PCI Financial Forum Cost Reasonableness and Compensation Cost Update

Transcription

1 PCI Financial Forum Cost Reasonableness and Compensation Cost Update September 8, 2015 Steven M. Masiello Gale R. Monahan

2 Agenda Cost Reasonableness Overview Trends and Issues Best Practices Compensation Cost Reasonableness Compensation Costs Generally Trends and Issues Select Compensation-Related Rules Fair Labor Standards Act Service Contracts Act Davis Bacon Act Executive Orders 2

3 Cost Reasonableness Overview Why is cost reasonableness important? Reasonableness is a component of cost allowability Under cost reimbursement contracts, government only pays allowable costs If a fixed price solicitation requires certified cost or pricing data, only allowable costs may be used to develop/support price Including unallowable costs in vouchers or certain proposals may: Result in cost disallowances Result in system disapproval Subject contractors to penalties for expressly unallowable costs Cause fraud allegations 3

4 Cost Reasonableness Overview (cont.) What makes a cost reasonable? 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 Reasonableness considerations Is the cost ordinary and necessary for the conduct of the contractor s business or contract performance? Is the transaction consistent with: Generally accepted sound business practices Arm s-length bargaining, and Federal and state laws and regulations What are the contractor s responsibilities to the government, other customers, the owners of the business, employees, and the public? Has the contractor significantly deviated from established practices? 4

5 Cost Reasonableness Overview (cont.) What makes a cost reasonable (cont.)? No presumption of reasonableness for costs incurred Subject-specific guidance contained in cost principles; e.g., FAR (compensation) FAR (travel) Historically, the government has focused on contractor processes/ procedures Methods of contractor performance and business decisions (and resulting costs) typically not second guessed 5

6 Trends and Issues in Cost Reasonableness Government Evaluation of Contractor Cost Reasonableness Kellogg Brown & Root Servs., Inc. v. United States, 728 F.3d 1348 (Fed. Cir. 2013); Kellogg Brown & Root Servs., Inc. v. United States, 742 F.3d 967, (Fed. Cir. 2013), cert. denied, 135 S. Ct. 167 (Oct. 6, 2014) Contractor Discretion Old Rule (e.g., Boeing Aerospace Operations, Inc., ASBCA Nos , 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 Decisions Courts are permitted to evaluate not only the process, but also employee decisions made implementing the process 6

7 Trends and Issues in Cost Reasonableness (cont.) Government Evaluation of Contractor Cost Reasonableness KBR (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 Decisions Strict application of FAR The words arbitrary, gross negligence, and willful misconduct do not appear in [FAR s] text. 7

8 Trends and Issues in Cost Reasonableness (cont.) Government Evaluation of Contractor Cost Reasonableness KBR (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 Disagreements will likely occur regardless Documentation is critical KBR decisions significantly increases the risk of cost disallowance on the basis of reasonableness under cost-type contracts Contractor s bear the burden of proof Business Judgment Rule is not a safe harbor 8

9 Trends and Issues in Cost Reasonableness (cont.) Cost Reasonableness Disputes are Fact Intensive BAE Sys. S.F. Ship Repair, ASBCA No , 14-1 BCA 35,642, BAE Sys. S.F. Ship Repair, ASBCA No , 14-1 BCA 35,667 CO, not DCAA, has the final say on cost reasonableness DCAA s verification or acceptance of costs does not mean the costs are reasonable Decision was a denial of BAE s MSJ Bottom line: disputes regarding cost reasonableness are very likely to require a discovery and a hearing due to their factual nature 9

10 Cost Reasonableness Best Practices Establish and Consistently Apply Processes A key element of demonstrating cost reasonableness is establishing, maintaining, and consistently applying policies/procedures Compensation Subcontractor cost/price analysis Related determinations (e.g., commerciality) Internal approvals and audits integrated into processes to ensure that documentation of business decisions is complete Reinforce Processes with Training Regular training should occur on all policies/procedures Document and retain records of attendance 10

11 Best Practices (cont.) Document (fully) all Significant Procurement or Business Expenditure Decisions DCAA/DCMA take the position that if an action is not documented, it did not happen Use checklists to ensure that cost/price analysis occurs and is fully and consistently documented Checklists should generally track FAR Part 15 guidance for cost/price analysis Use pre- and post-negotiation memos to record and explain decisions, particularly when a cost/technical tradeoff is made For large expenditures, employ a review process to evaluate and approve the commitment and amount expended (including cost/price analysis) Employ a Record Retention Policy Ensures documentation will be available to support cost reasonableness 11

