FAC 2005-37; FAR Case 2008-031, Limitations on PassThroughCharges, by yrr14496

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             PREVIOUS PAST CHAIR
                 Patricia A. Medllher
              582 Markel 51, SIp 301
            San Francisco, CA 94104                 Re:      FAC 2005-37; FAR Case 2008-031, Limitations on Pass-
                     (415) :162-6517

                COUNCIL MEMBERS
                                                             Through Charges, 74 Fed. Reg. 52853 (October 14, 2009)
              Melissa lavon Copeland
                        Columbia, SC

                    Anne M. Donohue
                                            Dear Sir or Madam:
                          Fairfax, VA

                       Mark E. Hanson
                           Vienna, VA              On behalf of the Section of Public Contract Law of the American Bar
                  lames A. Hughes, Ir.      Association ("the Section"), I am submitting comments on the above-referenced
                        Arlinglon, VA

                      David Kasanow
                                            Federal Acquisition Regulation ("FAR") interim rule issued with a request for
                      Wdshington, DC
                                            comments by the Civilian Agency Acquisition Council and the Defense
                     Pdul Farid Khoury
                      Washington, DC        Acquisition Council (the "Councils") on October 14, 2009. The Section consists of
                      Herman D. levy
                      Falls Church, VA
                                            attorneys and associated professionals in private practice, industry, academia, and
                    Rocco J. Maffei, Jr.    government service. The Section's governing Council and substantive committees
                           Akron,OH
                                            contain members representing these segments to ensure that all points of view are
                       Linda Maramba
                          Mclean, VA        considered. By presenting their consensus view, the Section seeks to improve the
                      W. Michael Rose
                       Alexandria, VA
                                            process of public contracting for needed supplies, services, and public works. 1
                    Kathryn E. Swisher
                     WashinRlon, DC
                                                   The Section is authorized to submit comments on acquisition regulations
               Thomas Craig Wheeler
                    Washinglon, DC          under special comment authority granted by the Association's Board of Governors.
                 Christopner R. Yukins
                      Washington, DC
                                            The views expressed herein have not been approved by the House of Delegates or
        EDITOR, PUBLIC CONTRACT
                       LAW/OURNAL
                       Karen L. Manos
                       Washington, DC
                                            I The Honorable Thomas C. Wheeler, a member of the Council of the Section of Public Contracts
EDITOR, THE PtlOCUREMENT LAWYER
                    John A. Burkholder      Law, did not participate in the Sections' consideration of or voting on these comments.
                       Los Angeles, CA

   BOARD OF GOVERNORS LIAISON
                 Charles E. English, Sr.
                   Bowling Green, KY

                 SECTION DIRECTOR
                     Marilyn Neforas                                             Fall Meeting. November 13-14, 2009 • lake Buena Visla, Fl
             321 N Clark 51, MIS 19.1
                   Chicago, IL 60654
                                                                                     Midyear Meeting. March 4-6, 201 0 • Annapolis, MD
                     (312) 988-5596                                                    Spring Meeting. May 14-15, 2010 • Seattle, WA
                                                                                    Annual Meeting. August 6-9,2010. San Francisco, CA
General Services Administration
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December 14,2009
Page 2




the Board of Governors of the American Bar Association and, therefore, should not
                                                                         2
be construed as representing the policy of the American Bar Association.

I.         BACKGROUND

        Section 852 of the National Defense Authorization Act for Fiscal Year 2007
("FY07 NOAA") required the Department of Defense ("DoD") to issue regulations
to address excessive pass-through charges on 000 contracts and subcontracts.
DoD published an interim rule on April 26, 2007 ("2007 Interim Rule,,).3 The
2007 Interim Rule required offerors and contractors to identify the percentage of
work to be subcontracted, and, if the subcontracted costs are expected to exceed 70
percent of the total work, to provide additional information on indirect costs, profit,
and the value being added by the contractor to the subcontracted work. Based on
its review of public comments on the 2007 Interim Rule, 000 issued a second
interim rule on May 13, 2008 ("2008 Interim Rule,,).4 The Section provided
comments on both the 2007 and 2008 Interim Rules, which are attached.

        On October 14,2009, the combined Councils issued an Interim Rule ("FAR
Interim Rule") amending the FAR to implement Section 866 of the National
Defense Authorization Act for Fiscal Year 2009 as well as Section 852 of the FY07
NOAA. The FAR Interim Rule applies to all executive agencies, including 000,
and establishes regulations to minimize excessive pass-through charges. The
Section respectfully submits these comments regarding the FAR Interim Rule to
highlight what it believes to be important points for the Councils to consider prior
to the release of a final rule.

II.        COMMENTS

         In its comments on the 2007 and 2008 DoD Interim Rules, the Section
concurred that pass-through charges should not be excessive and commended 000
for its thorough review of the comments and the issues those interim rules raised.
The Section also addressed the importance of guidance regarding the effective
implementation of the rule and stated that this guidance should include, among
other matters, direction that Contracting Officers consider in assessing contractor
added value the lower contract risk when cost reimbursable contracts are subject to

 2This comment letter is available in pdf format at
 http://www.abanet.orglcontract/federal/regscomm/home.html under the topic "Subcontracting and
 Teaming."
 3   72 Fed. Reg. 20758 (Apr. 26.2007).
 4   73 Fed. Reg. 27464 (May 13,2008).
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December 14, 2009
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full and open competition. In its notice accompanying the 2008 Interim Rule,
however, 000 deferred this issue to a point "when necessary." 73 Fed. Reg. at
27471.

