The ASBCA Giveth and the Federal Circuit Taketh Away

In a saga which conjures up the phrase: “It ain’t over till it’s over” (quotation attributed to the late, great Yogi Berra), the US Court of Appeals for the Federal Circuit (Case 21-2304) in a decision dated 01-3-2023, reversed an ASBCA Decision (60091, et al), the latter having found Raytheon’s policies for tracking potentially unallowable Lobbying and Organization costs to be reasonable, thus allowable.

I refer to this contract disputes’ activity as a “saga,” because it dates back to Raytheon’s annual incurred cost submissions for 2007 and for 2008, followed by somewhat untimely DCAA audits in 2012, COFDs (Contracting Officer Final Decisions) which identified expressly unallowable costs challenged by Raytheon in a number of ASBCA Cases (60091. et al). Although the Federal Circuit’s January 2023 decision only dealt with Lobbying (FAR 31.205-22) and Organization Costs (FAR 31.205-27), the “rest of the story” involved several other FAR Subpart 31 Cost Principles as listed on page 6 of 115 pages in the ASBCA Decision.   Thus, for any contractor dealing with, or potentially dealing with, incurred cost issues as a by-product of DCAA audits, these published decisions are worthwhile reading in terms of DCAA strategies/interpretations, Contractor rebuttals and the ultimate outcome (actually the penultimate outcome because the Federal Circuit reversed the ASBCA’s judgment and remanded for a determination of costs Raytheon must repay).

Lobbying Costs (FAR 31.205-22)

Costs associated with a number of activities (delineated in 31.205-22(a) are unallowable, paraphrased as anything associated with attempts to influence Federal, State or local elections or legislation through direct or indirect communications with elected officials or candidates for elected offices (“indirect” could be in the context of contributions to Political Action Committees).   In the issue at hand, DCAA focused its audit on Raytheon’s “Government Relations” costs (a Corporate Office staffed by employees and supplemented by consultants).   At issue was Raytheon’s labor charging policy which only considered time spent/charged by predominantly salaried employees during normal business hours (8-5 Monday-Friday) while not considering so-called uncompensated overtime (any/all other hours worked by the Government Relations salaried employees).   During the 2012 audits, DCAA interviewed a number of the (still-employed) Raytheon employees who all acknowledged performing lobbying while working nights, weekends, etc. Although FAR 31.201-6(e) provides an exception for employees who do not frequently engage in company activities outside of normal hours; the Federal Circuit noted that this exception obviously did not apply based upon statements made by Raytheon employees during DCAA audits/interviews.   Although it was clearly rejected by the Federal Circuit’s decision, the ASBCA had accepted, as reasonable, the Raytheon policy which was a “disclosed accounting practice” inclusive of a labor timekeeping policy which only required documentation (record keeping) by employees who spent more than 25% of their compensated hours for lobbying activity.

Steen observation:   Raytheon’s policy of employees not recording unallowable lobbying which was less than 25% is at-odds with the penalties clause for claiming expressly unallowable costs (FAR 52.242-3 and 42.709-6) which mandates a penalties’ waiver only when the total amount is less than $10,000. Hence, per the Raytheon policy, a Government Relations employee earning $100,000 annually, but only spending 20% of his/her time lobbying would fail to identify/exclude $20,000 in expressly unallowable lobbying costs.   Moreover, the $10,000 mandatory waiver applies to an entire incurred cost submission, not just the unallowable portion for the one employee.   One can argue (as has Raytheon among others) that the $10,000 waiver is an absurdly low amount, but “it is what it is”.

