Contents of this Section

click to navigate

Example of Specification Failures: Sure Shot Rocket Company

Sure Shot Rocket Company received a $6 million contract to do engineering development and deliver 25 prototype rockets; the medium range, attack type. The rockets had a 70-mile range and were designed to be carried on the B-1 bomber; they also had a specified speed which was classified as well as altitudes of attack at which they would operate to meet the range requirements.

Sure Shot was an experienced rocket motor manufacturer. It had been in this business for over 25 years. It employed the services as a subcontractor of Earth Dart Aerospace Company which likewise had tremendous experience in guidance systems and systems integration for similar types of rockets it usually delivered to the Air Force.

Because Sure Shot's rocket motor was the most critical item, it retained the role of prime contractor.

Sure Shot commenced development work and after two years, within the schedule provided in the contract, had the first of the prototype motors ready for testing. Earth Dart had the guidance system as well as fin and actuator assemblies complete and had worked with Sure Shot to integrate them correctly.

A successful first test was planned. The rocket was dropped from an RB-70 aircraft for testing purposes because the B-1 aircraft were not yet fully capable of dropping attack missiles of this size. The missile flew only 35 miles, falling short of its target by exactly one-half of the prescribed 70-mile distance. Post-flight analysis showed the rocket motors nozzle had ablated in an unexpected fashion causing it to lose its required size and shape and causing the rocket to run out of thrust prematurely.

Sure Shot spent the next six months trying to correct the nozzle problem but despite its very best efforts and the expenditure of $5 million above the contract price, it could not get the rocket to fly more than 37 miles. It continued to have problems with the nozzle assembly. That was agreed to be the root cause of the problem.

The government finally terminated the contract for default. Sure Shot's attorneys were called in to assess what could be done about the situation. The Air Force was also at the same time meeting with its attorneys, because the contracting officer had been required by the Commanding General to terminate the contract after feeling pressure from the Secretary of Defense due to adverse Congressional publicity. The Contracting Officer has his own concerns as to whether the action was correct.

Both sides are pondering the following background information which relates to this particular nozzle problem. The Air Force through its rocket propulsion laboratory in California, has over the last 15 to 20 years, funded almost all research and development efforts in connection with rocket motors and specifically in connection with developing high performance nozzles. For use on those rocket motors, the Air Force had spent millions of dollars on contractor's field-testing of various types of ceramic, graphite and other materials to be utilized in the nozzles so that they would maintain their structure during the intense heat and pressure being applied to them during a rocket motor being fired. Great strides had been made as a result of the Air Force's funding of this research over the last 15 years.

Nozzles that were destroyed after a few seconds of flight, now last for several minutes of flight in extraordinary heat and pressure circum-stances applied by modern high-technology rocket motors. The Air Force maintains a complete data bank on the results of this research work. The Air Force had technical committees in the rocket propulsion laboratory that met once every quarter and heard from contractors on suggested funding of additional research in the nozzle area. These committees took the contractor's advice under consideration, and made their own decisions on what type of further research would be funded as would be in the Air Force's best interests considering all upcoming projects known of.

The specifications for the medium range attack missile called for a high-performance nozzle which would satisfy the 70-mile range, would permit the motor to be started and stopped three separate times during its flight in order to evade enemy defenses and countermeasures. The specs also pro-vided types of high altitude and low level approaches. The Air Force had tested in previous research much of the technology expected to be utilized in this particular missile system and had high confidence that it would work.

Approximately six months before letting the contract, it pre-pared an internal report which stated that the technology was in hand and basically two to three design routes could be followed by a contractor to meet the unique requirements of the medium range attack missile; the application of the technology to these two or three design routes was obvious and competent contractors, given the two-year development period, should have no difficulty in perfecting nozzles which would satisfy the overall performance requirements of the missile.

What is to be made of this information?

How does it affect the claim process from both sides?
Who does it help the most?
How can it best be utilized?

Sure Shot's outside attorneys are recommending an impossibility of performance defense be submitted to the government's default action and that an attempt be made to recover the $5 million spent in attempting to surmount the impossibility before the default occurred. The contracting officer's attorneys are expecting this type of claim. They believe that Sure Shot's long expertise in the industry, its reputation as a leading innovator in design approaches and its membership on several of the nozzle development committees sponsored by the rocket propulsion laboratory will allow it to rebut any allegation of Sure Shot.

Is this the correct claim approach? Or is something being missed? What of the A-12 litigation?

Example of Specification Issue/Termination: Humperdink & Fud Accounting

Humperdink and Fud, one of the United States' big eight accounting firms was the successful bidder against all other big eight accounting firms to install a new accounting system for the Air Force’s Engine Turbine Management Program.

Basically Humperdink had contracted to do necessary work to convert from a manual system to a computerized system of keeping track of the expenses and the Air Center’s reimbursements as expended and received. The program involves taking appropriations Air Force wide for turbine maintenance; offsetting expense incurred by all bases and contractors to determine at any point in time exactly what funding remains.

In addition, there were numerous management reports, and special projects which had to be accounted for and distributed under complicated formulas to various commands and air centers. The accounting function itself, though straightforward, was highly complex and required much sophisticated programming. However, this was a job which could be done primarily from desk work at Air Force Headquarters in Washington. It was basically an issue of taking expenses, determining how they would be allocated, and keeping track of appropriations.

Humperdink proceeded on these assumptions as had most other bidders as could be seen from the clustering of bids. The government specifications for this job, as for most other installations of computerized data processing services were general and required overall performance standards.

Humperdink was confident that it could meet those performance standards. Humperdink had been required, as had others prior to contract award, to submit a detailed performance plan which showed its man loading and budgets it had established for doing various segments of the work, and all labor and material, including computer equipment that it needed to purchase.

After the contract was awarded, Humperdink went to the first design review for its system (one month after award). A design review was to be held every month, for the 24-month period of the contract. At the first design review, the government expressed concern about Humperdink's performance plan, stated that it did not believe Humperdink had scheduled an adequate amount of field work to ensure that proper accounting data was being received from various bases and Air Centers across the United States and there was concern that there was not an adequate track on expenditures of funds.

Humperdink pointed out that it had not planned on doing this. The government said it was not its concern but it was obviously required for an over-all, proper and competent job. The performance specifications required Humperdink to do all work necessary to install a proper functioning system with adequate checks and balances. The government reminded Humperdink that it had the right to reject its design in the middle of performance at critical design review and intended to do so unless this work was done now to its satisfaction. A default termination would then likely occur.

Humperdink argued with the government at the next two design review meeting months but to no avail. The government was insistent that this field work be performed and that it was part of Humperdink's original contractual obligations. More design submittals were due in another two months and it was obvious to Humperdink the government would reject those design submittals also.

What should Humperdink do? What are its chances of success in a claim or in default litigation? What practical alternatives are open to it to solve this particular problem?

Should Humperdink do what the government wants and simply file a claim? (Assume this is a $10 million contract - it will lose $20 million beyond its contract price to perform as the government wishes.

Answers

This is a constructive change case, about to become a default case.
Broad performance specifications do not insulate the government from constructive changes.
Unless the government lets the contractor sink or swim on its own.
Design reviews are dangerous to the government.
Claims of constructive change come from abridgement of a contractor’s low cost approach.
With performance specs. – the contractor largely determines how to perform.
Shouldn’t the contractor claim this constructive change is so large that it is cardinal or a breach? He would not have to spend the extra $10 million, but a T/D will likely occur.
The Government will still likely T for D.

Example of Specification Failures and the Need to Proactively Manage Claims: Atlas Blast Company

The Atlas Blast Company case: A case showing in vivid detail the problems created by lack of action on a contractor's part in dealing with claims as they are occurring under a contract.

Atlas Blast Co. [Contractor]

George Good, Project Manager Fred Frantic, Production Foreman

____________________________ U.S. Navy [Procuring Agency] Arthur Errant, Project Manager

Calvin Cautious, Contracting Officer

Superior Study Co. [a consulting organization retained by Atlas]

Fact Situation

The Atlas Blast Co. was awarded a fixed price contract on March 5, 2004 for furnishing 12,000 explosive bolts to the Navy Material Center, Point Retreat, Florida. The contract contained Standard Form 32, and provided for delivery of 1,000 units per month beginning September 3, 2004.

The explosive bolts were to be used on an advanced missile. This was the first production contract for the bolts which had been designed and originally manufactured by the Navy. The contract also contained a "Stop Work Order" clause and an exculpatory clause.

Appendix A

The following events occurred during contract performance; as you go through these materials, you should look for instances in these fact patterns where good claims management could have prevented or headed off the problems before they occurred or got out of control.

(1) The Navy's project manager, Arthur Errant, advised Atlas on March 20, 2004 that the Government contemplated making a change in the bolts within a week or two. Atlas project engineer, George Good, taped this phone conversation without disclosing it to Errant. The text of the tape is set forth in Appendix B. Good, in consultation with Fred Frantic, Atlas' production foreman, decided not to set up the production line until the content of the change was revealed.

Consider These Issues:

What is the propriety of taping telephone conversations? What is the usefulness of doing so?
Are there authority issues here from a claims management perspective; how do you routinely prevent them from occurring?
Could the failure to set up the production line have been made a claimable event?

(2) On May 3, 2004, Errant advised Atlas that the change involved packaging the bolts in packages of 36 instead of 12. The Change Order, formalizing this change, signed by Calvin Cautious, the Navy Contracting Officer, followed on May 5, 2004. A copy of the Change Order is contained in Appendix C.

Consider These Issues:

Does the way the change order was actually issued affect the perfection of the claim?

Should this be the case?

(3) Despite the holdup Atlas was able, through the use of overtime, to deliver the first batch 1,000 bolts on September 16, 2004. These bolts were tested by the Navy at Point Retreat and rejected for failure to meet the hardness requirements.

Upon return to Atlas, the bolts were examined and the entire manufacturing process was studied by the Navy technical evaluation team, Atlas, and Superior Study Co., a consulting organization retained by Atlas. All production was halted pending the outcome of the study.

Consider These Issues:

What thought should the use of overtime trigger?
What could the company do about the rejection of the bolts?
On return of the bolts, what actions should the company be taking? Could the retention of Superior Study be done in a more productive fashion from a claims management point-of-view?