       The FAR Interim Rule does not provide such guidance to Contracting
Officers, nor does it require that the Councils or 000 issue such guidance in future
Procedures Guidance and Instructions ("PGI") or other guidance or instructions.
As discussed in more detail below, the Section notes that a January 2008
Government Accountability Office report ("GAO Report") made this same
recommendation. 5

       In addition, the Section does not believe that the Councils have addressed
the conflict between 000 policies that the Section identified in its comments on the
2007 and 2008 000 Interim Rules. The Section also suggests that the Final Rule
make the threshold for flowing down the clause in cost reimbursable subcontracts
under contracts with executive agencies other than DoD the same as that for
subcontracts under DoD contracts. Finally, the Section recommends that the
Councils define the term "total cost of [the] work" as used in FAR 52.215-22 and
52.215-23. 6

           A.       Guidance Should be Available to Contracting Officers, As Noted
                    in the Section's Earlier Comments and in the GAO Report

        In its comments on the 2007 and 2008 000 Interim Rules, the Section
recommended that DoD provide guidance to Contracting Officers so that they can
effectively implement the goal of eliminating or reducing excessive pass-through
charges. In the discussion of "Planning and Guidance" in the Notice accompanying
the 2008 Interim Rule, 000 mentions the Section's statement that there is no
substitute for adequate contract planning and administration on the part of the
Government, and further relates the Section's concern that without adequate
guidance, there is potential for mischief. The 000 response stated that "DoD will
monitor implementation and will provide guidance when necessary." 73 Fed. Reg.
at 27471. To ensure that the 2009 FAR Interim Rule is implemented in an effective
manner and is not employed merely to reprice contracts, the Section repeats its
recommendation that the Councils and 000 proactively address the creation of
guidance to assist Contracting Officers with implementing the rule.


5See GAO, Defense Contracting: Contract Risk a Key Factor in Assessing Excessive Pass-Through
Charges, GAO-08-269 (Jan. 25,2(08).
6   FAR 52.215-22 and 52.215-23 use the terms "total cost of work" and "total cost of the work."
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        GAO, at the request of congressional committees, conducted a study
leading to the above-mentioned January 2008 report because one-third of DoD's
fiscal year 2006 spending on goods and services was for subcontracts. As a result,
000 auditors and Congress raised concerns about the potential for contractors to
assess excessive pass-through charges.? GAO reviewed and analyzed the FAR and
DFARS, discussed the issues with 000 acquisition policy, audit and contracting
officials, and interviewed private companies. As a result of this extensive review,
GAO recommended that DoD issue guidance to implement this rule and noted that
DoD concurred with the recommendation. Notably, the GAO Report states that:

           While the rule aims to provide contracting officers with more
           information on contractor value added, it alone will not provide
           greater insight into DOD's supply chain and costs-
           information that companies told us they use to mitigate
           excessive costs. In addition, while the rule is not yet final,
           contracting officials we spoke to indicated the need for
           guidance on how to effectively implement the rule since they
           were not clear what more they should be doing beyond
           applying tools in the FAR and DFARS. This would ensure that
           contracting officers, particularly newer and less experienced
           staff, consistently apply federal acquisition tools in conducting
           their assessments of contractor value added and take into
           account contract risk when determining the degree of
           assessment needed, documenting assessments, and involving
           DCAA and DCMA as appropriate. 8

        The Section believes that the GAO Report further supports the need for
guidance at the time of implementing this requirement as a final rule, and
recommends that the Councils provide such guidance in the final rule. The GAO
Report provides information and suggestions relevant to the creation of guidance
such as a description of unique circumstances that drive contracting arrangements
that include greater risk of excessive pass-through charges, including the lessons
learned on contracts awarded for Hurricane Katrina recovery efforts,9 which the
Section noted in its earlier comments was one of the excessive pass-through



7GAO, Defense Contracting: Contract Risk a Key Factor in Assessing Excessive Pass- Through
Charges, GAO-08-269 (Jan. 25, 2008).
8   [d. at 4 (emphasis added).
9   [d. at 14-17.
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                                                                                 lO
situations that gave rise to the statutory requirement for the DFARS rule             and
likely, the FAR Interim Rule.

        Evaluation of a program's cost and a contractor's proposed management
approach, including the subcontract plan, is a part of the Procurement Contracting
Officer's award determination. The Section believes that to the maximum practical
extent - for those procurements that are not otherwise exempt under the FAR
Interim Rule - any excessive proposed costs related to subcontract management
can be evaluated in the context of competition or addressed in negotiations in a
sole-source procurement. Indeed, the GAO Report stated that one of the key
elements for Contracting Officers in assessing contractor value added is whether
the contract is awarded on the basis of full and open competition and stated that
H[ w ]hen adequate price competition exists generally no additional information is
necessary to determine the reasonableness of price.,,11 The GAO recommended, as
the DoD finalizes its rule on preventing excessive pass-through charges and
develops implementing guidance to ensure consistency in how contracting officials
assess contractor value added, that DoD "[r]equire contracting officials to take risk
into account when determining the degree of assessment needed.,,12 GAO further
elaborated that: "[r]isk factors to consider include whether (I) the contract is
competed~ (2) the contract type requires the government to pay a fixed price or
costs incurred by the contractor~ and (3) any unique circumstances exist, such as
requirements that are urgent in nature.,,13 The Section urges the Councils to
consider these recommendations in formulating the final rule. In addition, the final
rule should serve as a tool to ensure consistency to the extent practicable between
contractors' proposals, as evaluated by the Procurement Contracting Officer, and
actual performance, monitored by the Administrative Contracting Officer, rather
than to serve as a basis to disallow cost after incurrence.

        With further regard to evaluation of negotiated procurements, the
Procurement Contracting Officer should, in light of the FAR Interim Rule, pay
special attention to those contract elements that would require multiple tiers of
subcontractors and thus multiple layers of indirect cost and profit. For example,
contracts that require the prime contractor to act as an integrator implicitly require
that the prime contractor employ subcontractors to accomplish the scope of the

10   See Section Comments on 2007 Interim Rule at 5 n. 3.
II GAO Report, Appendix II: Key Elements for Contracting Officers in Assessing Contractor Value
Added, at 29.
12   1d.
13   !d. at 22.
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December 14, 2009
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contract. A more explicit example would be the requirement to satisfy a small
business plan that could necessitate multiple subcontractors. Finally, the final rule
should carefully consider the potential effects on those small businesses performing
as prime contractors on contract set-asides given that small business prime
contractors could experience significant adverse financial impacts as a result of
disallowed pass-through costs under this rule. This is contrary to the protections
typically afforded small businesses that perform federal contracts.

         In all events, it would seem advisable that additional guidance be provided.
Even in the short time between the FAR Interim Rule's issuance on October 14,
2009, and the drafting of this comment, public contract lawyers have indicated that
contractors have sought clarification of the rule's requirements and how it will be
implemented only to be told by Contracting Officers that they lack knowledge of
this issue and are not prepared to discuss the rule other than to recite the FAR
requirement.

