Rules, Regulations, and Risks Government vs. Commercial Contracting BY Samuel G. Davidson AND Susan J. Moser 34
When transitioning from the commercial marketplace to the complex world of government procurement, a business must fully understand all of the rules, regulations, and risks. 35
In grade school, it used to be that the three R s stood for reading, riting, and rithmetic. But when contracting with the federal government, the three R s stand for something completely different rules, regulations, and risks. For businesses that plan to venture into the world of government procurement, it is imperative to first understand the three R s associated with the government s established procurement process. When a company s primary customers are federal agencies, understanding and dealing with the unique nature of federal requirements not only needs to become second nature, but also standard operating procedure. Processes, procedures, and corporate business practices should be specifically designed to comply with the Federal Acquisition Regulation (FAR), numerous agency guidelines, increasing government oversight, and voluminous regulations imposed on federal contractors. While this is certainly no small task for any company, a greater challenge exists when companies that have historically served commercial customers enter into the federal marketplace. In making any sort of commercial business decision, using sound common sense and consistently trying to do the right thing by your customer is generally the best way to go about achieving successful results. Unfortunately for companies entering the federal marketplace, it takes a greater understanding of the three R s of government contracting in order to be successful and to stay out of trouble. A number of high-profile incidents in recent years have seen contractors indicted or convicted of a host of charges, such as accepting kickbacks or bribes or overcharging a government agency. While many of these crimes are, in fact, serious offenses that result in fraud, waste, and abuse of our tax dollars, they often originate from a simple ignorance of a particular law or regulation. However, as we all know, ignorance is no excuse for breaking the law, and this lack of understanding is certainly heightened for companies who have not been immersed in the unique environment of the federal marketplace. An increasing number of historically commercial companies are now pursuing government contracts, and many have done so successfully. However, if a company does not fully comprehend the importance of the additional requirements involved, it can lead to real problems. While understanding some of the very significant differences between the commercial and federal marketplaces is an essential first step, adapting the business practices of a commercial entity to meet federal requirements can create even greater challenges. Increased Oversight in an Increasingly Hostile Environment Recent years have seen a significant increase in the level of oversight coming out of the government. Unlike commercial contracting, how a company prices its products and services, and how it performs on its government contracts, is no longer simply a matter between the company and the customer. Congress, the executive branch, the media, and special interest groups are continually placing federal contracts under greater scrutiny. Congressman Henry Waxman started this all off with his report, Dollars, Not Sense: Government Contracting Under the Bush Administration. Congressional hearings now occur on a day-to-day basis, and the Department of Justice has a Web site and a special corporate fraud task force aimed at uncovering contracting fraud. The Government Accountability Office has investigated Department of Defense interagency contracting programs with the General Services Administration, the Interior Department, and the National Aeronautics and Space Administration (NASA), and found all of them lacking. Also, the Defense Contract Audit Agency has, with fewer auditors, increased its audit coverage by over 40 percent over the last five years. Moreover, there is an additional incentive to turn in contractors for non-compliance. Whistleblowers can be awarded millions of dollars for reporting on contractors for misdeeds. Recent whistleblower cases have involved employees turning in their employers and competitors turning in each other. Criminal Sanctions Caveat emptor ( let the buyer beware ) does not apply when contracting with the government. As previously stated, dealings with the government are under greater scrutiny than ever before. Authorities are relying more and more on criminal prosecution, or a combination of civil and criminal actions, 36
Rules, regulations, and risks government vs. commercial contracting when they identify wrongdoings on the part of a contractor. Consider, for example, these four particular important laws that govern the federal procurement process: 1 The Anti-Kickback Act: This makes it a criminal offense for any subcontractor under a prime government contract to knowingly influence the award of a subcontract by making payments of any kind to any higher-level prime or subcontractor. These activities may be acceptable in the commercial market, but not when dealing with the government. 2 The False Statements Act: This declares it a criminal offense for a contractor to make false statements or provide false information to the government. It also provides for criminal penalties against individuals who submit false statements to the government. 3 The False Claims Act: Both criminal and civil penalties can be enforced under the False Claims Act against contractors who knowingly submit false claims for payment, or improperly and intentionally substitute specific products or services without the government s prior knowledge or consent. 