Contract Management October

Transcription

1 56 Contract Management October 2014

2 Contract Management October

3 Profit discussions are an important stage of government contract negotiations even more so because of the decreasing U.S. federal government budget. As federal agencies attempt to meet budget constraints, contractors may receive lower profit offers and experience more contentious profit discussions. Contracting officers are employing a relatively new rule concerning profit that may confound some contractors especially contractors that did not perform the now defunct cost-plus-award-fee facilities contracts. Nevertheless, contractors that comprehend the new rule and its application can obtain the greatest profit amount that the rule permits. This relatively new rule is found at Federal Acquisition Regulation (FAR) (c)(3) and was recently interpreted in the government s favor in the Armed Services Board of Contract Appeals (ASBCA) case Appeals of Space Gateway Support. 1 Based on FAR (c)(3) and the Space Gateway Support decision, contractors can expect contracting officers to challenge profit on contractor-acquired property to be charged directly to the contract. Prudent contractors must understand that the contracting officer cannot exclude profit on all contractor-acquired property to be charged directly to the contract, but only contractoracquired property categorized as equipment. Therefore, contractors need to categorize and disclose contractor-acquired property correctly in its proposal to preclude a contracting officer from disallowing available profit. Contractors must also decide whether to procure contractor-acquired property categorized as equipment with government funding, but without profit, or procure equipment with company funding and receive additional profit in accordance with the government weighted guidelines. Overview of FAR (c)(3) The ASBCA based its decision in Space Gateway Support on the rule stated in FAR (c)(3), formerly FAR (c). 2 FAR (c)(3) states: The contracting officer shall exclude from the pre-negotiation cost objective amounts the purchase cost of contractor-acquired property that is categorized as equipment, as defined in FAR , and where such equipment is to be charged directly to the contract. 3 Contractor-acquired property is property acquired, fabricated, or otherwise provided by the contractor for performing a contract and to which the government has title Contract Management October 2014

4 FAR defines equipment as: A tangible item that is functionally complete for its intended purpose, durable, nonexpendable, and needed for the performance of a contract. Equipment is not intended for sale, and does not ordinarily lose its identity or become a component part of another article when put into use. Equipment does not include material, real property, special test equipment, or special tooling. 5 Thus, based on the definition of equipment, profit is applied to contractoracquired property categorized as material, special test equipment, or special tooling, even if it is not a deliverable under the contract. Real property does not receive profit according to the facilities capital employed factor of the weighted guidelines. 6 Material is defined by FAR as: Property that may be consumed or expended during the performance of a contract, component parts of a higher assembly, or items that lose their individual identity through incorporation into an end-item. 7 FAR refers to Federal Management Regulation for the definition of real property, 8 which is defined as: used for general testing purposes or property that with relatively minor expense can be made suitable for general purpose. 10 Finally, FAR defines special tooling as: Jigs, fixtures, molds, patterns, taps, gauges, and all components of these items including foundations and similar improvements necessary for installing special tooling, and which are of such a specialized nature that without substantial modification or alteration their use is limited to the development or production of particular supplies or parts thereof or to the performance of particular services. 11 Background to FAR (c)(3) FAR (c)(3), published in 2010, replaced a similar rule stated in FAR (c), deleted in The former rule, FAR (c), stated: No profit or fee shall be allowed on the cost of facilities when purchased for the account of the government under other than a facilities contract. General purpose components of special tooling or special test equipment are not facilities. 13 Facilities were defined as: Any interest in land, together with the improvements, structures, and fixtures located thereon and appurtenances thereto, under the control of any federal agency. 9 FAR defines special test equipment as: Single or multipurpose test units engineered, designed, or fabricated, or modified to accomplish special purpose testing in performing a contract. Special test equipment consists of items or assemblies of equipment, including foundations and similar improvements necessary for installing special test equipment, and standard or general purpose items or components that are interconnected and interdependent so as to become a new functional entity for special testing purposes. Special test equipment does not include material, special tooling, real property, and equipment items [P]roperty used for production, maintenance, research, development, or testing. It includes plant equipment and real property. It does not include material, special test equipment, special tooling, or agencypeculiar property. 14 The government applied FAR (c) inconsistently because the definition of facilities contradicted the definition of plant equipment and real property. FAR Part 45 subdivided the term facilities into real property and plant equipment. 15 The Defense FAR Supplement (DFARS) further subdivided plant equipment into industrial plant equipment and other plant equipment. 16 When proposing the FAR Part 45 rewrite, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council explained that the policy directed by FAR (c) tended to be obfuscated by the Contract Management October

