Government Contract Industry Marketplace Outlook October 2013
Agenda Legal Update Craig Holman, Partner, Arnold & Porter DCAA/Regulatory Update Eric Sobota, Partner, and Shayla Ferguson, Senior Associate, BDO USA, LLP Industry Prospective Duane Piper, CFO, Silverback7 5
LEGAL UPDATE Craig Holman, Partner, Arnold & Porter October 2013
Topics Statute of Limitations Background Claim Accrual Defenses Case Examples Small Business Subcontracting Regulations Background Purpose Key New Requirements for Contractors Practical Considerations
Statute of Limitations: Background Under the Contract Disputes Act, the Government or contractor must assert its claim within 6 years of its accrual. 41 U.S.C. 7103(a)(4)(A). Six-year limitations period applies equally to contractors and the Government. Parties may agree to a shorter accrual period, but cannot enter in an agreement to lengthen the six-year period. FAR 33.206(b); Raytheon Co. v. United States, 104 Fed. Cl. 327, 331 n. 4 (2012). The statute of limitations is a jurisdictional prerequisite and bars an untimely Government claim.
Statute of Limitations: Claim Accrual Because the CDA does not define claim accrual, the COFC and ASBCA apply the definition in the FAR: "Accrual of a claim means the date when all events, that fix the alleged liability of either the Government or the contractor and permit assertion of the claim, were known or should have been known. For liability to be fixed, some injury must have occurred. However, monetary damages need not have been incurred." FAR 33.201.
Statute of Limitations: Claim Accrual To determine the accrual date of a claim: 1) Examine the legal basis of the claim, i.e., the elements of proof. 2) Determine when the party knew or reasonably should have known it had a potential claim. Once a party is on notice it has a potential claim, the statute of limitations can start to run. But, the statute of limitations "will not begin to run until the claimant 'learns or reasonably should have learned' of his cause of action." Raytheon Co., Space & Airborne Sys., ASBCA Nos. 57801 et al., 13-1 BCA 35,319. 3) Injury. For liability to be fixed, at least some injury to the claimant must be shown. No requirement that a sum certain be established before a claim can accrue: "It is enough that the government knows, or has reason to know, that some costs have been incurred, even if the amount is not finalized or a fuller analysis will follow." Id. Burden of Proof ASBCA: Party advocating that the claim is valid bears the burden of proof. COFC: Party raising statute of limitations argument as an affirmative defense bears burden of proof.
Statute of Limitations: Defenses Equitable Tolling: Party may argue it was "induced" or "tricked" by misconduct into allowing a filing deadline to pass. Mere excusable negligence not enough to establish equitable tolling. Accrual Suspension: Party may argue that the injury was "inherently unknowable" at the time the cause of action accrued. Continuing Claims: Party may argue its claim is "inherently susceptible to being broken down into a series of independent and distinct wrongs, each with its own damages." Does not apply if a claim is based on a single, distinct event.
Case Examples Government Claims Dismissed as Untimely Raytheon Missile Sys., ASBCA No. 58011, 13-1 BCA 35,241 (Jan. 28, 2013) Government claim arising from contractor's alleged noncompliance with approved cost accounting practices. Rejected Government's arguments that its claim could not accrue until DCAA issued its audit report that apprised the CO of the existence of a potential claim. Rejected Government argument that claim does not accrue until the CO knows or should have known of the events giving rise to the potential claim, even if events known to other government personnel. Raytheon Co. Space & Airborne Sys., ASBCA Nos. 57801, et al., 13-1 BCA 35,319. (Apr. 22, 2013) Government claims arising from changes in contractor's cost accounting practices. Claim accrual does not depend on the degree of detail the contractor provides, or whether the contractor revises calculations later. Sufficient that Government knows, or has reason to know, that some costs have been incurred, even if amount is not finalized or fuller analysis will follow. A claim relating to a contractor's unilateral change in cost accounting practices accrues when the Government knew, or reasonably should have known, that it had a basis to seek a cost adjustment because of the change.
Small Business Subcontracting Regulations: Background On July 16, 2013, the U.S. Small Business Agency ( SBA ) issued a final rule amending its regulations governing small business subcontracting to implement provisions of the Small Business Jobs Act of 2010. 78 Fed. Reg. 42,391. New rule effective as of August 15, 2013. Applies to all "covered contracts," defined as contracts that require a small business subcontracting plan. Creates new reporting requirements and obligations for prime contractors.
