A great deal of discussion has transpired regarding recent legislation that reportedly could alter significantly the established "follow-the-funds" test used for the allocation of intellectual property rights in data developed under a government contract. The legislation involved is a provision of the National Defense Authorization Act for Fiscal Year 2011 (the "Act"), signed into law on January 7, 2011. In particular, Section 824 of the Act provides "Guidance Relating to Rights in Technical Data" and, more importantly, amends Section 2320(a) of Title 10 of the United States Code, the provision that defines the allocation of rights in intellectual property under Government contracts.
Unfortunately, the amendment adopted in the bill is clearly flawed. The provision, read literally, makes no sense. Depending on what Congress actually intended to impose, the change is either a major "sea change" in the way rights in data are to be allocated, or it is merely a refinement and expansion of current law dealing with de mimimis activities. Many are raising alarms regarding the potential impact of the change, and such concern may be warranted. On the other hand, consideration of the legislative history leading to the provision suggests that only a modest change was intended but was transmogrified to something akin to Frankenstein's monster in the reconciliation of the House and Senate versions of the Act.
As enacted, the Act seems to require, at least to some extent, that Independent Research and Development ("IRAD") costs and Bid and Proposal ("B&P") costs be treated as "government expense" in applying the data rights follow-the-funds test. As such, the government would be allocated, at a minimum, a Government Purpose Rights License in data related to an item or process developed under an IRAD or B&P project or, more likely, an Unlimited Rights License in those data. This, obviously, would be a marked departure from established principles that define IRAD and B&P costs as "private expense." Indeed, the treatment of IRAD and B&P costs as "private expense" has its roots in the earliest interpretations of the rights in data provisions set forth in the Armed Services Procurement Regulation of the late 1950s and 1960s. This historic treatment of IRAD and B&P costs even avoided the assault on the Defense Federal Acquisition Regulation Supplement ("DFARS") data rights provisions adopted in the late 1987-88 time period (only to be reversed in the 1995 revisions).
In relevant part, the Act adopts the following changes to 10 USC §2320(a):
(b) Rights in Technical Data- Section 2320(a) of title 10, United States Code, is amended—
(1) in paragraph (2)(F)(i)—
(A) by redesignating subclauses (I) and (II) as subclauses (II) and (III), respectively; and
(B) by inserting before subclause (II), as so redesignated, the following new subclause (I):
(I) rights in technical data described in subparagraph (A) for which a use or release restriction has been erroneously asserted by a contractor or subcontractor;'; and
(2) in paragraph (3), by striking `for the purposes of definitions under this paragraph' and inserting `for the purposes of paragraph (2)(B), but shall be considered to be Federal funds for the purposes of paragraph (2)(A)'.
Act, Section 824 (emphasis added).
Incorporating the required changes into the relevant portions of 10
USC §2320(a) results in the following requirement:
§ 2320. Rights in technical data
(a)
(1) The Secretary of Defense shall prescribe
regulations to define the legitimate interest of the United States
and of a contractor or subcontractor in technical data pertaining
to an item or process....
(2) Such regulations shall include the
following provisions:
(A) In the case of an item or process that is developed
by a contractor or subcontractor exclusively with Federal
funds (other than an item or process developed under a contract
or subcontract to which regulations under section 9(j)(2) of the
Small Business Act (15
U.S.C. 638(j)(2)
) apply), the United States shall have the unlimited
right to—
(i) use technical data pertaining to the item
or process; or
(ii) release or disclose the technical data to
persons outside the government or permit the use of the technical
data by such persons.
(B) Except as provided in subparagraphs (C) and (D), in the case of an item or process that is developed by a contractor or subcontractor exclusively at private expense, the contractor or subcontractor may restrict the right of the United States to release or disclose technical data pertaining to the item or process to persons outside the government or permit the use of the technical data by such persons.
(E) In the case of an item or process that is
developed in part with Federal funds and in part at
private expense, the respective rights of the United
States and of the contractor or subcontractor in technical data
pertaining to such item or process shall be established as early in
the acquisition process as practicable (preferably during contract
negotiations) and shall be based upon negotiations between the
United States and the contractor, except in any case in which the
Secretary of Defense determines, on the basis of criteria
established in the regulations, that negotiations would not be
practicable....
