On October 18, 2019, the US Court of Appeals for the Federal Circuit affirmed the Armed Services Board of Appeals' ("ASBCA") decision in Appeal No. 57743 that salary costs for employees participating in lobbying activities are expressly unallowable costs subject to penalties. Raytheon Co. v. Sec'y of Def., No. 2018-2371, 2019 WL 5280873 (Fed. Cir. Oct. 18, 2019); see Raytheon Co., ASBCA No. 57743, 17-1 BCA 36724. As we have discussed in previous client alerts, the ASBCA's decisions are effectively expanding the range of costs that may be classified as expressly unallowable and subject to penalties and seem at odds with the industry understanding that expressly unallowable costs must be named and stated to be unallowable. See past client alerts here and here. The Court of Appeals' recent decision represents another step in that expansion.
In 2004, Raytheon included in its Final Indirect Cost Rate Proposal salary costs for employees that participate in unallowable lobbying activities. The contracting officer determined that the salary costs constituted expressly unallowable lobbying costs, and applied the associated penalties and interest pursuant to FAR § 42.709-1(a)(1). Raytheon appealed the contracting officer's final decision, first to the ASBCA, and then to the Court of Appeals for the Federal Circuit, arguing that salary costs of employees who participate in lobbying activities cannot be "expressly unallowable" because such costs are not "'mentioned or identified by name' to be expressly unallowable" in the FAR. Although FAR § 31.205-22 lists lobbying costs as unallowable, Raytheon argued that FAR § 31.205-22 does not explicitly identify salary and compensation costs for lobbying personnel as unallowable. The Court disagreed with Raytheon and determined that "'expressly unallowable' refers to a particular item or type of cost," rather than a specific cost listed in the FAR, and salary costs for employees participating in lobbying activities are a "prototypical lobbying expense."
What should worry contractors is that the Court went on to declare that, "[c]osts unambiguously falling within a generic description of a 'type' of unallowable costs are also 'expressly unallowable.'" This conclusion completely dismantles the industry's previous understanding of the rules regarding expressly unallowable costs―that they must be specifically named and stated to be unallowable or mutually agreed to be unallowable. If broadly interpreted, this conclusion could represent a pivotal moment because the government can now potentially argue that any unallowable cost is "within a generic description of a type of unallowable costs," and thus expressly unallowable and subject to penalties.
Taking the Court's position to the extreme, for example, it is now possible for the government to argue that any costs that are determined to be unreasonable (oftentimes, ironically, by an auditor with no experience operating a company) are "within a generic description of a type of unallowable costs" pursuant to FAR § 31.201-3(a)(1) and are therefore expressly unallowable and subject to penalties. This interpretation is incorrect because unreasonable costs are not selected costs subject to penalty in FAR § 31.205. Nevertheless, this example illustrates the dangerously broad language the Court used in determining the applicability of penalties associated with expressly unallowable costs. In any case, all costs disallowed and/or limited in FAR § 31.205 are now at risk of penalty application.
In light of this decision, contractors should carefully assess the costs they include in their final indirect cost rate proposals, with close attention to the selected costs addressed in FAR § 31.205, and especially those costs that may previously have been considered peripheral to unallowable costs.
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