12 Best Practices (cont.) Anticipate Challenges to Cost Reasonableness All policies and practices should be designed with the expectation that DCAA will question the reasonableness of any significant expenditures (particularly direct costs) Challenges are becoming more common 12

13 Compensation Cost Reasonableness Compensation costs FAR : all remuneration paid currently or accrued, in whatever form and whether paid immediately or deferred, for services rendered by employees to the contractor FAR (d): includes compensation paid, or to be paid in the future, to employees in the form of: Cash Corporate securities Other assets, products, or services While generally allowable, the FAR contains detailed guidance and limitations on the allowability of specific forms of compensation 13

14 Compensation Cost Reasonableness (cont.) General criteria for allowable compensation Must be for work performed in the current year Total compensation for individual employees must be reasonable for the work performed Must be based upon/conform to contractor s established compensation plan or practice Must comply with other cost principles 14

15 Compensation Cost Reasonableness (cont.) General criteria for allowable compensation (cont.) Compensation costs subject to both: General test for reasonableness (FAR ) Specific reasonableness requirements (FAR ) Reasonableness factors include, but not limited to, conformity to practices of other firms of Same size Same industry and Same geographic area If requirements of FAR are met, requirements of FAR should be satisfied as well 15

16 Current Issues in Compensation Costs Government review of contractor compensation Compensation cap of $487K from Bipartisan Budget Act applies to all contractor employees, not just executives Contractors are now likely required to provide DCAA total compensation breakdown for all employees, not just executives Compensation is reasonable if the aggregate of each element amounts to reasonable total (FAR (b)(2)) DCAAM acknowledges that offsets are permitted A compensation element may be unreasonable, but total compensation may still be reasonable Unreasonable compensation elements are still high risk DCAA relies on 10% range of reasonableness test Rejected in recent decisions (Metron, Inc., ASBCA No , 12-1 BCA 34,920; J. F. Taylor, Inc., ASBCA No , 12-2 BCA 35,066) DCAA continues to apply this test 16

17 Current Issues in Compensation Costs (cont.) Executive compensation New compensation ceiling ($487K) effective on June 24, 2014 Final rule will likely be issued in 2015 Multiple ceilings may apply to a contractor depending on date of contract award and agency of award FY 2012, executive compensation cap = $952,308 Effective June 2013, cap for all employees = $952,308 Effective June 2014, cap for all employees = $487,000 DOD issued guidance stating that use of a blended rate approach is a practical and cost efficient solution for contractors to implement FAR requirements DCAA disagrees: DCAAM describes blended rate method as unacceptable and in violation of Anti-Deficiency Act Contractors should seek advance agreements prior to using a blended rate method 17

18 Select Compensation-Related Rules Cost reasonableness and compensation cost principles govern maximum allowable compensation costs the government will pay FLSA, SCA, DBA, and Executive Orders govern minimum compensation and other benefits contractors must provide employees Failure to adhere to applicable statutes and rules can have serious consequences, including suspension and debarment Labor and employment issues are an area of emphasis for the current Administration 18

19 Fair Labor Standards Act ( FLSA ) FLSA establishes minimum employment standards for employees of government contractors Minimum wage Exec. Order 13658/DOL regulations established the minimum wage at $10.10 for contracts awarded after Jan. 1, 2015 If applicable state minimum wage exceeds FLSA, employer must payer higher wage Overtime pay employees who work in excess of 40 hours per week must be paid 1.5 time their hourly wage unless exempted (executive, administrative and professional employees) Proposed DOL regulations may reduce scope of exemption by raising minimum salary ($50K) and require exempt employees to meet a duty test (high-level work only) Record keeping requires employers to keep employee time and pay records Three years for payroll records, collective bargaining agreements, sales and purchase records Two years for time cards, work/time schedules, records of wage additions/deductions Also requires employers to display FLSA poster in workplace 19

20 The Service Contract Act ( SCA ) McNamara-O Hara Service Contract Act of 1965, codified at 41 U.S.C Service Contract Act of 1965, as Amended (FAR ) Statement of Equivalent Rates for Federal Hires (FAR ) Fair Labor Standards Act and Service Contract Act - Price Adjustment (Multiple Year and Option Contracts) (FAR , -44, -46, -48, -49) Regulations describing the labor standards (29 C.F.R. Pt. 4) Department of Labor ( DOL ) guidance: 20

