The Armed Services Board of Contract Appeals recently dismissed a government claim that Lockheed Martin Integrated Systems, Inc. (LMIS), failed to comply with its prime contract terms by not adequately managing its subcontractors and therefore all subcontract costs (more than $100MM) were unallowable.

Although the government claim was directed at a large contractor, some of the amount in question, presumably, included invoiced amounts by small business subcontractors.  At least by implication, had the government prevailed, it could have resulted in requirements for prime contractors to become far more demanding and intrusive in terms of subcontractor documentation and/or access to subcontractor records.

At issue in Lockheed Martin Integrated Systems, Inc., ASBCA Nos. 59508, 59509 (2016) was DCAA’s assertion and the Contracting Office agreement, that a prime, in accordance with FAR 42.202(e)(2), Assignment of Contract Administration, must perform in the role of the CO, CAO and DCAA when managing subcontracts.  DCAA went on to assert that this responsibility includes, among other things, requiring subcontractors to submit Incurred Cost Proposals (ICP) to the prime and the prime performing an audit on that ICP, or requesting an assist audit by DCAA.

Because LMIS had no documentation requiring its subcontractors to submit ICPs, the government asserted a breach of contract and therefore questioned all subcontract costs as unallowable.  Fortunately, the Board adamantly disagreed, stating that FAR 42.202 (the whole basis on which subcontract cost were questioned) is not a contractual clause nor a clause incorporated by reference.  The Board concluded that FAR 42.202 is a regulation pertaining only to the government’s administration of contracts and nowhere is it implied that a prime take on the role of CO, CAO or DCAA for its subcontractors.

Whew, good news for contractors, right?  Some may assume the outcome of this case will force DCAA to relent on its current obsession with prime management of subcontracts.  If you have had the fortune of an ICP audit or a Paid Voucher audit recently, you understand my statement, “current obsession with prime management of subcontracts.”  These audits, in particular, place significant emphasis on the processes and procedures in place which demonstrate and document the prime’s management of subcontracts.

Many small business primes have expressed concern about DCAA’s requests and expectations, during these audits, and what impact it may have on the allowability of historical subcontract cost.  In my professional opinion, I doubt DCAA is going to take a step back in its auditing approach, nor relent in its expectation of subcontractor monitoring.  But, at least now there is precedent stating that primes are not auditors and it’s not the prime’s responsibility to require subcontractor ICPs nor audit subcontractor ICPs.

So, what is the prime’s responsibility for monitoring subcontractors?  First, note that the responsibility of the prime to “manage” subcontractors stems not from FAR 42.202 but rather from other regulations and at different phases of the contract process.

Pre-award phase:

• FAR 9.104-4(a) – Subcontractor Responsibility: “Prospective prime contractors are responsible for determining the responsibility of their prospective subcontractors.”
• FAR 15.404-3(b) – Subcontract Pricing Considerations: “Prime contractor shall perform appropriate cost or price analysis to establish the reasonableness of subcontract prices and include the results in the price proposal.”

Post-award phase:

• FAR 52.216-7 (d)(5) – Allowable Cost and Payment: “The prime contractor is responsible for settling subcontractor amounts and rates included in the completion invoice or voucher and providing status of subcontractor audits to the contracting officer upon request.

Primes must still ensure subcontractor capability and contract compliance.  This is best achieved by implementing policies motivated towards an on-going monitoring approach and well documented subcontract files.  Best practices considerations include, but are not limited to the following:

• Perform and document Price Analysis or Cost Analysis. Although this documentation primarily supports cost estimates, it ultimately supports the reasonableness of subcontract costs as a component of prime ICPs.
• Obtain subcontractor self-certifications (accounting system, provisional rates, ICP submission); note, however, that self-certifications without any corroborating data is risky.
• Insert subcontract clauses with access to specified records and/or the requirement of third party verification (reasonable assurance, but not an audit). For example, a subcontract clause with rights to detailed subcontractor supporting records such as time sheets, travel expense receipts intermittently.  The purpose is to selectively document that the subcontractor can support costs invoiced.
• Focus on billing policies and procedures providing reasonable assurance of satisfactory subcontract performance.
• Define managing subcontracts in the context of review and approval of subcontractor invoices (substation of hours, rates). Avoid references to “audits” unless expressly required by a specific contract.
• Consider contract close-out expediencies
  • Quick close-out and/or DCAA Low Risk (concept)
  • Convert to FFP (FAR 16.103(c)) with support for the fixed price)
  • Third party reviews (agreed upon procedures/limited transaction verification)

Regardless of the outcome and what evolves from the ASBCA cases, primes are ultimately responsible for the allowability of subcontract costs.  There is always risk that subcontractor cost will be challenged at the prime contract level.  However, these ASBCA cases confirm that the contractual requirements imposed on primes is far less onerous than anything envisioned by DCAA.

Courtney Edmonson, CPA is the VP of Small Business Consulting at Redstone Government Consulting and provides contract compliance services to small business government contractors.  Her areas of expertise include pricing and cost volume proposals, indirect rate forecasting and modelling, incurred cost proposals, and DCAA compliance. Courtney is the lead instructor for the Federal Publication Seminars course, “Government Contractor Accounting System Compliance”, and provides instruction for other compliance courses including, “Preparation of Incurred Cost Submissions”, “FAR 31, Cost Principles”, and “Cost Accounting Standards.” Courtney graduated from Jacksonville State University with a Bachelor of Science and obtained a Master of Accountancy from the University of Alabama in Huntsville.  She is also a Certified Public Accountant.

Redstone Government Consulting – 4240 Balmoral Drive, SW Suite 400 Huntsville, AL 35801 www.redstonegci.com

Phone: 256-704-9840                       Email: cedmonson@redstonegci.com

GovCon Voices is a regular feature dedicated to providing SmallGovCon readers with candid news, insight and commentary from government contracting thought leaders.  The opinions expressed in GovCon Voices are those of the individual authors, and do not necessarily reflect the opinions of Koprince Law LLC or its attorneys.