Sequestration and the Impact on Government Contractors
By Jonathan DeMella & Kate Kennedy
Despite that the House passed a continuing resolution (“CR”) on Wednesday, September 20, which would continue funding for Government programs, albeit at the sequestration levels, the conditions set forth in the CR defunding “ObamaCare” make it unlikely that the Senate will pass the bill. Furthermore, with the focus of the budget now on the CR, the likelihood of budget negotiations that would eliminate sequestration prior to the commencement of Fiscal Year 2014 is remote. Thus, at this time, it is incumbent upon contractors to assess the current Government contracting climate, prepare for continued sequestration into FY 2014, and prepare for a potential government shutdown.
A Government shutdown would have significant effects on contractors. Contracting Officers are not within the class of Government employees exempt from furloughs and a shutdown of the Government would result in their immediate furlough – interfering with contract administration as well as operations. Additionally, the shutdown would suspend funding of new and ongoing contracts. To prepare for the potential suspension of funding, contractors should immediately assess the Government’s payment obligations; their payment obligations to subcontractors (e.g., whether their subcontract contains a pay when paid clause that would defer future payment obligations); and how costs resulting from the potential shutdown will be tracked in order to facilitate their recovery when the Government resumes operations.
Although the devastating effects that were predicted to result from sequestration and associated funding cuts in FY 2013 may have been overstated, there remains widespread concern among contractors as to what will happen and how to best navigate this period of uncertainty as the budget continues to be tightened. And while continued sequestration will not result in as immediate or dramatic an impact on contractors as would the potential shutdown, continued sequestration shall materially impact contractors’ operations.
I. 2013: A Brief Review
The sequester officially took effect on March 1, 2013, and required approximately $85 billion in cuts, Government-wide, across nearly all federal agencies. While the cuts were to be divided between Defense and non-Defense programs, Congress enacted a one-time modification in 2013 which instead divided the cuts between “Security” and “non-Security” programs. By doing so, select non-Defense programs such as international affairs and veterans’ programs were grouped with Defense programs under the “Security” category. As a result, reductions to Defense programs were lessened by approximately $20 billion in FY 2013, with cuts amounting to roughly $37 billion.
Although initial uncertainty regarding sequestration may have resulted in exaggerated concerns regarding its effect, sequestration’s impact on federal contractors cannot and should not be ignored as we head into the second fiscal year of cuts. Among the leading concerns are that disruption caused by the cuts will increase and that whatever budgetary flexibility agencies may have retained in 2013 has since been eliminated. The concern regarding increased disruption arises from both a quantitative increase in the cuts, as well as the fact that many agencies were forced to supplement their 2013 budgets with prior appropriations and such additional funding sources are not expected to be available going forward. Consequently, both Agencies and contractors can expect to feel the effects of sequestration more acutely in 2014.
II. 2014: What to Expect
The current law calls for cuts of $109 billion to be split equally across Defense and non-Defense budgets in FY 2014. As described above, due to Congress’ one-time modifications to the 2013 budget, which reclassified the programs to which the cuts were to be applied from Defense and Non-Defense to “Security” and “Non-Security,” the DoD’s 2013 budget retained approximately $20 billion that sequestration otherwise would have cut. Looking ahead to 2014, sequestration will apply to “Defense” and “non-Defense” programs, as initially contemplated, and the distribution of cuts will be assessed equally between these two sectors. Accordingly, the Defense programs will feel an additional strain as the 50/50 balance of spending cuts is implemented across Defense and non-Defense programs, and programs that were previously categorized as “Defense” programs (and thereby able to absorb a portion of Defense budget cuts) are reallocated to the non-Defense category in 2014.
The 2014 Defense budget is expected to decrease by over $50 billion, or more than 9.5%. This reduction will likely be felt disproportionately by Government contractors due to the fact that certain DoD budget items, such as military personnel accounts, are exempt from sequestration, shifting the impact of sequestration to contractors and civilian personnel. Speculation as to the specific cuts that will be made is premature at this time, but it is likely that cuts will be implemented through contract and procurement activities because such reductions are considered easier to implement and control than reductions in force (i.e., dismissals of civilian personnel).