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6 term facilities. 17 Therefore, FAR (c) was deleted in Despite deleting FAR (c), the councils wanted to continue to exclude profit on contractor-acquired property. In order to continue this policy, the councils proposed revising the FAR to exclude all profit or fee on contractor-acquired property if it was not a deliverable under the contract. 19 This proposed rule was broader than the previous rule that, at a minimum, permitted profit on special tooling, special test equipment, material, and agency-peculiar property. 20 After receiving comments on the proposed rule, the councils revised the rule as currently published in the FAR and permitted profit on material, special tooling, and special test equipment. 21 The councils explained that including profit on contractor-acquired property that is categorized as equipment will unduly compensate the contractor for obtaining equipment it should already have and for risks it did not incur. 22 The councils referred to FAR and FAR (f) to support its position. 23 FAR states that contractors are ordinarily required to furnish all property necessary to perform government contracts, 24 and FAR states that [t]o be determined responsible, a prospective contractor must [h]ave the necessary production, construction, and technical equipment and facilities, or the ability to obtain them. 25 The Space Gateway Support Ruling In Space Gateway Support, the ASBCA examined whether FAR (c) and/or FAR (c)(3) bar a contractor s receipt of profit or award fee on the cost of the equipment it acquired for a government s account and utilized to perform production, maintenance, research, development, and/ or testing work under its services contract. 26 Beginning in 1998, Space Gateway Support, LLC, performed support services for the National Aeronautics and Space Administration (NASA) Cape Canaveral Spaceport under a cost-plus-award-fee contract. 27 In March and May 2005, the contracting officer directed Space Gateway Support to procure replacement core technical capability and propellants, petroleum, and gases equipment at dates earlier than set forth in the contract schedule to maintain the spaceport s laboratory and other capabilities. 28 The government reimbursed Space Gateway Support for the costs of the change orders, but declined to adjust the contract to include additional award fee. The government asserted that fee was barred by FAR (c). 29 As the contracting officer stated in the negotiation memorandum: Since the purpose of this acquisition is to accelerate the replacement of governmentfurnished equipment and utilize government funds rather than the contractor s own capital, no risk is associated with this acquisition and it is considered a passthrough cost. Award fee is not applicable to this action based on the premise that the government is replacing equipment that would have eventually been contractor-replaced and capitalized by the contractor. 30 Space Gateway Support s manager countered that the equipment procured fell within the exceptions of special tooling or special test equipment and, therefore, award fee was allowable. 31 The contracting officer contacted the NASA Industrial Property Office, which verified that the items were not special tooling or special test equipment and were considered plant equipment that was classified as facilities and did not receive profit. 32 In November 2006, Space Gateway Support asserted a Contract Dispute Act claim with the ASBCA for $121,000 for expected profit. 33 Contract Management October

7 In 2013, six years after Space Gateway Support filed its claim, five years after the deletion of FAR (c), and three years after the adoption of FAR (c)(3), ASBCA Judge Terrence S. Hartman issued an opinion denying Space Gateway Support the profit on the contractor-acquired facilities. 34 Judge Hartman explained that the former FAR (c) and the newly published FAR (c)(3) prohibited profit on government-reimbursed costs of facilities acquired to perform military contracts. 35 This policy existed because the military did not want to discourage contractors from using their own funds to invest in and acquire equipment or facilities necessary for the performance of military contracts. 36 For over 140 years, the government had not supplied its military contractors with equipment or other facilities, but expected its contractors to have obtained with their own funds all equipment and other facilities necessary for performance of contract work. 37 Furthermore, the government expected contractors to have the fixed capital necessary to successfully perform contracts awarded to them. 38 Contractors who are furnished equipment by the military to perform government contracts receive a significant benefit. 39 They have monies available to them to be utilized as operating or working capital that they otherwise would have expended for the acquisition of fixed capital. 40 They are also exposed to less risk with respect to contract performance than the contractor who uses its own equipment and facilities to perform a military contract. 41 Judge Hartman relied on two cases to justify his opinion: Mason & Hanger-Silas Mason Co. v. United States 42 and Newport News Shipbuilding & Dry Dock. 43 The Court of Claims in Mason & Hanger explained that a contractor invests its own funds in equipment and other facilities needed to perform contracts intending to make a profit. 44 In acquiring equipment and other facilities for its own account to perform military contracts, the contractor did not receive profit or fee on the costs incurred for equipment and facilities acquired. 45 Rather, it hoped to receive profit or fee on items produced with the equipment and facilities acquired. 46 The Court of Claims stated in Newport News that contractors are encouraged to perform with minimum financial, facilities, or other government assistance and, if this kind of crutch is provided, it must modify what is deemed a fair and reasonable profit. 47 The Space Gateway Support decision is important because it gives contracting officers precedent to challenge profit on contractor-acquired property categorized as equipment. Although FAR (c) (3) provides contracting officers with the authority to challenge profit on contractoracquired property categorized as equipment, contracting officers now know that the ASBCA will support the challenge. Contractor Response to Appeals of Space Gateway Support In order to obtain the maximum profit permitted by FAR (c)(3), contractors must correctly categorize the contractoracquired property within their proposals. Without proper disclosure, a government 62 Contract Management October 2014