(4) On November 20, 2004 Atlas and Superior concluded that the problem was caused by the fact that the type of carbon steel prescribed by the Navy specifications became brittle when heat-treated for 37 minutes as called for by a note on the Navy-furnished drawings. Atlas promptly called this to Errant's attention, who notified Calvin Cautious by a memorandum which also discussed some of the problems encountered by the Navy during early production. The memorandum is contained in xxxxx (sentence fragment)

Appendix B

In response to Atlas, Calvin Cautious sent a letter dated December 3, 2004 stating that the heat treating time called out on the drawing note was proper but that "in light of Atlas' concern and difficulties and in view of urgent Navy requirements, a heat treating period of nine minutes or more will be considered acceptable." The letter also advised Atlas that it was delinquent in deliveries and that if satisfactory progress was not demonstrated by January 1, 2005, the contract might be terminated for default.

Consider These Issues:

What of the Navy's argument that the 37 minute heat-treat requirement is manufacturing detail? Are contractors responsible for such manufacturing detail?
What of the Navy's relaxation of the specification?
What of the Navy's threat that the contract will or may be terminated for default?
What should Atlas be doing as soon as this information comes to its attention? What preventative claims management approaches are open to it?

(5) Atlas immediately began working its production engineers 12 hours per day to ready the line, and on December 19, 2004 it commenced production on two ten-hour shifts. This required hiring 15 new production workers who had to be trained on the job and whose presence caused reduced efficiency to both shifts.

Consider These Issues:

What is the first claims theory that comes to mind in this situation?
Has Atlas dealt with the claims management issues correctly? What is required?

(6) The next lot of 1,000 bolts was delivered to Point Retreat on January 9, 2005. In light of the difficulties which have resulted in the rejection of the first lot in September, the Navy inspected every third bolt instead of one out of 15 as called for in the contract specifications. The specification provided for rejection of a lot if over 3 defects were found during inspection. Five defects were discovered in the lot delivered on January 9, 2005, and it was rejected. The production line was shut down again and all of the bolts reinspected. The lot was resubmitted on January 26, 2005 and accepted.

Consider These Issues:

What has the Navy done by requiring every third bolt to be inspected?
What has Atlas done from a claims management point of view? What should it have done?

(7) The production line was run thereafter at 80% speed and a quality control engineer hired to monitor quality. Lots were subsequently delivered and accepted on February 24, 2005 and March 22, 2005.

Consider These Issues:

What is the 80% speed issue? Is this a de-acceleration claim? Is this an inefficiency claim arising out of defective specifications? Is this a straightforward, pure delay claim? Does it make a difference? What can be made of the government's ultimate acceptance of these units?

(8) On April 12, 2005, Calvin Cautious, the Contracting Officer, issued a Change Order (a) directing Atlas to increase the width of the bolts by .085 inches effective with the next shipment; and (b) stating that the "ceiling price" of the change was $57,000. Atlas Contract Administrator, Samuel Salt, sent a memorandum to George Good (Atlas Project Manager) pointing out the ceiling and suggesting a meeting with Cautious. The memorandum is contained in Appendix E.

However, Good was reluctant to call a meeting because of all the problems under the contract. He proceeded with the change and Atlas scrapped the 1,200 bolts then in various stages of production, shut down the production line and re-tooled. On May 12, 2005 production was recommended. Atlas estimated the change would cost over $90,000, including the cost of the scrapped bolts, and promptly advised Cautious.

Cautious responded that $57,000 was the best he could do as that was all he had been allotted to cover this change. The next lot was delivered on June 21, 2005 and accepted.

Consider These Issues:

What is the status and effectiveness of the "ceiling price" stated?
What of the passage of time between April 12, 2005 and May 12, 2005 before Atlas advised the government that the ceiling price would be exceeded?
What is the effectiveness of the contracting officer's advice that he only has $57,000 for the change?

(9) On July 7, 2005, the Naval Facilities Engineering Command condemned land to increase the safety zone at the Naval Air Station near the Atlas plant. Included in the condemned land was a half- mile of the road leading from Atlas' plant to the nearest highway. This required Atlas to build a private road from the rear of the plant running to a secondary road which, in turn, ran into the highway 15 miles away. This delayed delivery of the next shipment until September 2, 2005.

Consider These Issues:

What type of a claim does Atlas have in this situation?
Would it make a difference if it owned the land in question?
Does it have a compensable delay claim for the additional time that took place before the next shipment could be made and the additional road could be built?
Does it have an excusable delay claim?
Would there be exceptions to this rule, based upon the nature of the government's condemnation action?

(10) On September 7, 2005, the contracting officer sent a long letter to Atlas pointing out its failure to meet the delivery schedule, noting that the government's stockpile of bolts was down to a three-months supply, and warning that, if its delinquency continued, the contract might be terminated for default. About that time, Atlas discovered it has already spent over $800,000 on the contract and the total contract price (excluding the price for the change with the $57,000 ceiling) was $700,000. Atlas was at this time dangerously close to insolvency.

Consider These Issues:

Will the government succeed if a termination for default is issued?
How will Atlas resist the termination action or pay for the termination litigation?
Who will benefit from the termination action?
Is there any action that Atlas can take to recover its funds? REA Contracts Dispute Act certified claim?
Is there a moral to this story?

Appendix A

Clause XV - Government-furnished Drawings

The drawings being furnished hereunder are being furnished for such information and assistance as they may provide the contractor with respect to the general nature of the items to be delivered under this contract and for the use of the contractor in meeting the requirements of this contract respecting interchangeability as set forth in the clause of the contract entitled "Interchangeability."

The government does not represent that the government- furnished drawings are legible or accurate or complete or that they cover or disclose any of the requirements of the specifications or that they are adequate to permit manufacture of items in accordance with the specifications.

Appendix B

Text of Taped Telephone Conversation Between Arthur Errant, Government Project Manager and George Good, Atlas Blast Co., Project Manager.

GOOD: Hello, Good speaking.

ERRANT: George, this is Art Errant. I wanted to let you know that we have several changes to the bolts in the mill and that they should be ready for C.O. signature in about a week or two.

GOOD: Art, can you let me know which changes. As you know, we have been considering several.

ERRANT: George, you know I can't discuss details over the phone because of security. I just wanted to warn you in case you could do anything to reduce the possibility of obsolescence.

GOOD: O.K. Art, I'll see what we can do.

Appendix C

Change Order No. 2 5 May 2004 Contract NOP-80-111

Pursuant to the authority of General Provisions 2, entitled "Changes", this contract is hereby amended as follows:

Specification MILPAK-201, Rev C, dated 15 May 2004, incorporated into this contract by reference, is hereby revised to provide for shipment of 36 bolts per package in lieu of 12. Confirming 3 May 2004 verbal order, all requests for equitable adjustments must be received within 30 days from the date of this change.

Calvin Cautious Contracting Officer Department of Navy

Appendix D

Interoffice Memorandum November 25, 2004

TO: Calvin Cautious Contracting Office Code Z-15

FROM: Arthur Errant Project Manager Code A-1

SUBJ: Production Problems - Contract NOP-80-111

Atlas Blast Co. has just informed me of their opinion that rejections under subject contract are caused by heat treating as called out on our drawing ST-31-5200. I have checked into the files on this matter and find that our ordinance plant had encountered somewhat similar difficulties early in production.

It was ultimately decided that placement of the metal in the heating chamber, the heat rise period, and initial cool period are all critical to heat treating this type metal. Once our production people were able to work out a special procedure, they had no difficulties with the 37-minute period.

However, in the four months it took them to devise the procedure we found that a minimum heat treat of 9 minutes would produce acceptable bolts without specialized procedures, but that the optimum quality we were looking for would not result.

In view of this background, we could accept a minimum 9-minute heat treat. I have no objection to your informing Atlas to that effect. However, I recommend against your bringing up the ordinance plant difficulties since I believe that it was a matter of production know-how or procedures and that is the contractor's responsibility. If we bring it up now, I am sure that Atlas would attempt to use it as a basis for a claim.

Appendix E

Company Confidential Memorandum

April 15, 2005

TO: George Good

FROM: Sam Salt

I have just reviewed the April 12, 2005 change order increasing the width of the bolts under Contract NOP-80-111. All appears to be in order except the "ceiling price" of $57,000 called out on this change. The Government has no authority to impose such a requirement as part of a change order and we have no duty to accept a change which incorporates such a provision.

I suggest you set up a meeting with the contracting officer to discuss this matter. I consider this of utmost importance because if we proceed with the change without objecting, it could be considered that we accepted the ceiling.

Example of Specification Requirements: Reliable Electronics

Reliable Electronics, Inc. is awarded a $10 million contract for the construction of Global Positioning Systems (GPS) for long haul cross-country railroad locomotives. This is a demonstration project for the Department of Transportation to show the safety enhancements that can be made in train operations in the United States through the use of GPS technology.

Reliable won this contract in heavy competition with other commercial GPS producers. Its winning bid was $505 per complete hardware unit for each train.

It intends to buy standard high-end recreational marine GPS units for $295. The balance of the purchase price per hardware unit is for the cost of antennas and mounting brackets (vibration suppressing) for the locomotives.

All other bidders intended to use standard, commercially available GPS units to satisfy the contract requirements. All bids for the demonstration project are tightly clustered between the winning bid at $10 million and the others, which ranged upwards only to $11.2 million.

The specifications for the GPS system are very broad: GPS units may be located anywhere in the engineer’s compartment in the locomotive; the antenna may be attached anywhere on the locomotive. As to the GPS handheldhand held computer-processing unit, the specification says only "any type of necessary GPS unit and system may be utilized."

Recreational GPS units have become so inexpensive and so reliable in the last five years, and satellite coverage so extensive for North America, that no one gave this specification any real thought or concern.

The Transportation Department issues a press release announcing the award to Reliable, pointing out the extremely low prices obtained for taxpayers by the use of commercial GPS technology.

Unfortunately, much to the surprise of everyone, the first system when installed on the initial locomotive, does not work properly. Instead of locating the train anywhere in North America within 100 feet of its actual location, the equipment is generally off by a mile or two, which is completely unacceptable for safety purposes, particularly in congested urban areas where numerous locomotives are present at the same time.

Although no one is sure why the units are not working accurately, various opinions range from degradation of signals due to additives in train diesel fumes passing over the top of the antenna, to interference from new Russian satellites just launched.

The Government refuses to accept any units until accuracy is achieved. It points to the broad open-ended performance specifications in the contract, and states that the contractor could have performed the job however it chose to do so.

In fact, the contractor determines that if it buys an interference processing unit from another company, the GPS units work correctly, but the cost will be $23 million to complete the contract. This will bankrupt the company.

What claims processing approaches should Reliable use?