(3) The Secretary of Defense shall define the
terms "developed", "exclusively with Federal
funds", and "exclusively at private expense" in
regulations prescribed under paragraph (1). In defining such terms,
the Secretary shall specify the manner in which indirect costs
shall be treated and shall specify that amounts spent for
independent research and development and bid and proposal costs
shall not be considered to be Federal
fundsfor the purposes of paragraph (2)(B), but shall be
considered to be Federal funds for the paragraph
(2)(A).
10 USC §2320(a), Subparagraph (3) modified to capture the
changes adopted by the Act (emphasis added).
The revision seems to maintain the traditional treatment of IRAD
and B&P costs as "private expense" in those
situations in which the development cost was accomplished
exclusively at private expense (Subsection 2(B)), but alters the
traditional definition in those situations in which the development
cost was accomplished "exclusively at government expense"
(Subsection 2(A)). The modification is silent as to any impact on
so-called "mixed funding" development involving both
private and federal expense contributions. The problem with this
approach, of course, is that IRAD and B&P development efforts
are part of what needs to be defined in making the
"private" and "federal" expense determination.
The absurdity of the new provision is best illustrated by
attempting to apply its requirements to an item, component, or
process developed entirely through an IRAD or B&P effort. The
only answer to the question of whether such an item, component, or
process was developed "exclusively at private expense" or
"exclusively at government expense" is
"yes."
Assuming that what is stated is not what Congress intended, the
question remains: What did Congress intend? Did Congress mean to
make a fundamental change to the 50+ year old follow-the-funds test
as it pertains to IRAD and B&P costs? A review of the very
limited legislative history of Section 824 of the Act at least
suggests that Congress had no such "sea change" in mind.
Section 824 has its genesis in the Senate. The Senate adopted a
relatively modest change to 10 USC §2320(a). The House bill
had no comparable provision. The Senate bill proposed amending
subparagraph (a) of §2320 to read as follows:
§ 2320. Rights in technical data
(a)
(1) The Secretary of Defense shall prescribe
regulations to define the legitimate interest of the United States
and of a contractor or subcontractor in technical data pertaining
to an item or process....
(2) Such regulations shall include the
following provisions:
(A) In the case of an item or process that is developed by a contractor or subcontractor exclusively with Federal funds without a significant contribution by a contractor or subcontractor (other than an item or process developed under a contract or subcontract to which regulations under section 9(j)(2) of the Small Business Act (15 U.S.C. 638 (j)(2)) apply), the United States shall have the unlimited right to...
(3) The Secretary of Defense shall define the terms "developed", "exclusively with Federal funds", "exclusively at private expense" and "significant contribution by a contractor or subcontractor" in regulations prescribed under paragraph (1). In defining such terms, the Secretary shall specify the manner in which indirect costs shall be treated and shall specify that amounts spent for independent research and development and bid and proposal costs shall not be considered to be Federal funds for the purposes of paragraph (2)(B).
Senate Bill S.3454 (emphasis added).
The Senate language in general reaffirms the traditional treatment
of IRAD and B&P costs as representing "private
expense" in the application of the follow-the-funds test. At
the same time, it treats as "government expense" (or,
alternatively, renders inapplicable) those contractor-incurred IRAD
and B&P costs that do not represent a "significant
contribution" to the development of an item, component or
process. This proposed change, while significant and the potential
source of important issues, does not represent the "sea
change" feared by many. Unfortunately, how Congress got from
the Senate proposal to the language in the Act is largely
undocumented. The "Joint Explanatory Statement to Accompany
H.R. 6523 [the adopted House version]" states only:
Guidance Relating to Rights in Technical Data (Sec. 824)
The Senate committee-reported bill contained a provision (sec. 824) that would require the Secretary of Defense to revise guidance on rights in technical data to promote competition and ensure that the United States is not required to pay more than once for the same technical data.The House bill contained no similar provision.The agreement includes the provision with a clarifying amendment.
Joint Explanatory Statement to Accompany H.R. 6523, page 446.
The issue that the Senate provision seems to have been drafted
to address relates to what has been called the "oldest game
available to contractors." In brief, that "game" is
the product development strategy of analyzing a particular product
to identify the single component or process that is the key to
proper functioning of the overall product or otherwise provides the
contractor with a clear technological competitive advantage.