4 The Sherman Antitrust Act: Bid rigging and collusive pricing are covered under the Sherman Antitrust Act. Corporate officers and directors can be held personally liable for the awareness of contract compliance violations and the conscious failure to address and resolve such violations. pricing restrictions In the commercial marketplace, a contractor is able to price its products and services based entirely on the impact of competition and what the buyer will agree to pay. Profit margins are theoretically unlimited and can be very lucrative. In the government marketplace, the contractor may lose the freedom to establish prices. There are legislated restrictions placed on the amount of profit a contractor can receive and ground When a company s primary customers are federal agencies, understanding and dealing with the unique nature of federal requirements not only needs to become second nature, but also standard operating procedure. rules have been established to define how profit levels are to be determined. Government levels of profit are almost entirely risk-based considering the level of contractor effort in the contract, the level of performance risk, the level of technology involved, the contractor s history of cost efficiency, and the amount of capital investment that the contractor will be required to make. Even the type of contract being established and who is assuming the risk of performance on time and on budget can impact the level of profit a contractor may receive. Under cost-type contracts, the government assumes a large share of the risk involved, whereas the contractor takes on the risk under fixed-price contracts. According to the FAR, cost-plus-a-percentage-of-cost contracts are illegal. 1 Experimental, developmental, or research contracts awarded on a cost-plus-fixed-fee (CPFF) basis have a profit limit of 15 percent, 2 profit on CPFF contracts for architectural and engineering services cannot exceed six percent, 3 and profit on all other CPFF contracts is limited to 10 percent. 4 There is no legislated limit on negotiated firm-fixedprice contracts, including time-and-material, labor-hour, or GSA Schedule contracts, that are all commercially-based procurements. 37
Rules, regulations, and risks government vs. commercial contracting This is a very complex area, and the correct procedure in terms of what can be done from a pricing standpoint; what is allowable in accordance with FAR Part 32, Contract Cost Principles; and how much profit is too much starts with fully understanding the contract type and the environment of the competition (e.g., full and open, sole-source, and commercial item competition, among others). changes and terminations One significant difference between contracting with the government and contracting with commercial organizations is the government s insistence on the right to make changes in work scope during contract performance. In return for this right, the government provides the contractor access to an equitable adjustment to the contract price and/ or schedule whenever a change is made that will increase or decrease the cost of contract performance or impact contract deliveries or completion. The equitable adjustment is also used to contractually remedy situations where the government is in breach of contract. During this change process, the contractor must continue to perform on the contract while awaiting relief from the government or be terminated for default. The government also has the right to terminate a contract for the convenience of the government or for default on the part of the contractor. Terminations for convenience allow some recovery of costs, but no recovery of lost profits. While, in theory, this may not appear to be a considerable area of risk to a contractor, the legal and accounting costs that are often incurred in getting a contractor made whole in a termination for convenience can be daunting and extraordinarily time consuming. disputes Consider this hypothetical scenario: you think that you have won your contract and start hiring people to ramp up for performance, when your competitor the one that was not chosen files a protest. Everything stops, no work is done on the awarded/ protested contract, additional expenses not planned for are incurred, and no revenue is received until the protest is resolved. The entire process is established to ensure that the contractor receives a fair opportunity to compete and be awarded government contracts. Protests are generally not the result of actions on your part, but the result of specific actions or inactions of the government s procuring agency. This can be due to the request for proposal being improperly issued or if the evaluation process was not done fairly and as stated. The list of possible reasons can go on and on. When an incumbent contractor protests, it can continue performing on his existing contract until the protest is resolved. It is your loss and their gain. In today s environment, such protests are a way of life. As a losing contractor who has spent large sums of money trying to win a contract and lost, the investment of a few more dollars for the chance of reversing the award is not a bad bet. In the commercial sector, the buyer has complete control over who is chosen and for what reasons. No one can question their decision and that decision cannot be reversed. conclusion Contracting with the federal government can be quite lucrative, and it is hard for a contractor to ignore the potential volume of business available. But prospective government contractors need to be aware of the three R s of government contracting before jumping in headfirst. CM About the Authors SAMUEL G. DAVIDSON is a director in Cherry Bekaert & Holland, LLP s Government Contractor Services Group. He can be reached at sdavidson@cbh.com. SUSAN J. MOSER, CPA, CITP, is the partnerin-charge of Cherry Bekaert & Holland, LLP s Government Contractor Services Group. She can be reached at smoser@cbh.com. Send comments about this article to cm@ncmahq.org. Endnotes 1. FAR 16.102(c). 2. 3. 4. FAR 15.404-4(c)(4)(i)(A). FAR 15.404-4(c)(4)(i)(B). FAR 15.404-4 (c)(4)(i)(c). 38