Allowability of Subcontractor/ Consultant Costs and the Challenges Presented for Procurement System Management

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2 Allowability of Subcontractor/ Consultant Costs and the Challenges Presented for Procurement System Management Breakout Session #: B11 Presented by: Melanie Burgess and Phillip Seckman Date: July 22, 2013 Time: 2:30-3:45 p.m.

3 Speaker Introductions Melanie Burgess, CPA, CPCM, CFCM, Fellow Phillip Seckman, JD, CPCM 2

4 Agenda or Objectives Defining Subcontract Professional Services Purchasing System Attributes Case Law Best Practices The Bottom Line 3

5 Defining Subcontract FAR Part 2 FAR Part 2 under Contract Contract means a mutually binding legal relationship obligating the seller to furnish the supplies or services and the buyer to pay for them. It includes all types of commitments that obligate the Government to an expenditure of appropriated funds and that, except as otherwise authorized, are in writing. In addition to bilateral instruments, contracts include (but are not limited to) awards and notices of awards; job orders or task letters issued under basic ordering agreements; letter contracts; orders, such as purchase orders, under which the contract becomes effective by written acceptance or performance; and bilateral contract modifications. 4

6 Defining Subcontract, cont d. FAR Part 44 FAR Part 44 Subcontract (44.101) Subcontract means any contract as defined in Subpart 2.1 entered into by a subcontractor to furnish supplies or services for performance of a prime contract or a subcontract. It includes but is not limited to purchase orders, and changes and modifications to purchase orders. Subcontractor means any supplier, distributor, vendor, or firm that furnishes supplies or services to or for a prime contractor or another subcontractor. 5

7 Defining Subcontract, cont d. FAR Part 44 FAR Section Defines a subcontract as any contract as defined in Subpart 2.1 entered into by a subcontractor to furnish supplies or services for performance of a prime contract or a subcontract. A subcontract exists for purposes of the subcontracting provisions contained in a prime contract only when an agreement is entered into for the specific purpose of furnishing supplies or services required to perform a government contract or subcontract. By contrast, a contract that supports general business operations and/or supports multiple prime contracts should not be considered a subcontract. 6

8 Defining Subcontract, cont d. Anti-Kickback Act The FAR expands the definition of subcontract in certain circumstances. In implementing the Anti-Kickback Act, FAR explicitly provides that subcontractor includes any person who offers to furnish or furnishes general supplies to the prime contractor. Meaning of Subcontract also adjusted in FAR Part 12 The difference in language is meaningful. FAR Part 44 subcontracts are specifically for performance of the requirements of a prime contract. 7

9 Defining Subcontract, cont d. B&P / IR&D Costs The proper accounting and allowability of IR&D and B&P costs turns upon a phrase similar to the language used in the FAR Part 44 definition of subcontract, i.e. furnished... for the performance of a prime contract or subcontract. (FAR ) CAS states The basic unit for the identification of IR&D and B&P costs shall be the individual IR&D or B&P project. CAS states IR&D and B&P project costs shall include (1) costs, which if incurred in like circumstances for a final cost objective, would be treated as direct costs that final cost objective. 8

10 Defining Subcontract, cont d. B&P / IR&D Costs Efforts are IR&D or B&P depending upon, among other things, whether the nature of the purported IR&D or B&P work is required in the performance of a contract. (48 CFR ; FAR ). This similar phrasing in the context of IR&D and B&P has been interpreted to mean that the effort must be specifically required to accomplish the express requirements of the contract. 9

11 Defining Subcontract, cont d. Cost Principles FAR Part 31 does not define subcontract or subcontractor. Defines Professional and consultant services. FAR Professional and consultant services means those services rendered by persons who are members of a particular profession or possess a special skill and who are not officers or employees of the contractor. [S]ervices are generally acquired to obtain information, advice, opinions. Unlike other FAR sections which include language regarding direct subcontracts, FAR does not include this language. 10

12 FAR Professional Services Largely interpreted to apply to indirect costs only. Some auditors are applying the cost principle to direct subcontractors. Paragraph (f) states Fees for services rendered are allowable only when supported by evidence of the nature and scope of the service furnished. However, retainer agreements generally are not based on specific statements of work. Evidence necessary shall include: Details of all agreements Invoices including sufficient detail as to the time expended and nature of the actual services provided, and Consultants work products and related documents. 11

13 FAR Professional Services, cont d. To safeguard against audit questions arising later: Ensure standard agreements state the work to be performed, pay rate, and billing terms for non-labor costs. Request detailed invoices based on contract type bill rate, hours worked, summary of work performed, dates worked, total invoiced, non-labor expenses with receipts. Retain evidence of work performed s, expense reports, work product. 12

14 FAR Professional Services, cont d. When do legal and other professional services become unallowable? Important to note the differences between FAR and When considered a professional service must comply with FAR When a covered legal proceeding exists, you must look to FAR