Though the specific cuts are not yet finalized, the following have been proposed by Defense Agencies: a 14% cut in appropriations by the Navy, which would affect not only its acquisitions, but contracts for maintenance and repairs to its existing fleet; a 25% cut to the Army’s headquarters budget and further deferment of more than $70 million of maintenance on aircraft, vehicles, weapons, and communications equipment; reductions by the Air Force to flying time, acquisitions, and modernization; and significant reductions to Defense Contract Management Agency (“DCMA”) personnel. Not only can these cuts be expected to impact large prime contractors, but service contractors and downstream subcontractors will also be affected by the reductions to the Defense budget.
III. 2014 and Beyond: Strategies for Contractors
The full implication of the ongoing sequester remains understandably uncertain, however, contractors can and should now take affirmative steps to protect their interests.
Contract ComplianceSince its inception, sequestration has forced Contractors to question whether it is necessary to provide notice to employees pursuant to the Workers Adjustment and Retraining Notification Act, the WARN Act. Though the Department of Labor (“DOL”) has issued guidance that blanket WARN notices are not necessary, strict compliance with the letter of the regulation may require that contractors do provide these notices. In considering whether the notice is appropriate, Contractors with more than 100 employees should assess whether mass layoffs or plant closings, as defined by the law, are foreseeable. If these reductions are foreseeable, execution of WARN Act notices may be prudent, despite the DOL’s guidance. Indeed, the implementing regulations of the WARN Act explicitly note that, while the DOL provides assistance in understanding the WARN Act, it has "no legal standing in any enforcement action and, therefore, will not be in a position to issue advisory opinions of specific cases."
Contract ModificationsOver the past year, Contracting Officers have implemented strategies in response to shrinking budgets designed to extract more value from Contractors, including by broadening contractors’ scope of work. Contractors should thus closely and carefully monitor “scope creep,” maintain tight project controls, and ensure that all contractual and regulatory procedures regarding changes to contract work are followed, so that the Government does not and cannot overstep its bounds.
If the Government should push back against a contractor’s reasonable request for an increase in contract price or time arising from a Government-directed increase in scope, it bears noting that agency acquisition planning is expensive and time consuming, and that bid protests (which almost always delay contract award and increase agency acquisition costs) are on the rise. Consequently, agencies should be hesitant to pursue actions that will likely result in excessive contract administration costs and, likewise, contractors should be better positioned to challenge extraordinary and/or impermissible contract actions with greater force and confidence.
For incumbents contractorsIncumbent contractors will benefit from proactively engaging Contracting Officers regarding efficiencies, savings, and benefits provided to the Government. Such discussions carry the ancillary benefit of maintaining a proactive and positive public relations with the individuals responsible for contract award and administration, which will become increasingly important as budget dollars continue to decline.
For prospective biddersContractors bidding on new work should closely follow the solicitation guidelines and be mindful of the Government’s increased reliance on lowest price technically acceptable (“LPTA”) contracts. With the continuation of sequestration, contracts can be expected to be tailored so as to provide the most stability and lowest cost to the Government. Thus, there will likely be an increase in the use of LPTA contracts. Contractors should bear in mind that LPTA is a form of “best value” procurement and therefore should not assume that, because a Solicitation states it will be evaluated on the basis of “best value,” a proposal offering all of the bells and whistles will be favored over a more “bare bones” but lower priced proposal. Though this rule of thumb should always be considered in proposal preparation, it is especially important that Contractors now study the stated evaluation factors and tailor their offers to best satisfy those factors.
For disappointed bidders:Finally, disappointed offerors should carefully weigh the benefits and costs of pursuing a bid protest. While protests can be appropriate and should not be shied away from when cause to protest exists, it is not advised that contractors resort to indiscriminately protesting every loss. Furthermore, certain protest grounds relating to sequestration have been explicitly rejected by the GAO. Specifically, the cancellation of a solicitation due to sequestration is not a viable basis for a protest.
In conclusion, we can safely assume that sequestration will continue for the foreseeable future. While the current Congressional stalemate and budgetary crisis presents challenges to Government contractors, contractors can manage these challenges and emerge from sequestration in a strong and competitive position. Best practices highlight a return to contract formation and administration fundamentals. This includes maintaining close attention to detail (in other words, actually reading the contract), proactively engaging contracting officers and representatives prior to award (through discussions) and throughout performance, and protecting your contract from improper or uncompensated modifications.