Small Business Subcontracting Regulations: Purpose Increase federal subcontracting opportunities for small businesses. Address underutilization of small businesses. Give small business subcontractors more rights in their dealings with prime contractors.
Small Business Subcontracting Regulations: Key New Requirements for Contractors Prime must make a "good faith effort" to utilize the small business subcontractor "used in preparing the bid or proposal" during contract performance. Must provide a written explanation to the CO if it fails to utilize the subcontractor. CO must consider these issues in evaluating prime's overall performance. Prime must provide the CO written notification and explanation when the prime reduces payments to a small business subcontractor or when payments to the subcontractor are more than 90 days late. CO directed to use "best judgment" in determining whether the reduced or late payment is justified. CO must consider these issues in evaluating prime's overall performance. Information on reduced or late payments may be recorded in FAPIIS. Contractors holding certain multiple award contracts must annually report small business subcontracting achievements to the CO. Prime must submit a written explanation to the CO at the conclusion of contract performance if it did not meet its subcontracting plan.
Small Business Subcontracting Regulations: Practical Considerations Primes must provide small business subcontractors "maximum practicable opportunity" to participate in performance of the contract. Must conduct market research and use "all reasonable means" to identify small business subcontractors and suppliers. Prime may not prohibit a small business subcontractor from discussing directly with the CO any material matter regarding the subcontractor's payment or utilization. Rule authorizes agencies to consider subcontracting plan compliance as an evaluation factor or subfactor in award decisions.
DCAA/Regulatory Updates October 2013 Eric Sobota, Partner, BDO USA, LLP
Areas of Discussion Developments on Executive Compensation DCAA Audit Alerts & Recent Guidance FAR Final, Interim, and Proposed Regulations DFARS Interim Rules 18
GAO Report on Executive Compensation Federal law has placed a cap on the amount of compensation that contracts can charge to federal contracts since the late 1990s. NDAA directed GAO to provide information on the effect of reducing the compensation limitation for FY13 equitable to the salary of the U.S. President ($400,000) or Vice President s salary at $230,700. GAO identified: (1) estimates the number of employees of a sample of DoD contractors whose compensation would have exceeded a cap set at the salaries of either the President or Vice President and the amount of compensation that would not have been allowed and (2) the views of the government and contractor representatives on potential effects of a reduction in the cap. GAO collected data from a non-generalized, stratified random sample of 10 large-tier, 10 mid-tier, and 10 small-tier contractors; reviewed relevant laws and regulations, interviewed government and contractor representatives. GAO s report noted that data on the number of employees affected by the cap was received from 90% of the contractors; whereas the three larges contractors did not provide any data/ Ultimately, GAO did not make any recommendations in the report and DoD cited the need for more research give GAO s sample size. 19
Developments on Executive Compensation Proposed FAR Case 2012-025 Applicability of the Senior Executive Compensation Benchmark; effective June 26, 2013 The National Defense Authorization Act for FY12 was signed into law and effective on December 31, 2011 for contracts awarded before this date. Section 803 expands the applicability of the existing executive compensation benchmark (cap) for DoD, NASA, and Coast Guard contracts with respect to the contractor compensation costs incurred after January 1, 2012. The proposed rule applies the compensation cap to all employees of a contractor instead of the five most highly compensated employees only in management positions at each home office and each segment of the contractor. This proposal suggests amending FAR 31.205-6(p) and DoD will separately handle amending 803(a), in which Congress has authorized the Secretary of Defense to establish one or more narrowly targeted exceptions for scientist and engineers upon a determination that such exceptions are needed to ensure that the Department of Defense has continued access to needed skills and capabilities. The implementation of section 803 is similar to section 808 of the NDCAA for FY98. Like 803, section 808 retroactively applied to contracts that already existed on the date of its enactment. However, courts held that section 808 breached contracts awarded before the statutory date of enactment (General Dynamics Corp. v. U.S., 47 Fed. Cl. 514 (2000); and ATK Launch Systems, Inc., ASBCA 55395, 2009-1 BCA 34118 (2009)). 20