21 What is the SCA? According to DOL, intent of the SCA is to remove wages as a competition factor in government service contracts Establish minimum compensation for federal service employees Close the gap in labor standards Basic requirement: pay wages and fringe benefits at rates set forth in Wage Determination ( WD ) incorporated into federal contracts Applies to service contracts Wages and fringe in WD based on corresponding classes of laborers employed on similar projects in the area Administered by DOL Wage and Hour Division 21

22 Applicability SCA applies to all government service contracts in excess of $2,500 Includes any subcontract at any tier and must be flowed down When performing as a subcontractor, be aware of potential SCA requirements A service contract is any contract, the principal purpose of which is to furnish services through service employees Service employee = any person engaged in the performance of a service contract other than one employed in a bona fide executive, administrative, or professional capacity 22

23 Exemptions Contracts Performed outside the U.S. Transportation where published tariff rates are in effect Furnishing services by radio, telegraph, or cable companies subject to the Communications Act of 1934 Public utility services Contracts for delivery of goods subject to the Walsh-Healey Public Contracts Act (42 U.S.C ) Construction contracts subject to the Davis-Bacon Act (40 U.S.C ) 23

24 Wage Determinations ( WD ) Each WD identifies: Classes of service employees with corresponding wage rates Fringe benefit requirements Health and Welfare Holidays Vacations Wages and fringe required by WD generally are based on either: Wages and fringe that prevail in the locality Collective Bargaining Agreements In the absence of a WD, must pay federal minimum wage (FLSA) Usually included in RFP, if not included, ask CO for the WD CO may periodically provide revised WD Based on DOL determination that prevailing wages have increased May require increase in employee wages Revised WD can trigger right to equitable adjustment 24

25 Davis Bacon Act ( DBA ) Very similar to SCA Applies to government contracts in excess of $2,000 for the construction, alteration, or repair (including painting and decorating) of public buildings or public works Requires contractors to pay laborers and mechanics prevailing wages and fringe benefits listed in the applicable WD Related acts Many federal laws authorize federal assistance for construction through grants, loans, loan guarantees, and insurance Require application of DBA labor standards to most federally assisted construction projects Examples: Federal Aid Highway Acts, the Housing and Community Development Act of 1974, and the Federal Water Pollution Control Act 25

26 Consequences of Noncompliance Failure to comply with FLSA, SCA or DBA may result in Rejection of a proposal Breach of contract Potential grounds for termination for default Liability for deductions, rebates, refunds or underpayments (including nonpayment) of compensation CO may withhold the corresponding amounts needed to compensate such underpaid employees from accrued payments due CO may withhold from subject contracts or any other prime contract Government may sue for any remaining underpayments Suspension or debarment No government contract may be awarded for three years Debarment penalties apply to both the prime contractor and to any of its violating subcontractors Violators may appear in List of Parties Excluded from Federal Procurement and Nonprocurement Programs 26

27 Fair Pay and Safe Workplaces Executive Order Executive Order (July 2014) Requires agencies to consider contractors history of compliance with labor laws and state law equivalents when determining contractor responsibility DOL proposed regulations published in May 2015 Prior to Award Contractors bidding on procurement contracts in excess of $500K required to represent, to the best of the [their] knowledge and belief, whether there has been any administrative merits determination, arbitral award or decision, or civil judgment rendered against the contractor within the preceding three-year period for violations of the FLSA, SCA, DBA, ADA, ADEA, FMLA, NLRA, OSHA, Title VII of the Civil Rights Act and others, as well as equivalent state laws This information factored into the CO s responsibility determination Contractors required to disclose similar information for subcontractors on subcontracts (other than COTS items) valued over $500K Contractors required to include provisions in their subcontracts requiring subcontractors to disclose and update such information. 27

28 Fair Pay and Safe Workplaces E.O. (cont.) Post Award Contractors and subcontractors performing work on covered contracts must provide updated information every six months Information brought to the attention of the CO or the Labor Compliance Advisor may result in government action: Appropriate remedial measures Compliance assistance to avoid future violations Contract remedies, including government not exercising contract option, contract termination, or referral to the agency suspension and debarment official Dispute Resolution For contracts in excess of $1M, contractors cannot force employees to arbitrate employment disputes Applies to subcontracts exceeding $1M threshold Public comment period for proposed DOL regulation ended on Aug. 28 ABA cautioned against increased costs/burdened on contractors Council of Defense and Space Industry Associations advocated for withdrawal 28

29 Questions? Steven M. Masiello Partner Government Contracts Gale R. Monahan Managing Associate Government Contracts

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