Deltek Insight 2012: Excessive Pass-Through Costs – The Newest FAR Unallowable

Excessive Pass-Through Costs — The Newest FAR Unallowable

Rich Wilkinson, Director, Watkins Meegan LLCKiran Pinto, Manager, Watkins Meegan LLCGC-189

2 ©2012 Deltek, Inc. All Rights Reserved

Background

Public awareness

Enabling legislation and chronology

The FAR changes

The FAR Mechanisms

DCAA audit guidance and its effects

Contractor exposure

Mitigation strategies

A look forward

Session Content

©2012 Deltek, Inc. All Rights Reserved3

Background


Limitation on “Excessive Pass-Through” goes back to 2006

“Clean Contracting Act” introduced in 2006 Sponsored by Representative Henry Waxman (D-CA) Partially a response to public outcry over FEMA contracting post-

Katrina Would have…

Prohibited “layer-cake” deals that inflate costs through tiers of subcontractors Banned “monopoly contracts” and most IDIQs Ended all sole source contracts to Alaska Native Corporations Banned award fee contracts Required Prime contractors to perform 65% of all work on all contracts

Origin of the Concept


Provision inserted in 2007 NDAA to require DOD to “prescribe regulations to ensure pass-through charges are not excessive” Language was vague at best and applied only to DOD Implemented by weak DFARS rule effective 26 April 2007 Starting point for future efforts

Similar bill, “Accountability in Government Contracting Act” introduced in 2007 Sponsored by Senator Susan Collins (R-ME) Would have required tiering of subcontracts to be “minimized” Flawed in many respects and never reported out of committee



Another bill, “Honest Leadership & Accountability in Contracting Act” also introduced in 2007 Sponsored by Senator Byron Dorgan (D-ND) Also failed to survive committee consideration

Another version of “Clean Contracting Act” introduced in 2008 Also sponsored by Representative Henry Waxman (D-CA) “Watered down” version of the original, but contained the excessive

pass-through provisions Also seemed unlikely to pass



Public Awareness


Little or none (even in the GovCon community) despite the new rule at DFARS 215.408

Rule promulgated in response to requirement of Section 852 of FY2007 NDAA which required DOD to prescribe regulations not later than 1 May 2007 to…

“ensure that pass-through charges on contracts and subcontracts that are entered into for or on behalf of DoD are not excessive in relation to the cost of work performed by the relevant contractor or subcontractor”

Public Awareness of the Issue


Surfaced in the 2008 Presidential Campaigns when Senator John McCain introduced it in stump speeches

Referred to the issue as “layer cake contracting” Speeches cited examples of cost doubled or tripled through layers No specifics ever presented

Public response was a resounding yawn

Congressional response somewhat more alert

Public Awareness of the Issue


Enabling Legislation & Chronology


Anticipating yet another failure of the Clean Contracting Act… Representative Waxman inserted the entire bill into the FY2009 NDAA

(HR 5658) as an amendment One Section entitled “Anti-Fraud Provisions” Another entitled “Curbing Abuse-Prone Contracts” Another entitled “Excessive Pass-Through Costs”

Enabling Legislation


Section 866 of the FY2009 NDAA required new regulation within one year to…

“minimize the excessive use by contractors of subcontractors, or of tiers of subcontractors, that add no or negligible value, and to ensure that neither a contractor nor a subcontractor receives indirect costs or profit on work performed by a lower tier subcontractor to which the higher-tier contractor or subcontractor adds no, or negligible, value.”

Passage of the NDAA on 14 October 2008 kicked off therule-making process

Applies to all Agencies even though initiated in the NDAA

Enabling Legislation


Regulation 14 October 2009 – Interim rule published for comment 14 December 2009 – Comment period ended 13 December 2010 – Final rule published in the Federal Register 13 January 2011 – Final Rule became effective

Implementation 18 February 2011 – DCAA issued Audit Guidance on the new FAR

provisions (AGM 11-PSP-003)

Chronology


The FAR Changes


FAR changes included… Prohibition on excessive pass-through charges on cost-type contracts

with civilian agencies in excess of the simplified acquisition threshold Prohibition on excessive pass-through charges on cost-type contracts

with DOD in excess of the $650k (exception for FFPs w/ adequate price competition and for commercial items)

Flowdown requirement Reporting requirement…

In proposals when proposed subcontracting would exceed 70%, or After award when actual subcontracting exceeds 70%

The FAR Changes


The FAR Mechanisms


New instructions to Contracting Officers In FAR Part 15, 15.408(n) – The Contracting Officer shall insert the

new solicitation provision (52.215-22) in all contracts… In civilian agencies, in cost-type contracts over $100k In DOD, in all contracts over $650k except certain FFPs with adequate price

competition or for commercial items

Resulting contracts are to include the new clause (52.215-23)

No instructions on monitoring or reporting

The FAR Mechanisms


The new solicitation provision at FAR 52.215-22 is entitled “Limitations on Pass-Through Charges – Identification of Subcontractor Effort”

The provision requires… That excessive pass-through charges be excluded from the proposal That the proposal identify $ amount of work to be performed by subs If subcontracted work is in excess of 70% of total cost…