Government funds are then sought and utilized to
"develop" all portions of the product except for the key
component or process. For the development of the key component or
process, only private funds are used – generally IRAD or
B&P funds. As a result of this strategy, if the government
wishes to buy the end item, it must "sole source" the
procurement to the company that controls the data rights to the key
component or process. Thus, an important limitation is placed on
the government's ability to compete future procurements
– a phenomena that the DoD and Congress apparently find,
at least to some extent, to be bad policy. See,
e.g., Joint Explanatory Statement to Accompany H.R. 6523,
page 446, supra. The proposed Senate change to 10 USC
§2320(a) would attempt to assure that any partial funding of
an item, component, or process that is relied upon by a contractor
to restrict the government's rights to compete the end item
involves private expenditures that represent a
"significant" contribution to the overall use or
functioning of the item.
What Can Be Done To Clarify the Amendment?
The Defense Federal Acquisition Regulation Supplement Council
("DFARS Council"), the body charged with implementing the
new law through an amendment to the DFARS, established a
"DFARS Case" on January 19, 2011 to accomplish the
required new, amended coverage. A DFARS Case is assigned to a
working group that gathers relevant data and research and drafts
proposed new regulations. A report was due from the working group
to the Council on April 13, 2011. It is possible, but unlikely,
that a draft proposed regulation could be published in the Federal
Register soon thereafter. As you know, if a substantive regulation
change is proposed, the public must be permitted an opportunity to
comment on the proposed new regulation. Unfortunately, because the
change is based on an act of Congress, the Council may decide that
it has little ability to substantively stray from the language of
the Act in adopting a proposed regulation. Well founded criticism,
however, likely will cause the DFARS Council to delay
implementation and cause the Council to seek, via the Office of the
Secretary of Defense, corrective or clarifying legislation.
Clearly the most effective method of seeking an amendment of
Section 824 of the Act is through trade associations. Both the
National Defense Industry Association and the Public Contract Law
Section of the American Bar Association, for example, are active in
responding to proposed regulatory amendments. Moreover, individual
contractors may have the resources to lobby Congress directly. All
such avenues should be pursued.
What Are the Policy Issues Raised By the
Amendment?
There are a number of points that can be made to illustrate the
problems with a policy that significantly alters the current bases
for allocating rights under DoD contracts. The following summarizes
some of the more significant.
- Effect on the Development of New Technologies: There can be little doubt that the change proposed will have a significant impact on DoD contracting companies' willingness to undertake IRAD projects. Without the ability to protect intellectual property rights through such projects, companies are more likely to insist on direct government reimbursement for their development efforts. There is little or no incentive otherwise to incur the IRAD or B&P expense. Even if the IRAD or B&P project involves a so-called "dual use" product, a product with a commercial as well as a military application, development of the product as part of an IRAD or B&P effort runs the risk of an allocation of an Unlimited Rights License to the government – a license that largely destroys the commercial value of the product. While an argument can be made that independent development programs might be funded out of non-contract funds (profit, equity, or other private investment), such an approach under typical DoD cost and accounting rules would place the entire development cost on the contractor and the government would gain use of any product utilizing the technology without paying more than the cost to produce the product. Unlike commercial entities and the accounting practices available to them, companies under DoD contracts cannot capitalize and amortize intellectual property costs over the anticipated useful life of the technology or product. Similarly, DoD cost rules would prevent including in any negotiated contract proposal an amount not supported by estimated, future expense as opposed to expended private funded costs. As a result of these limitations, if the essential thrust of Section 824 is implemented, the DoD likely will find that new products and technologies will not be developed unless the associated costs are paid for as a direct cost by DoD. As a further result, many such projects simply will not be undertaken because of limited government funding.
