United States: Industry Struggles With Ever Changing Acquisition Rules

Note: This post was originally published in the October 2017 issue of the National Defense Industrial Association's National Defense magazine.

Recent studies show that the percentage of overall research and development spending sponsored by the government has dropped sharply over the last 50 years.

Whereas government funding accounted for 67 percent of R&D in 1964, it accounted for 23 percent in 2015, a 44 percent reduction. For the government, this is not a salutary development. Increasingly, "state of the art" is being defined by the commercial marketplace, without government participation and often without its access to the resulting technological advances.

One need only recall the intense media furor over the government's inability, for months, to obtain access to the shooters' encrypted cell phone data following the December 2015 San Bernardino terrorist attack to appreciate the consequences when the developers of advanced commercial technology eschew the federal marketplace.

The government has attempted for years to reverse this trend. In fact, the Federal Acquisition and Streamlining Act of 1994, popularly known as "FASA," had, as one of its primary purposes, the attraction of commercial entities into the federal marketplace. The trend, however, continues.

One of the principal reasons for this, and one that receives little attention, is that while policymakers "talk a good game" in terms of easing the regulatory burdens on non-traditional government contractors, they often fall woefully short on delivery. Succinctly stated, commercial contractors find it difficult to trust promises of legislative and regulatory reform when these promises can be undermined, as they have so often been in the past, by subsequent legislative and/or regulatory developments, or by implementation at the field level that ignores the purpose of the statute or regulation.

Perhaps the most obvious example of the government's willingness to impair a statutory mandate designed to benefit non-traditional government contractors can be found in the nullification of FASA's exemption for commercial item contracts from the requirement to provide cost or pricing data. For years, companies that had developed and priced their commercial items using a commercial market model were reluctant to provide cost or pricing data as a condition of contracting with the government.

The reasons for this reluctance are not difficult to divine. First, if the product is being successfully sold in the commercial marketplace, then the price, by definition, is reasonable because it reflects what a prudent buyer is willing to pay and what a prudent seller is willing to accept in an arm's length transaction.

Second, the government audits product prices based on current information — for example current material costs, current labor and indirect rates — relating to a particular contracting action. But that is not how commercial companies customarily price their products, relying instead on a long-term assessment of the projected market, the likely quantities that may be sold over a period of time, the pace of product obsolescence and the investment necessary to bring the product to market.

Products so priced yield less profit on the front-end of the product's life, but increasingly handsome profits on the back-end. If the government buys the item on the back-end of the product's life, an audit of "current" cost or pricing data will demonstrate what the contractor knew all along, which is that it's recouping in later sales the investment sunk in the front-end development of the product and not recovered in sales made prior to the break-even point in the product cycle. An auditor will characterize this late life profit margin as "gouging."

Unsurprisingly, FASA's exemption for commercial items came as welcome relief, both to established contractors and new players alike. The statute expressly stated that submission of cost or pricing data shall not be required.

Alas, that exemption was short-lived. By 1996, FASA's commercial item exemption was effectively gutted when the prohibition on "submission of cost or pricing data" was changed in the National Defense Authorization Act to a prohibition on submission of "certified" cost or pricing data. It was only one word, but a word that makes a world of a difference because it facilitated statutory and regulatory changes allowing contracting officers to require potential vendors to submit "data other than certified cost or pricing data."

What is "data other than certified cost or pricing data?" There is nothing tricky here — it is identical to the pre-FASA cost or pricing data that could be required to support offers of commercial items, minus only the certification. So, how trustworthy was FASA's "bait" of a commercial item exemption from the Truth in Negotiations Act to lure non-traditional contractors into the federal market? The readers should be the judges.

The government will, of course, contend that the elimination of the certification requirement renders the current regulatory scheme faithful to the original intent of FASA. But this is wrong on two counts.

First, it ignores the problem inherent in soliciting and using current information to challenge a proposed price that was based on a model that is inconsistent with the government's traditional way of evaluating price.

Second, the lack of an express certification may not necessarily insulate contractors for errors in the data. The Supreme Court's 2016 ruling in Universal Health Services v. US ex rel. Escobar reaffirmed the potential for False Claims Act liability based on implied certifications. It sounds counterintuitive for liability to be imposed on the basis of a false "implied certification" of "data other than certified cost or pricing data." After all, if an express certification is statutorily prohibited, can that data really be "material?"

There is a pre-Escobar district court decision that says, "No." But, in that case the government filed an amicus curiae brief arguing that "data other than certified cost or pricing data" can in fact be material. This certainly suggests that some enterprising future whistleblower may well find a government ally on this issue. The early betting line heavily tilts toward that outcome.

Moving from contract pricing to rights in technical data and computer software, the pattern is often all too similar. There are, and long have been, multiple regulatory traps designed to deprive contractors of their rights in privately developed intellectual property — the "list it or lose it" requirements, the mandatory nature of the prescribed markings, and the use of a low-dollar federal contract to "improve" an item already fully developed at private expense.

But even when contractors successfully navigate the shoals of those tricky waters, they will find — as the case law confirms — government personnel who are all too willing to disclose properly protected intellectual property to others for competitive purposes.

Does a non-disclosure agreement signed by government personnel afford protection? Don't count on it unless it is signed by a warranted contracting officer. All those other government folks who sign those agreements? They may not be able to bind the government, and it is unlikely that they have sufficient assets to make a contractor whole when they disregard the non-disclosure agreement.

Even if the government is liable for the improper disregard of contractor markings and the disclosure of the intellectual property to third parties, the relief available to the contractor is scarcely adequate, generally awarding the contractor a "reasonable royalty" for the conversion of the assets and leaving the contractor to fight corollary battles with the recipients of the property wrongfully disclosed by the government.

Its financial liability for destroying the value of the contractor's market position with respect to its own intellectual property is, thus, generally far less than the value lost by the contractor and far less than the government would have had to pay in an arm's length acquisition of that property.

Should such folks be entrusted with the most precious privately developed intellectual property, particularly if federal sales would constitute but a small fraction of the total business?

The government does, with increasing frequency, attempt to acquire rights in contractor intellectual property in connection with its supply contracts for the underlying items.

The regulations clearly state that when it does this a potential vendor "shall not be required, either as a condition of being responsive . . . or as a condition for award, to sell or otherwise relinquish any greater rights in technical data when the offeror is entitled to provide the technical data with limited rights."

That's what DFARS 227.7103-10 says. But the reality often works out much differently.

No, there is not any "disqualification" or "ineligibility" language in these requests for proposals. However, there is an evaluation scheme that makes it virtually impossible for a contractor to prevail in a competition unless it is willing to relinquish its limited rights by weighting the data rights factor heavily and placing a cap on the rating available for that factor if data rights are not relinquished.

Although there is no technical non-compliance with DFARS 227.7103-10, the practice is not exactly what the regulatory language evokes in the reader.

There are some who will say that this is being hypercritical and carping about imbalances in the system that have been there for years and are a price of doing business with the government, like the empty handshake and the oral agreement that "isn't worth the paper it's written on."

Maybe so. But the examples discussed above illustrate why, over the decades, more and more companies that have solid commercial business bases regard the price of doing business with Uncle Sam to be unacceptable and the federal marketplace to be a non-starter.

Companies like to deal with reliable business partners. Business partners who can change the rules to suit their fancy or to pander to some political constituency do not fit that mold. Business partners that can misappropriate intellectual property with little meaningful consequence are really not tolerable in the commercial world.

So, when the government asks why it cannot attract more non-traditional contractors into its web, it ought to look in the mirror. It will often find the answer staring back.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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