Developments on Executive Compensation Interim FAR Case 2012-017 Expansion of Applicability of the Senior Executive Compensation Benchmark; effective June 26, 2013 Similar the proposed rule, it expands the application to a broader scope of contractor employees on contracts awarded by DoD, NASA, and the Coast Guard which limits the reimbursement of compensation costs. This interim rule applies section 803 prospectively to contracts awarded on or after December 31, 2011 for contractor compensation costs incurred after January 1, 2012 for all employees. Compensation means the total amount of wages, salary, bonuses, deferred compensation, and employer contributions to defined contribution benefit plans for the fiscal year, whether paid, earned, or otherwise accruing, as recorded in the contractor s cost accounting records for the fiscal year. 21
Developments on Executive Compensation What does this mean? For 2010-2012, contractors identified over $180M/yr. in compensation costs would have exceeded a cap set at the President s salary and at least $440M/yr. if set at the Vice President s salary. DoD, GSA, and NASA do not expect the new rules to have a significant economic impact on a substantial number of small entities; however, larger size companies would bear the effect. Most contracts awarded to small entities use simplified acquisition procedures, or are awarded on a competitive basis, do not require the application of the cost principal. Furthermore, it is not expected that a substantial number of small entities will have any employees, other than possibly among the five most highly compensated management employees at each home office and each segment of the contractor, whose compensation costs exceed the executive compensation benchmark. The cap also imposes a significant burden of additional record keeping; which will negatively impact small businesses. Contractor executives incur compensation costs in excess of the cap; but reducing the cap will significantly increase compensation unallowable costs for individuals below the executive level. 22
Developments on Executive Compensation What does this mean? OMB has noted the growth of the cap has outpaced inflation and the rate of growth of federal salaries. Industry associations and contractors representatives noted that the compensation they offer to their employees is generally based on market surveys of compensation paid by private sector companies. Reducing the cap will not prelude contractors from compensating their employees above the cap; yet doing so would come at the expense of company profits, which may result in challenges in attracting capital from the financial markets. All agencies, contractors, and industries have acknowledged that reducing the cap make affect its ability to attract and retain top talent: those with experience, knowledge, skills, and resources. Ultimately, the executive compensation cap make lead companies to reassess its business and staffing models and potentially shift work from the government to the commercial sector. 23
Historical Executive Compensation Benchmarks Benchmark Executive Compensation Amount Fiscal Year For Costs Incurred After $763,029 2011 & 2012 January 1, 2011 $693,951 2010 January 1, 2010 $684,181 2009 January 1, 2009 $612,196 2008 January 1, 2008 $597,912 2007 January 1, 2007 $546,689 2006 January 1, 2006 $473,318 2005 January 1, 2005 $432,851 2004 January 1, 2004 24
DCAA Updates DCAA Audit Alert Alternate Procedures for Labor When Real-Time Testing of Labor not Performed (MAAR 6) DCAA Audit Alert on Testing to Payment Testing Contractor Compliance with Certain Sections of FAR 52.216-7, Allowable Cost and Payment Clause during Incurred Cost Audits DCAA Audit Alert on Access to Contractor Employees DCAA Audit Guidance on Placing Reliance on Scanned Images 25
DCAA Audit Alert Alternate Procedures for Labor When Real-Time Testing of Labor not Performed (MAAR 6) On July 18, 2013, DCAA issued an audit alert describing how to test for the existence of employees as part of post year-end audit procedures. The purpose of this procedure is to ascertain that employees are actually at work, performing within their job classification, and charge their time appropriately to the cost objective(s) on their timesheet. To verify the allocability of costs, it is essential to review (i) contract requirements, (ii) statement of work and work orders/authorizations to ensure that the employee s labor category is required to perform on the contract, and (iii) determine if the Contracting Officer has any evidence that corroborates the employee s existence. 26
DCAA Audit Alert on Testing to Payment Testing Contractor Compliance with Certain Sections of FAR 52.216-7, Allowable Cost and Payment Clause during Incurred Cost Audits On July 26, 2013, DCAA issued an audit alert on testing for compliance of the Allowable Cost and Payment clause during incurred cost audits. The DCAA auditor is responsible for testing the contractor s compliance with FAR Part 52.216-7(b)(1); which states that allowable costs should be reimbursed only when paid in the ordinary course of business. If the auditor determines that the contractor billed and was subsequently paid by the Government for claimed costs that were never actually paid by the contractor, then the auditor will question the costs and consider this act as a fraud risk indicator. 27