           B.      The Interim Rule Does Not Reconcile Conflicts with Existing
                   Policies

        The Section's comments on the 2007 and 2008 DoD Interim Rules noted
that those rules could impact team assembly and formation decisions, conflicting
with 000 policy that seeks both to ensure robust competition for subcontracts and
to prevent bias on the part of prime contractors toward in-house sources. The
Section notes that the FAR Interim Rule may conflict with the policy of the
recently enacted Weapons Systems Acquisition Reform Act, which directs the
Secretary of Defense:

                 to ensure that the acquisition plan for each major defense acquisition
                 program includes measures to maximize competition at the prime
                 contract level and the subcontract level of such program throughout
                 the life cycle of the program. 14

The FAR Interim Rule requires Contracting Officers to review, with little guidance,
instances where contractors subcontract more than 70 percent of the work to
determine whether to disallow or reduce the contract price to eliminate pass-
through charges on the subcontracted work. 15 This process could result in
decisions to retain in house work that could be more efficiently performed by


14   Section 202 of the Weapons Systems Acquisitions Reform Act of 2009.
15   FAR 52.215-23(d).
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December 14, 2009
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subcontractors. The Section recommends that DoD reconcile its policies to avoid
confusion.

       In the discussion of "Impact on Business Strategy, Spares Contracting, and
Indefinite-Delivery Indefinite-Quantity or Delivery Order Contracts" in the Notice
accompanying the 2008 DoD Interim Rule, DoD mentioned the Section's concern.
DoD stated that the policies are not inconsistent, and that this:

                  rule is intended to protect the Government from those situations where
                  there appeared to be an agreement with the contractor to perfonn the
                  contract scope of work, including "managing" subcontractors, and
                  then after award, the contractor subcontracts substantially all the effort
                  without providing the required "added value.,,16

The Section believes that the 2008 DoD Interim Rule and the FAR Interim Rule go
far beyond such situations. DoD's 2008 statement connotes a situation where there
is active misrepresentation of the prime contractor's intent and perhaps its
capabilities. The 2008 DoD Interim Rule, however, addressed much more than
misrepresentation, and reached all situations where subcontracting can be used to
create a strong team.

         Nevertheless, DoD's response did not address the Section's concern. The
Section supports the Wynne Memorandum's purpose, 17 which is to foster
competition through assembly of a strong team that can address and satisfy the
required capabilities while avoiding the favoring of an affiliate over an unrelated
entity. The Section remains concerned that the FAR Interim Rule, like the 2007
and 2008 DoD Interim Rules, exerts pressure to keep work in-house to address the
reporting requirement, and believes that the Councils should be aware - and
concerned - about this unintended impact. It seems inconceivable that the FAR
Interim Rule would not have an impact on contractor team assembly and fonnation
decisions. The Section restates that the FAR Interim Rule's emphasis on limiting
the amount of subcontracted work conflicts with the Wynne Memorandum's
emphasis on ensuring robust competition to ensure consideration of subcontracting
to independent companies. As the Wynne Memorandum indicates, a key DoD goal
is to facilitate the most effective combination of complementary skills to ensure
that the prime contractor can provide best value and accomplish the task efficiently

16
     73 Fed. Reg. at 27470.
17 On July 12,2004, Michael W. Wynne, then-Under Secretary of Defense, Acquisition, Technology
and Logistics (acting), issued a memorandum for the secretaries of the military departments entitled
Selection of Contractors for Subsystems and Components ("Wynne Memorandum").
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and effectively. If the amount of subcontracting is limited to an arbitrary share of
the total work effort, this goal will be seriously jeopardized.

         Additionally, the FAR Interim Rule may be interpreted and applied so as to
conflict with the requirements of the Cost Accounting Standards ("CAS"). CAS
requires that all indirect costs be fully absorbed and allocated to final cost
objectives, and defines certain mandatory rules for the measurement, assignment,
and allocation of those costs. The FAR Interim Rule provides a basis for
Contracting Officers to disallow costs if the contractor fails to demonstrate "added
value," which is defined in FAR 52.215-23(a) as "subcontract management
functions that the Contracting Officer determines are a benefit to the Government."
Under the FAR Interim Rule, the Contracting Officer is responsible for determining
the value that certain allocable indirect costs actually add to the contract.
Nevertheless, General and Administrative ("G&A") costs are by their very nature
residual and do not permit the assignment of a clear beneficial or causal
relationship between the cost incurred and a benefit to any particular final cost
objective. As a result, there is a potential that the G&A applied to all tiers of
subcontracts could be deemed to be "excessive" and therefore unallowable, even if
it is incurred in accordance with the contractor's approved disclosed cost
accounting practices. If a contractor incurs cost in accordance with CAS and its
disclosed practices, the only question should be the allowability and reasonableness
of the cost, both of which can be dealt with prior to award and incurrence of those
costs.

        To the extent a Contracting Officer believes that an adjustment to the
amount of indirect cost applied to final cost objectives is appropriate because
certain contracts receive more or less benefit from residual expenses than would be
indicated by the contractor's standard allocation practices, those should be
addressed through special allocations, such as those at CAS 410-50(j) and CAS
418-50(f), not through the disallowance of costs.

        The Section believes that a distinction should be made with regard to G&A
applied to contracts versus applied profit. This will serve to protect the contractor's
recovery of allowable G&A if incurred in accordance with CAS and the
contractor's disclosed practices, while focusing the Government's attention to the
negotiated item of profit. Application of indirect cost, including G&A, is not only
governed, but required by the CAS and FAR. Although public law and regulation
determine the manner in which a contractor may apply those costs, they provide no
methodology or guideline for the calculation and application of profit beyond
justifying its existence. As a result, guidance should be issued to Contracting
Officers to evaluate applied profit more stringently rather than to determine
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December 14, 2009
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unallowable those actual costs that have been incurred and allocated in accordance
with applicable and approved guidelines.

       C.      A Consistent Threshold Should be Established Across All
               Executive Agencies for the Flowdown of the Clause to
               Subcontracts

        The Section acknowledges and supports the Councils' adoption of a
minimum threshold for the mandatory flowdown of the requirement to
subcontractors under DoD contracts. The Section believes that the threshold to
obtain cost or pricing data in FAR 15.403-3 is appropriate. The summary of
comments accompanying the 2008 DoD Interim Rule demonstrates the value of
reasonable parameters with regard to the number of subcontractors to whom this
requirement flows down. The Section suggests that the Councils should also apply
this same threshold to subcontracts under contracts with executive agencies other
than DoD. There should be a consistent minimum threshold among all executive
agencies for subjecting subcontracts to the pass-through charges requirements.