Requires Prime to describe and substantiate the value added (indirect) Requires Prime to identify $ amount of of indirect cost and profit applicable

to (each) sub’s work

A flowdown clause to subs for proposal purposes

The New Solicitation Provision


The new clause at FAR 52.215-23 is entitled “Limitations on Pass-Through Charges”

The clause includes… A statement that the Government will not pay excessive pass-through

charges A provision for the Contracting Officer to determine if excessive pass-

through charges exist A reporting requirement A statement that excessive pass-through charges are unallowable A flowdown requirement (subs report to the Prime, Prime reports to the

Government)

The New Contract Clause


DCAA Audit Guidance

Their Interpretation of the Rule and

The Effect of the Audit Guidance


DCAA issued guidance in the form of AGM 11-PSP-003 on 18 February 2011

Memo states, in part… “as part of a forward proposal pricing audit, auditors should perform

procedures to evaluate a contractor's proposed support to demonstrate its added value when the proposed subcontracts are expected to exceed 70 percent of the total costs of the work performed”

It further directs…“during incurred cost audits and evaluations of final vouchers, auditors should also perform procedures to test compliance with the subject FAR provisions”

DCAA Audit Guidance


One more time…

“during incurred cost audits and evaluations of final vouchers, auditors should also perform procedures to test compliance with the subject FAR provisions”

DCAA Audit Guidance


FAR requires “a description of the added value it (the Prime) will provide”

The AGM requires auditors to “evaluate the reasonableness of the contractor’s description and supporting documentation of the added value”

Neither “reasonableness of the description” nor “supporting documentation for the added value” are required by the FAR

Their Misinterpretation of the Rule


On final vouchers, the AGM requires auditors to “provide a description and a demonstration of the added value by the contractor”

Directs auditors to question pass-through costs and profits as excessive if “the contractor cannot demonstrate its added value efforts”

AGM reminds auditors that “functions/costs not determined excessive under FAR 31.203(i) are still subject to the general (FAR 31.2) allowability, allocability, and reasonableness criteria”

Their Misinterpretation of the Rule


Whether a proposal, a contract or a delivery order… G&A and profits will likely be questioned when sub costs exceed 70%

regardless of documentation of value added efforts Most CO’s will simply adopt the recommendations The new FAR solicitation provision and contract clause will almost

certainly be misused

The clause has already appeared in commercial item acquisitions despite exception

One protest of such use in a DLA solicitation has already been denied

Likely Effects of the AGM


Contractor Exposure


Intent of changes is for PCO to make a pre-determination that pass-through charges are excessive and unallowable

NO REQUIREMENT for PCO to make any determination

Failure to do so does not protect contractor from future determination

No provision for prospective determination of allowability

Government gets as many bites of this apple as it wants!

Contractor Exposure


Failure to comply with reporting requirement is contractual non-compliance

Could result in finding of significant system deficiency

AGM 11-PSP-003 specifically states… “If the auditor finds through the procedures below that the contractor

failed to comply with the requirements of FAR 52.215-23(c), this should be considered an accounting and/or purchasing system deficiency.”

For all contracts where sub costs exceed 70%, AGM says… “If the contractor cannot demonstrate its “added value” efforts, then the

indirect costs (and profit) added by the contractor to the subcontracted work should be questioned.”

Contractor Exposure


AGM requires review of pass-through costs in… Proposals Incurred cost submissions Final voucher review

but NO OTHER TIME!

Issue may surface in proposal review

If not, any opinion by DCAA on allowability of pass-through costs may not be expressed until YEARS after the costs were incurred reported and billed

The new clause treats each delivery order separately

Contractor Exposure


Mitigation Strategies


Consider a Value Added G&A base if large teams or high sub content are part of your business model or strategy

FAR 52.215-23 contains a specific exception for “subcontract management costs”

Costs to be disallowed are “other than charges for the costs of managing subcontracts and any applicable indirect costs and associated profit/fee based on such costs”

Seems to specifically exempt the traditional (M&SH) rate from disallowance

Exclusion of subs from G&A base could result in a near automatic recommendation of no profit by DCAA



Carefully document functions performed with respect to subs

Develop a standardized description of value added efforts performed and make sure it’s included in EVERY proposal

Examine teams very carefully Large team/order pass-through strategies may be less attractive

unless Orders are to be fixed price and competed, or Prime will perform at least 30% of each order

Monitor subcontract content of all contracts and make reporting standard

Make sure EVERY contract brief contains description of value added efforts performed for that contract



A Look Forward


FAR changes could have implications for IDIQ programs where pass-through is common and often near 100%

Seaport-e orders are heavily cost-type and sometimes 99% sub’ed G&A and profit may be unallowable on such orders Other IDIQ MAC programs may be similarly affected

Because emphasis is on examination during the ICS and final voucher review, it may be years before we know

A Look Forward


Questions?


Call to Action/Contact Us


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Rich Wilkinson, Director(703) [email protected]

Kiran Pinto, Manager(703) [email protected]

Contact Us

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Deltek Insight 2012: Excessive Pass-Through Costs – The Newest FAR Unallowable