DCAA Audit Alert on Access to Contractor Employees On July 30, 2013, DCAA Policy and Plans issued an audit alert due to the alarming amount of FAO feedback submitted. Contractors are challenging DCAA s right to interview and observe employees during performance audits (i.e. floor checks). DCAA opines that timely access to the contractor s employees is essential for its audit services as the auditor does his/her due diligence to comply and satisfy the necessary audit procedures for the Generally Accepted Government Auditing Standards (GAGAS). GAGAS 5.06, require auditors to inquire of contractor personnel during the planning stage of the audit and to identify previous audits, attestation engagements, and other studies that directly relate to the subject matter of the examination under audit. AT 601.4 (c) require auditors to inquire of contractor personnel during the planning stage to obtain an understanding of the specified compliance requirements. This is obtained through discussions/inquiring with appropriate individuals within the contractor s organization. 28
DCAA Audit Alert on Access to Contractor Employees cont. AT 601.45 requires auditors to obtain an understanding of relevant portions of internal control compliance sufficient to plan the engagement. AT 601.46 states that an auditor generally obtains an understanding of the contractor s relevant controls by inquiring of appropriate management, supervisory, and staff personnel, inspecting contractor documents, and observing the contractor s activities and operations. The contractor s failure to cooperate with DCAA by not allowing its employees to be accessible will result in DCAA taking the appropriate steps towards initiating access to records issue in accordance with DCAA Instruction 7640.17 following the guidance set forth in DCAA s CAM Section 1-504.5, Resolution of Contractor Denial; which ultimately elevates to the contractor s upper management and the Contracting Officer. 29
DCAA Audit Guidance on Placing Reliance on Scanned Images On August 15, 2013, DCAA issued guidance regarding the testing of scanned images in order to provide reasonable assurance and determine if reliance can be placed on contractor s scanned images during the course of audits. Scanned images are considered to be paper invoices, not the scanning of financial and cost accounting records. FAR 4.703(c) allows contractors to duplicate and store original records in electronic format. Contractors are not required to maintain or produce the original record during an audit if the electronic image of the original record meets the requirements of FAR. Specifically, this FAR requirement states that the contractor must have established and implemented procedures that maintain the integrity of the original record, including signatures and other written or graphic images, and that the imaging process is reliable and secure. DCAA auditors will test the reliability and accuracy of the contractor s scanned images on an annual basis ongoing with an audit being performed at contractors with over $100 M Auditable Dollar Value (ADV) and select contractors with ADV below $100 M based on the DCAA FAO s discretion. 30
DCAA Audit Guidance on Placing Reliance on Scanned Images cont. If original documents were preserved, the auditor will establish reliability by selecting a sample of scanned documents and validating them to its original format. If the original document was not maintained, the auditor must consider the contractor s control environment and review the contractor s permanent files for risk factors to ensure there is no obvious reason that reliance cannot be placed on the scanned documents. At minimum, the auditor will obtain an understanding of the contractor s system and control activities overseeing the process of converting the original document into a scanned image and develop procedures to ascertain that the contractor is compliant with FAR 4.703(c). If no deficiencies are noted and the scanned images appear to meet the requirements of FAR, then generally scanned documents can be relied on for the period covered. Subsequently a Memorandum for Record will be prepared to summarizing the detail working paper did not disclose a noncompliance. If testing disclosed a significant deficiency that is considered a material weakness the auditor will prepare an accounting system deficiency report citing FAR 4.703(c) and/or FAR 4.703(d) and DFARS 252.242-7006(c)(1), Accounting System Administration. 31