Example of Specification Requirements: Gen Testing

Gen Testing receives a competitively negotiated contract for $15 million with the Air Force to create a new type of test equipment for projecting the remaining life in jet engine turbine blades.

The contract provides that all models of turbine blades in military aircraft from 16 different manufacturers will be subject to forward-looking life testing. The specifications are very broad, allowing great latitude of Gen Testing in its design approach.

The contract contains a standard changes clause, and a government furnished property clause (which refers to the changes clause for the calculation of any needed equitable adjustment).

After award, Gen Testing needs information from the 16 manufacturers to complete the design of its equipment; this information includes manufacturing techniques, heat strengthening, hardness data, and trace element content for each type of blade. It asks the Air Force for this data.

The Air Force says it does not think its data is complete: Gen Testing should ask the 16 manufacturers. It does; they refuse to provide all such data, claiming it discloses proprietary manufacturing techniques and other trade secrets.

Gen Testing’s costs for doing the work are mounting. It does not know what to do. The Air Force says the lack of needed data is Gen Testing’s problem and responsibility.

What claim approaches are open to Gen Testing?

Example of Specification Requirements: Woodworth and Tweed Accounting

Woodworth and Tweed is an accounting firm that has been selected after competitive negotiations by the Department of State to create a new database for a shared data environment of diplomatic data for all Foreign Service grade employees. The contract’s face value is $20 million.

The form and contents of reports generated by the new system for the State Department’s Information Management Office is spelled out in great detail. Little room for judgment is left for the contractor. Woodworth does the reports exactly the way the detailed directions in the contract require.

In the six months that it takes the contractor to prepare his data report forms for review by the Information Office, and unbeknownst to his firm, the Information Office has received numerous grievances, and disability claims, relating to a new eye related occupational disease, which various experts think comes from constantly analyzing particularly wide reports.

The Information Office determines internally to discontinue the use of the customary wide report format to prevent future worker disability claims.

Woodworth submits their reports for review at the end of the 6-month development cycle. The reports are in the standard wide format, and contain exactly the information and sizing required in the State Departments' detailed specifications.

The State Department rejects the wide format, pointing out the rash of recent occupational claims and pointing to a provision in the contract which says "notwithstanding any other provisions of this contract, all computer equipment, software and displays shall be undertaken and formatted in a way to insure worker's safety."

Woodworth will spend approximately $5 million extra on this $20 million contract to reformat all of the wide reports in the fashion that the State Department’s Information Office now wants.

What claim processing techniques should Woodworth employ?

Example of Specification Issues: Troublesome Construction

Troublesome Construction Company had a contract at a western test range to link up all of the outlying command and control and data gathering functions from data gathering sites to the central control area of the base. The base was spread over several hundred miles of desert area. Because of the volume of data transmission and the quality, it was necessary to establish a microwave link. This was the only technology available which would do the job and all prospective bidders knew it. Because of the curvature of the earth, towers would have to be installed on the six major legs of the control system at 26-mile intervals.

A fixed-price contract with pure performance specs was let for the job. There were no drawings, there were no soil borings conducted as all construction was in sandy, desert soil. There was no designation of sites where the towers would have to be installed. The only requirement was that towers not be installed in certain restricted areas or certain areas where there were existing buildings.

Troublesome Construction and other bidders could see that there was ample room by looking at a map of the base to build the towers with no interference.

The construction company needed a qualified microwave electronics equipment supplier. XYZ Microwave was selected.

The performance specs for the contract further provided a certain volume of data which had to go into the system from the outlying control and gathering sites and the volume that had to come out at the central processing facility, the range headquarters building. XYZ Microwave examined these specifications and matched its standard telephone transmission microwave system to them and could see that the requirements were easily met with much performance leeway.

The bid of Troublesome Construction acting as prime, XYZ Microwave as sub was low and was accepted by the government. XYZ proceeded in its plant to commence fabrication of the necessary microwave equipment and Troublesome moved on to the test facility to commence construction of the towers at the selected 26-mile intervals for six legs.

There was a requirement in the contract that the design of the tower be submitted ten days prior to start of construction for review and approval to determine compliance with specifications. Troublesome planned on submitting two drawings for each tower; one showing the super-structure and the other showing the foundation.

When it submitted its foundation drawing for the first tower, it showed spread footings of a customary design. It had examined other data for the area and found that peak winds in the area never exceeded

40 knots except for once a year they might reach 75 knots. Being a desert, there was neither precipitation nor flooding to worry about. The government specification, which as stated was purely performance in nature, stated nothing of how the tower was to be designed except for the fact that it was to be in accordance with good design practices and in accordance with available local weather information.

When the first foundation drawing was submitted by Troublesome, it was rejected by the government. The government claimed that it was not in accordance with good design practices because the government had questions about whether the foundation was sizable enough to hold the tower superstructure that was being proposed.

As the basis for its concern, the government cited meteorological data which showed over the past 100 years there had been two instances in which there had been some ice at the base, from unusual weather conditions associated with typhoons and movement of Canadian air masses. This information had not been available to contractors.

The government also raised the fact that because of the sandy soil conditions they were unsure of possible differential settlement in the towers which would cause the microwave towers to move out of alignment and disrupt basis operations.

The contractor retained two engineering experts including the former Commanding General of the Corps of Engineers, Middle Eastern Division. Both experts expressed the view that the government's approach was ultra-conservative and not needed to meet good engineering practices, but simply an attempt at gold plating. They further expressed the view that the spread-footing design was adequate; if there was any movement in settlement (and settlement was always a possibility,) the tower simply could be jacked, or shimmied on the side that it settled so as to restore alignment.

Alignment could also be restored by adjusting on the towers, the area in which the microwave equipment was actually contained. Tower settlement, if it were to occur, would occur over a long period of time so as to allow an adequate amount of time to see problems and make corrections before transmission of data was effected.

The Air Force was unmoved, rejected this tower design by final decision and stated that all other similar tower designs would be rejected unless the foundation size was beefed up to comply with the Air Force concerns. Troublesome took an appeal to the Armed Services Board of Contract Appeals. The attorney recommended that they go talk to the Commanding General and his attorney before plunging into full-scale board proceedings.

What argument should be made at this important litigation conference aimed at settling this matter? What legal theories should be advanced? What practical issues should be dealt with?

Example of Inspection and Acceptance: Fast Foods, Inc

Fast Foods, Inc. has a contract with the Army to supply chicken dinners to the troops in Iraq. The turkey dinners are considered “commercial items” in the solicitation.

The contract included a “tailored” clause, which represents a warranty against any and all defects in the products provided for a period of 1 year.

The contract contained a Commercial Item Inspection clause, FAR § 52.212-4, which provides:

(a) Inspection/Acceptance

The Contractor shall only tender for acceptance those items that conform to the requirements of this contract. … The Government must exercise its post-acceptance rights (1) within a reasonable time after the defect was discovered or should have been discovered ….

The contract also contained special USDA clauses that required the contractor to perform inspections and tests, including tests for salmonella and other diseases that might be in turkey products.

The contractor was required to perform these tests with government agency personnel observing the sampling process. The samples were tested first by the contractor at its facility and were then sent to USDA laboratories for final testing.

Following three consecutive years of successful tests of its turkey products, Fast Foods entered its fourth year by collecting 6 turkey samples at random. These samples were then sent to the USDA laboratory for testing.

At the USDA laboratory, a part of each sample was cut off and tested. Two of these cut-off samples were found to contain salmonella.

The test results along with the unused portion of the samples were sent back to Fast Foods. In shock, the company sent portions of each of the remaining samples to a USDA certified laboratory for testing. All of the portions from each sample, including the samples that had tested positive, were retested. None contained salmonella.

Pursuant to the contract, Fast Foods requested a formal retest from the Contracting Officer. The remaining portions of the original samples were sent to a different Government laboratory and retested. Once again, no salmonella was identified.

On this basis, Fast Foods requested that the agency accept the turkey, concluding that the first Government laboratory had contaminated the original sample portions that were tested. The Contracting Officer, based on technical advice, agreed and the lots were accepted.

After acceptance, however, another technical branch of USDA with greater knowledge of salmonella rejected the lots. This group stated that the retests did not prove that the original samples were salmonella- free. On the contrary, it was common for salmonella to be found in one part of a sample but not another.

Since there was no evidence that the samples had been contaminated at the test facility, and because the presence of salmonella was a health hazard to the troops, the Contracting Officer rejected the lots, and ordered that they be destroyed. In rejecting the lots, the Government cited the one-year warranty, which had not yet expired.

Were the lots defective? Is the presence of salmonella a “latent” defect”? Does it matter?

What is the effect of the Government’s acceptance with its knowledge that salmonella had been found in the first Government test?

Assuming the Government’s technical branch is correct, is the Government’s inspection clause adequate?

Example of Prompt Claims Recognition and Resolution: Splash Electronics Company

The Case of Splash Electronics Company: A Case Study in the prompt resolution of contract problems and the benefits to be obtained thereby.

Splash Electronics Company was awarded a contract on June 1, 2004 for the Central Sensing System of a magnetic mine. The sensing system is a highly complex, state-of-the-art electronics assembly; it is approximately the size of a roll of paper towels. At each end there are electrical connections which passed out as terminals at their ending points. Splash Electronics delivered the electronics assembly itself, with connectors left exposed for hookup later by the government in Keyport, Washington, to the container in which the mine was actually dropped in the water.

Splash had the first production contract for this new generation of electronic section of the mine. The unit, however, was on a straight build- to-print basis. A development contractor generated 150 detailed drawings of the electronics components and terminal hookup section. There was also a detailed performance specification. The development contractor had developed the item under one contract and then made 25 of the units under a prototype production contract.

Splash's contract was a fixed-price production contract for 5,000 units. It had been given 45 days to bid on the data package and had submitted the lowest responsive bid beating out its nearest competitor by only $14,000. The next four bidders above Splash were clustered in a two percent price variance range. It was obviously a highly competitive procurement.

As stated, the contract was awarded on June 1. Splash immediately took the drawings upon contract award and handed them to its production-engineering department which had not reviewed the drawings previously. The prior drawing review had been conducted by the bidding evaluation group of Splash which contained several highly experienced electronics engineers. Those engineers had reviewed the drawings in the course of getting bids from vendors for various items which needed to be subcontracted and in the course of preparing their labor and material estimates.

During the first month of contract performance (i.e., June of 2004), Splash's production engineers were going over the drawings to deter-mine exactly how the plant would be set up for the necessary electronics and mechanical assembly work. During the course of this review, errors began to be uncovered in the drawings package. They were not major errors but they were errors which had some material and labor impact. Splash's initial estimate was that those drawing errors would amount to no more than $20,000, with discussion in the Company as to whether the government should be notified of this.