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Federal Contractors at Heightened Risk for Acts of Employees under Anti-Kickback Act
By Lisa M. Marchese & Jessica Andrade
Federal contractors face heightened risk exposure under the Anti-Kickback Act in the wake of United States v. Kellog, Brown & Root, Inc., No. 12-40447 (5th Cir. July 19, 2013). In Kellog the Fifth Circuit held that federal contractors are vicariously liable for their employees’ violations of the Anti-Kickback Act, even where the employee was not acting to benefit the employer. This ruling makes it much easier for qui tam relators and federal prosecutors to prove vicarious liability under the Anti-Kick Back Act, thereby increasing contractor’s risk exposure substantially. The adoption of this lenient standard may encourage more enforcement actions under the Anti-Kick Back Act as well as an increase in qui tam lawsuits under the False Claims Act. In the wake of Kellog, federal contractors should reexamine their internal training, compliance and reporting programs to ensure that their employees are fully aware of the scope of this decision as well as its anticipated consequences.
Enacted in 1946, the Anti-Kickback Act, 42 U.S.C. §§ 8701-07 (AKA), was aimed at ending the practice engaged in by World War II defense subcontractors who obtained lucrative subcontracts by paying a fee to prime contractors. Ultimately, prime contractors passed these additional costs on to the federal government – and ultimately, to tax payers. The AKA has subsequently been amended and its scope expanded to enhance the government’s ability to prevent and prosecute the practice of kickbacks or ‘commercial bribery’ on federal contracts. For example, the AKA broadly defines a “kickback” as:
any money, fee, commission, credit, gift, gratuity, thing of value, or compensation of any kind that is provided to a prime contractor, prime contractor employee, subcontractor, or subcontractor employee to improperly obtain or reward favorable treatment in connection with a prime contract or a subcontract relating to a prime contract.
41 U.S.C. §8701(2).
Generally, the AKA prohibits a “person” from providing or attempting to provide a kickback--anything of value, any type of compensation or fee-- to obtain favorable treatment with regard to a contract. 41 U.S.C. § 8702. Key to the court’s ruling in Kellogg, the AKA defines “person” as a “corporation, partnership, business association of any kind, trust, joint stock company, or individual.” 41 U.S.C. §8701(3). The penalties for accepting or giving kickbacks are as follows:
- The Federal Government in a civil action may recover from a person---
- that knowingly engages in conduct prohibited by section 8702 of this title a civil penalty equal to-
- twice the amount of each kickback involved in the violation; and
- not more than [$11,000] for each occurrence of prohibited conduct; and
- whose employee, subcontractor, or subcontractor employee violates section 8702 of this title by providing, accepting, or charging a kickback a civil penalty equal to the amount of that kickback.
41 U.S.C. § 8706.
In Kellog, qui tam relators filed the original suit in the U.S. District Court for the Eastern District of Texas. The complaint alleged that Kellogg employees had inappropriately accepted kickbacks from subcontractors who wanted to receive work under Kellogg’s lucrative prime contract with the U.S. Army. Ultimately the federal government intervened and asserted claims against Kellog under the AKA. Kellog successfully obtained a dismissal of the case before the trial court, arguing that “vicarious liability” did not apply to Section 8706(a)’s enhanced or double-damages provisions, and that Kellogg, as a corporation, could not be liable for the acts of its employees where the employees were not acting to benefit the corporation.
The Government appealed the trial court’s order of dismissal. Specifically, the Government argued that vicarious liability did apply to Section 8706(a) and further, that the employee’s knowing acceptance of kickbacks should be imputed to the corporation. Under this reasoning, Kellogg would be held liable even though the employees’ illegal actions were not done to benefit Kellogg.
The Fifth Circuit considered two issues on appeal: (1) whether the principles of vicarious liability apply to Section 8706(a); and, (2) what the standard of intent is for a corporation to be held liable. Ultimately, the Fifth Circuit reversed the district court’s ruling, reasoning not only that vicarious liability applied to Section 8706(a), but that the corporation could be liable for the employees’ knowing acts so long as the employee was acting with “apparent authority” of the corporation.