Regulatory Updates New FAR Rules FAR Case Title Synopsis Rule Type 2013-004 Contracting Officer s Representative Improves contract oversight by providing clarification on the contracting officer s representative (COR) responsibilities. The final rule mandates that the COR must be a federal employee with adequate training and experience, nominated by the required activity or in accordance with agency procedures, and states in writing the extent and period of the COR s authority. Maintaining the FAR for Contracting Officer Representative (FAR-COR) has been included as a duty. Lastly, the COR may not be assigned any responsibilities that have been delegated to a contract administration office and the COR does not have the authorization to make changes to any contract terms or conditions. Final 32 Effective Date: July 22, 2013
Regulatory Updates New FAR Rules FAR Case Title Synopsis Rule Type 2012-009 Documenting Contractor Performance Includes standardized past performance evaluation factors and performance rating categories Governmentwide. Past performance information must be entered into the Contractor Performance Assessment Reporting System (CPARS); which is the Government-wide past performance reporting system. FAR 17.207(c)(6) has been revised to add a new section at (c)(7) to make certain that past performance evaluations are performed on all recently completed task/delivery orders so that contracting officers can make well informed decisions based on the most recent performance information. Significant changes to FAR 42.1502 and 42.1503 An important capability of the system allows the seller to post a response to all reviews as well as the buyer is able to review is able to review an evaluation. Per FAR 42.1503(d) contractor s comments, rebuttal, and/or additional information are welcome in response to agency evaluations; however, it is at the agency s sole discretion to make the final determination. Final 33 Effective Date: September 3, 2013
Regulatory Updates New FAR Rules FAR Case Title Synopsis Rule Type 2012-018 Price Analysis Techniques Specifies the use of price analysis techniques in order to establish a fair and reasonable price; effective July 22, 2013. FAR 15.404-1(b)(2)(i) is amended to change the reference in this FAR section from FAR 15.403-1(c)(1) to 15.403-1(c)(1)(i). It was determined that the prior reference was too broad; therefore, the amendment was necessary to provide an exact reference to the rules. This enactment correlates the price analysis technique of comparing multiple proposed prices received in response to a solicitation; described in FAR 15.404-1(b)(2)(i), with the adequate price competition standard of comparing proposed prices submitted by more than one independent offeror. This change makes certain that the revised reference directly relates to the topic covered in 15.404-1(b)(2)(i). Currently, FAR 15.403-1(c)(1)(i) addresses adequate price competition when proposed prices are received from multiple offers instead of the existing reference FAR 15.403-1(c)(1). In the past this has been regarded as too general and addressed various standards for adequate price competition. This rule should bear no impact on the request of data other than certified cost or pricing data. Final 34 Effective Date: July 22, 2013
Regulatory Updates Interim FAR Rules FAR Case Title Synopsis Rule Type 2013-015 Pilot Program for Enhancement of Contractor Employee Whistleblower Protections DoD, GSA, and NASA issued an interim rule, section 4712, to amend the FAR in order to implement a fouryear pilot program that boosts the present whistleblower protections for contractor employees at subpart 3.9. The NDAA for FY 2013 was enacted on January 2, 2013 and both section 827 and 828 are effective 180 days after enactment (July 1, 2013). This program is mandated by section 828 of the National Defense Authorization Act (NDAA) for fiscal year 2012, enacted January 2, 2013. Paragraph (a) of section 828 adds to title 41 a new section that contains the elements of the pilot program; which became lawful on July 1, 2013 and is effective until January 1, 2017. Paragraph (c) of section 828 suspends the pre-existing whistleblower projection is 41 U.S.C. 4705 for the duration of the pilot program. However, as the new provision expires, the preceding ones will automatically be reinstated. Section 827 bounds title 10 agencies to the required terms specified therein and will revise the respective FAR supplements. Interim 35 Effective Date: September 30, 2013
Regulatory Updates Interim FAR Rules FAR Case Title Synopsis Rule Type 2013-015 Pilot Program for Enhancement of Contractor Employee Whistleblower Protections cont. In accordance with FAR 1.108(d)(3), the changes to these rules should be incorporated as modifications to contracts and orders awarded prior to the effective date of this interim rule by contracting officers. Section 828 is implemented by amending FAR 3.900, Scope of subpart, to make the interim rule, FAR 3.901 through 3.906, not applicable to DoD, NASA, and the Coast Guard and to prohibit the use of these sections for new awards by all other agencies subject to the FAR. The three excluded agencies are covered by 10 U.S.C. 2409, which was amended by section 827 of the NDAA to impose permanent requirements comparable to the temporary constraints of the pilot program recently established. FAR 3.907 addresses that the whistle blower protections provided under the American Recovery and Reinvestment Act of 2009 have not been altered by the interim ruling. Section 4712 regulations protect the contractor (or subcontractor) employees against reprisal for activities shielded by FAR 3.908-3(a) and there is no alteration to any protection, right, or remedy otherwise available to the employee. Written comments to the Regulatory Secretariat should be submitted no later than November 29, 2013 for consideration of implementation into the final rule. Interim 36 Effective Date: September 30, 2013
