The issue of excessive profits received by private contractors working for the government during wartime is certainly not new.1 In December 1778, George Washington wrote: “No punishment in my opinion is too great for the man who can build his greatness upon his country’s ruin.”2 The war in Iraq, unfortunately, has again brought back this centuries-old issue. In a statement made on June 19, 2007, before the House Committee on the Judiciary Subcommittee of Crime, Terrorism, and Homeland Security, Thomas F. Gimble, the principal deputy inspector general of the Department of Defense (“DoD”), noted that since the start of the war in Iraq, the Defense Criminal Investigative Services office of the DoD Inspector General had conducted 83 investigations of government contractors performing war-supporting contracts in areas such as corrupt business practices, loss of funds through contract fraud and loss of Iraqi military equipment. It had also conducted 56 investigations related to the war effort in other areas of war profiting, contract fraud and contract corruption.3 These investigations have resulted in $9.84 million paid in restitution, plus hundreds of thousands of dollars in fines, penalties, forfeitures and seizures.4
There is now proposed legislation to discourage and punish excessive war profits that will alter the course of government contracting. The introduction of the War Profiteering Prevention Act of 2007 by Senator Patrick Leahy (D-Vermont), however, is not the first time Congress has enacted legislation to rein in war profiteers.
Excessive War Profits — A Twentieth Century Approach
In World War I, the government used excess profits taxes, price control and “cost-plus” contracts to limit excess profits.5 Cost-plus contracts set the amount of profits received by a contractor at a certain percentage of actual costs.6 This proved ineffective as contractors began increasing costs in order to increase profits, thus reducing efficiency.7 Cost-plus contracts were then replaced with “cost-plus-a-fixed-fee” contracts, which fixed the fee based on an advance estimate rather than actual costs.8
Between World War I and World War II, numerous bills and resolutions related to managing profits in future wars were introduced.9 In 1934, Congress passed the Vinson-Trammell Act, which required Navy contractors for vessels and aircraft to pay the government profits in excess of 10 percent of the contract price.10 Several years later, the Second Revenue Act of 1940 was enacted, which imposed a tax on excess profits and partially suspended the Vinson-Trammell Act.11
A major impetus for a change in the law was created by the Supreme Court’s 1942 decision in United States v. Bethlehem Steel Corp.12 In Bethlehem, the government challenged 13 contracts made with the Bethlehem Shipbuilding Corporation to build ships.13 The contracts were negotiated in 1917 and 1918 when it was “necessary for the United States to build the greatest possible number of ships in the shortest possible time.”14 The actual cost to Bethlehem of building the ships was approximately $109 million.15 The total profits claimed by Bethlehem under the contracts were approximately $24 million, slightly more than 22 percent of the estimated cost.16 As part of the suit, the government asserted that Bethlehem had a duty to “perform the contracts fairly, honestly and economically ‘in the shortest practicable time’ for no more than a ‘fair and reasonable profit’ and that any provisions in the contract for payment of more are ‘void and unenforceable.’”17 The Court denied relief to the government, affirming the judgments of the lower courts.18 Denying the government’s arguments, the Court reasoned: “If the Executive is in need of additional laws by which to protect the nation against war profiteering, the Constitution has given to Congress, not to this Court, the power to make them.”19
In response to the Court’s decision, in 1942 Congress enacted the Renegotiation Act. Renegotiation immediately became the principal device utilized by the government throughout World War II to limit profits on war contracts.20 The 1942 act essentially gave the government unilateral power to re-price war contracts during or after performance, once better cost information was available and the government’s bargaining position was stronger.21 In Lichter v. United States, the Supreme Court, emphasizing the broad war powers of Congress, upheld the constitutionality of the Renegotiation Act of 1942.22
Congressional Attempts to Rein in War Profits — The Renegotiation Act of 1951
In March of 1951, after the invasion of the Korean Republic and the escalation of the Korean War, Congress enacted the Renegotiation Act of 1951. This act was premised on the recognition that “accurate pricing and the control on contractors’ profits cannot be achieved during a build-up of production for defense of war.”23 Thus, the purpose of the Renegotiation Act of 1951 was to “control by recapture the skyrocketing profits on goods produced for war and national emergency without impeding either the volume or efficiency of that production.”24
The Renegotiation Act of 1951 was “an elaborate recodification of the law of renegotiation,” and for the first time a renegotiation board (“Board”), independent of procuring agencies, was entrusted to examine excessive profits on government contracts.25 The act covered contracts and related subcontracts made with the Department of Defense, the Army, the Navy, the Air Force, the Department of Commerce, the General Services Administration, the Atomic Energy Commission, the Reconstruction Finance Corporation, the Canal Zone Government, the Panama Canal Company, the Housing and Home Finance Agency and “such other agencies of the government exercising functions having a direct and immediate connection with the national defense as the President shall designate.”26 The act also contained a floor, which exempted contracts from renegotiation when the aggregate of the amounts received during a fiscal year by the contractor or subcontractor fell below $250,000.27