8 auditor or contracting officer may categorize all contractor-acquired property as equipment and exclude profit on all contractor-acquired property. The burden rests on the contractor to explain if and why contractor-acquired property is special test equipment, special tooling, or material in order to obtain profit. It is the responsibility of a contractor s estimators and engineers to categorize the contractor-acquired property. The contracting officer bears the burden to exclude the profit from the government s pre-negotiation profit offer. 48 In furtherance of categorizing contractoracquired property, contractors may apply profit to contractor-acquired property that adheres to the following general factors: Delivered directly to the customer; Consumed or expended during contract performance; Use is limited to performance on one contract; Required specialized engineering, design, fabrication, modification, or alteration for use; and/or Cannot be disassembled with relatively minor expense to be made suitable for general purpose. To explain the new contractor-acquired property categories and the aforementioned factors, Prof. Douglas N. Goetz published several articles on the FAR Part 45 rewrite. Judge Hartman s Space Gateway Support opinion cites Goetz s articles and examples. 49 As explained by Goetz, examples of material include: [N]uts, bolts, screws, washers, transistors, resistors, diodes, capacitors, integrated circuits, bar stock, sheet metal, paper, lumber, propellers, batteries, silver, gold, cloth, gas, oil, hydraulic fluids, epoxy, paint, radar system, aircraft engines, and bullets. 50 The example of special tooling provided states Contractors may use the examples provided by Goetz in conjunction with the FAR definitions to assist with properly categorizing contractor-acquired property and obtaining the maximum profit permitted. Weighted Guidelines As explained by the councils and the ASBCA, FAR (c)(3) exists to encourage contractors to procure equipment with company funds. 53 FAR (c)(3), however, is not the only regulation that exists to incentivize this policy. The weighted guidelines facilities capital employed factor provides for a reward if a contractor procures equipment with company funds. 54 Contracting officers are required to use a structured approach for developing a pre-negotiation profit objective on any negotiated contract action when cost or pricing data is obtained. 55 The approach typically adopted is the weighted guidelines method. 56 The weighted guidelines method focuses on four profit factors: Performance risk, [A] generic drill bit in a holding fixture that is irremovable, plated with titanium, and coated with diamond swarf so that its only function is to drill holes into the composite wing coating of an F Contract type risk, Facilities capital employed, and Cost efficiency. 57 Goetz also provided a situation involving special test equipment : The contractor is in the process of developing the Next Generation tactical aircraft. In order to test the avionics planned for use on this aircraft, the contractor plans to design and fabricate special test equipment. The only use for this special test equipment is to test the avionics of the Next Generation tactical aircraft. The tests that are to be performed have never been used before and there are no commercial equivalents. The contractor designs the test set that includes general purpose equipment as well as special purpose test items, and incorporates all of these components into a larger rack, creating a new functional entity. 52 The facilities capital employed factor rewards a contractor for its capital investment in facilities that benefit the government. 58 To determine the appropriate rating for equipment within the facilities capital employed factor, the DFARS provides the evaluation criteria discussed as follows. 59 The contracting officer may assign a higherthan-normal value if the facilities capital investment has direct, identifiable, and exceptional benefits. 60 Indicators include new investments in state-of-the-art technology and investments in new equipment for research and development applications. 61 Thus, contractors need to decide whether to procure equipment with government funding, but without profit, or procure equipment with company funding and receive additional profit in accordance with the government weighted guidelines. Contract Management October