The Court of Appeals noted in particular that Section 8706(a) prohibits a “person” from accepting or giving kickbacks, and further that “person” is defined to include corporation. Here, the Court reasoned that Section 8706(a) was meant to apply to corporations. The Court also found that that vicarious liability subjects corporations to liability for the acts of their employers, reasoning that Congress is presumed to have enacted the AKA within established common law tort rules.
With regard to vicarious liability, the Court of Appeals concluded that the standard of apparent agency should apply. Under “apparent agency,” the acts of an employee are imputed to the employer, when the agent has “the power to affect the legal relations of another person by transactions with third persons, professedly as an agent for the other, arising from and in accordance with the other’s manifestations to such third persons.” Thus, as long as it is apparent to a third party that the agent is acting within the authority of the corporation (regardless of whether the agent actually has that authority), the corporation can be found liable.
Notably, the Court rejected arguments from Kellogg that a higher standard of proof should apply for there to be vicarious liability. Kellogg argued unsuccessfully that a corporation should only be liable where (a) an employee acts with intent to benefit the corporation or (b) the employee was a manager acting within his or her scope of employment under traditional vicarious liability standards. In rejecting this argument, the Fifth Circuit has enunciated a rule that subjects contractors to liability for the actions of even low-level employees where such action is taken with “apparent authority.”
Although Kellog is considered persuasive authority outside of the Fifth Circuit, this ruling does have the potential to increase anti-kickback litigation throughout the U.S. Potential damages in the Kellogg case amounted to nearly $1.5 million. With lower levels of vicarious liability, and increased government prosecution under the False Claims Act and the AKA in general, government contractors should be increasingly vigilant. Contractors should train employees and institute systems both to prevent kickback activities and to discover and investigate allegations if they occur. In the wake of Kellog, chief compliance activities should include the following:
- Fully brief all employees and in particular, those responsible for contracting relationships on activity that will constitute a “kickback” and the legal implications of giving or accepting a kickback.
- Institute systems and controls for subcontracting that prevent kickback behavior.
- Have compliance personnel conduct periodic audits to ensure that contracting relationships are free of side-benefits, promises, or other activities that might be characterized as kickbacks.
- Establish a protocol for immediate investigation of potential AKA violations. Generally when tips or allegations are received, it is important to move quickly to investigate the validity of reported misconduct. A well-prepared contractor will be in a position to respond swiftly and thoroughly to vet such allegations and minimize business disruption in the process.
These recommendations provide the best safeguards to minimizing contractor risk exposure to liability under the AKA.
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Ten Best Practices for Alaska Native Corporations (ANCs) Applying to the SBA 8(a) Program
By Sara K. Peterson & Rachel Richards
This article is the first in a series of best practices articles, and it focuses on ten best practices for ANCs applying to the 8(a) program and navigating through the application process. Applying to the SBA 8(a) program takes significant time and resources, so you want to get the application right the first time. To assist in your application’s success, here are ten best practice tips and reminders for when you submit your ANC 8(a) application:
- Start early. Putting together an 8(a) application takes considerable time, thought, due diligence and resources. If an application is denied, waiting a year to reapply can be devastating to a company and its business strategy and development. It is important to plan ahead and allow ample time to understand the rules and regulations, as well as collect and analyze all of the required information prior to submission. Additionally, the processing time for applications, once an application is complete, can be 90-120 days.
- Understand the Rules and Regulations and Stay Current. While the regulations were last amended in 2011, further changes are anticipated before the end of the year. Applicants are often times surprised to learn of new regulations and changes, as well as the levels of scrutiny that ANC applications face, particularly for those individuals who may have applied to the program before the rule changes in 2011. Special rules apply to ANCs regarding eligibility requirements. For an ANC applicant to be eligible, the applicant must be owned and controlled by socially and economically disadvantaged individuals, qualify as a small business, and demonstrate its potential for success. An applicant’s potential for success can be demonstrated by showing (i) it has been in business for two years (unless waiver granted) which is evidenced by its tax returns and having operating revenue (generally third party and not sister company revenue) in its primary NAICS, (ii) the individual tasked with managing and controlling the daily business operations of the applicant has significant expertise and experience to successfully perform government contracts, and (iii) a commitment from the ANC parent corporation to financially support the applicant’s operations and evidence of the parent corporation’s financial capability.