15 FAR Unallowable Costs Related to Legal Proceedings Certain professional consulting services costs are unallowable when incurred in connection with a covered legal proceeding. The term costs defined broadly. Includes inhouse and outside counsel, and accountants, consultants, or others if retained to assist with the proceeding. 14

16 FAR Unallowable Costs, cont d. Key to compliance is the primary purpose test. If the primary purpose of internal or external effort relates to a covered proceeding, the costs must be segregated and treated as unallowable. Note Defense and settlement costs may later be claimed as allowable in certain cases. 15

17 Purchasing System Attributes Purchasing System contractor s system(s) for purchasing and subcontracting, including make-or-buy decisions, selection of vendors, analysis of quoted prices, negotiation of prices, placing/administering orders, and expediting delivery of orders. Approved Purchasing System a purchasing system that has been reviewed and approved in accordance with FAR Part 44 and, when applicable, complies with the system criteria in DFARS (c). DFARS Business System Rule sets forth 24 criteria for a purchasing system to be acceptable. 16

18 Purchasing System Attributes, cont d. Note that agreements with professional and consultant services that are not directly in performance of the prime contract are not subcontracts. Accordingly, within the company, define what is considered a: Subcontract; and What is not a subcontract. Determine when to issue: Purchase Orders. Subcontracts. Consulting Agreements. 17

19 Purchasing System Attributes, cont d. Just because it is not a subcontract does not mean purchasing system best practices should not apply. Document how you determined the price to be fair and reasonable. Comparison with in-house costs. Comparison with other companies. Comparison with historical prices paid. Develop standard terms and conditions. By purchase type. By contract type. 18

20 Purchasing System Attributes, cont d. Prime contract flow down determination. Not all clauses need to be flowed down to subcontractors. When you have an indirect consulting agreement, it is not a subcontract and, therefore, FAR clauses are not required. Small businesses should pay heed to purchasing system requirements. Necessary to support costs. Easier transition to large business status. Company will be more desirable for acquisition. 19

21 Relevant Case Law Tip Top Construction Tip Top Construction, Inc. v. Donahoe Adheres to the Bill Strong Enterprises Inc. v. Shannon. Confirms that the primary purpose and allocation test are the dividing line between FAR and To assess the allowability of third party costs, the question is whether the genuine purpose of the costs is materially furthering the negotiation process. Other notable cases Southwest Marine Inc. v. U.S. In re Fire Security Systems, Inc. 20

22 Relevant Case Law Bearing Point Involves costs incurred in under a support contract in Iraq. USAID questioned allowability of certain subcontractor costs ($4.5 million of $5.3 million claimed) based on lack of written documentation. Subcontractor costs incurred for logistical support in country on a T&M basis. The board confirmed that support for subcontractor costs does not demand nice, neat little files. 21

23 Relevant Case Law Hydrothermal Energy Corp Contract to develop a geothermal heating system was terminated for convenience. DoE questioned allowability of labor costs due to lack of timesheets support hours incurred. DoE questioned allowability of applied indirect costs. Court ruled in favor of Government and demanded that some costs already paid to the contractor be refunded. Documentation required according to ruling: Summary of time worked is sufficient in lieu of daily timesheets. Segregation of types of costs or by activity. Evidence of payment to subcontractors. 22

24 Best Practices For Indirect Consultants Prepare invoice templates that include the information described in slide 12. Be willing to gather competitive rates to support your rate as fair and reasonable. Negotiate contract terms with clients wanting you to sign their standard subcontract agreements. Most of these agreements are designed for direct type work and include terms that should not apply to you. Resist accepting FAR, DFARS, and other flowdowns that are not mandatory. 23

25 Best Practices for Contractors Write and follow purchasing policies and procedures. Consider whether there should be differences between practices for subcontracts v. other agreements. Even when an indirect consulting agreement is at issue, certain best practices should be followed. Understand the requirements for an adequate/approved purchasing system under the FAR and DFARS. 24

26 Best Practices for Contractors, cont d. Require indirect consultants to provide detailed invoices and receipts. Provide clear direction or an invoice template. Reject invoices that do not comply with your requirements. Obtain and retain engagement letters. 25

27 Best Practices for Contractors, cont d. For outside counsel invoices, note: Invoices from counsel can, and frequently do, contain information that is subject to either the attorney client communication and/or work product privilege. Invoices from counsel should not be provided unless appropriate redactions are made. This is consistent with recent DCAA guidance. When a request for invoices is made, contractors should resist but express willingness to find an alternative means to enable audit to confirm compliance with FAR

28 The Bottom Line Auditors are continuing to heavily test consultant and legal expenses. Subcontractor costs are also regularly tested for compliance with the terms of the contract and subcontract. May need to defend against the application of FAR

29 QUESTIONS?? Melanie Burgess President, Burgess Consulting, LLC Phillip Seckman Partner, McKenna, Long & Aldridge, LLP 28