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10 Conclusion Based on FAR (c)(3) and the Space Gateway Support decision, contractors need to categorize and disclose contractoracquired property correctly in its proposal to preclude a contracting officer from disallowing available profit. Without proper disclosure, a government auditor or contracting officer may categorize all contractor-acquired property as equipment and exclude profit on all contractor-acquired property. The burden rests on the contractor to explain if and why contractor-acquired property is special test equipment, special tooling, or material in order to obtain profit. Estimators and engineers within the company must categorize the contractor-acquired property. The contractor s only precaution is to disclose the categorized contractor-acquired property in its proposal. The burden rests on the contracting officer to exclude the profit from the pre-negotiation profit offer. 62 Furthermore, contractors must decide whether to procure equipment with government funding, but without profit, or procure equipment with company funding and receive additional profit in accordance with the government weighted guidelines. Contractors that appropriately disclose, categorize, and charge contractor-acquired property will obtain all available profit during a period of limited funding. CM ABOUT THE AUTHOR GEOFFREY A. LAWSON, ESQ., LLM, CFCM, is a senior associate government contracts specialist in the Foreign Military Sales office at Sikorsky Aircraft Corporation. Prior to working at Sikorsky, he served in the government contracts office of a State Department contractor in Arlington, Virginia, where he traveled to Kabul, Afghanistan, and Islamabad, Pakistan. He is a graduate of Ohio Northern University College of Law and Miami University (Ohio). Send comments about this article to cm@ncmahq.org. ENDNOTES 1. Appeals of Space Gateway Support, LLC, ASBCA Nos , BCA P35, See BCA P35, FAR (c)(3). 4. Ibid., at Ibid. 6. Ibid., at (b)(1). 7. Ibid., at Ibid. 9. Federal Management Regulation, 41 C.F.R FAR Ibid Fed. Reg. 38,675, 38,678 (July 2, 2010) (to be codified at 48 C.F.R (c)(3)); 72 Fed. Reg. 27,364 (May 15, 2007). 13. FAR (c) (deleted 2007). 14. Ibid. 15. See Douglas N. Goetz, The Final Rule! The Rewrite of FAR Part 45 Government Property and its Associated Clauses, NPMA Property Professional (2007). 16. Ibid Fed. Reg. 38,675, 38,678 (July 2, 2010) (to be codified at 48 C.F.R (c)(3)) Fed. Reg. 27,364 (May 15, 2007) Fed. Reg. 39,263 (August 6, 2009). 20. FAR (c) (deleted 2007) Fed. Reg. 38,675, 38,678 (July 2, 2010) (to be codified at 48 C.F.R (c)(3)) Fed. Reg. 38,678 (July 2, 2010) (to be codified at 48 C.F.R (c)(3)). 23. Ibid. 24. FAR Ibid., at BCA P35, 232 at 172, Ibid., at 172, Ibid., at 172, Ibid. 30. Ibid.., at 172, Ibid Ibid Ibid., at 172, See BCA P35, Ibid., at 172, Ibid. 37. Ibid Ibid., at 172, Ibid., at Ibid. 41. Ibid Ct. Cl. 106, 518 F.2d Ct. Cl. 97, 374 F.2d 516 (1967). 44. Mason & Hanger-Silas Mason, op cit., at Ibid. 46. Ibid. 47. Newport News Shipbuilding, see note See FAR (c)(3). 49. See BCA P35, 232 at 172, Douglas N. Goetz, The Classification of Government Property Under the New FAR Part 45 Rewrite, NPMA Property Professional (2007). 51. Ibid. 52. Douglas N. Goetz, Special Test Equipment: A Counterpoint of Thought Regarding Definition, Policy, and Allowability, NPMA Property Professional (1998). 53. See FAR (c)(3). 54. DFARS (b)(1). 55. Ibid. 56. Ibid. 57. Ibid., at (a). 58. Ibid. 59. Ibid., at (g)(1). 60. Ibid., at (g)(2)(i). 61. Ibid. 62. See FAR (c)(3). Contract Management October