        Given that the clause requires Contracting Officers to make determinations
with regard to subcontracts as well as the prime contract, the potential burden for
satisfying this requirement with respect to subcontracts of a value above the
simplified acquisitibn threshold but below the threshold for requiring cost or
pricing data will be considerable. Although many such relatively low value
subcontracts may be awarded on a competitive basis or fit the definition of
commercial items, many will not. The risk to the Government is minimal with
respect to such lower tier subcontracts. If the Councils use the threshold in FAR
15.403-4, the rule will exclude a significant number of subcontracts from this
burdensome requirement, but still cover the vast majority of the total value of
subcontracts and apply a consistent minimum threshold across all executive
agencies.

       D.      The FAR Interim Rule Should be Clarified to Define the Terms
               "Total Cost of Work"

        The FAR Interim Rule prescribes the use of a new provision, FAR 52.215-
22 Limitations on Pass-Through Charges-Identification of Subcontract Effort~ and a
new clause, FAR 52.215-23 Limitations on Pass-Through Charges. Neither the
provision nor the clause defines the terms "total cost of the work" and "total cost of
work," as these terms are used in the provision and the clause. The Section
recommends that the provision and the clause be amended to include definitions of
these terms.
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        Paragraph (c) of FAR 52.215-22 requires prime contractors to identify in
their proposals the total cost of the work to be performed by the prime contractor,
and the total cost of the work to be performed by each subcontractor, under the
contract, task order, or delivery order. It further provides that if the prime
contractor proposes to subcontract more than 70 percent of total cost of the work to
be performed under the contract, task order, or delivery order, the prime contractor
shall identify in its proposal the amount of its indirect costs and profit/fee
applicable to the work to be performed by the subcontractor(s), and a description of
the added value provided by the prime contractor as related to the work to be
performed by the subcontractor(s). An identical reporting requirement applies to
any of the prime contractor's subcontractors ("higher-tier subcontractors") that
intend to subcontract to lower-tier subcontractor(s) more then 70 percent of the
total cost of work to be performed under a higher-tier subcontract.

        The Section recommends that FAR 52.215-22 be amended to provide that,
for purposes of determining whether the 70 percent subcontracting threshold is
reached, the "total cost of [the] work" to be performed by the prime contractor or a
higher-tier subcontractor shall include the prime contractor's or higher-tier
subcontractor's direct and indirect costs of the work, excluding applicable profit or
fee, to be performed under the contract or higher-tier subcontract, as the case may
be, and the "total cost of the work" to be performed by each subcontractor to the
prime contractor or to a higher-tier subcontractor shall include its direct and
indirect costs, including applicable profit or fee, of the work to be performed under
its subcontract.

        Similarly, the Section recommends that FAR 52.215-23 be amended to
provide that, for purposes of determining whether a prime contractor, or higher-tier
subcontractor, changes the amount of subcontract effort after award such that it
exceeds 70 percent of the total cost of work to be performed under the contract or
higher-tier subcontract, the "total cost of [the] work" to be performed by the prime
contractor or a higher-tier subcontractor under the contract or higher-tier
subcontract shall include the contractor's or higher-tier subcontractor's direct and
indirect costs of the work, excluding applicable profit or fee, to be performed under
the contract or higher-tier SUbcontract, as the case may be, and the "total cost of
[the] work" to be performed by each subcontractor to the prime contractor or to a
higher-tier subcontractor shall include its direct and indirect costs, including
applicable profit or fee, of the work to be performed under its subcontract.

III.   CONCLUSION

       The Section supports the goal of the FAR Interim Rule on excessive pass-
through charges, but remains concerned that without additional guidance, issues
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December 14, 2009
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will arise in the implementation of the final rule. Also, the Section recommends
that DoD reconcile the FAR Interim Rule with the policies reflected in the Wynne
Memorandum and also adopt as a minimum threshold for all subcontracts the
minimum threshold tied to the cost or pricing threshold proposed for subcontracts
under DoD contracts. The Section further recommends that the Councils clarify the
term "total cost of [the] work."

        The Section appreciates the opportunity to provide these comments and is
available to provide additional information and assistance as the Councils may
require.

                                    Sincerely,



                                    Karen L. Manos
                                    Chair, Section of Public Contract Law



Attachments A and B - Prior Section Comment Letters




cc:    Donald G. Featherstun
       Carol N. Park Conroy
       Mark D. Colley
       David G. Ehrhart
       Allan J. Joseph
       John S. Pachter
       Michael M. Mutek
       Patricia A. Meagher
       Council Members, Section of Public Contract Law
       Chair(s) and Vice Chair(s) of the Strategic Alliances, Teaming &
               Subcontracting Committee
       Kara M. Sacilotto
                                                                                                                                                ATTACHMENT A




                                 2007·2tMII                                      AMERICAN BAR ASSOCIATION                            Section of Public Contract Law ~
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           Mary Ellen C04lc.r Williams
        717 MadiMln PI, NW, 51" Ii 12            Defense Acquisition Regulations System
               Wa,hinlllo<l, DC 20005
                        (202l 357 ·1>b60         Attn: Ms, Sandra Morris
            IMMEDIATE PAST CHAIR
                  Michoi..IA. HClIdcoll          OlISO (AT&L) DPAP (CPF)
             600 I ~lh SI, NW, Slh rtr
               Wa.ninJllrm.      rn: ~ooos
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                   RClbo-rt L. Sch""#•.,.
                IlWI C.il1lino L)o~ Ri'"
                                                 Washington, D.C. 20301-3062
            I hu"'and O.ks, I:A Y1.11.0
                        (/1051 )7)-4606

                 COUNCIL MEMllflS
                    D"n;"1 r. Oex'll.n
                                                          Re:      DFARS Case 2006-D057, Excessive Pass-Through
                          Oet,";I.MI
                                                                   Charges, 73 Fed. Reg. 27464 (May 13, 2008)
                       Mark E. Han""n
                           \'oI'l1fl.l. VA

