …” Section 851. Finally, in Section 852, Congress instructed GAO to submit a report in six months “on pass-through charges on contracts or subcontracts (or task or delivery orders)” entered into by DOD. This report must assess: “the extent to which [DOD] has paid excessive pass-through charges to contractors who provided little or no value to the performance of the contract”; “the extent to which [DOD] has been particularly vulnerable to excessive pass-through charges on any specific category of contracts or by any specific category of contractors”; “the extent to which any prohibition on excessive pass-through charges would be inconsistent with existing commercial practices for any specific category of contracts or have an unjustified adverse effect on any specific category of contractors.”

Section 852 further requires DOD to issue regulations not later than May 1, 2007, “to ensure that pass-through charges on contracts or subcontracts (or task or delivery orders) … are not excessive in relation to the cost of work performed by the relevant contractor or subcontractor.” DOD’s regulations would not apply to contracts or subcontracts awarded through adequate price competition or for acquisition of a commercial item.

Contractors are well advised to examine the definition of “excessive pass-through charge”: “with respect to a contractor or subcontractor that adds no, or negligible, value to a contract or subcontract, means a charge to the Government by the contractor or subcontractor that is for overhead or profit on work performed by a lower-tier contractor or subcontractor (other than charges for the direct costs of managing lower-tier contracts and subcontracts and overhead and profit based on such direct costs).”

DOD regulations required by Section 852 have the potential to upset and contradict decades of established cost accounting rules, regulations, and practices. The definition of “excessive pass-through charge” is fraught with subjective concepts such as “no or negligible value.” Section 852 not only resurrects the discredited “intrinsic value” concept from the 1980s, it also poses a significant risk of undermining the “benefit” and “beneficial or causal relationship” concepts underlying cost allocation theory in government contracts.

As problematic as these provisions from the FY 2007 DOD Authorization Act may be, legislation proposed by Democrats should concern contractors even more. A bill introduced by Rep. Waxman, H.R. 6069, the “Clean Contracting Act,” would signal a return to 1980s-era Congressional attitude regarding contractors. That bill would:

1. require FAR revisions to restrict to 240 days the contract period for a contract awarded under the “urgent and compelling” exception to competition;
2. require FAR revisions to mandate competition in award of individual purchases (i.e., a task order, delivery order or other purchase) in excess of $100,000 under a multiple award contract (including any IDIQ contract awarded to two or more sources), with such FAR revisions to apply to all individual purchases regardless of the effective dates of the multiple award contracts;
3. require each agency to develop and implement a plan to minimize the use of contracts entered into using procedures other than competitive procedures, with measurable goals;
4. require public disclosure of justification and approval documents and other determinations for noncompetitive contracts;
5. prohibit award of “monopoly contracts” (defined as a task or delivery order estimated to exceed $10,000,000 awarded to a single contractor);
6. require FAR revisions to “minimize the excessive use by contractors of subcontractors or tiers of subcontractors to perform the principal work” of any cost-reimbursement contract in excess of the simplified acquisition threshold;
7. require each agency to implement a plan to minimize the use of cost-reimbursement contracts;
8. restrict the use of commercial item authority;
9. restrict the use of “other transaction” authority;
10. require each agency to use an amount equal to one percent of the aggregate amount of contracts entered into by the agency during the fiscal year for, among other things, contract administration and oversight, and contract audits and enforcement;
11. impose additional restrictions on contracts for the performance of “a function relating to contract oversight”, where the contractor has a “conflict of interest” (defined to include a separate ongoing business relationship, such as a joint venture or contract, with any of the contractors to be overseen or any related entity);
12. require each agency to submit quarterly reports to Congress detailing audits or other reports that describe contractor costs in excess of $1,000,000 identified as “unjustified, unsupported, questioned, or unreasonable under any contract, task or delivery order, or subcontract” and the specific amounts so identified, as well as a list of audits that identify significant or substantial deficiencies in contractor performance or contractor business system;
13. require agencies to provide, within fourteen days of a Congressional request, unredacted copies of any documents “required to be maintained in the contracting office contract file, the contract administration office contract file, and the paying office contract file,” including source selection documentation, cost or price analyses, and audit reports;
14. change the Rules of the House of Representatives to require the Committee on Government Reform to hold hearings “to investigate credible evidence or allegations of waste, fraud, abuse, or mismanagement in Federal contracts, including allegations or evidence presented in reports by an Inspector General of a Federal agency, the Government Accountability Office, or the Defense Contract Audit Agency”;
15. restrict payment of award or incentive fees on “cost-based contract[s]” to “above-satisfactory performance”;
16. expand the “revolving door” prohibitions of the procurement integrity provisions of the OFPP Act Amendments; and
17. prohibit a contracting officer from finding that a contractor has a satisfactory record of integrity and business ethics if that contractor “has exhibited a pattern of overcharging the Government under Federal contracts; has exhibited a pattern of failing to comply with the law, including tax, labor and employment, environmental, antitrust, and consumer protection laws; or has an outstanding debt with a Federal agency in a delinquent status.”

Many of these provisions find their origin in 1980s-era policy, and pointedly roll back changes made during Acquisition Reform in the early 1990s. Contractors are well advised to scrutinize their compliance systems and ascertain that they have appropriate record-keeping to defend against the inevitable audits and investigations.

II. Regulations

Contractors should take note of several proposed and final regulations. For example, USAID published a proposed rule to limit post differential and danger pay allowances to extended workweeks under cost-type contracts, or contracts or task orders using another pricing structure but allowing for reimbursement of these allowances. 71 Fed. Reg. 62229. The proposed rule would limit such payments to a maximum 40-hour work week, regardless of whether the contracting officer has authorized a work week in excess of 40 hours.

FAC 2005-13 promulgated a rule to adjust various acquisition-related dollar thresholds. The regulation raises the threshold for submission of cost or pricing data from $550,000 to $650,000. 71 Fed. Reg. 57363.

On October 3, 2006, Shay D. Assad, Director, Defense Procurement and Acquisition Policy, issued a memorandum stating that his office is working with the military services, DCMA and DCAA to determine the full impact of the Pension Protection Act of 2006 on forward pricing rates and contract pricing. He expected guidance to be issued soon.

III. Litigation

In AM General LLC, on reconsideration the ASBCA granted the government’s motion to strike an expert affidavit on CAS 418 proffered by the contractor, citing prejudice to the government and the Federal Circuit’s decision in Rumsfeld v. United Technologies Corporation, 315 F.3d 1361 (Fed. Cir. 2003), cert. denied, 540 U.S. 1012 (2003). In the 2003 United Technologies decision, the Federal Circuit rejected the use of expert testimony on CAS interpretation issues, contrary to established case precedent at the boards of contract appeals and the court, as well as the provisions of the Federal Rules of Evidence. The court stated, “The views of the self-proclaimed CAS experts, including professors of economics and accounting … as to the proper interpretation of those regulations is simply irrelevant to our interpretative task; such evidence should not be received, much less considered, by the Board on interpretive issues. That interpretive issue is to be approached like other legal issues – based on briefing and argument by the affected parties.” Neither the court in United Technologies nor the ASBCA in AM General ventured to explain why testimony on such regulations is unacceptable when proffered by the contractor but acceptable when contained in a DCAA audit report. The courts and the boards are ill served by excluding such expert testimony.

LINKS TO RECENT DEVELOPMENTS IN GOVERNMENT CONTRACTS

I. LEGISLATION

III. CASES

IV. REPORTS