Understanding that it will punish innovative contractors for engaging in independent research and development (IR&D) and taking on risks that would otherwise be borne by the government, on November 4, 2016, the US Department of Defense (DoD) proposed a rule amending the Defense Federal Acquisition Regulation Supplement (DFARS) to “ensure that substantial future independent research and development expenses, as a means to reduce evaluated bid prices in competitive sources selections, are evaluated in a uniform way during competitive source selections.” In essence, DoD wants to ensure that the government’s possible reimbursement of allowable IR&D overhead costs is reflected in a contractor’s total evaluated offer price for competitively awarded contracts to create a level playing field where none, for good reason, has previously existed. This proposed rule was issued after DoD had requested input on concepts for how to evaluate contracts that relied upon IR&D and the near universal industry condemnation of these concepts. Rejecting industry’s opposition, the proposed rule would significantly reduce contractor incentives to engage in IR&D by reducing the benefits contractors receive from successful IR&D projects. In light of these proposed changes, contractors should immediately evaluate their IR&D and competitive bid strategies on the assumption that this proposed rule will be made final in the near future.

For major defense acquisition programs and major automated information systems acquisitions, the proposed rule would require that contracting officers adjust upward a contractor’s total evaluated offer price to the extent the contractor is expected to rely upon future IR&D costs to reduce its proposed price. Accordingly, in order to support this objective, the proposed rule requires an offeror to “include documentation in its price proposal to support this proposed approach” of using IR&D to meet contract requirements. The rule would apply to contracts above the simplified acquisition threshold, but would not apply to contracts for commercial items.

In the “Implementation Directive for Better Buying Power 3.0—Achieving Dominant Capabilities Through Technical Excellence and Innovation,” dated April 9, 2015, the Under Secretary of Defense for Acquisition, Technology and Logistics raised a concern that offerors may gain an unfair price advantage when future IR&D efforts are used to “substantially reduce” the bid price on competitive procurements. However, DoD’s concerns are misplaced. Contrary to DoD’s position, relevant decisional authority confirms that IR&D efforts properly permit contractors, willing to undertake IR&D projects at their own risk, to gain a relative price and technical advantage over their competitors. Moreover, DoD’s position that IR&D costs should be treated as contract costs (which they are not) for evaluation purposes during the competitive procurement process would effectively penalize contractors for conducting IR&D that is relevant to a competitive government procurement, often the fundamental reason for engaging in IR&D. As a result, contrary to congressional policy, the proposed rule is very likely to deter contractors from engaging in robust IR&D for DoD’s benefit.

Furthermore, the proposed rule appears at odds with established statutory and regulatory policy because it arguably requires contractors to provide cost or pricing data to support their offers, despite the fact that no such data is required when awards are based on adequate price competition. See 10 U.S.C. § 2306a(b)(1)(A)(i); 48 C.F.R. §§ 15.403-1(b)(1); 15.403-3(b). Finally, the proposed rule leaves certain practical questions unanswered, such as: (a) whether IR&D costs expected to be reimbursed by non-DoD agencies must also be included in the total evaluated offer price adjustment; and (b) what methodology contractors should use to account for anticipated IR&D reimbursements.

Dentons submitted comments in response to the advance notice of proposed rulemaking issued on February 8, 2016, which discuss these and other issues more fully. You can read Dentons’ comments in full here.

Additionally, Dentons advised the American Bar Association Section of Public Contract Law on its comments on the proposed rule, which can be found here.

Contractors and industry groups are encouraged to submit written comments to the proposed rule by January 3, 2017.