         Annt'jalVlle kk>eb f'k!ck/noin
                         Herndon, VA
                                                 Dear Ms. Morris:
                     L Sanrit>rson Hoe
                      Washi"lllon. DC                    On behalf of the Section of Public Contract Law of the American Bar
                   James A. HUllN:s. Ir.
                         A,lingWI. VA            Association ("the Section"), I am submitting comments on the above-referenced
                          David F. Innis         Defense Federal Acquisition Supplement (DFARS) interim rule issued with a
                     ~n Fr~ncilCo,       CA

                      Shalon l. Larki"
                                                 request for comments by the Defense Acquisition Regulations System on May 13,
                      W,shinl\IOn, DC
                                                 2008. The Section consists of attorneys and associated professionals in private
                    Rocco I. Mail.. i, Jr.
                           Akron. O~f            practice, industry ~ academia, and government service. The Section's governing
                     Lind.. 1. Ma,~mba
                            MrLe.ln, VA          Council and substantive cOinmittees contain members representing these segments
                       SIUM1 R. Nibl"y
                      \"v;6shinglnn. DC
                                                 to ensure that all points of view are considered. By presenting their consensus
                       xun E. P,d,,,ns           view, the Section seeks to improve the process of public contracting for needed
                      Washiny,lon. OC
                                                 supplies, services~ and public works. I
                         leri K. SOnlers
                      W...hinBlolI, OC
                   Holly Emrick 5vell
                    Tysons Co<oe<. VA
      EDITOR, PUIJLlC CONT.,.,CT
                       LAW /OU.1YAl              I Jeri KayJene Somers, James A. Hughes, Jr., and Sharon Larkin, Council Members of the Section of
                       Karen l. M;anos
                      Wa~hinllion.      IX       Public Contract Law, and Mary Ellen Coster Williams, the Section of Public Contract Law's
EOIIOR, THE /'flCXUIiEMENT {AWl".                representative to the ABA House of DeJegates, did not participate in the Section's consideration of
                   Joiln .... Burl<holder
                      los A"K"I.... CA           these comments and abstained from voting to approve and send this letter.
 BOARD OF GOVERNORS LIAISON
                      CharIE'S A,   W.~"
                         Sl.lOUlS, MO

                SEC,.ION DIRECTOR
                     MdrilYlI Nemra.
             l21 N CI.,k SI, ,YJS 19,1                                            Fall Meeting • November 2-3, 20(J7 • Denver. CO
                    t;hi"'RO, Il flU1l1U
                       (JIll <J88-SSQI>
                                                                                 Midyear Meeting • March 6·6. 2008 • Annapol;~, MD
                                                                                    Spring Meeting. May 2·3, 2008 • Auslin, TX
                                                                                 Annual Meeting. Augulil 6-11. 2008 • New York, NY
Defense Acquisition Regulations System
July 14, 2008
Page 2




       The Section is authorized to submit comments on acquisition regulations
under special comment authority granted by the Association's Board of Governors.
The views expressed herein have not been approved by the House of Delegates or
the Board of Governors of the American Bar Association and, therefore, should not
be construed as representing the policy of the American Bar Association. 2

         BACKGROUND
        The Department of Defense (DoD) reported and published an Interim Rule
amending the DFARS in order to implement Section 852 of the National Defense
Authorization Act for Fiscal Year 2007. Pursuant to Section 852, DoD is required
to issue regulations that address excessive pass-through charges on DoD contracts
and subcontracts to ensure that such charges are not excessive in relation to the cost
of the work being performed.

         The DoD published that interim rule on April 26, 2007, 72 Fed. Reg. 20758
(Apr. 26, 2007) ("2007 Interim Rule"), and included a solicitation provision and a
contract clause requiring otTerors and contractors to identify the percentage of work
that will be subcontracted. If the subcontracted costs are expected to exceed 70
percent of the total work, additional information is to be provided on indirect costs,
profit, and the value being added to the subcontracted work. The DoD received
comments from fourteen sources, including comments from the Section, which are
attached. 3 As a result of its review of the cOlnments, DoD issued a second interim
rule on May 13, 2008. 73 Fed. Reg. 27464 (May 13, 2008) ('42008 Interim Rule").
The Section respectfully submits these additional comments to highlight what it
believes to be important points for DoD to consider prior to the release of a final
rule.

         COMMENTS

        In its comments on the 2007 Interim Rule, the Section noted that it agrees
pass-through charges should not be excessive. The Section has examined the
extensive discussion of the conunents submitted by fourteen sources on the 2007
Interim Rule and commends DoD for its thorough review of the comments and the


2This comment letter is available in pdf format at
http://www.abanet.org/colltractlfederallregscomm/home.html under the topic "Subcontracting and
Teaming."

3The Section's previous comment letter, dated June 25, 2007, also is available in pdf format at
http://www.abanet.org/contract/federal/regscomm/home.html under the topic "Subcontracting and
Teaming."
Defense Acquisition Regulations System
July 14, 2008
Page 3




issues raised by that interim rule. In its comments on the 2007 Interim Rule, the
Section addressed the importance of guidance regarding the effective
implementation of the rule. In its notice accompanying the 2008 Interim Rule.
however, 000 has deferred this issue to a point Hwhen necessary." As discussed in
more detail below, the Section calls to DoD's attention the January 2008
Govemment Accountability Office (GAO) report that makes the same
recommendation. 4 In addition, the Section does not believe that the DoD has
addressed the conflict between DoD policies that the Section identified in its
comments on the 2007 Interim Rule. The Section also suggests that the Final Rule
include a threshold for flowing down the clause in subcontracts.

A.      Guidance Should be Available to Contracting Officers, As Noted in the
        Section's Earlier Comment and in a More Recent GAO Report

        In its comments on the 2007 Interim Rule, the Section recommended that
DoD provide guidance to contracting ofticers so that they can effectively
implement the goal of eliminating or reducing excessive pass-through charges,
which is an important goal. In the discussion of "Planning and Guidance" in the
notice accompanying the 2008 Interim Rule, DoD mentions the Section's statement
that there is no substitute for adequate contract planning and administration on the
part of the Government, and further relates the Section's concenl that without
adequate guidance, there is potential for mischief. The DoD response states that
"DoD will monitor implementation and will provide guidance when necessary." 73
Fed. Reg. at 27471. To ensure that the 2008 Interim Rule is implemented in an
effective manner and is not employed merely to reprice contracts, the Section
repeats its recommendation that DoD proactively address the creation of guidance
to assist contracting officers.

