subcontract and material vendor costs
TRANSCRIPT
mckennalong.commckennalong.com
Steven M. Masiello
Gale R. Monahan
January 13, 2015
Subcontract and Material Vendor
Costs
• 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
Subcontractor Cost Allowability
2
• 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
Standards for Government Contracting –
Subcontracts
3
• 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 § 31.201-3(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
Standards for Government Contracting –
Subcontract Cost Reasonableness
4
• 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
DCMA/DCAA Subcontract Cost Allowability
Positions
5
• Kellogg Brown & Root Services, Inc. v. United States, No.
2012-5106, -5115 (Fed. Cir. Sept. 5, 2013)
– Contractor Discretion
• Old Rule (e.g., Boeing Aerospace Operations, Inc., ASBCA
No. 46274, 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
Heightened Risk of Subcontract
Reasonableness Challenge
6
• 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 § 31.201-3
– “The words ‘arbitrary,’ ‘gross negligence,’ and ‘willful misconduct’ do not
appear in [FAR § 31.201-3’s] text.”
Heightened Risk of Subcontract
Reasonableness Challenge (Cont.)
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• 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
Heightened Risk of Subcontract
Reasonableness Challenge (Cont.)
8
• Kellogg Brown & Root Servs., Inc. ASBCA No. 56358, 14-1
BCA ¶ 35639 (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
Subcontractor Costs Reasonableness
Example
9
• 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
Risks by Subcontract Type
10
• 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
Risks by Subcontract Type (cont.)
11
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
• T&M contracts (cont.):
– Old Rule
• Subcontractor labor billed at contract labor rates improper
– Serco, Inc., CBCA No. 1695, 11-1 BCA ¶ 34662 (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
Risks by Subcontract Type (cont.)
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• 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 52.232-7(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
Risks by Subcontract Type (cont.)
14
• 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
Risks by Subcontract Type (cont.)
15
• FAR § 52.244-6, 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
Commercial Item Subcontracting
16
• 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
Commercial Item Subcontracting (cont.)
17
• 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
Invoices
18
• “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
31.205-26(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 § 31.205-26(e))
– Transfer may occur at price if (FAR § 31.205-26(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
Material Costs
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• 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 231.205-71: 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)
Allowability of Counterfeit Parts Rework /
Remediation
20
• 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 § 31.201-2(d): Requires maintenance of “adequate” support and
permits disallowance
– FAR § 52.215-2: 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. 55354, 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
Adequate Support of Subcontract Costs
21
• 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
DCAA Sampling / Decrements
22
• 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
DCAA Sampling / Decrements (cont.)
23
• 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. 58569, 14-1 BCA ¶ 35,618
(Report identifying deficiencies in subcontractor management system
commenced SOL) cf. Combat Support Associates, ASBCA No. 58945,
2014WL5563724 (Adequate support detail necessary to begin SOL)
– Indirect – look at date of incurred cost submission
• Raytheon Space & Airborne Sys., ASBCA No. 57801, 13-1 BCA ¶
35,319
• But CSA decision says that adequate support detail is necessary for the
government to know of claim
Application of Statute of Limitations
24
• Statute of limitations provides support to limit questioned
costs for subcontracts (cont.)
– Sikorsky Aircraft Corp. v. United States, No. 2013-5096, 2014
WL 6915672 (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
Application of Statute of Limitations (cont.)
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• 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
Best Practices
26
• Steven M. Masiello
303-634-4355
• Gale R. Monahan
303-634-4311
Presenter
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