The act covered three classes of subcontracts. The first class of subcontracts covered “any purchase order or agreement…to perform all or any part of the work, or to make or furnish any materials, required for the performance of any other contract or subcontract,” except for agreements to furnish office supplies.28 The second class covered “any contract or arrangement covering the right to use any patented or secret method, formula, or device for the performance of a contract or subcontract.”29 The third class of subcontracts related mainly to contracts with brokers and manufacturers’ agents,30 and was subject to a floor of $25,000 rather than $250,000. The class included any contract or arrangement under which “(A) any amount payable is contingent upon the procurement of a contract or contracts with a Department or of a subcontract or subcontracts; or (B) any amount payable is determined with reference to the amount of a contract or contracts with a Department or of a subcontract or subcontracts; or (C) any part of the services performed or to be performed consists of the soliciting, attempting to procure, or procuring a contract or contracts with a Department or a subcontract or subcontracts.”31 This class excluded “a contract or arrangement between two contracting parties, one of whom is found by the Board to be a bona fide executive officer, partner, or full-time employee of the other contracting party.”32
The act also contained seven mandatory exemptions. Exempted were: (1) contracts with “any Territory, possession, or State, or any agency or political subdivision thereof, or with any foreign government or any agency thereof”; (2) contracts for certain agricultural commodities; (3) contracts “for the product of a mine, oil or gas well, or other mineral or natural deposit, or timber, which has not been processed, refined, or treated beyond the first form or state suitable for industrial use”; (4) certain contracts with a common carrier for transportation or with a public utility; (5) certain contracts with tax-exempt organizations; (6) “any contract which the Board determines does not have a direct and immediate connection with the national defense”; and (7) “any subcontract directly or indirectly under a contract or subcontract” that falls under one of the other six exceptions.33 In addition, the act authorized the Board to exempt five more classes of contracts in its discretion. These included (1) “any contract or subcontract to be performed outside of the territorial limits of the continental United States or in Alaska”; (2) “any contracts or subcontracts under which, in the opinion of the Board, the profits can be determined with reasonable certainty when the contract price is established”; (3) “any contract or subcontract or performance thereunder during a specified period or periods if, in the opinion of the Board, the provisions of the contract are otherwise adequate to prevent excessive profits”; (4) “any contract or subcontract the renegotiation of which would jeopardize secrecy required in the public interest”; and (5) “any subcontract or group of subcontracts not otherwise exempt from the provisions of this section, if, in the opinion of the Board, it is not administratively feasible in the case of such subcontract or in the case of such group of subcontracts to determine and segregate the profits attributable to such subcontract or group of subcontracts from the profits attributable to activities not subject to renegotiation.”34
Under the act, “excessive profits” was defined as “the portion of the profits derived from contracts with the Departments and subcontracts which is determined in accordance with this title to be excessive. In determining excessive profits favorable recognition must be given to the efficiency of the contractor or subcontractor, with particular regard to attainment of quantity and quality production, reduction of costs, and economy in the use of materials, facilities, and manpower.”35 In addition, the act stated that six factors should be taken into account: “(1) Reasonableness of costs and profits, with particular regard to volume of production, normal earnings, and comparison of war and peacetime products; (2) The net worth, with particular regard to the amount and source of public and private capital employed; (3) Extent of risk assumed, including the risk incident to reasonable pricing policies; (4) Nature and extent of contribution to the defense effort, including inventive and developmental contribution and cooperation with the government and other contractors in supplying technical assistance; (5) Character of business, including source and nature of materials, complexity of manufacturing technique, character and extent of subcontracting, and rate of turn-over; (6) Such other factors the consideration of which the public interest and fair and equitable dealing may require, which factors shall be published in the regulations of the Board from time to time as adopted.”36 “No single fact or factor is determinative. All the facts must be taken into account, all the statutory factors considered.”37
War Profiteering Act of 2007
Similar to the goals of the renegotiation acts to control excessive war profits, the War Profiteering Act of 2007 (“WPA”) seeks to amend the federal criminal code to prohibit profiteering and fraud by levying more stringent penalties on such illegal actions. The WPA provides in relevant parts that it shall be a violation of law for any person involved in the performance of a contract “in connection with a war, military action, or relief or reconstruction activities within the jurisdiction of the United States Government,” who “ knowingly and willfully” defrauds or attempts to defraud the government or “materially overvalues any good or service with the specific intent to defraud and excessively profit from the war, military action, or relief or reconstruction activities.”38 A contractor found to have overcharged the government may be fined the greater of $100,000 or not more than twice the gross profits or other proceeds derived from the overvaluation.39 In addition, such parties may also be subject to imprisonment for up to not more than ten years.
As proposed, the WPA provides little guidance on what constitutes “excessive profits” or how adjudicative bodies will make such a determination. Cases interpreting the Renegotiation Act of 1951 may shed some light on the possible elements or factors that may be used to determine “excessive profits.” As such, contractors should review their calculations of profit now, in consultation with inside or outside counsel, to ensure conformity with those factors related to excessive profits in the Renegotiation Act of 1951 cases, because regardless of whether the WPA ultimately is signed into law, Congress has signaled increased scrutiny of war profits such that a preemptive response now may prevent future liability.