         Since the Section submitted its comments on the 2007 Interinl Rule, GAO,
at the request of congressional committees, conducted a study because one-third of
DoD's tlscal year 2006 spending on goods and services was for subcontracts. As a
result, DoD auditors and Congress raised concerns about the potential for excessive
pass-through charges by contractors. 5 GAO reviewed and analyzed the Federal
Acquisition Regulation, the DFARS, discussed the issues with DoD acquisition
policy, audit and contracting officials, and interviewed private companies. As a
result of this extensive review, GAO recommended that DoD issue guidance to


4GAO, Defense Contracting: Contract Risk a Key Factor in Assessing Excessive Pass-Through
Charges, GAO-08-269 (Jan. 25, 2008).
    Defense Acquisilion Regulations System
    July 14,2008
    Page 4




    implement this rule and noted that DoD concurred with the recommendation.
    Notably, the GAO report states that:

                While the rule aims to provide contracting officers with more
                information on contractor value added, it alone will not provide
                brreater insight into DOD's supply chain and costs-
                information that companies told us they usc to mitigate
                excessive costs. In addition, while the rule is not yet tinal,
                contracting officials we spoke to indicated the need for
                guidance on how to efTectively implement the rule since they
                were not clear what more they should be doing beyond
                applying tools in the FAR and DFARS. This would ensure that
                contracting officers, particularly newer and less experienced
                staff, consistently apply federal acquisition tools in conducting
                their assessments of contractor value added and take into
                account contract risk when determining the degree of
                assessment needed, documenting assessments, and involving
                DCAA and DCMA as appropriate. 6

        The Section believes that the GAO report further supports the need for
guidance at the time of implementing this requirement as a final rule, and
recommends that 000 reconsider its intent to provide guidance "when necessary."
The GAO report provides information and suggestions relevant to the creation of
guidance such as a description of unique circumstances that drive contracting
arrangements that include greater risk of excessive pass-through charges, including
the lessons learned on contracts awarded for Hurricane Katrina recovery efforts,?
which, the Section noted in its earlier comment, was one of the excessive pass-
through situations that gave rise to the statutory requirement for this DFARS rule. s

        Evaluation of a program's cost and a contractor's proposed management
approach, including the subcontract plan, is a part of the procurement contracting
officer's award determination. The Section believes that to the maximum practical
extent - for those procurements that are not otherwise exempt under the 2008
Interim Rule - any excessive proposed costs related to subcontract management
can be evaluated in the context of competition or addressed in negotiations in a sole
source procurement. The Section further believes that the new rule should serve as

6   1d. at 4.

7   Jd. at 14-17.

8   See Section Conuuents on 2007 Interim Rule at 5 n. 3.
Defense Acquisition Regulations System
July 14, 2008
Page 5




a tool to ensure consistency to the extent practicable between contractors'
proposals, as evaluated by the procurement contracting officer, and actual
perfonnance, monitored by the contracting officer, rather than to serve as a basis to
disallow cost after incurrence.

        With further regard to evaluation of negotiated procurements, the
procurement contracting officer should, in light of the 2008 Interim Rule, pay
special attention to those contract elements that would require multiple tiers of
subcontractors and thus, multiple layers of indirect cost and profit. For example,
contracts that require the prime contractor to act as an integrator implicitly require
that the prime contractor employ subcontractors to accomplish the scope of the
contract. A more explicit example would be the requirement to satisfy a small
business plan that could necessitate multiple subcontractors. Finally, the final rule
should carefully consider the potential effects to those small businesses performing
as prime contractors on contract set-asides given that small business prime
contractors could experience significant adverse financial impacts as a result of
disallowed pass-through costs under this rule. This would be contrary to the
protections typically afforded small business federal contractors.

B.      The Interim Rule Docs Not Reconcile Conflicts with Existing Policies

        In its comnlents on the 2007 Interim Rule, the Section noted that the 2007
Interim Rule could impact team assembly and formation decisions, and that it
conflicts with DoD policy that seeks both to ensure robust competition for
subcontracts and absence of bias on the part of prime contractors toward in-house
sources. The Section recommended that DoD reconcile its policies to avoid
confusion.

         In the discussion of HImpact on Business Strategy, Spares Contracting, and
                                                                        H
Indefinite-Delivery Indefinite-Quantity or Delivery Order Contracts in the notice
accompanying the 2008 Interim Rule, DoD mentions the Section's concern. 000
states that the policies are not inconsistent, and that this Hrule is intended to protect
the Government from those situations where there appeared to be an agreement
with the contractor to perform the contract scope of work, including 'managing'
subcontractors, and then after award, the contractor subcontracts substantially all
the effort without providing the required 'added value.'" 73 Fed. Reg. at 27470.
The Section believes that the 2008 Interim Rule goes far beyond such situations.
DoD's statement connotes a situation where there is active misrepresentation of the
prime contractor's intent and perhaps its capabilities. The 2008 Interim Rule,
however, addresses much more than misrepresentation, and reaches all situations
where subcontracting can be used to create a strong team.
Defense Acquisition Regulations System
July 14, 2008
Page 6




         Nevertheless, DoD's response does not address the Section's concern. The
Section supports the Wynne Memorandum's purpose,9 which is to foster
competition through assembly of a strong team that can address and satisfy the
required capabilities while avoiding the favoring of an affiliate over an unrelated
entity. The Section remains concerned that the 2008 Interim Rule exerts pressure
to keep work in-house to address the reporting requirement, and believes that DoD
should be aware - and concerned - about this. It seems inconceivable that the 2008
Interim Rule would not have an impact on contractor team assembly and fomlation
decisions. TIle Section restates that the 2008 Interim Rule's emphasis on limiting
the amount of subcontracted work conflicts with the Wynne Memorandwn's
emphasis on ensuring robust competition to ensure consideration of subcontracting
to independent companies. As the Wynne Memorandum indicates, a key DoD goal
is to facilitate the most effective combination of complementary skills to ensure
that the prime contractor can provide best value and accomplish the task efficiently
and etIectively. If the amount of subcontracting is limited to an arbitrary share of
the total work effort, this goal will be seriously jeopardized.