The divisional vice president in charge of the plant said he wanted the drawing errors recorded as they were uncovered and sent to the government in a letter every 15 days until he saw how many drawing problems there were. Splash's contract administration department undertook this effort, dispatched a letter to the government every 15 days reporting on a drawing discrepancy form that had been generated. The drawing discrepancy form also stated the estimated costs that would be required to fix it.

Splash received no response from the government on any of these submittals. For the next four months of contract performance, numerous additional errors were found in the drawings and the government was notified in all instances. Splash's contract administration department now estimated and advised the government in writing that the drawing problems cost between $300,000 and $600,000 to correct and stated it would provide additional cost information as soon as it was available.

In November, 2004, Splash received in the mail 65 additional drawings from the government. The contracting officer's cover letter stated that these drawings superseded 65 of the 150 drawings originally in the data package and contained only updating information to "clarify and correct" various matters which Splash has raised in its deficiency notices and they were part of the "ongoing development process" of the prototype contractor.

Splash promptly turned the drawings over to its production engineering department which was forced to necessarily check to see if issues raised previously by Splash had been corrected (they found out in most instances they had not.) Then they had to search through the drawings laboriously to determine if additional changes had been made in the drawings that they had bid on which would increase their costs, and to see if there were any errors in the new drawings. Splash found both.

Splash's divisional vice president himself wrote a letter to the government contracting officer five days after the receipt of the "updated" data package of 65 drawings advising the contracting officer of the foregoing facts and expressing his overall concern that the program from the government's point of view seemed to be out of control.

He inquired specifically as to when final drawings would be received from the development contractor, i.e., were there additional drawings beyond the 65 coming? He encouraged the government to come and meet with Splash's engineers to attempt to resolve what were now over 250 separate errors in the drawings, some of which were major, some of which were minor.

Splash's engineers, as they continued to review the drawings, were finding additional small things for which they were issuing discrepancy notices to the government on almost a daily basis by now.

The contracting officer replied 30 days thereafter to the divisional vice-president stating that one additional set of 42 drawings was expected in approximately another month--just about Christmas time--and he would hand deliver them to Splash so that any problems could be promptly detected. He did this.

Splash found some lesser number of errors in these drawings. On January 2, 2005 (after the divisional vice president worked the staff through the Christmas vacation) the government was presented with a claim in final form for $800,000 covering all the drawing errors in the initial 65 drawing revision set, and the final 42 drawing revision set.

That claim contained a detailed 3-page narrative statement explaining the problem, and how it occurred. A one-paragraph engineering write-up on each of the now 285 drawing errors and changes and detailed costing information naming a price (in many cases estimated because the work had not been done) was submitted for each of the 285 drawing discrepancies. Splash's letter covering the claim explained (as the cost volume showed) that $600,000 had already been expended in production engineering time in having to deal with the drawing problems. In addition, the program was now six months behind schedule for which a delay claim was also submitted.

Included in the total $800,000 figure, Splash estimated that there was another $175,000 of production impact to be felt when the items were actually produced. Splash's letter closed by asking for immediate payment for money spent and an audit on the total $800,000 figure.

Paralleling the foregoing six months series of events was a problem that Splash was having with the terminal connectors, the ends of the wires the government would use to hook up to its portion of the mine. Drawings initially showed the terminals but did not show how they were connected to the wires or how the connection would be effectuated.

The initial drawing package to which Splash bid was simply electronics schematic drawings containing some overall statements about the fact that terminals would be connected in a workmanlike manner and to provide water tightness. In each of the two drawing revision packages received above, (the 65 and the 42 unit drawing revisions) a new drawing was contained for the terminal connectors.

The drawings were no longer schematic. They showed in both the first and the second revision a highly sophisticated type of connector. It is only manufactured by one company in Denver, Colorado. It was a proprietary product Splash had considered using on a previous electronic job for water tightness, but had rejected out of hand because instead of costing approximately a million dollars for terminals, these terminals were quoted as $2.5 million by the proprietary vendor. Splash thought that those terminals probably did a better job. Price was prohibitively high. In any event, with the original schematic drawings used for bidding, this job simply provided for water tightness.

Splash planned to do as it had in the past on numerous other underwater electronic systems that it had built for the military, utilize a winding machine to tape the terminal ends and bake on protective coating. Splash had delivered thousands of underwater devices with this type of terminal connection with no objection from the government.

It became clear; however, after the second drawing revisions were made on December 24 (and in a meeting with the contracting officer it became even clearer) the government expected and would only accept terminals which had the proprietary terminals made by the vendor in Denver, Colorado.

Splash pointed out both orally and in a letter dated December 26, that costs to do this as a minimum would be an additional $1.5 million. Splash stated that the government's interpretation was unreasonable and out of step with previous actions of the parties. If the government insisted, Splash would have no choice but to submit a claim.

The contracting officer on December 26, sent a TWX back to Splash stating that the program was six months behind schedule, work had to get going and Splash was directed to use the proprietary terminals because the contract clearly initially called for water tightness and in the contracting officer's view it could be seen on the original schematic drawings that's what was required. The contracting officer also noted (and Splash knew this) that there had been a number of complaints from the field over the last year about its type of terminal installation breaking after several years in the water.

Splash's divisional manager directed that the terminal item be written up as a claim (and it was in four pages of text) and it was submitted on January 5, 2005. Splash included a quotation from its original terminal vendor wanting $998,000 to do the work and it included a letter from the proprietary terminal vendor showing a charge $2.46 million for the same material to be delivered to Splash. Splash claimed the difference.

What result do you expect from the foregoing claim actions for Splash?

Evaluate the strength of Splash's positions on the various issues.

Evaluate their claims management technique. Evaluate their relationships with the agency involved as a result of the actions that they have taken.

[Real life result: The contracting officer and Splash had four meetings in January, some of them several days long; some at times acrimonious; in the fourth meeting on January 30, the engineers arrived at a plan which would require expensive terminals on only half the connectors, thereby, immediately reducing Splash's claim approximately $750,000 to $1.5 million for this item.

The government, with some exceptions, acknowledged the drawing deficiencies and the problems created thereby. It stated that it would be at least six months before it could conduct an audit on these claims. The government issued two contract modifications February 10th.

1. One provisionally increasing the contract price by $600,000 for the drawing discrepancies and stating that modification would be definitized following audit and in any event, within eight months. Production impact would be dealt with at that time.

2. A separate modification was issued on the terminal change increasing the contract price $700,000, permitting Splash to bill amounts only if and when a signed contractual arrangement existed with the proprietary source in Denver.]

Does the real life result make sense? Is the government's interest protected? Is this really a victory for the contractor?

Example of Recovering from Initial Management Failures: Microprocessor Radar Company

Microprocessor Radar Company was awarded a fixed-price contract for miniaturized radar systems to be utilized in guidance of Air Force drone vehicles. The contract was fixed-price incentive, 20 percent spread from target price to ceiling and a 90/10 share ratio. It was a very large production contract for these items, to be utilized in a whole new purchase of drones to be chased in exercises by pilots in an F-14, 15, 16 and 18 aircraft. The initial contract price was $100 million at target price, ceiling price of $120 million. The contract would cover a four- year program life.

The contractor commenced performance on January 1, 2004. The first year of contract performance most effort was devoted to design work. The contractor was given some overall drawings stating outlines and sizes into which its radar had to go, and some detailed performance requirements. Electrical output and inputs were specified. Basically the contractor was left to design the unit himself. Some requirements did impose constraints upon him.

At the end of the first year of performance, i.e., December 31, 2004, the contractor began producing prototype units. The government furnished expensive chambers in which the contractor was to subject, environmentally, prototype units to a stringent reliability program to be sure that they would comply with the Air Force's needs.

The radar units were then installed in the drones; the drones would be used over and over again so reliability was important to contract performance. A particular type of new circuitry had been involved. Much semiconductor material was a new generation. The contractor knew that his work through the design phase was to be arduous and difficult.

In the spring of 2005, during a routine quarterly audit, one of Microprocessor's accountants from Humperdink and Fud was surprised to see a new estimate to complete the contract showing $120 million would be spent. He inquired of division management about this issue and was told not to worry about it. There were certain production engineering "improvements intended". When the items got into production, costs would begin to decrease allowing the company to bring in the job at $100 million which would cause it to lose most of its profit but would "properly position it" to the next buy of drones, which would be even larger than the current one.

The Humperdink auditor was concerned about this. He had heard this type of glowing pre-diction from other defense contractors, and felt an ethical obligation (probably a legal one also) to disclose these facts to senior management. He made an appointment to see the group executive responsible for this division of Microprocessor and five other company electronics divisions. He explained to him the factual situation and the group executive was most upset by it and immediately directed that a package of information be prepared for his personal use containing a detailed estimate to complete, a statement of current problems on the program, a statement of current government actions which might have caused the overrun that appeared to be forthcoming.

In approximately two weeks, he received a phone call from the division manager involved who assured the group executive that the situation was under control and that their was really no need for the report. The contract could be brought in, although with no profit, well within the ceiling price and future marketing plans looked extremely bright because of an upcoming buy and the company's positioning of itself in the marketplace because of this contract.

The group executive said things which don't require repeating. He also said that he expected the report within one week he originally had asked for. He didn't want a bunch of pabulum. He wanted answers to his questions now or he would install a division manager who would give him those answers.

A report was provided the next week, it contained a bunch of pabulum as expected: the government had not been involved in any way, there were some initial mis-estimates, and state-of-the-art problems; while the company was now experiencing difficulty with the reliability testing being performed in the government's chambers, it expected that all things would work out; that there would be little overrun on the contract.

As might be expected when the group executive received this report, he flew into a rage. After performing deep breathing exercises that his stress therapist had recommended, he picked up the telephone and made three phone calls. He called the general manager of his training department who had previously prepared claims for other divisions when he was the manager of contracts in those divisions. He told him he was detailed for two months to a claims investigation activity and that he should turn over all of his responsibility to the deputy manager of training. He could accept no business phone calls from any one in this two- month period that he was on special assignment.

The group executive's next call was to the accountant at the Humperdink firm. He told him to be in his office the next morning, told him to relieve himself of as much of his responsibilities as he could, that a two-month claim investigation was planned at the Microprocessor plant and he wanted his personal attention to it.

