The Federal Circuit's recent decision in Gates v. Raytheon Co.,—F.3d—, 2009 WL 2914340 (Fed. Cir. Sept. 14, 2009), has upped the ante for timely computation and payment of accounting adjustments under the Cost Accounting Standards (CAS) for Government contracts. The court held that failure to make an adjustment during the current accounting period stemming from the sale, discontinued operations or other closure of a business segment violates CAS 413-50 (48 C.F.R. § 9904.413-50) and results in increased payments by the Government. Most important, the court found that Raytheon owed interest, compounded daily on the amount it was required to repay the Government.

The case is an appeal of a decision by the Armed Services Board of Contract Appeals (ASBCA) with its origins in Raytheon's sale of two business units, in December 1998 and July 2000, which had performed CAS-covered Government contracts. After each sale, Raytheon and the Government eventually agreed on the amount of the Government's share of surplus pension costs for the closed business segments under CAS 413-50(c)(12). On September 21, 2004, Raytheon paid the agreed upon amounts ($487,305 and $14,681,268), but refused to pay the simple interest the Government had requested on those amounts. The Contracting Officer later issued a final decision that Raytheon had not complied with the CAS 413 requirements to make pension surplus adjustments in the current accounting period and therefore owed interest to the Government.

The ASBCA initially held that Raytheon's failure to promptly provide an adjustment for the Government's share of the surplus pension costs resulted in noncompliance with CAS 413. Raytheon Co., ASBCA No. 54907, Aug. 21, 2007, 07-2 BCA ¶ 33,655. Because the board found that Raytheon's noncompliance led to increased Government costs, Raytheon was held liable for interest under the "CAS clause" in its Government contracts, Federal Acquisition Regulation § 52.230-2. Id. The board also found that this interest should be calculated using daily compounding under 26 U.S.C. §§ 6621-22. Id. On reconsideration, however, the ASBCA found that the record was unclear on the accounting treatment of the surplus adjustments and that the Government had failed to show that any increased costs resulted from a CAS violation. Raytheon Co., ASBCA No. 54907, Apr. 28, 2008, 08-1 BCA ¶ 33,859. The board therefore concluded that the CAS clause did not apply and no interest was due. Id.

On appeal, the Federal Circuit found that "[o]n the undisputed facts, it is clear that Raytheon violated CAS 413" by not paying the pension adjustments in the same accounting periods in which the sales of the business segments occurred. The court also found that this noncompliance increased the Government's costs on the Raytheon contracts that were open during those accounting periods (rather than examining whether the Government had overpaid during previous accounting periods, as the board had done). Having found that Raytheon violated CAS 413 and that the violation resulted in increased costs to the Government, the court then turned to 41 U.S.C. § 422(h) to determine how interest on the Government's overpayments should be calculated.

Section 422(h) applies the annual interest rate designated by Section 6621 of the Internal Revenue Code to CAS violations:

The interest rate applicable to any contract price adjustment shall be the annual rate of interest established under section 6621 of title 26 for such period. Such interest shall accrue from the time payments of the increased costs were made to the contractor or subcontractor to the time the United States receives full compensation for the price adjustment.

Section 6622 of the Internal Revenue Code then requires daily compounding of "any interest required to be paid under this title or sections 1961(c)(1) or 2411 of title 28, United States Code." 26 U.S.C. § 6622(a). In Raytheon, the Federal Circuit explained that it had previously held that statutes like 41 U.S.C. § 422, "which require interest payments at the rate set out in § 6621[,] require compound interest." See Canadian Fur Trappers Corp. v. United States, 884 F.2d 563, 568 (Fed. Cir. 1989) (applying compound interest to international trade and tariff duties). The court twice noted that it could not contradict Canadian Fur Trappers, even if Raytheon's briefs "may support" a different interpretation of the statutes. These statements seem to hint at the possibility of a future en banc decision to overturn Canadian Fur Trappers.

Unless and until such a decision is issued, however, contractors will be forced to pay huge interest penalties for any CAS violation that results in increased Government costs. This is particularly troublesome given the length of time often required to negotiate a payment amount with the Government. In some cases, it may be cheaper for contractors to seek a final decision of noncompliance as quickly as possible and proceed to litigation rather than attempt to negotiate a settlement. The additional leverage this decision may give the Government is yet another reason contractors must exercise vigilance in the area of CAS compliance.