Not that it received any “airtime” in the Federal Circuit decision, but the ASBCA seemed to penalize the Government for injecting strategies/assertions that proved to be unsupported (i.e. “speculation”) including DCAA assertions that part-time employees “might not” have recorded unallowable lobbying and DCAA/DCMA asserting that neither employees nor consultants received training on unallowable lobbying (Raytheon’s training records proved otherwise).   Government speculation and/or misstating the facts were of no consequence to the extent the Federal Circuit’s decision was based upon the explicit wording in FAR 31.205-22 coupled with the documentation requirements incumbent upon Government contractors (FAR 31.201-2(d)).   Also, contractors should note that DCAA will use interviews of contractor employees (years after the fact) to bolster DCAA’s case for asserting unallowable costs.   In contrast, DCAA will almost always discount a contractor’s use of employee statements (years after the fact) to supplement contemporaneous records to support cost allowability. Perhaps this is a reason to reject DCAA requests for employee interviews if requested years after the fact.

FAR 31.205-27 Organization Costs

Costs (expenditures) in connection with planning or executing the organization or reorganization of the corporate structure of a business, including mergers and acquisitions (M&A) are unallowable.   Such expenditures include, but are not limited to, costs of attorneys, accountants, brokers, promoters and organizers, management consultants and investment counselors, whether or not employees of the contractor.   Excluded (thus allowable) are Economic Planning costs (FAR 31.205-12) and costs to acquire or reacquire stock primarily for employee compensation for bonuses, savings plans or ESOPs.

Raytheon’s M&A activity was embedded in its Corporate Development costs.   At issue was Raytheon’s policy related to the point in time when allowable economic planning crossed over to unallowable M&A activity (aka “A&D” activity within the published decisions).   Raytheon’s “bright line” practice was submission of an indicative offer/decision to go to market at which point subsequent costs were charged as unallowable “A&D” activity.   Although not expressly stated in Raytheon’s policy, but identification of a specifically targeted entity had to exist before Raytheon considered costs to be potentially unallowable.   DCMA contended that FAR 31.205-27 does not clearly limit its applicability to costs of targeting a specific merger or acquisition.   Although the ASBCA determined that Raytheon’s policy was a reasonable interpretation of FAR 31.025-27 juxtaposed against FAR 31.205-12, the Federal Circuit disagreed. Specifically, “by only reporting time after the submission of an indicative offer or the decision to go to market with offering materials—the bright line rules—Raytheon’s policies are plainly inconsistent with the regulation...as a matter of both logic and common sense, a decision on submitting an offer or to go to market cannot be made unless at least some planning is made…Raytheon’s policies drawing bright lines that start the clock at points obviously later than the FAR permits.  

Although the Federal Circuit failed to determine when the clock should have started, it clearly rejected Raytheon’s policy (and by implication the long-held policies of numerous other Government contractors who have “compared notes” over the years yielding an untold number of other “M&A” or “A&D” corporate policies now at risk).   By implication, the Federal Circuit rejected “long held” policies or “industry standards” to the extent those have now been deemed to be “plainly inconsistent” with the regulations.   Now the ASBCA along with Raytheon and DCMA are left to determine the amount of unallowable expenditures starting at an ill-defined point in time earlier than that reflected in Raytheon’s policy.   Falling into the category of “not that it really matters at this point”, but coincidentally, DCAA’s website (Selected Areas of Cost) includes Chapter 50 – Organization Costs and concludes with the following: “Costs incurred for actually planning the organization or reorganization of a business such as by a specific merger or acquisition are unallowable. The costs of surveying various business opportunities, making demographic and economic studies, and evaluating potential markets or firms for mergers or acquisitions would be allowable.   On the contrary, once a target for mergers or acquisitions has been identified, the costs of planning or executing organizational changes would be unallowable.”

Steen observation: DCAA’s policy was never considered by either decision and most certainly not be the Federal Circuit; however, DCAA’s interpretation appears to be logically consistent with the Federal Circuit in the context of segregating unallowable planning at the point that “a” target has been identified.   That said, as long as a contractor is “surveying” among two or more potential acquisitions, it could assert that it is not yet engaged in unallowable planning.   Perhaps obvious and for reasons beyond limiting unallowable M&A costs, these activities should be “close hold” with few employees and professional and consulting agreements which are carefully, but accurately, worded to differentiate allowable economic planning from unallowable M&A costs.