Subcontract and Material Vendor Costs. Steven M. Masiello Gale R. Monahan January 13, 2015

Transcription

1 Subcontract and Material Vendor Costs Steven M. Masiello Gale R. Monahan January 13, 2015 mckennalong.com

2 Subcontractor Cost Allowability Standards for Government Subcontracting DCMA/DCAA Subcontract Cost Allowability Positions Heightened Risk of Subcontract Reasonableness Challenge Cost Allowability Risks by Contract Type Commercial Item Subcontracting Invoices Material Costs Allowability of Counterfeit Parts Rework/Remediation Adequate Support for Subcontract Costs DCAA Sampling/Decrements Applicable Statute of Limitations Best Practices Questions 2

3 Standards for Government Contracting Subcontracts Contractors required to compete subcontracts to the maximum practical extent Despite Government insistence to the contrary, FAR procurement requirements do not apply directly to subcontracts (i.e., FAR Parts 12, 15, 16, etc.) But do provide guidance for supporting reasonableness Subcontractors must be responsible; not suspended or debarred Contractor discretion in selecting/establishing subcontract relationships but must use its proper business judgment Lack of compliance with purchasing procedures or effective subcontract administration creates risk of unallowable subcontract costs 3

4 Standards for Government Contracting Subcontract Cost Reasonableness Most challenged element in subcontractor cost allowability is reasonableness A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business (FAR (a)) Examples, government challenges of subcontract cost allowability: Used a contract type not identified in FAR Part 16 Contract was incorrectly identified as a commercial item contract Relevant memorandum not in file Ineffective subcontract administration/surveillance/documentation Inadequate cost or price analysis 4

5 DCMA/DCAA Subcontract Cost Allowability Positions DCMA/DCAA emphasis on subcontractor cost allowability Second guessing teaming arrangements/procurement decisions Reevaluation of subcontract price reasonableness determinations Deviations from established purchasing system practice results in unreasonable costs Allegations of ineffective subcontract administration Focus on lack of adequate documentation 5

6 Heightened Risk of Subcontract Reasonableness Challenge Kellogg Brown & Root Services, Inc. v. United States, No , (Fed. Cir. Sept. 5, 2013) Contractor Discretion Old Rule (e.g., Boeing Aerospace Operations, Inc., ASBCA No , 46275, 94-2 BCA 26,802) Costs may not be disallowed on the basis of unreasonableness if the contractor has acted within the scope of its discretion in a nonarbitrary manner. Government may not substitute its judgment for that of the contractor KBR Decision Courts are permitted to evaluate not only the process, but also employee decisions made implementing the process 6

7 Heightened Risk of Subcontract Reasonableness Challenge (Cont.) KBR Decision (cont.): Standard of Performance Old rule (e.g. Best Foam Fabricators, Inc. v. United States, 38 Fed Cl. 627 (1997)) Under cost-type contracts, contractors provided their best efforts Costs recoverable absent misconduct / gross negligence Supported by over 70 years of decisional law KBR Decision Strict application of FAR The words arbitrary, gross negligence, and willful misconduct do not appear in [FAR s] text. 7

8 Heightened Risk of Subcontract Reasonableness Challenge (Cont.) KBR Decision (cont.): Potential significance for contractors DCAA and contracting officers may attempt to substitute their post hoc judgment for that of the contractor Increases need to fully explain both reasonableness determinations and the context in which the determinations were made Even still, disagreements will occur 8

9 Subcontractor Costs Reasonableness Example Kellogg Brown & Root Servs., Inc. ASBCA No , 14-1 BCA (June 17, 2014) DCAA disallowed approx. $103M in subcontractor costs for private security in Iraq Amounts billed for private security amounted to 2.3% of total billings and were less than other contractors were charging Board held that costs were reasonably necessary to accomplish mission Board dismissed one government claim as untimely ($55M) Board awarded KBR $44M with interest 9

10 Risks by Subcontract Type Prime contractors possess discretion in the administration of subcontracts, including choice of contract type Contract types: Fixed price Time and materials ( T&M ) Cost reimbursement Commercial Item 10

11 Risks by Subcontract Type (cont.) Fixed price contracts: Provide for a firm price or sometimes an adjustable price May include a ceiling price, a target price, or both Issues: Negotiation Documentation 11

12 Risks by Subcontract Type (cont.) T&M contracts: Priced on the basis of direct labor hours at specified fixed hourly rates Hourly rates include wages, overhead, general and administrative expenses, profit and the actual cost of materials Issues: Negotiation Price reasonableness assessments and documentation Appropriateness of contract type Confirmations of expertise for labor categories billed Cost reimbursement of material costs

13 Risks by Subcontract Type (cont.) T&M contracts (cont.): Old Rule Subcontractor labor billed at contract labor rates improper Serco, Inc., CBCA No. 1695, 11-1 BCA (Jan. 14, 2011) (cannot bill subcontract labor under fixed rates; addressed by new regulation) All subcontractor labor must be charged at cost Post-2007 Rule Contractors entitled to opportunity to recover a profit on subcontractor work Composite rates for both subs and prime labor permitted but must be clear; DOD rule may require separate prices for labor 13

14 Risks by Subcontract Type (cont.) T&M contracts (cont.) Revenues often challenged for lack of support; i.e., contractor can t prove labor meets qualification requirements for labor rate FAR (a)(3) Labor hours incurred to perform tasks for which labor qualifications were specified in the contract will not be paid to the extent the work is performed by employees that do not meet the qualifications specified in the contract, unless specifically authorized by the Contracting Officer MRD 14-PPD-008(R) (May 2014) encourages auditors to question labor hours for work performed by underqualified workers; authorizes COs to negotiate value of labor provided 14