Regulatory Updates Interim FAR Rules FAR Case Title Synopsis Rule Type 2013-017 Allowability of Legal Costs for Whistleblower Proceedings DoD, GSA, and NASA issued an interim rule to amend the FAR to implement a section of the National Defense Authorization Act (NDAA) for fiscal year (FY) 2013. This amendment concentrates on the allowability of legal costs incurred as a result of contractors and subcontracts whistleblower proceedings commenced by the submission of a compliant of reprisal by the contractor or subcontractor employee. FAR 31.205-47 Costs related to legal and other proceedings now reads: (b) In accordance with 41 U.S.C. 4310 and 10 U.S.C. 2324(k), costs incurred in connection with any proceedings brought by a Federal, State, local, or foreign government, by a contractor subcontractor employee submitting a whistleblower compliant of reprisal in accordance with 41 U.S.C. 4712 or 10 U.S.C. 2409, for violation of, or a failure to comply with, law or regulation by the contractor (including its agents or employees), or costs incurred in connection with any proceeding brought by a third party in the name of the United States under the False Claims Act, 31 U.S.C. 3730, are unallowable if the result is Interim 37 Effective Date: September 30, 2013
Regulatory Updates Proposed FAR Rules FAR Case Title Synopsis Rule Type 2012-028 Past Performance Evaluations The objective of this proposal is to place provisions around the time limit allowed for contractor comments on past performance evaluations and to make past performance evaluations available to source selection officials sooner. Currently FAR provides a minimum of 30 days for contractor comments, rebutting statements, or additional information in response to the Government s past performance evaluations and the evaluation is made available post contractor comments. The proposal of this rule will affect the contractors response procedures whereas the contractor will have a maximum of 14 days to provide comments prior to posting to PPIRS. In the event that the contractor does not meet the 14 day deadline, the contractor s comments will be added to the past performance evaluation after the evaluation has been entered into the PPIRS. The amendment also includes an amendment to FAR 42.1503(d) and (f) that will allow the Government to revise a past performance evaluation in PPIRS if the 14-day period has expired, that corrections should be made to the past performance evaluation. Proposed 38 Written comments to the Regulatory Secretariat should be submitted no later than October 7, 2013 for consideration in the formation of the final rule.
Some Industry Perspective October 2013 Duane Piper, CAFO, Silverback7
Budget Cuts/Sequestration/Program Drawdowns Perspective from the middle market Increased competition in the market Shrinking opportunities Program cancellations and delays Re-competes for cost savings Greater reliance on IDIQ s Unexpected players in the middle market Large biz looking downward and small looking up Greater pressure on getting the price right General level of competition creates a squeeze Increased use of LPTA Are rate and cost structures supportive of the current market Are business models and cost structures set for the demands of the market Ability to compete on equal footing Is past performance adequate Ability to offer appropriate amount and type of innovation 40
Budget Cuts/Sequestration/Program Drawdowns Perspective from the middle market Key considerations Market space and program pursuits What is the core market Too big to be small too small to be big Where to find the highest P-Win Prime versus sub pursuit Diversify for growth Widen the aperture to find additional opportunities Look to secondary capabilities Middle market focus abroad Structure The right people in the right seats Cost structures Branding What is the affect on the company brand 41
Budget Cuts/Sequestration/Program Drawdowns Perspective from the middle market Preparing for adjustments No backing up to readjust 18-24 month horizon Past and future adjustments It takes time to see results Business philosophy What to pursue How to pursue it Who to pursue it with Structural adjustments Personnel and infrastructure Consider previous investments Risk to growth and operating efficiency Greater emphasis on cash flow Greater reliance on credit P&L effect 42
Contact Information Craig Holman: craig.holman@aporter.com Eric Sobota : esobota@bdo.com Shayla Ferguson: sferguson@bdo.com Duane Piper: dpiper@silverback7.com October 2013