United States: Independent Research And Development Effort: Back To The Future?

Since the reforms of the early 1990s, the US government has taken a largely hands-off approach to independent research and development (IR&D) effort and the allowability of the related costs, in contrast to the rigorous oversight and allowability caps applied prior to these reforms. This approach, however, began to change with the 2012 requirement applicable to Department of Defense (DOD) contractors to report IR&D projects to the Defense Technical Information Center to permit assessment of whether particular IR&D projects were of potential interest to DOD.

The shift toward greater DOD oversight of IR&D projects is accelerating, especially regarding research and development (R&D) effort in support of a contract (i.e., "parallel" or "concurrent" R&D) that is IR&D effort because it is not specifically required by a contract and multiple potential benefits exist. This shift is occurring because of the ill-conceived position that apparently underlies DOD's Better Buying Power 3.0 (BBP3)—i.e., that the government should be concerned about the benefits and risks of such IR&D effort when such efforts also support contract performance. DOD's increasing push for information and oversight of contractor IR&D projects should prompt contractors to revisit their IR&D strategies. Now, and likely in the future, the classification and initiation of IR&D projects will carry greater risk regarding the allowability of related costs and achieving profit objectives.

The irony of DOD's apparent new approach is that the US Court of Appeals for the Federal Circuit stated recently, in the context of a bid protest, that IR&D effort includes:

[R]esearch conducted by the contractor but not specifically for a particular government project. See 48 C.F.R. §§ 31.205-18, 9904.420. Although such work is contract-independent, its fruits can actually help the contractor deliver the goods or services promised in a particular contract. When that is so, the cost of work implicitly needed for a particular contract, which otherwise might have been built into the price for that contract, may instead be treated as an IR&D cost . . . . The result is a "cost reduction" for the particular contract without compromising the contractor's ability to fulfill its promises in that contract.

Raytheon Co. v. United States, No. 2015-5086, 2015 WL 6405390 (Fed. Cir. Oct. 23, 2015

The Federal Circuit, therefore, recognizes three important aspects of the current IR&D rules:

  • As established by ATK Thiokol, Inc. v. United States, 598 F.3d 1329 (Fed. Cir. 2010), contractor R&D effort is properly classified as IR&D effort, even when the effort supports a contract (whether or not a government contract), when the contract does not specifically require performance of the effort and the effort has multiple potential benefits beyond that single contract.
  • Supporting contract work with IR&D does not alter the contractor's legal obligation to fulfill its contractual obligations. For example, a contractor agreeing to deliver an operational product that is dependent on a successful R&D effort must meet this delivery obligation whether the contractor chooses to perform this necessary R&D as contractual effort or IR&D effort. In either circumstance, a delivery failure because the necessary R&D effort fails or is not performed could result in a breach of contract or termination for default and past performance issues.
  • Performing R&D effort as IR&D reduces government procurement costs.

In contrast, DOD's BBP3, the subsequent August 26, 2015 white paper from Frank Kendall and the impending change to DFARS § 231.205-18 to comply with BBP3 show that DOD, inexplicably, is likely to disregard what even the Federal Circuit understands regarding IR&D. Recent government actions in various procurements confirm this where Requests for Proposals, among other things, have: (1) required prior administrative contracting officer approval of any IR&D project proposed as support for a contract; (2) capped the allowable amount of costs for a parallel IR&D project; and/or (3) required that the contractor commit in writing to complete the supporting IR&D project.

These DOD actions affect all proposals to DOD where the contract requires the delivery of a product or service that requires R&D. A contractual opportunity that is based upon concurrent or parallel IR&D may be renegotiated, for example, to specifically include the R&D effort so that no IR&D exists, impacting competitive positioning against an incumbent or a competitor that previously had developed the product or service. Or, as another example, the buying agency may request a commitment to complete the IR&D project and then an auditor may rely on this commitment to support the position, well after the contract has been priced, that the R&D effort is specifically required contract effort and its costs must be charged to the relevant contract, eliminating the anticipated contract profit.

Clearly, contractors must recognize the risks of DOD's changing philosophy regarding IR&D. Contractors also should examine the draft rule that is likely to be circulated in 2016 and resist its likely restrictions on using IR&D to enhance competitive positioning (and reducing DOD costs!).

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