He made the same call to the partner in the law firm who did most of the company's government contract work and asked that particular partner to make the same commitment as the Humperdink accountant, which he did.

A meeting of these three people and the group executive was held the next morning in the group executive's office. He explained the investigation procedure that he expected to be conducted, stated that he had confidence in these people because of their experience in the past and that he wanted to get to the bottom of this matter. He had had enough double talk from division personnel. He wanted answers.

The group executive was doing his deep breathing exercises as these three people left for their assignment. The three-person, claims investigation team checked into the local Holiday Inn.

They formulated their claims investigation procedures, talked about how much time to work, and decided their overall schedule for getting the job done. They basically decided to work from 7 a.m. to 8 p.m. each day for the foreseeable future, seven days a week and meet for dinner after work and to meet at 6 a.m. for breakfast the next day, discussing results and actions to be taken.

The training manager was an electrical engineer. It was decided that he would deal with the technical people; the accountant would deal with the finance department; the attorney would deal with the contracts administration department and other management personnel.

After two weeks of investigation, the following facts were disclosed:

The training manager learned that the engineering department was in turmoil, the prototype units were failing reliability testing overwhelmingly. There had been redesign activities taking place to try to correct these problems but the redesign simply made matters worse and more units were failing. The engineers were unsure as to whether they could ever design a unit that would comply with the reliability requirements.

The Humperdink accountant also found out startling information from the finance department.

The accountant learned the finance department was in shock having just done a new cost-to-complete analysis. The cost-to-complete analysis showed two things:

One, great uncertainty as to whether any analysis was reliable because of the engineering department's concerns over recent testing failures.
Two, as a minimum, the contract was going to cost $175 to $200 million to complete.

The accountant had done an analysis of the records and determined most of this increased cost was in the production phase of the work yet to be done and therefore, there was great uncertainty as to its accuracy; the numbers could rise. The estimates to complete seemed to show startling growth in material costs, but not much increase in labor costs. Material was approximately 75 percent of the cost of production; therefore that caused a huge increase in the cost to complete.

The attorney, because initial interviews of contracts administration and program management people had proven to be inconclusive, decided that he would spend his days starting from the first days of contract performance reading every shred of contract information and program management documentation generated by the company and received from the government. There were two file cabinets, five drawers each full of materials. The attorney started reading. He wore his walkman playing acid rock music the 11 hours a day he was in the plant to keep himself awake while performing this task.

He had heard from program people that they suspected the task was impossible; that perhaps the company should think about stopping work and submitting an impossibility claim. Contracts administration people were in total disarray. They simply said that the group who had estimated the bid (who had all received large bonuses when the contract was awarded and were now working on other bids at a plant in the Bahamas) was at fault. It was said they had grossly underestimated the work that was required.

On the last day, Friday of the second week, the investigation team was to go home for the weekend. They then planned on spending another solid two weeks at the plant. On that day the attorney found a document at 6:30 p.m. from a contracting officer. The document made the following statement:

Experience with recent reliability tests in the government- furnished chambers indicates that the units delivered as prototypes are not satisfactory for the Air Force's intended use. Specifications provide that these units will operate full function and with no performance degradation from a maximum of 180° F to a minimum of minus 65° F to accurately reflect the environmental conditions to which the units will be subjected during flight. Your testing procedures do not accurately reflect those environmental conditions. Accordingly, I am directing that the current testing approach that you have selected be discontinued and that a new performance test for reliability in accordance with the following instructions be implemented.

The attorney spoke on the phone that evening with the contracts administration manager and the engineer responsible for these tests. He found that the company had originally selected a test for the prototype units between minus 15° F and plus 120° F because the contract had provided that as a "design to" goal in a separate specification.

He further found that this was a customary way of testing such radar equipment. The government had used this "design to" goal in many other con-tracts. He further found out that the government had initially approved Micro's test plans utilizing this testing set up and temperature range.

The attorney was encouraged. The document he saw had been a major government change in testing requirements but he had no idea as to the impact this had. The next morning both he and the training manager met with the entire engineering staff.

The engineering staff said they had been attempting to design to the minus 65 to plus 180-degree standard because units subjected to that test were failing. They did not know the government had directed the testing be increased from minus 15° to 120° F, to the higher standard, and felt this was simply a phased-in increased testing requirement demanded by the company's own internal engineering staff in charge of the tests. Plus there had been much pressure by their Air Force customers to "do better" in reliability.

Things were starting to fall together. It appeared to all three team members that a claim could now be prepared pointing in the direction of increased testing requirements having direct relationship to the testing failures and the cost increases for production. (At least the direction appeared to be confirming something that had been happening informally: engineer to engineer).

The Humperdink accountant confirmed from his own investigations that much more expensive materials were being bought. He now recalled conversations with purchasing saying that was because reliability was insufficient in original parts. It was starting to fit together.

Consider the following points:

Evaluate the claims management techniques of the company.
Determine how claims processing should proceed from this point. What theory should be utilized?
Discuss the problems that late discovery of the claim will create.
How can this problem be prevented in the future? How is the company financing this extra work? How can the Contract Disputes Act be utilized effectively?
Who should get a bonus for his work?

[Real life result: actual costs to completion were $167 million. The contractor, after two more years of negotiation, received a total of $47 million in increased costs due to the testing upgrade directed by the contracting officer. The contractor experienced in excess of a $20 million loss on the job. Its competitors' received the next $200 million follow on contract for the same units. There were eight bidders, Micro was the high bidder. It protested that the seven low bidders did not know what they were getting into and that the government requirements were not accurately stated. It lost the protest at GAO, the follow on contractor is now processing a $150 million claim against the government based upon withholding of information and superior knowledge.]

Example of Product Misuse, Supply and Construction, and the Outer Limits of Claims Theories: Rapid Deployment Systems

Rapid Deployment Systems received a contract from the Air Force to construct a parachute escape mechanism for experimental, high altitude rocket planes in which the Air Force has been doing selective ballistic type launch tests from B-52 bombers looking towards eventual launch of smaller rocket planes from B-1 and B-2 bombers. The escape mechanism essentially calls for a parachute of tremendous size to deploy in stages upon command of the pilot, breaking loose the entire forward section of the aircraft in the case of emergency and floating it gently back to the earth, landing at approximately 20 miles per hour. The last and largest chute deploys at 7,000 feet.

The parachute system is constructed of state of the art nylon and Kevlar materials. The system had been in use for approximately ten years in various rocket plane test applications by both the Air Force and NASA.

The Air Force had purchased them on a sole-source basis from Rapid Deployment Systems for that entire period of time.

The Air Force had drafted performance specifications dealing with the escape system. Among other things, specification provided that the escape system would have a shelf life of two years and would have a further “in plane” installed life of 16 months.

As stated the Air Force had utilized the same escape system for approximately ten years. The system had been deployed in 16 different emergencies and always functioned flawlessly bringing the pilot back to earth safely and at a less than 20 mile per hour landing speed.

On January 24, 2004, a high altitude test was in process when trouble developed. The pilot pressed the rapid deployment command button. The system seemed to function properly initially breaking the forward portion of the plane loose and bringing it back toward earth. When the final chute deployed, however, several pieces of the nylon strapping broke loose causing the chute to sit at a 45 degree angle of attack and permitting the plane section to bang into the side of the mountain at approximately 50 miles an hour.

There were two pilots in the plane at the time, one of whom was basically unhurt, the second pilot suffered serious injury resulting in paralysis on one side of his body. Because of the Feres doctrine, he could not sue the government for his injuries and he sued Rapid Deployment Systems directly for $10 million. That suit was ultimately settled for $800,000 before trial. (The settlement occurred after the Boyle decision by the Supreme Court.)

During the course of the private lawsuit, Rapid Deployment System learned a number of things about the government’s use of the deployment system in question. In the first place, the system in the chute in question had been on the shelf for three years instead of two before it was installed in the plane; secondly it had been installed in this particular aircraft for a series of tests and had been in use for over three years. Both of these use requirements were contrary to the applicable specification under which Rapid Systems had designed the system to function.

The Air Force had done several series of tests on the system itself which show that there was no reason that the system could not be utilized for a longer period of time and based upon the successful uses of the system in the past, and no problems during deployments, it had high confidence that the system’s useful life was far beyond that set out in the specifications. It also did not have the budget to change all chutes.

Rapid Deployment Systems also learned of photographs (during civil discovery) which showed that on the particular system installation, between the forward section of the rocket plane and the rear in which breakout occurred, the parachute assemblies had not fit correctly and completely into the assigned pod. The actual photographs showed Air Force technicians with crowbars and hydraulic jacks forcing parachute strapping material for the large drove chute into the pod, and closing the pod, with substantial pressure applied to the strapping material.

Rapid Deployment Systems obtained an expert who was prepared to testify at the trial of the pilot that improper installation of the parachute in the aircraft had caused stress concentrations to be placed on the strapping materials and over the three years that the plane was in flight had caused fatigue to develop. He explained that he had demonstrated under laboratory conditions the tearing away and breakage of those straps when the chute was actually deployed.

The Air Force states that as a result of the failure of the particular chute in question, it is going to be required to replace chutes in its entire fleet of 12 experimental rocket planes and that it will cost $5.7 million to do this which costs it expects Rapid Deployment to pay. Rapid Deployment intends to resist that claim of the government and wishes to recover $800,000 that it has paid out in settlement of the pilots claim.

The Air Force issues a cure notice to Rapid Deployment under its most current contract stating that it will terminate the contract for default in ten days if the problems are not corrected, and will claim the $5.7 million as a refund from prior contracts.

What problems do you foresee in each side presenting its claim and succeeding? What of the Boyle decision?

Consider decision in Midwest Industrial Painting of Florida, Inc. v. U.S., 4 Cl.Ct. 124 (1983) (Discussion of “new for old” rule of damages.) This will be explained during the lecture.)

What procedural actions and notices should the Air Force undertake?

Answers

Claim or Excusability Basis – Government misuse of equipment contrary to specification requirements.
The Boyle decision would let the contractor move to dismiss (successfully?) on “government contractor” defense? Not clear.
What if no one was hurt – government simply insisted on replacement of items (Midwest case likely holds that useful life is gone here – therefore no recovery by the Government).

Example 2 of Product Misuse, Supply and Construction, and the Outer Limits of Claims Theories: Pango Construction

Pango Construction Company received a fixed-price contract to construct three eaves-dropping towers in South Korea near the demilitarized zone. The government had constructed a number of these towers in the past and had paid an architect and engineer to generate a detailed set of drawings and specifications including a bill of materials.