15 Risks by Subcontract Type (cont.) Cost reimbursement contracts FAR Subpart 31.2 A cost is allowable when it is: Reasonable Allocable Consistent with GAAP/CAS Consistent with the terms of the relevant prime contract Not made unallowable by one of the cost principles contained in FAR Subpart 31.2 Issues: Negotiation Reasonableness assessments and documentation 15

16 Commercial Item Subcontracting FAR , Subcontracts for Commercial Items, encourages commercial item subcontracting to the maximum extent practicable If services are of a type offered and sold competitively and items are of a type customarily used by the general public then they may qualify as commercial items Commercial item subcontracts exempt from certain requirements No TINA or cost analysis required to determine price reasonableness Commercial item subcontracting is beneficial to both prime contractors and subcontractors 16

17 Commercial Item Subcontracting (cont.) Commercial item determination must be documented Objective evidence and justification of commerciality and price reasonableness Procurement checklists Training Possible subcontract indemnity/certification to manage risks 17

18 Invoices Prime contractors must pay subcontractors in accordance with the terms of the prime contract and subcontract Lack of available data increases risk of disallowance of subcontractor invoiced costs Labor rate records Compensation system information 18

19 Material Costs Material costs include the costs of such items as raw materials, parts, sub-assemblies, components, and manufacturing supplies, whether purchased or manufactured by the contractor (FAR (a)) If purchased specifically for a contract, actual cost should be used If taken from inventory, any generally recognized method of pricing such material is acceptable if that method is consistently applied and the results are equitable DCAA/DCMA scrutiny of inter-company transfers Must occur at cost (FAR (e)) Transfer may occur at price if (FAR (e)): Established company practice is to transfer at price Certified cost or pricing data is not required (i.e. TINA exceptions) CO has not determined price to be unreasonable 19

20 Allowability of Counterfeit Parts Rework / Remediation Contractors are required to implement counterfeit parts detection, avoidance and reporting systems for electronic parts Typically, costs of rework and corrective action allowable unless: DFARS : cost of counterfeit or suspect counterfeit parts and the cost of rework or corrective action is unallowable Exception, if: Contractor has a reviewed and DoD-approved counterfeit parts detection and avoidance system; Counterfeit parts are government-furnished property; and Contractor provides timely notice to the government (60 days) 20

21 Adequate Support of Subcontract Costs DCAA regularly questions subcontract/material costs based upon broad allegations of lack of support Relevant requirements for documentation provide guidance to address allegations, including: FAR (d): Requires maintenance of adequate support and permits disallowance FAR : Requires records be made available for audit until three years after final payment or for a shorter period specified in FAR FAR Subpt. 4.7: Provides limited record retention requirements measured from fiscal year to which records relate BearingPoint, Inc., ASBCA No , 09-2 BCA 34,289 Contractor records need not be maintained in nice neat little files The FAR does not prescribe a particular form for records or other evidence supporting costs 21

22 DCAA Sampling / Decrements DCAA/DCMA increasingly employs decrements to recover alleged unsupported or unallowable subcontract/material costs Decrements are typically loosely based upon sampling results or previous audit findings Indirect costs sampling may be acceptable, but Sampling methodology may be incorrect Sampled items often generate inappropriate error rate based upon judgmentally applied criteria Direct costs decrement based on sample of broad populations of costs is likely improper No nexus to an unallowable direct subcontract cost incurred under specific contract 22

23 DCAA Sampling / Decrements (cont.) Recent DoD Inspector General s Office Hotline complaint led to finding that DCAA failed to comply with GAGAS DCAA found that $33M in subcontract costs were not supported based on sample of 70 invoices DCAA applied an arbitrary 20% decrement factor DCAA disallowed $6.6M in subcontract costs without sufficient evidence to support finding DCAA failed to consider contractor s rebuttals to audit findings DCAA should not consider subcontractor performance/delivery Focus should be on allowability, allocability and reasonableness DODIG did not state that decrements are not properly applied to direct costs 23

24 Application of Statute of Limitations Statute of limitations provides support to limit questioned costs for subcontracts Direct look at invoice date and level of detail Laguna Constr. Co., Inc., ASBCA No , 14-1 BCA 35,618 (Report identifying deficiencies in subcontractor management system commenced SOL) cf. Combat Support Associates, ASBCA No , 2014WL (Adequate support detail necessary to begin SOL) Indirect look at date of incurred cost submission Raytheon Space & Airborne Sys., ASBCA No , 13-1 BCA 35,319 But CSA decision says that adequate support detail is necessary for the government to know of claim 24

25 Application of Statute of Limitations (cont.) Statute of limitations provides support to limit questioned costs for subcontracts (cont.) Sikorsky Aircraft Corp. v. United States, No , 2014 WL (Fed. Cir. Dec. 10, 2014) SOL not jurisdictional, which may require resolution of staleness of disallowance with merits of government claim May permit parties to toll SOL to negotiate resolution prior to CO final decision 25

26 Best Practices Subcontract Costs Maintain copies of agreements, invoices and supporting documentation Establish and document source selection and fair and reasonable pricing Demonstrate need for subcontract services Material Costs Establish, document, and consistently apply a practice for costing material Ensure that material purchased specifically for contract performance is accounted for at actual cost If issued from inventory, be sure pricing is defensible, equitable Inter-Company Transfers If an inter-company transfer is to occur at cost, follow disclosed practices for applying indirect rates Inter-company transfers at price are heavily scrutinized document all aspects of the transaction, especially commerciality 26

27 Presenter Steven M. Masiello Gale R. Monahan