- Competitive Marketplace for Intellectual Property: A correlative impact of the likely outcome discussed above, is the effect on the competitive marketplace for technological development. Under the current treatment of IRAD and B&P costs, a great deal of the decision making regarding which development projects are worthy of pursuit is left to each individual contractor. (A practice under separate attack by proposed regulatory changes such as those related to IRAD reporting; see, e.g., 76 Fed. Reg. 11414 (Mar. 2, 2011)). To the degree that new development efforts, as a result of the impact of the Section 824 policy changes, will need to be directly funded by DoD, greater control of IRAD projects will be vested in DoD. Control of technology innovation will shift significantly. Only those technologies that DoD deems worthy of federal expenditures will be financed. The open marketplace of competing technologies in the military field will be displaced. U.S. defense technology planning increasingly will emulate that of the 1960s and '70s, as well as the that of the former Soviet Union with its 3 year, 5 year, and 10 year structured technology plans. Oddly, such an approach largely was abandoned in the late 1980s and 1990s with the adoption of various procurement policy changes culminating with the Clinton-Gore initiatives to increase U.S. worldwide competitiveness in technological innovation. The changes to the allocation of rights in data adopted by the Act, is a reversion to the prior, micro-management policies of the 1970s and early 1980s that was found to have been counterproductive.
- Availability of Commercial Products: Based on the changes to data rights policy inherent in the Act, commercial sellers at both the prime contract and subcontract levels will be extremely reluctant to accept DoD contracts and subcontracts. Should the new regulations implementing the Act be written aggressively to allocate to the government rights in data related to products developed with IRAD funds, commercial entities will abandon the DoD market. All of the efforts and progress made by the DoD over the last 15 years to attract commercial vendors (see, e.g., "Intellectual Property: Navigating Through Commercial Waters – Issues And Solutions When Negotiating Intellectual Property With Commercial Companies," Under Secretary of Defense for Acquisition, Technology and Logistics (October 15, 2001) (hereinafter "Navigating Commercial Waters")) would be squandered and the impact on DoD programs would be dramatic. The following chart, for example, is taken from a report issued by the National Science Foundation and illustrates the likely magnitude of technologies DoD will find unavailable for its programs.
What this chart demonstrates is that the federal government clearly
was the proverbial 700 pound gorilla in sponsoring R&D efforts
prior to the 1980s. The chart also demonstrates that while the DoD
largely financed its own technology/product development efforts
prior to the early 1980's, that phenomenon has changed
dramatically over the years. Today it is a very import player, but
no longer dominant. As of 2008, close to 70% of all United States
R&D expenditures were funded by commercial businesses.
Importantly, of the 25% federal government expenditures for
R&D, only approximately half were DoD expenditures. See,
e.g., Navigating Commercial Waters, Forward. Thus, an
enormous amount of cutting edge technology is being developed in
the private sector without DoD financing. A DoD procurement policy
that discourages participation by commercial vendors, particularly
those in high technology disciplines, likely will have a major
impact on DoD's ability to achieve its procurement objectives.
Those companies will not sell their products to DoD under contracts
that threaten to allocate to DoD expansive rights in technologies
developed in IRAD projects. As a result, critical, advanced
technologies and products in such areas as telecommunications,
super computers, and software simply will not be available to be
used in DoD procurements.
It is not clear how far-reaching changes to the technology policies
will extend as a result of the changes adopted by the Act. The
thrust of the Act, however, and the proposed changes in control of
IRAD reporting suggest a movement back to policies that were
abandoned in the '80s and '90s. Like Frankenstein's
monster, the changes seem to have been adopted without considered
thought of their long term reach. While focusing solely on apparent
short term advantages to the DoD (obtaining greater rights in
intellectual property), they ignore likely market reaction and the
longer term detrimental effect on (a) U.S. technology policy and
(b) DoD's ability to access cutting-edge commercial
technologies. The new policies seem to ignore the findings and
guidance the DoD expressed in (a) the Under Secretary of Defense
for Acquisition, Technology and Logistics [USD(AT&L)] Policy
Letter of January 5, 2001 (Subject: Reform of Intellectual Property
Rights of Contractors), (b) the USD(AT&L) Policy Letter of
September 5, 2000 (Subject: Training on Intellectual Property), (c)
the USD(AT&L)] Guidebook "Navigating Commercial
Waters," as well as (d) Congressional policy decisions
reflected in the Federal Acquisition Streamlining Act
("FASA"), The Federal Acquisition Reform Act
("FARA"), and the Information Technology Management
Reform Act ("ITMRA"). Common sense would indicate that
considerably more analyses and debate should accompany this new
policy decision than that which is reflected in the adoption of the
Act.
Additional proposed changes to IRAD reporting are also discussed here.
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.