On October 18, 2019, in Raytheon Company v. Secretary of Defense, No. 2018-2371 (Fed. Cir. Oct. 18, 2019), the Federal Circuit affirmed a decision of the Armed Services Board of Contract Appeals (“ASBCA”), holding that “salary costs for lobbying activities are expressly unallowable” under FAR 31.205-22 despite the fact that FAR 31.205-22 does not expressly list such salary costs as unallowable. Given the penalties contractors face for requesting reimbursement of expressly unallowable costs, this decision has troubling implications. The Federal Circuit’s rationale, and its new interpretation of the term “expressly unallowable,” has the potential to significantly broaden the scope of what costs can be considered “expressly unallowable” because it gives short shrift to the “expressly” part of the equation. And with this loosened interpretation of “expressly,” contractors now face an increased risk of auditors and contracting officers labelling unallowable costs as being expressly unallowable, and the associated risk of penalties under FAR 42.709-1(a)(1). In short, contractors now face the risk of penalties for non-enumerated “expressly unallowable” costs.

In June 2005, Raytheon submitted a cost proposal for a cost-plus-fixed-fee engineering services contract associated with the Patriot missile defense system. In April 2006, the Defense Contract Audit Agency (“DCAA”) concluded that Raytheon’s cost proposal included various expressly unallowable costs. Then, in May 2011, the Defense Contract Management Agency (“DCMA”) issued a final decision determining that Raytheon’s proposal included, among others, over $220,000 in expressly unallowable lobbying salary costs. The contracting officer demanded repayment for these previously reimbursed costs and assessed penalties and interest against Raytheon under FAR 42.709-1(a).

Raytheon appealed the contracting officer’s final decision to the ASBCA. Raytheon argued that while its in-house lobbying salaries were unallowable, they were not “expressly unallowable” because they were not explicitly listed in FAR 31.205-22 (Lobbying and political activity costs). The ASBCA rejected Raytheon’s argument and upheld the DCMA finding, concluding that lobbying salary costs were “expressly unallowable” because the “[c]osts associated with certain named lobbying activities are stated to be unallowable under FAR 31.205-22 . . . .” Raytheon Co., ASBCA Nos. 57743 et al., 17-1 BCA ¶ 36,724, at 178,851 (Apr. 17, 2017). Alternatively, relying on FAR 31.201-6(a) and (e)(2), the ASBCA held that the lobbying salary costs were “expressly unallowable” because salary costs of employees who participate in unallowable activities are also expressly unallowable as “directly associated costs” of that unallowable activity. Id. Raytheon appealed to the Federal Circuit.

On appeal, Raytheon argued that “salary costs of employees who participate in lobbying activities are not ‘expressly unallowable under a cost principle in the FAR’ under § 42.709-1(a)(1)” because lobbyists’ salaries are not specifically “‘mentioned or identified by name’” in the regulation, and the inclusion of costs associated with lobbying is insufficient to clearly include these salary costs. The Federal Circuit rejected this argument. Referring to FAR 31.001 and the definition of an “expressly unallowable cost,” the Court seized upon the first part of the definition, which refers to “a particular item or type of cost.” From this language, the Court stated that “an ‘expressly unallowable’ cost includes more than an explicitly stated ‘item’” and that “[c]osts unambiguously falling within a generic description of a ‘type’ of unallowable cost are also ‘expressly unallowable.’” The Court then concluded that because the salaries of in-house lobbyists are a “prototypical lobbying expense” and because FAR 31.205-22 disallows costs “associated with” lobbying expenses, “[s]alaries of corporate personnel involved in lobbying are unambiguously ‘costs associated with’ lobbying.” Thus, Raytheon’s costs for in-house lobbyists were expressly unallowable. Finding that “the plain language of the rule is unambiguous,” the Federal Circuit did not further examine the ASBCA’s alternative holding.

What is troubling about the decision is that it completely ignores the remainder of FAR 31.001’s definition of an “expressly unallowable cost,” which reads in full:

a particular item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable.

FAR 31.001 (emphasis added). A basic structural interpretation of that definition indicates that both “item” and “type” of cost is modified by the requirement that the item or type of cost be one that, “under the express provisions” of a law or regulation “is specifically named and stated to be unallowable.” This also makes intuitive sense: to be an “expressly” unallowable cost, a law, regulation, or cost principle must specifically (expressly) identify that particular cost as unallowable. That was Congress’s intent in including this language in the first place — so contractors would not be penalized where the regulations lack explicit specificity. But the Federal Circuit ignored this patent qualification. Instead, the Federal Circuit’s decision stands for the proposition that a cost can be “expressly unallowable” — and thus subject to penalties — so long as the cost “unambiguously fall[s] within a generic description of a ‘type’ of unallowable cost.”

So what should contractors do?

First, contractors should remove all salary allocations attributable to lobbying activities from their indirect cost proposals as this Federal Circuit decision (ironically) expressly repudiated the 2015 ASBCA Board decision finding that “[n]either [bonus and incentive compensation] cost nor ‘compensation’ cost is specifically named and stated as unallowable under th[e] cost principle [in FAR 31.205-22], nor are these costs otherwise identified [as unallowable] in any direct or unmistakable terms.” Raytheon Co., ASBCA Nos. 57576 et al., 15-1 BCA ¶ 36,043, at 176,051 (June 26, 2015).

Second, contractors must tread carefully in reviewing their future indirect cost proposals for similar cost items that may fall within a “type” of costs deemed unallowable under the FAR cost principles. Under this broadened test, contractors must consider not just specifically named unallowable costs, but also what types of costs may unambiguously fall within generic definitions of types of unallowable costs. Although the Raytheon decision addresses only lobbying costs under FAR 31.205-22, several other cost principles include similar “associated with” provisions that auditors could seize upon in the future. For example, FAR 31.205-1 addresses the allowability of public relations activities “associated with areas such as advertising, customer relations, etc.” And FAR 31.205-27 covers “expenditures in connection with” business organization costs. Previously, these borderline cases may ultimately have been found to be unallowable, but under this Federal Circuit decision, claiming such costs can now expose contractors to the imposition of penalties and interest. Although it remains to be seen how aggressive government auditors become in asserting this new, non-express “expressly unallowable costs” option, it seems likely that further “expressly unallowable” cost disputes are on the horizon.