For a number of years, contractors have been required to expend substantial sums challenging baseless legal theories initiated by the Defense Contract Audit Agency (DCAA) and rubber-stamped by the Defense Contract Management Agency (DCMA) without proper exercise of its authority.

A recent decision by the Armed Services Board of Contract Appeals (ASBCA) in Lockheed Martin Integrated Systems (ASBCA Nos. 59508 and 59509) exposes what has been in recent years an all-too-familiar practice by the Government of questioning the allowability of contractor costs based on meritless arguments. That practice starts with the disallowance by the DCAA of costs based upon a novel “theory” which has no identifiable factual, legal or contractual basis. Then, without altering DCAA’s findings, in disregard of its responsibilities under the Federal Acquisition Regulation (FAR), the DCMA wholly adopts them as the basis for the COFD and any subsequent appeal. (We provide several such examples below.) Contractors are forced to incur substantial sums that are treated as unallowable under the FAR even though the contractor should not have been forced to incur those costs in the first place.

As many are aware, this practice has evolved, in part, because DCAA has been granted expanded authority in recent years and, correspondingly, in too many cases, DCMA has become increasingly reluctant to challenge DCAA audit findings. Where they have done so, pursuant to internal policy (see Assad Memorandum, Subject: Resolving Contract Audit Recommendations (Dec. 4, 2009)), the issues are elevated to DCMA headquarters for review and, in at least one instance, a contracting officer who challenged DCAA’s findings subsequently was the target of an IG investigation. The ASBCA’s decision in Lockheed Martin may finally mark the beginning of the end for this unfair practice, which, as our examples below demonstrate, is not limited to this one reported instance.

Lockheed Case

In Lockheed, the government asserted breach of contract claims totaling approximately $116.8 million based upon two DCAA-originated theories: 1) direct subcontract costs were disallowed based solely on the difference between subcontract costs actually billed by prime contractor Lockheed to the government and costs determined to be unallowable in assist audits of the subcontractors performed by DCAA offices other than the Lockheed DCAA office; and 2) subcontract costs charged at the prime level deemed unallowable because Lockheed failed to meet its alleged obligation to manage its subcontractors, including but not limited to, its failure to obtain incurred cost submissions from its subcontractors.

One would think that before a COFD is issued asserting entitlement to $116 million, the underlying legal theories would receive thorough analysis to assure they were at least credible, if not rock-solid. That type of analysis appears not to have been performed in this instance. The Board flatly rejected each government breach theory; its reasoning in each instance speaks eloquently to the problems with the Government’s approach. With regard to the direct subcontracts costs issue, the Board found:

“Based on our review, the government’s claim for direct subcontract costs fails to state a claim upon which relief can be granted. The complaint offers no legal theory for its claim of disallowance nor does it provide any allegations of fact. It states conclusorily that there were questioned costs and some variances that entitle the government to disallow subcontract costs. Our pleading standard requires factual assertions beyond bare conclusory assertions to entitlement. The audit report, which was incorporated into the complaint, states that some assist audits questioned costs but does not explain on what grounds [ … ] It also states there were differences between amounts in [Lockheed Martin Integrated Systems’] proposal and costs under subcontracts but provides no facts regarding these differences [ … ]. More importantly, the COFD does not cite a single actual fact, only the audit report’s unsupported conclusions.”

With regard to the allegation of breach in charging subcontract costs at the prime level, the Board found:

“In this case, we are presented with a claim based on a legal theory, originated by an auditor, that LMIS, as a prime contractor, had a contractual duty to retain for purposes of an incurred cost audit the same documentation that it used to substantiate its billings during the course of performance of the contract and, moreover, had a duty to initiate audits of its subcontractors’ incurred costs and be able to prove during the course of an incurred cost audit that it did so. LMIS’s “breach” of these non-existent duties is the government’s only basis for asserting that the subcontract costs for which it has reimbursed LMIS are unallowable. The government does not allege that LMIS did not adequately substantiate its billings during performance of the contract, or that the subcontract services were not provided to its satisfaction, or that the costs billed were not incurred by LMIS. Rather, it has gone forward with a claim for over $100,000,000 that is based on nothing more than a plainly invalid legal theory.” (Emphasis added)

The ASBCA also repeatedly noted these theories originated with the DCAA and that the DCMA added nothing to either the complaint or the COFD (e.g., “COFDs and complaint allegations add nothing to what is stated in the audit report. They simply refer to or quote from it.”).