The bill of material provided that a certain type of steel would be used for the tower structure and that it would be fabricated in accordance with set procedures.

Pango commenced contract performance and began erecting the towers after it had purchased necessary materials and mobilized them on site. After approximately 100 feet of the first tower had been constructed, one of the large structural sections inexplicably exploded, scattering shrapnel down on the workmen below. Fortunately, except for some superficial wounds, none of the workmen were seriously hurt. Construction was immediately halted.

Both the government and Pango brought in experts to assess the reason for the pipe's explosion. Pango's expert determined that although these towers had been constructed in the past in various parts around the world using the same design, the South Korean site was unusual.

The towers were being constructed in the middle of the winter in which there was high wind loading on the towers, and extremely cold temperatures; because of local climatic conditions, large amounts of moist air was being successively frozen and then unfrozen during the course of the day on the structure as it was being placed.

The combination of these conditions, and certain stress loading created by the government's design, caused the tower leg to uncontrollably fail and break into many small pieces because of stress loading. The expert predicted it was likely that these conditions would continue. The towers were to be erected during the six months of the year when these weather conditions were likely to continue in effect.

The government would hear nothing of Pango's experts position. It contended that Pango's fabrication techniques were improper, that it had not bought correctly certified pipe that the design called for, and that in any event, explosion of the pipe was a unique, one-time occurrence that would not reoccur. It directed Pango to go forward with construction of the towers at once, making certain modifications in its fabrication techniques and utilizing certified materials.

Pango thought the government's position was flat wrong, was seriously concerned about the safety of its workers, had already been sued by four of the workers because of the explosion before and it knew that its insurance would be revoked on all of its operations if it had another major failure such as the pipe explosion.

What should Pango do?

What should the government do to protect itself? Can these claims be resolved short of litigation? What of the Boyle decision?

Example of Third Party Disputes: Contractor

Contractor has the Army contract to place two modern water purification plants on two barges. This is a fixed-price incentive contract with a 120% spread to ceiling. The contractor is permitted to purchase used barges that it renovates. The work is completed and the barges are delivered. All funds are paid by the government under the contract.

The contractor notices during the process of delivery of the barges that certain equipment on the barges are not what were originally represented to it by the seller of the barges. It files claims against the barge owner, and litigation ensues. At the end of two years the parties settle the case. The barge owner pays $2 million -- $1 million for each barge to cause the litigation to end.

What must the contractor do with the $2 million? It is now 2 years since it received the final payment on the contract, but the contract price and overhead rate have not been finally determined.

Answer: Write the government a check and send it in with a brief cover letter. Deduct the legal fees and other administrative costs. See if it is accepted in that form. The credit cost principle requires this refund.

Example of False Statement Issues: Rapid Deployment Missile Company

Rapid Deployment Missile Company is the winner of a major DOD Air Force contract to develop a third generation, air launched, short range, attack missile (SRAM).

After two years of performance by Rapid Deployment, it becomes apparent that this extended range, high performance, missile is having various elements of its guidance system disrupted during performance. An independent DOD investigation shows that the guidance system disruption is caused by a peculiar interaction between several DOD satellite systems operating on various frequencies. The guidance system, accordingly, needs a major redesign to function correctly.

All other elements of the SRAM missile built by the contractor are operating to or in excess of specifications. Rapid Deployment contends that the Government knew of the possibility of this interference because of work in various research labs that was not disclosed to Rapid Deployment before the contract was awarded. The Government’s position is that it gave the company pure performance specifications, and that it was the company’s obligation to exercise its expertise in all areas, particularly in the area of potential external interference with guidance system elements.

Rapid Deployment ultimately submits a claim for $123 million for increased costs involved in shutting the program down at an advanced stage, and redesigning the guidance system of the SRAM. The redesigns are successful and initial production deliveries of the missile start.

Meanwhile, Rapid Deployment submits its claim to the Government. The Government refuses to pay it, and Rapid Deployment files an action at the Armed Services Board of Contract Appeals, based largely on impossibility of performance, superior knowledge, and defective design information.

One of the principal elements of Rapid Deployment’s claim is the delay in the program, and the increased costs incurred during this delay period. A portion of the claim involves standard “unabsorbed overhead elements” and associated contentions.

The parties’ conclude discovery, and are preparing for trial. Both parties determine that an ADR Proceeding might be beneficial in settling the case short of trial. Because of the large amount of money involved, they determine that they need a very senior official, unconnected with either party, to act as the ADR mediator. They select the Retired Chief Judge of the Federal District Court for Chicago, who does this type of ADR work in highly contested, high visibility cases.

The ADR Proceeding commences with both parties traveling to Chicago. It is scheduled for two days with various documents and witness presentations, then followed by mediation sessions individually of each party’s principals with the mediator. The ASBCA Judge incorporates the ADR mediation requirements in an order, and issues them to the parties.

During the mediation, Rapid Deployment presents a number of exhibits. One exhibit was prepared solely for the purpose of the ADR Proceeding. It had not been presented in any prior way in the ASBCA proceeding. The exhibit is professionally done. There are handouts of it, and there is a large flip chart version of it, containing several see-through overlays. In effect, the exhibit depicts various costs incurred as a result of the seven-month hiatus in the program, while the design problems in the guidance system for the SRAM were fixed.

The Retired Federal Judge, who is the mediator, is impressed by this exhibit. He says so in the middle of the proceedings. Rapid Deployment’s attorneys are feeling particularly good about this; the Air Force’s attorneys are feeling bad. They spend the night between the first and the second ADR session closely examining the exhibit, and several backup calculation sheets provided for the exhibit. A DCAA auditor is present who has worked on the case, and he assists them.

Here are their findings:

The backup documentation notations for the exhibit say that the charts are based upon actual cost information taken from the company’s books and records. The DCAA auditor questions this in light of the fact that the company is always late in making overhead determinations, and employs rate projections for a year before finalizing them. How could these rates be actual?
The chart depicts various stop and start dates for the program when the redesign was taking place. The Air Force trial attorney in charge knows that some of the dates stated are not correct, and that is provable by documents obtained from the appellant during discovery. The dates are off by several days to one week.
The charts and the overlays are done in a fashion which reflects the fact that Rapid Deployment had no responsibility during the seven-month delay period for delays of its own. In fact, the Air Force knows that Rapid Deployment had concurrent, inexcusable delays with several of its vendors who are working on other sections of the missile. There is no disclosure of that on the charts.

The second morning of the ADR proceeding goes forward. The Air Force has made its presentation the previous day. The parties are now going off into separate rooms with their principals to deal with the presentations of both sides on the first day. This activity goes forward until late in the afternoon on the second day. The mediator has the parties very close to agreeing on a final settlement figure, with the Air Force agreeing to pay $35 million to settle the claim, and the contractor willing to accept a figure of $45 million.

On the mediator’s next trip into the Air Force room, the Air Force for the first time raises general problems with the particular chart. Things get emotional during this meeting. The Air Force accuses the mediator of siding with and being too favorable to the contractor. The mediator points out that he is trying to be even-handed with both sides, and press them as to the problems with their case so that they move forward and resolve it now.

The Air Force principal, who is a director of the procuring activity, blurts out the three precise problems that he saw with the one chart, and stated that it is outrageous for a contractor to make such a presentation in an ADR, and that when he goes home he is going to report that as a fraud violation, as part of an attempt to cause the ADR to come out in the contractor’s favor.

The mediator discloses this problem with the chart to the other side. The other side states that it was unaware of these problems, but that in any event they seem to be the type of issues that are just arguments and errors in detailed presentations being made. The Air Force disagrees, and the ADR proceeding degenerates into a half an hour of everyone yelling at each other in the conference room. The parties go home.

The head of the procurement activity refers the issue of the chart to the local U.S. Attorney through channels for prosecution. The local U.S. Attorney determines that the Air Force has a case for prosecution of the contractor.

What are the bases for that prosecution? Fraud or attempted fraud of the Government based on submission of false information to the arbitrator; Civil False Claims Act?

What are the chances of its success? Unclear Compare Wilentz, Goldman & Spitzer v. ABC Corp., 253 F.3d 176 (3rd Cr. 2001) (FCA claim dismissed for submission of false billing statements to Bankruptcy Court where the funds were to be paid by private party.

Should the Air Force have made a clean breast of these issues the first thing the second morning of the proceeding, before it went further? (No, “crime” had been completed with submission to the arbitrator).

How seriously should the contractor take this matter? (Very)

What compliance procedures or controls could the contractor put in place to prevent a recurrence?

Case reference: United States v. Litton Systems, Inc., 722 F.2d 264 (5thCir.1984) cert. denied 466 U.S. 973 (1984) (submissions made to the Board of Contract Appeals were the subject of a criminal prosecution)

Example of TINA Issues with Other Disclosure Items: Flight B

What if a company knows that the ten special forces aircraft (Flight A) being produced in the outboard section of a hanger will be delayed, and thereby prevent the ten differently equipped aircraft (Flight B) which are to be built in the inboard section from moving outboard with the probable result of increasing Flight B’s costs? Negotiations are now under way for a definitive contract for Flight B after starting as a letter contract.

Possible Scenarios.

Although there has been no formal schedule change for Flight A, does the company have a duty to disclose the delay and possible cost impact to the Government negotiator for the new contract? A practical need?
What if the company discloses the delay during the negotiations, for Flight B and increases its cost, but thinks there is a potential work around plan available for moving the outboard ten aircraft elsewhere; must this be disclosed?
What if Flight A's delivery will be early with a possible result of reducing Flight B costs?
What if the company has assurances from a commercial customer that it plans to buy ten planes from the company in the next year, which if it happens, would expand the business base?
During these same negotiations, a decision is made at the company that its business base in the next year will not support the manpower roll the company now has, and it will need to reduce its roll with one result being a substantial increase in overhead rate. The company does not want that to be a topic of public discussion. Does it have a duty to disclose this coming roll reduction to the Government negotiators? To the SEC? To the press? Are there disclosure relationships?
Answers.
Note that this is a cost increase. Wouldn’t you want to disclose it? Of course; this is not really a TINA issue. Disclose it and get the cost or price increase as part of the new contract.
The work around plan means a potential cost-savings. That is data which the Government could utilize to negotiate a lower price. This data/information must be disclosed.
This is the reverse of situation a, above. Again, if you know of potential cost savings, compared to data you have disclosed, you must disclose the additional potential cost savings.
This would likely cause a reduction in overhead, and thus a cost savings. This is data the Government could use to negotiate a lower price -- it must be disclosed.
Again, note that this is a cost increase. Of course the company would want to disclose it in negotiations to get the advantage of the price increase. Can it be confident the Contracting Officer will not disclose this sensitive information? Perhaps not -- we know of situations in which the disclosure was made to senior agency officials confidentially, and the agency official told the Contracting Officer to take a specific price reduction that the contractor would agree to.

