ASBCA Makes it Clear How the Wavier of Penalties Works

On November 7, 2024, the Armed Services Board of Contract Appeals (ASBCA) issued a decision that every small business needs to read. ASBCA Case 62458 Left Hand Design Corporation Decision explains exactly how the Federal Acquisition Regulation (FAR) implements the statutorily required penalties through FAR 42.709-6, Waiver of the penalty, and provides a cautionary tale for small businesses or large businesses that are new to government contracting.

The penalties addressed in this case relate to the claiming of expressly unallowable cost in your final indirect cost rate proposal required by FAR 52.216-7, Allowable Cost and Payment. FAR 52.242-3, Penalties for Unallowable Costs, is required to be included in all Cost Reimbursement and Fixed-Price Incentive contracts over $800,000.

The Wavier Requirements Placed on the Contracting Officer

As found by the Board, the contracting officer has very little discretion when it comes to the assessment of penalties or the waiver of these penalties as the requirements are set forth in the statute. The penalties are prescribed in 10 U.S.C. 3748 or 41 U.S.C. chapter 43, as applicable, which is implemented in FAR 42.709.

FAR 42.709-6, Waiver of the penalty, provides that the contracting officer shall (yes, that means they must) only waive the penalties under three conditions:

• The contractor withdraws its proposal before a government audit is initiated and removes the unallowable costs.
• The amount of the unallowable costs allocated to applicable contracts is $10,000 or less.
• “The contractor demonstrates, to the cognizant contracting officer’s satisfaction, that-
  1. It has established policies and personnel training and an internal control and review system that provide assurance that unallowable costs subject to penalties are precluded from being included in the contractor’s final indirect cost rate proposals (e.g., the types of controls required for satisfactory participation in the Department of Defense-sponsored self governance programs, specific accounting controls over indirect costs, compliance tests which demonstrate that the controls are effective, and Government audits which have not disclosed recurring instances of expressly unallowable costs); and
  2. The unallowable costs subject to the penalty were inadvertently incorporated into the proposal; i.e., their inclusion resulted from an unintentional error, notwithstanding the exercise of due care.”

Requirements (a) and (b) above are straightforward. I have quoted (c) as that is the requirement on which the ASCBA decision is based.

ASCBA Decision on FAR 42.709-6(c)

The key points addressed by the Board are:

1. Can a waiver be granted if only one of the FAR 42.709-6(c) requirements is met? The Board’s answer is NO. The Board states: “The regulation requires both requirements – the existence of policies AND the inadvertent submission of the unallowable costs – to be met for a contractor to merit a waiver of the penalty.” The Board drives this home by saying: “These are not alternative conditions, they must BOTH exist to merit a waiver of the penalty.”
2. Can a contractor implement new policies and training to support the FAR 42.709-6(c)(1) requirement? The Board’s answer is NO. The Board states: “It is well settled that a contractor must have established policies, personnel training, and an internal control and review system to ensure that unallowable costs are not included in final indirect cost rate proposals at the time the costs in question are included in the indirect cost proposal.” The Board again drives this home by saying: “Accordingly, we conclude that the policies must be in place at the time the questioned costs are submitted.”
3. What is the expectation related to inadvertently incorporating an unallowable cost and the exercise of due care? While the Board did not state what would meet this requirement, it did make clear the following does not meet the expectation:
   1. The contractor did not understand the FAR part 31 cost principles.
   2. The contractor’s accounting staff turned over, and the new staff had not been trained on the FAR part 31 cost principles.
   3. The Defense Contract Audit Agency (DCAA) has not educated the contractor on the FAR part 31 cost principles. (DCAA does not train contractors)
   4. DCAA did not question the same cost in a prior year.
   5. The contractor did not intentionally include the unallowable cost; it was just an error/mistake.
   6. We used the same format as in a prior year’s proposal, so it cannot be intentional.
   7. The unallowable cost had no financial benefit as the contractor was over the funding limitation on all of its contracts.
   8. The DCAA auditor said the contracting officer can waive penalties (i.e., just because they can does not mean they will).

Key Takeaways

• If you are doing business with the Federal Government, you must understand the FAR Part 31 Cost Principles – yes, get training or call us.
• The Government, especially DCAA, is not going to be there to help or assist you.
• Just because you are over the funding limitation on your contracts does not mean you can take shortcuts on your final indirect cost rates proposal.
• FAR 42.709-3, Responsibilities, requires both the contracting officer and auditor to consider referring the inclusion of unallowable costs to the appropriate criminal investigative organization for review and for appropriate coordination of remedies if there is evidence that the contractor knowingly submitted unallowable costs.

Be safe and contact us for help if you do not have the in-house expertise.

How Can Redstone Help

Redstone GCI assists contractors throughout the U.S. and internationally with understanding the Government’s requirements and implementing an adequate accounting system, including the necessary policies and procedures for unallowable costs and training. We would be happy to be part of your team.