- Collect, Collate and Submit Every Required Document. An applicant is required to submit current financial statements, current aging A/R and A/P reports, tax returns, corporate filings (articles, bylaws or operating agreements, biennial reports) for both the applicant and in cases of ANC applicant, the parent and if applicable the holding company. ANC applicants are also required to submit additional information including a list of all companies in which the ANC has ownership, including the name of the company, percentage of the ANC’s ownership interest, whether company is a current or previous 8(a) participant, identification of individuals who manage and control each company by serving as officers, directors, managers, the primary NAICS at time of certification, whether majority of revenues for past three years were generated from primary NAICS code at time of certification. The SBA has a useful Alaska Native Corporation checklist that identifies all of the documents required to be submitted with an application. Keep in mind, however, that the SBA can, and frequently does, ask for documents that may not necessarily be identified on the checklist.
- When in doubt, ASK. The SBA has great online resources, training modules and checklists. Unfortunately, the modules and checklists do not necessarily provide advice on how best to put your application together, help you decide which box to click, or tell you if your application is properly completed. Finding a qualified resource to assist you in completing your application can save you time.
- Take the Time to Go through and Understand the Online Application Process. The SBA requires applications to be submitted on-line, downloaded, signed and, for ANC applications, mailed to San Francisco for processing. Applicants are also required to set up a SBA General Login System (GLS) login to access and fill out the electronic application and annual updates. Although many glitches have been fixed, the online application is not specifically tailored for ANCs or limited liability companies. By way of example, the online application does not allow an individual to be identified as the manager or general manager of an LLC. Instead of selecting “other” which seems to be a natural choice, you should select “officer” and change the name on the hard copy submitted to the SBA. This allows the online application to then generate all forms required for the manager of the LLC, including Form 912 (Personal History).
- Don’t Overlook Good Contracting Practices. In addition to providing a list of all federal and non-federal contracts for the past two years, the SBA also requires copies of those contracts. Ensure that the contracts are signed, identify the proper parties, and contain a sufficient description of the scope of work.
- NAICS Code Analysis. As part of the SBA’s review process, the SBA will look to the copies of contracts and proposals submitted with the application to ensure the scope of work supports the applicant’s choice of a primary NAICS code. It is highly recommended that applicants who are operating in multiple NAICS codes analyze the percentage of revenue in those NAICS to ensure the majority of the revenue falls within the selected primary NAICS. In some cases, the SBA may find an applicant’s scope of work and revenue does not fall within an applicant’s NAICS code and request the applicant choose a different NAICS.
- Deficiency Letters. Once an application is submitted, the SBA will likely send you a deficiency letter. There’s no need to panic. Deficiency letters from the SBA are common and likely just identify certain information or documents that the SBA needs in order to deem an application complete. Applicants have 15 calendar days to respond to a deficiency letter, and are directed to only submit the information requested. Once the SBA has received your written response to the deficiency letter and an application is deemed complete, the SBA will notify an applicant in writing that the applicant has been accepted for processing.
- Certifications. Be honest, truthful and complete in your application, and know what it is you are submitting, signing and certifying. The consequences for falsely certifying an application are significant and can include suspension, disbarment, and criminal fines and penalties.
- Tone. Being aware of the tone of your application is critical. Remember the goal of the SBA 8a program is not to be a contracting vehicle for companies. Rather, the goal is to provide assistance and support to small socially and economically disadvantaged businesses in order to develop and gain access to federal and private markets and opportunities.
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Contractors: Keep Your Differing Site Conditions Claims Alive and Avoid the Pitfalls of North Pacific Erectors
By Traeger Machetanz & Scott Skinner-Thompson
In the recent decision of North Pacific Erectors, Inc. v. State of Alaska Dep’t of Administration, the Alaska Supreme Court seemingly erected several barriers to contractors attempting to bring differing site condition and/or superior knowledge claims against the State of Alaska. But the opinion should not be read too broadly. With careful analysis of the opinion and diligent compliance with record keeping requirements, contractors can continue to successfully bring claims based on differing site conditions or the State’s superior knowledge.