Additional Thoughts.

(i) SEC Disclosure.

Disclosure to the SEC may be required. This is a separate issue under SEC regulation requirements that companies must inform investors of their financial conditions, and the true nature of their financial statuses, in public filings. This may be required under the SEC’s Sarbanes-Oxley regulations.

(ii) Press Disclosure.

Is there an obligation to disclose to the press? That is purely discretionary and a public relations issue.

(iii) TINA Relationships.

Note that it is easy to confuse TINA obligations with other mandatory or non-mandatory disclosure requirements.

Example of Overhead Scenario: Boilermakers

Factual Assumptions.

The company makes boilers for military purposes. Commercial boilers and military boilers are built in the same plant. The company historically earns profit of 25% to 35% on fully burdened costs (material, labor, overhead, and G&A) for its commercial units. It is unable to make more than an 8% to 10% profit on its military units.

The company determines that it must, as part of a reorganization and reengineering of its plant, increase the profit margin on its military units or else headquarters will shut the entire plant down, commercial business itself alone being not enough to maintain the plant if military work is not pursued.

The Director of Contracts determines that he will allocate more from overhead pools to military contracts. The basis for doing this is various accounting reports, which the Government has commissioned (Coopers and Lybrand, etc.) showing, that it costs approximately 15% more in total costs to do military work, and comply with all the procedural requirements imposed as a result of it. Using this figure, the contractor increases his overhead rate from 20% to 35% on military work, continuing with a 20% rate on commercial work.

Military boilers are delivered infrequently to the Government. It has been approximately three years since a new military boiler was delivered. Boilers are delivered on a fixed price basis, although change orders are negotiated on a cost basis.

The contractor is required to submit cost and pricing data for the new fixed price military boiler bid where he shows a 35% overhead rate. There has been turnover in the Government agency involved, and no one notices the increase from 20% to 35%. The contract is awarded and the contractor performs.

During a post-performance audit, DCAA notices the large increase in overhead from previous bids. They also notice in their negotiator’s notes, prepared at the time the contract was signed, that a question was asked about, “Were there any significant changes in labor, material, or overhead rates from the contract performed several years before?” There is a notation in the DCAA’s files that the contractor said, “No, no changes except for increased overhead to compensate for Government regulatory requirements per Government studies.”

There is also a notation in the Government’s files that the contractor was asked whether there were commercial products involved in the sale, and the contractor said, “All of these products were essentially commercial with some modest tightening of specs in manufacturing for military use, and that prices are low as a result of these commercial initiatives except for Government caused overhead increases which are estimated.”

In response to a subpoena, the contractor’s bidding files are examined for this job, and they contain statements that are remarkably similar to the ones quoted above in DCAA’s file.

The contractor is charged with pricing fraud for improperly using a 35% overhead rate when he “knew” that his actual overhead rate was 20%.

Discussion re Possible Results.

Will this charge succeed? This is a very close case -- note the following:

(i) Oral Disclosures.

All disclosures were made orally. Fortunately for the contractor both sides’ negotiation notes seem to coincide. As stated in the text, relying upon oral disclosures is a big mistake. Here the contractor appears to dodge the bullet and the consequences that would result if such overall important disclosures had not been made.

(ii) Outcome: Oral vs. Written Disclosure.

If the contractor had made a written disclosure (perhaps a paragraph or so in writing during negotiations) that explained why overhead increases existed that would have ended this matter. Despite the fact that doing so may have upset the Contracting Officer, or the contractor’s 15% increased overhead cost estimate may have been wrong, the disclosure of the estimate or factor that was placed in the contractor’s bid would have been made. The Government could have then simply argued with the contractor during negotiations. Win or lose in negotiations, the contractor would have avoided fraud charges.

Case reference is United States v. Foster Wheeler Corporation, 316 F.Supp. 963 (S.D.N.Y. 1970), aff’d 447 F.2d 100 (2nd Cir. 1971).

Example of Factors and Contingencies in Cost Proposals: A Positive Result?

Factual Assumptions.

A contractor is negotiating a contract to provide food services to a large Army Base in the Midwestern United States. The contractor has performed two prior contracts on that base, and has a good amount of historical labor costs -- not just the amounts paid, but turnover, retraining, and associated labor costs.

After disclosure of initial cost and pricing data, the contractor meets with the Contracting Officer to reach a final rate per hour for various labor classes being utilized. This is a fixed price contract. The negotiations are not pretty:

The Contracting Officer accuses the contractor of putting in all sorts of unfounded contingency factors, and other items, to push up the labor cost rates. The Contracting Officer states that his auditors have reviewed the rates in detail, and they are full of unacceptable factors pushing the rates up.
The contractor states that he knows what he has been paying historically to perform contracts on the base, and that the last labor rates negotiated were completely unsatisfactory, and resulted in losses given the high labor turnover rate, and the resulting expensive retraining costs.
The Contracting Officer does not want to hear any of this. He is only interested in looking at the rates, and not about all sorts of management reserves and other similar factors that have affected the bottom line in the past.
The contractor counters by saying that he has an obligation under TINA to disclose all data that could affect price, and that is why he has disclosed all of the different problems and related contingencies that are pushing his labor rates up.
The Contracting Officer suggests an hour’s break in negotiations -- the contractor can go off and list all of the factors that are pushing labor rates up, and then the parties can resume negotiating a bottom-line price.
The contractor does this. He lists all of the various factors that he believes are pushing up costs, he references the disclosures that he has previously made to the Contracting Officer and the auditors, as well as the various document submissions that have taken place. He covers the waterfront in terms of listing those items that could increase labor rates.
The parties return to the room, the contractor distributes the document he prepared, the parties never talk further about it, and simply proceed to negotiate bottom-line rates.
About six months after the contract has been awarded, and the contractor has proceeded with performance, he is approached by Edison International, a nationwide charter school operator. They are starting to perform site training services for the contractor’s various workers on military contracts. The contractor looks at Edison's training rate structure and decides to go with Edison. In fact, using Edison saves roughly $700,000 across the remaining two years of the contract.
The DCAA audits and finds the $700,000 cost savings and asserts a defective pricing claim. Its argument is that the contractor failed to disclose its potential use of Edison prior to contract award, or for that matter the possibility that it might contract training services out at all.
The contractor's disclosure list that he gave the Government during negotiations has one line that states “must attempt to reduce training costs -- far too expensive -- try all alternatives possible including restructuring of all internal processes to reduce costs given high turnover rates”.
The contractor asserts that it had no specific knowledge of Edison entering this field of business. However, both the contractor and the Government agree that there were numerous outside training sources available at the date of contract award that could have done similar work -- there was no consideration of their training rates, or for the potential cost savings that could be realized from using them.

Discussion re Possible Results.

Who wins this defective pricing case? Answers:

Like many of the problems, this is a close case. We think the contractor should win.
Do not be confused by the fact that the contractor disclosed and discussed numerous other factors, contingencies, and other items to reduce labor costs. That is exactly what TINA requires. Even though the Government many times does not want to hear about those contingency factors that push costs up, the contractor has an obligation to disclose them. If the contractor does not disclose them that would be a prima facie TINA violation.
The issue is whether the contractor made an adequate disclosure of the possibility that he could go to outside lower-cost training organizations to cut down the training cost portion of its total labor rate. We think it is likely that he can show that he made an adequate disclosure. Look at the language quoted above. He told the Government he was trying to do everything.
Note also the fact that both sides agree it was general knowledge that there were outside sources available, and the contractor did not get any quotes. Thus, he had no data on this particular issue other than the broad generalized knowledge that there was something out there.
Although the defense of “bottom-line” negotiations in this potential scenario could be made, we do not believe that is something anyone should rely upon. Nonetheless, it might be possible to make that argument here given the Contracting Officer's position.
This case really boils down to the issue of whether there was adequate disclosure of what the contractor knew about training reduction options. We think he has a good case that he made all possible disclosures.

Example of Factors and Contingencies in Cost Proposals: A Negative Result?

Factual Assumptions.

An electronics manufacturer in the South Eastern United States bids on many unique spare parts orders for radios that were all built 20 years ago, but is still operational in various military aircraft. Many of these orders are over $550,000, require the submission of cost or pricing data, and are effectively sole-source.

The Estimating Department that provides the cost and pricing data for the spare parts is run by Joe Smith. He has been in that job for 39 years and no one knows more about spare parts and their cost makeup than Joe. He has dealt with a series of DCAA auditors over the years, and all agree that it was best for Joe and the DCAA auditor to simply exchange information before negotiating a quote into a final price because the information related to the spares was so complex and so numerous. In many cases historical information as to labor costs and material costs was 5 to 10 years old for the particular parts being ordered.

Joe retires at age 75. Sally Smith is his replacement -- she is 31 and has an MBA from a fine business school. She commences her review of records when she takes over Joe’s position in order to start the process of supplying cost data for upcoming quotations and negotiations. She is shocked at what she finds:

There are virtually no historical or other cost records to backup the quotes that Joe has been providing for the last 39 years. He would try to find the old records from the previous job. If he could find labor and material figures for them, it appeared to her that he would simply increase each by 15%, and use that figure to send in to the Government.
She saw cryptic notes in the files occasionally that he “explained this" to DCAA. She also saw evidence that on many occasions when no historical cost figures were available or found, Joe simply made up some numbers for the estimate, added 15%, and sent those to the Government.
When she looked in a closet adjacent to Joe's office, she found that the filing system consisted primarily of paper supermarket bags marked at the top with classes of spares, which were filled with unintelligible cost information.
A new DCAA auditor has been assigned to the company's plant. Sally has two weeks before the first quote has to be submitted to DCAA.
Sally has a meeting tomorrow morning with the Vice President of Pricing, who expressed concerns about Joe's work practices when Sally took over the job several weeks ago. She has to brief him as to how to start preparing for the upcoming quotations.

What should Sally tell her Vice President tomorrow morning?

Framework - Possible Resolutions.

