In an April 2017 decision, the Armed Services Board of Contract Appeals (ASBCA) once again rejected the position of the Defense Contract Audit Agency (DCAA) that a cost or type of cost for which allowability depends on the circumstances or Contracting Officer discretion can nonetheless be "expressly unallowable" and subject to penalties under FAR 42.709-1(a).  Although the law is clear that penalties are appropriate only when such costs are named and stated to be unallowable in a cost principle such that a counter position is unreasonable, the DCAA has continued to assert its erroneous position in its audit guidance and findings.

A contractor is subject to penalties if it includes in its indirect cost submission an indirect cost that is "expressly unallowable under a cost principle in the FAR, or an executive agency supplement to the FAR."  FAR 42.709-1(a)(1).  The ASBCA has explained the standard for whether a cost is expressly unallowable is "objective."  General Dynamics Corp., ASBCA No. 49732, 02-2 BCA ¶ 31,888, reversed on other grounds, Rumsfeld v. General Dynamics Corp., 365 F.3d 1380 (Fed. Cir. 2004).  An item of cost is expressly unallowable if it is "specifically named and stated as unallowable...."  Raytheon Company, ASBCA Nos. 57576, 57679, 58290, June 26, 2015.  Moreover, "the Government must show that it was unreasonable under all the circumstances for a person in the contractor's position to conclude that the costs were allowable."  General Dynamics Corp.

In twin Memoranda for Regional Directors (MRDs) dated December 18, 2014 and January 7, 2015, the DCAA provided its audit teams with guidance concerning the identification of expressly unallowable costs that contradicted these clear rules.  14-PAC-021(R); 14-PAC-022(R).  Relying on an ASBCA case from the 1980s, Emerson Electric Co., ASBCA No. 30090, 87-1 BCA ¶ 19,478, November 19, 1986, the DCAA opined that "a cost can be unallowable even though the cost principle does not explicitly state that the cost is unallowable or not allowable."  14-PAC-022(R).  "[I]n situations where a cost principle does not specifically state that the applicable cost is unallowable or not allowable, the audit team will have to employ critical thinking when determining whether the cost principle identifies expressly unallowable costs" and "whether the cost principle identifies a cost or type of cost clearly enough that there cannot be a reasonable difference of opinion as to whether a questioned cost meets the criteria specified."  Id.

In examples included in the MRDs, the DCAA illustrated how it would apply this standard.  For instance, the DCAA stated that costs of travel by contractor-owned, -leased, or -chartered aircraft that exceed the allowable amounts in FAR 31.205-46(b) are expressly unallowable unless they meet one of four exceptions.  14-PAC-021(R).  FAR 31.205-46(b) provides:

Airfare costs in excess of the lowest priced airfare available to the contractor during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements.  However, in order for airfare costs in excess of the above airfare to be allowable, the applicable condition(s) set forth above must be documented and justified.

Plainly, determining whether these various criteria and exceptions are satisfied involves a good deal of judgment, and reasonable minds may differ.  The DCAA nonetheless has instructed its audit teams (through the MRDs) that whenever a DCAA auditor judges that the exceptions are not satisfied, the costs are expressly unallowable and subject to penalties.

Not only were the MRDs' conclusions unreasonable on their face, but their reliance on Emerson Electric Co. is misplaced.  In Emerson Electric Co., the ASBCA opined that a cost principle in the Defense Acquisition Regulation providing that foreign selling costs "shall not be allocable" to U.S. Government contracts was effectively equivalent to a statement that they were unallowable.  There was no question in that case over whether the costs in question were foreign selling costs, and there were no judgment calls to be made concerning whether they met certain criteria.

The basic flaw in the DCAA guidance – that it ignores the distinction between costs that may be unallowable depending on application of judgmental criteria and those that are "specifically named and stated as unallowable..." – is emphasized by the fact that the MRDs ignore the holdings of cases that preceded Emerson Electric and that conflict with the very examples they provide.  For example, the ASBCA considered in a 2007 case whether the costs of travel by contractor-owned, -leased, or -chartered aircraft were expressly unallowable.  In Fiber Materials, Inc., ASBCA No. 53616, 07-1 BCA ¶ 33,563, April 17, 2007, the ASBCA rejected the Government's assessment of penalties on leased aircraft costs included in indirect cost proposals, even though it held that the Contracting Officer had properly disallowed the costs because allowability under the cost principle depended on the exercise of the Contracting Officer's discretion.

The ASBCA's most recent decision is yet another rebuke to the DCAA's overreaching interpretation of the term "expressly unallowable."  In Raytheon Company, ASBCA Nos. 57743, 57798, 58280, April 17, 2017, the ASBCA again considered a Government assertion that costs were expressly unallowable under FAR 31.205-46.  The Government argued that aircraft fractional lease costs included by Raytheon in its indirect cost proposal were expressly unallowable because they exceeded the amounts allowed in an advance agreement.  The ASBCA again held that FAR 31.205-46 "contemplates circumstances where airfare costs in excess of the lowest customary standard, coach, or equivalent airfare could be allowable," and also gives the Contracting Officer the "discretion to approve higher costs."  The ASBCA also noted that FAR 42.709-1(a) does not provide for penalties when a cost is included in an indirect cost proposal in violation of an advance agreement.  The ASBCA thus concluded that Raytheon's aircraft fractional lease costs were not subject to penalties even though they exceeded the amounts allowed under the advance agreement.

The DCAA's position that a cost can be expressly unallowable depending on the circumstances was unsupported when it was issued and has been thoroughly discredited by subsequent ASBCA cases.  Until the DCAA withdraws its incorrect audit guidance, or until Contracting Officers recognize the error in this guidance, however, contractors will likely continue to face unwarranted claims for penalties.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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