         Additionally, the 2008 Interim Rule may be interpreted and applied so as to
conflict with the requirements of the Cost Accounting Standards (CAS). CAS
requires that all indirect costs be fully absorbed and allocated to final cost
objectives, and defines certain mandatory rules for the measurement, assigrnnent,
and allocation of those costs. The 2008 Interim Rule provides a basis for
contracting officers to disallow costs if the contractor fails to demonstrate Hadded
value," which is defined in DFARS 252.215-7004(a) as "... subcontract
management functions that the Contracting Officer determines are a benefit to the
Goverrnnent." Under the 2008 Interim Rule, the contracting officer is responsible
for determining the value certain allocable indirect costs actually add to the
contract. Nevertheless, General and Administrative (G&A) costs are by their very
nature residual and do not permit the assignment of a clear beneficial or causal
relationship between the cost incurred and a benetit to any particular final cost
objective. As a result, there is a potential that the G&A applied to all tiers of
subcontracts could be deemed to be "excessive" and therefore unallowable, even if
it is incurred in accordance with the contractor's approved disclosed cost
accounting practices. If a contractor incurs cost in accordance with CAS and its
disclosed practices, the only question should be the allowability and reasonableness
of the cost, both of which can be dealt with prior to award and incurrence of those
costs.


9 On July 12,2004, Michael W. WyJUle, then-Under Secretary of Defense, Acquisition, Technology
and Logistics (acting), issued a memorandum for the secretaries of the military departments entitled
Selection o/Contractors/or Subsystems and Components ("Wynne Memorandum").
Defense Acquisition Regulations System
July 14,2008
Page 7




        To the extent a contracting officer believes that an adjustment to the amount
of indirect cost applied to final cost objectives is appropriate because certain
contracts receive more or less benefit from residual expenses than would be
indicated by the contractor's standard allocation practices, those should be
addressed through special allocations, such as those at 48 C.F.R. 9904.410-500)
and 9904.418-50(1), not through the disallowance of costs.

        The Section believes that a distinction should be made with regard to G&A
applied to contracts versus applied profit. This will serve to protect the contractor's
recovery of allowable G&A if incurred in accordance with CAS and the
contractor's disclosed practices, while focusing the Government's attention to the
negotiated item of profit. Application of indirect cost, including G&A, is not only
governed, but required by the CAS and FAR. While public law and regulation
detennine the manner in which a contractor may apply those costs, they provide no
methodology or guideline for the calculation and application of profit beyond
justifying its existence. As a result, guidance should be issued to contracting
officers to evaluate applied profit more stringently rather than to determine
unallowable those actual costs that have been incurred and allocated in accordance
with applicable guidelines.

C.     A Threshold Should be Stated for Subcontracts That Must Flow Down
       the Clause

        The summary of comments accompanying the 2008 Interim Rule
demonstrates the value of reasonable parameters with regard to the number of
subcontractors to whom this requirement flows down. The Section suggests that it
is reasonable that subcontracts that are minimal in value or less than one to two
percent of the total cost of the contract should be exempt.

        DoD's response to these comments indicates that it agrees that a minimum
threshold is required and that it has established a threshold tied to the cost or
pricing data threshold. This establishes a threshold at the prime contract level.
DoD did not, however, include a threshold for subcontracts in paragraph (f) of
DFARS 252.215-7004. As a result, prime and higher tier subcontractors through
each tier of the supply chain will be required to include the clause in every
subcontract, regardless of value, except for those that meet the four exclusions
currently identified in the clause. Given that the clause requires contracting
officers to make determinations with regard to subcontracts as well as the prime
contract, the potential burden for satisfying this requirement with respect to low
value subcontracts will be considerable. While lTIany low value subcontracts may
be awarded on a competitive basis or fit the definition of commercial items, many
will not. The risk to the Governnlent is minimal with respect to lower tier
Defense Acquisition Regulations System
July 14, 2008
Page 8




subcontracts. If DoD uses the threshold in FAR 15.403-4, it will exclude a
significant number of subcontracts from this burdensome requirement, but still
cover the vast m~jority of the total value of subcontracts.

CONCLUSION

        The Section supports the goal of the 2008 Interim Rule on excessive pass-
through charges, but remains concerned that without additional guidance, issues
will arise in the implementation of the final rule. Also, the Section recommends
that DoD reconcile the 2008 Interim Rule with the policies reflected in the Wynne
Memorandum and that it address a threshold for subcontracts.

         The Section appreciates the opportunity to provide these conlments and is
available to provide additional infonnation and assistance as thc Councils may
require.

                              Sincerely,




                              Patricia A. Meagher
                              Chair, Section of Public Contract Law

cc:    Michael W. Mutek
       Karen L. Manos
       Donald G. Featherstun
       Carol N. Park-Conroy
       John S. Pachter
       Michael A. Hordell
       Robert L. Schaefer
       Council Melnhers, Section of Public Contract Law
       Chair(s) and Vice Chaires) of the Strategic Alliances,
       Teaming and Subcontracting Committee
       Chaires) and Vice Chair(s) of the Accounting,
       Cost and Pricing Committee
       Scott M. McCaleb
       Kara M. Sacilotto
                                                                                                                                                                                                  ATTACHMENT 8



                                                                                                                                                                                                    Defending Liberty
                                                                                                                                                                                                     Pursuing Justice
.. --._.. _---_._ ..               _- -  .. .. ... _---._._..               _----------
                                                                                                           AMERICAN BAR ASSOCIATION                                              Section of Public Contract law
                                                     CHAlW                                                                                                                       Writer's Address and Telephone
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                                                                                                                                                                                    Fax: (202) 220-1665
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                                                                            Attn: Mr. John McPherson
               IMMElllAlf PAST CI-tAIW
                                                                            OUSO (AT&L) DPDP (Cpr) IMD 3C132
                             Rolx'lll               ~(II.wlt"
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                                   '.'~)},       ,1'1(,·1,1')3