Remember that telling the truth is always the best course.
Consider the ability to let sleeping dogs lie -- doing nothing is always an attractive alternative.
What do we really know about what Joe was doing, what he was disclosing to the auditor, and what the auditors have in their files?
Are there any ongoing orders for which the Company is receiving payments, or were billings for progress continuing based upon Joe's cost work ups? (This a problem that must be dealt with)
Is this something that the Company's Board of Directors needs to be aware of?
Is this a Sarbanes-Oxley problem?
Should Sally make appropriate reports?

Example of an Unknown, Unreliable Vendor

Factual Assumptions.

The prime has solicited quotes from various vendors of a complex circuit board used in radio development. The contractor has obtained 20 quotes. Of the 20 quotes, some very low quotes came from vendors that had poor performance records. Another group of quotes came from previously unknown vendors. These vendors were contacted.

The prime’s purchasing agent determined that the new vendors did not understand what they were doing. As a result, only 8 of the 20 quotes were evaluated and award was made to a higher priced but known, high-quality vendor. Only the 8 evaluated quotes were disclosed to the agency.

A year after award, one of the prime contractor’s representatives (not the purchasing agent) attended a trade show. One of the new vendors demonstrated a product that employed new technology that the prime had only vaguely heard of. When the prime asked the new vendor about the applications for the technology, the vendor replied that it could be used in circuit boards and that in fact, the vendor had even submitted a quote to the prime for the procurement at issue the year before.

Based on this recently discovered information, the prime conducted a new evaluation of the vendor’s circuit board. The prime discovered that this product was a vast technical improvement and significantly less expensive.

A decision was made to cancel the current circuit board vendor’s contract and use the new vendor’s boards in their place. The agency was notified of the change. The agency officials viewed the change as a beneficial technological advance. The result was a significant profit to the prime; however, as would be expected in a fixed price contract, the Government was not informed of this consequence.

Three years later after the contract was completed, the DCAA audited the contract, and concluded that the Prime had defectively priced the circuit boards.

Questions and Answers.

Who wins? (Likely the Government).
See Aerojet Solid Propulsion Co. v. United States, 291 F.3d 1328 (Fed. Cir. 2002) (unopened bids were cost and pricing data); Hughes Aircraft Company, ASBCA No. 46321, 97-1 BCA ¶ 28,972 (contractor should have disclosed “unreliable” data); Cutler-Hammer, Inc. v. United States, 416 F.2d 1306 (Ct. Cl. 1969) (failure to disclose quote from unreliable vendor.)
Can you develop elements of your compliance program that prevent these problems? (Yes, disclose all data, and tell the government why you are not relying on parts of it. Document such disclosures.)

Example of Disclosing Possible Cost Savings Never Realized: Drone Manufacturer

Factual Assumptions.

The contractor is a maker of drone aircraft for the Army. It is negotiating a large upcoming sole-source contract.

It is during the time of the year when the contractor receives quotes from its health-care insurers as to what will be available in terms of coverage and prices for the next year’s contract. This directly affects the contractor's overhead.

The contractor provides cost or pricing data to the Government for the upcoming drone procurement. It states that its overhead rate projections are accurate, and tells the Government that it is in negotiations with its health-care provider for the next year’s coverage, and that it expects the rates will be approximately 10% higher than what has been included in the contractor’s overhead.

In fact the rates actually paid are 12% higher. But the contractor does not disclose to the Government that one of the options proposed by its health-care provider would have resulted in a 0% rate increase. The company rejected this plan, which was low-cost, because it had numerous exclusions and increases in deductibles that the company thought would be unacceptable to its employees, thereby creating morale problems.

The DCAA learns indirectly that the company considered and rejected the zero increased plan. It understands that the company has made no cost savings because it actually paid for the plan that caused a 12% increase. The DCAA regional office refers the matter to headquarters to determine if a cost or pricing data refund claim, or any other claim, is available because of the non-disclosure. The contract being performed is a fixed-priced, incentive-fee contract with a final price renegotiation based upon actual costs incurred.

Answer — Framework

Does it matter whether this contract was firm fixed price or fixed-price incentive fee? Yes, in terms of total potential Government claims.
The gut issue is whether the cost or pricing data statute, regulations, and/or clauses, apply to a situation in which the contractor might have failed to disclose data, but in which the contractor hasn’t realized any cost savings. What do you think based upon the knowledge obtained in this course?
What other potential claims exist for the Government’s use in recouping the potential savings?
What of the contractor's right to run its business as it sees fit to enhance employee morale?

Example of Disclosing Third Party Data: Conveyer’s Conveyers

Factual Assumptions

Company A sells massive conveyor systems to warehouses. These conveyor systems are used to manage the inventory of large containers through a system of bar coding and RFI that enables the packages taken off a truck or train to be routed on conveyor belts to the appropriate location within the warehouse.

Company A’s conveyor system can cost upward of $50 million depending on the size of the warehouse(s) being serviced.

The Army has a number of huge warehouses in which military supplies that must be sent around the world are housed. The Army wants to purchase new conveyor systems through a specialized prime contractor that will be building special warehouses on a sole source basis to stock the additional supplies being needed for the war in Iraq. Under its contract, the prime will be required to supply cost or pricing data.

The special structures and the systems will enable the Army to organize the materials, know their location and be able to quickly unload and load necessary packages from trucks, rail, and ships for shipment.

However, because a percentage of the Army’s packages contain explosives, which are included within shipments, an “off the shelf” commercial conveyor system must be adapted to quickly identify the explosives and send them on a separate path that is not subject to possible bumps or similar conditions that could potentially cause an explosion.

The Army has previously commissioned research on existing commercial conveyor systems that handle explosives. There are small commercial conveyor systems for explosives, but none which operate with anything close to the typical speed and efficiency of the large commercial conveyor systems.

To meet the Army’s needs, it will require some hardware and software development. This type of development to modify the system is typical in the industry as most warehouses have unique products that have to be handled differently. The new software needed will be embedded in the existing proprietary software that was developed at 100% private expense.

There are several companies, including Company A, that sell these systems. One of them, like Company A, advertises its large commercial systems on the Internet. The prices for the large unmodified systems of the two firms are roughly comparable.

However, after discussing the potential procurement with these contractors, only Company A appeared to be willing to modify its commercial system to meet the new requirements. The other companies were either unwilling to do so because of the potential liabilities involved, the possible loss of proprietary data, the lack of a significant market for the improved explosive conveyor systems, and/or were otherwise non- committal.

The cost of the development, while not significant in terms of the technology or effort involved, will cost $2.75 million or approximately 5.5% of the estimated contract price of $50 million. Company A, while willing to perform the modification, absolutely refuses to provide cost or pricing data to the prime or to subject itself to a Government audit. It is only willing to provide its commercial price lists to the prime like it does for its other commercial customers.

Questions and Answers

Question and Answer 1:
Question: Can the prime purchase this system for its contract without requiring Company A to provide C&P data? What will the prime risk by doing so, assuming that it must submit cost and pricing under its prime contract?
Answer: Yes but will be at risk. The Army could reject the prime’s proposal. If the commercial “other than cost or pricing data” that is provided is inaccurate, the prime could be responsible for defective pricing.
Question and Answer 2:
Question: What should the prime do to avoid this risk?
Answer: Seek an advance agreement with the agency that one of the exemptions below applies. Perform market research and/or solicit assistance from Company A in obtaining any data it has or which is found in the industry that could help establish that its price is fair and reasonable.
Question and Answer 3:
Question: Will Company A be protected from TINA defective pricing or an audit or other Government action?
Answer: Potentially not. Company A will have a contractual defense with its prime, but it could still be exposed to the Government, and typically the Government looks first to the prime if there is a problem.
However, notwithstanding the absence of privity, TINA specifically requires Government subcontractors to submit C&P data absent an exemption. Based on this statute, the GAO will always have an audit right for TINA information in a negotiated or sole source procurement. The IG can always review any instance in which fraud is suspected.
If the commercial price lists given to the prime are inaccurate, there is also a possible False Claims Act claim since arguably Company A knew that the prime would be submitting this information with its bid to persuade the Government that the price was fair and reasonable based on the limited pricing information available.
It could also be a TINA and FCA violation since Company A knowingly submitted incomplete information to the prime, knowing it would be forwarded to the Government.
Question and Answer 4.
Question: What potential exemptions apply?
Answer: Adequate Price Competition, Commercial Item. (Catalog and market are no longer in the regulations.)
Question and Answer 5.

Question: How would these exemptions be argued to apply?

Answer: Adequate price competition would arguably exist by virtue of the comparable pricing that exists in the advertised prices of competitors on the Internet. Although none submitted bids for the incremental development to modify the system, it is only 5.5% of the contract price and thus, not significant for purposes of establishing adequate price competition.

The Commercial Item regulation requirement that C&P data be provided for DoD procurements where modifications are $550,000 or 5% would not apply since there is another exemption available — adequate price competition.

Contents of this Section

Example of Specification Failures: Sure Shot Rocket Company

Example of Specification Issue/Termination: Humperdink & Fud Accounting

Example of Specification Failures and the Need to Proactively Manage Claims: Atlas Blast Company

Fact Situation

Appendix A

Appendix D

Appendix E

Example of Specification Requirements: Reliable Electronics

Example of Specification Requirements: Gen Testing

Example of Specification Requirements: Woodworth and Tweed Accounting

Example of Specification Issues: Troublesome Construction

Example of Inspection and Acceptance: Fast Foods, Inc

Example of Prompt Claims Recognition and Resolution: Splash Electronics Company

Example of Recovering from Initial Management Failures: Microprocessor Radar Company

Example of Product Misuse, Supply and Construction, and the Outer Limits of Claims Theories: Rapid Deployment Systems

Example 2 of Product Misuse, Supply and Construction, and the Outer Limits of Claims Theories: Pango Construction

Example of Third Party Disputes: Contractor

Example of False Statement Issues: Rapid Deployment Missile Company

Example of TINA Issues with Other Disclosure Items: Flight B

Possible Scenarios.

Additional Thoughts.

Example of Overhead Scenario: Boilermakers

Factual Assumptions.

Discussion re Possible Results.

Example of Factors and Contingencies in Cost Proposals: A Positive Result?

Factual Assumptions.

Discussion re Possible Results.

Example of Factors and Contingencies in Cost Proposals: A Negative Result?

Factual Assumptions.

Framework - Possible Resolutions.

Example of an Unknown, Unreliable Vendor

Factual Assumptions.

Questions and Answers.

Example of Disclosing Possible Cost Savings Never Realized: Drone Manufacturer

Factual Assumptions.

Answer — Framework

Example of Disclosing Third Party Data: Conveyer’s Conveyers

Factual Assumptions

Questions and Answers

We are always transparent about our fees.