Overview of the Decision:North Pacific Erectors centered on whether the contractor could recover additional costs that were incurred in its removal and abatement of asbestos from the Juneau State Office Building. The Building contained indented or dimpled surfaces, causing the removal of asbestos to be much more labor intensive. The work was so painstaking that the contractors had to use toothbrushes to clean the dimpled surfaces. The dimpled and bumpy nature of the surfaces was hidden, nor was it clear that an inspection would have revealed this expensive site condition.
Notwithstanding these facts, the Court held that a contractor could not recover where the governing contract expressly required the contractor to keep an accurate and detailed record regarding the actual cost of work done under the alleged differing site condition and the contractor failed to keep such records. The Court also reversed the hearing officer (the original fact finder) and held that no superior knowledge claim could be brought because the contractor could have obtained information regarding the dimpled surfaces independently, including by asking other contractors (that is, competitors). The Court also glossed over procedural irregularities, including the fact that the ADOT deputy commissioner and assistant Attorney General were, in effect, allowed to usurp and overrule the original, unbiased and objective decision of the hearing officer.
Key Take Aways for Contractors:
- Contractors Can Protect Themselves by Keeping Diligent Records of Increased CostsWhile the North Pacific Erectors decision ignores the realities and practicalities of contracting work and the contractor’s focus on getting the job done, in order to preserve differing site condition claims, contractors should impress upon their teams the need to keep diligent records regarding the cost of work done as a result of the differing site condition.
- Keep Records of Lost Efficiency, TooThe North Pacific Erectors decision ignores the fact that often the losses caused by a differing site condition are not discrete cost items which are easily measured, but instead are delays or lost efficiency/productivity. Accordingly, in any dispute regarding site conditions damages, contractors should emphasize lost efficiency and productivity and also keep diligent records of their original, projected schedule and their actual, delayed schedule. In other words, it would be prudent for contractors to maintain records that give them the ability to perform a measured mile analysis of impacted and unimpacted costs of production.
- Focus on Your Specific Contract TermsSignificantly, the North Pacific Erectors decision was based on the fact that the contract specifically required the contractor to keep detailed records in order to recover for a differing site condition claim, and specifically disallowed the contractor to provide impact claims through use of the total cost, modified total cost or jury verdict methods. Therefore, before bidding, contractors should analyze whether the contract contains such a provision and, if so, factor it into the cost of its bid. If the contract does not contain such detailed claim requirements, then in the event of any dispute, contractors should distinguish North Pacific Erectors by arguing that its holding was limited and specific to the situation where the contract imposed an onerous recording and proof requirements, particularly given that in earlier decisions the Alaska Supreme Court has allowed modified total cost and jury verdict claims in the construction context.
- Superior Knowledge and Reasonable EffortsIn addressing the superior knowledge claim, the Court focused on whether the contractor could have “reasonably acquired the information without resort to” the State. In so doing, the Court did not discuss in any depth the practicalities surrounding bidding, including the short time frame often available for assembling a bid. Thus, if a contractor becomes involved in superior knowledge litigation, they should focus on what was “reasonable” under the circumstances of their case and emphasize that practicalities and realities make it unreasonable, difficult, and often near impossible to obtain the information without the State providing the information. Furthermore, a prudent contractor should also utilize the same evidence of effort and practical limitations on pre-bid investigation whenever making a differing site conditions claim because an owner may wish to utilize the North Pacific Erectors superior knowledge language to argue lack of a reasonable pre-bid investigation in connection with a differing site conditions claim.
- Preserve and Press Your Procedural ArgumentsWhile the Supreme Court avoided addressing head on some of procedural irregularities in the agency’s decision making process, North Pacific Erectors serves as a reminder that contractors should remain attuned to the agency’s direct involvement in the adjudicative process, preserve any claims that the agency’s involvement might violate due process norms, and press for a trial de novo by the Superior Court after the administrative decision if the agency overrides the decision of the hearing officer.
Conclusion:In summary, while North Pacific Erectors represents a setback to contractors, the opinion should be read in the context in which it arose—that is, in a case where the contract specifically required diligent record keeping. Going forward, contractors can best mitigate the impact of North Pacific Erectors by maintaining detailed and accurate daily records of production (based on actual cost) during the course of the project. If you have any questions about this case or our analysis of it, please don’t hesitate to contact us.
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