                      COUNCil M(MIIUIS
                                                                                     Fed. Reg. 20758 (Apr. 26,2007).
                         II'rHld.~r I i ).111""
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                               1.1,1I1U,I'          I)(){)g.lll
                                                                                    On behalf of the Section of Public Contract Law of the American Bar
                                              DetrOIt. ~'I
                                                                            Association ("the Section"), I am submitting comments on the above-referenced
                                 lJ.I'V,d        CI. l-.hrhdrt
                                          U,lVloll,OII                      OFARS case.\ The Section of Public Contract Law consists of attorneys and
                                 1'~lul      H. t·l ..l.S("lI)•.-Ul
                                             1\lln)r~l. ('.()
                                                                            associated professionals in private practice, industry and Government service. The
                               f. ~,IPdt;l~)ll"'jUt"                        Section's governing Council and substantive committees have members
                                \V;j~h'lIgtOIl, Dr:
                                                                            representing these three segments, to ensure that all points of view are considered.
                                       n.\\"d I              hll"!;
                              S~lIl fr.lIWISUl,                    CA       By presenting their consensus view, the Section seeks to improve the process of
                                  "'h,lI~,n
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                                                                            public contracting for needed supplies, services and public works.
                                   ""1 II.! ,1    H. S,hll'\
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                                   ~ql;1         I Pick"Ils.
                                                                                   The Section is authorized to submit comments on acquisition regulations
                                 \V,i~hingh)n, 1)("
                                                                            under special authority granted by the Association's Board of Governors. The
                                R,r'l.lfll J-'           f,{,.'(   tl..lr
                                 VV,I~;hif'gWll,                   1)(      views expressed herein have not been approved by the Iiouse of Delegates or the
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                           Jo:;Hl'l1l.M,lIlos
                                 \·..··:l~111:1gl()lI, l)(~                 in the Section's consideration of these comments and abstained from the voting to approve and send
UI10W, lIiII'MOClIWEM"NT lAWYER                                             this letter.
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Defense Acquisition Regulations System
June 25, 2007
Page 2




Board of Governors of the American Bar Association and, therefore, should not be
construed as representing the policy of the American Bar Association. 2

Introduction

        On April 26,2007, the Department of Defense ("DoD") published in the
Federal Register an interim rule, 72 Fed. Reg. 20758, amending the Defense
Acquisition Regulation Supplement ("DFARS") with respect to pass-through
charges on DoD contracts and subcontracts ("Interim Rule"). The Interim Rule
implements Section 852 of the National Defense Authorization Act for Fiscal Year
2007 (Pub. L. No.1 09-364), which requires the DoD to prescribe regulations to
ensure that pass-through charges on contracts or subcontracts that are entered into
for or on behalf of the DoD are not excessive in relation to the cost of work
performed by the relevant contractor or subcontractor.

        The Section agrees that pass-through charges should not be excessive.
Furthermore, the Section commends the DoD for its recognition of the effect of
market forces indicated by the exclusion of certain contracts and subcontracts from
the requirements of this Interim Rule. Nevertheless, the Section notes that
inconsistent policies exist at 000 with regard to subcontracting. Therefore, the
Section recommends that 000 reconcile its policies to avoid confusion. In
addition, the Section believes that express guidance should be provided to
contracting officers so that they can effectively implement the goal of eliminating
or reducing excessive pass-through charges. This guidance should recognize that
one value a contractor or subcontractor provides is competency in identifying,
forming, and managing contractual arrangements with best-in-class companies. In
these arrangements, the prime contractor or higher tier subcontractor can bring
considerable integration talents to the program. Without recognition of this value,
the Interim Rule could result in arbitrary "make" decisions rather than reasoned
"buy" decisions that provide best value, and the Interim Rule could be used merely
as a tool to reprice contracts.

Current Policies Conflict

        On July 12, 2004, Michael W. Wynne, then-Under Secretary of Defense,
Acquisition, Technology and Logistics (acting), issued a memorandum for the
secretaries of the military departments entitled Selection o/Contractors/or
Subsystems and Components ('"Wynne Memorandum" or "Memorandum"). The


2 This letter is available in pdf format at hUp://www.abanet.org/contract/regscomm/home.hlml under
the topic "Subcontracting and Teaming."
Defense Acquisition Regulations System
June 25, 2007
Page 3




purpose of the Wynne Memorandum is to foster competition for major program
subsystems and components. To achieve this purpose, the Memorandum mandates
action by the Govermnent during the acquisition planning process and by industry
when assembling a team to deliver the required capabilities.

       The Wynne Memorandum notes that defense acquisition benefits from the
assembly of a strong team at both the prime and subcontractor levels. Furthermore,
the Memorandum points out that because of defense consolidation, large defense
contractors more often than not must choose between an affiliate and an unrelated
company for major program subsystems or components. The potential for bias
favoring the affiliate is a stated rcason in the Wynne Memorandum for the
Govermnent to seek greater insight into the prime contractor's team-selection
process.

        On October 27, 2004, the Section submitted comments to the DoD on the
Wynne Memorandum. These comments stated that the Section understands and
fully supports the Government's efforts to foster robust competition at both the
prime contract and subcontract levels. 3 In fact, the first principle in the Principles
of Competition in Public Procurements adopted by the American Bar Association
urges that public acquisitions use full and open competition to the maximum extent
practicable. The Section also strongly supports upholding the integrity of the
acquisition process. With these principles in mind, the Section suggested that 000
recognize that the Wynne Memorandum does not distinguish between competitive
and sole source situations, and suggested that a revision to the Memorandum or
implementing guidance may be helpful to address the fact that, in competitive
situations, the marketplace exerts an incentive to assemble the most competitive
team possible, along with legal and regulatory restraints against anticompetitive
behavior. As discussed in the Section comments, the marketplace tends to punish
wrong decisions. The Section also noted that the Government has sought to avoid
unnecessary involvement in team assembly decisions and has relied on the
marketplace.

        The Section believes that the 000 should recognize that the Interim Rule
may impact team assembly and formation decisions. In particular, the
Memorandum's emphasis on the desirability of teaming with independent
companies conflicts with the Interim Rule's emphasis on limiting the amount of
work being subcontracted out. As the Wynne Memorandum indicates, a key DoD
goal is to facilitate the most effective combination of complementary skills to

] The Section's comments on the Memorandum are available at
http://www.abanet.org/contract/federal/regscomm/subk_003.pdf.
Defense Acquisition Regulations System
June 25, 2007
Page 4




ensure that the prime contractor can provide best value and accomplish the task
efficiently and effectively. If the amount of subcontracting is limited to an arbitrary
share of the total work effort, this goal will be seriously jeopardized.

      The Section further wishes to point out that the Federal Trade Commission
('4FTC") and the Department of Justice ("DoJ") have noted that in order to compete
in today's marketplace, companies that are competitors might need to collaborate as
teammates. 4 The FTC and DoJ have also found that such teams may be pro-
competitive. "Nevertheless, a perception that antitrust laws are skeptical about
agreements among actual or potential competitors may deter the development of
procompetitive collaborations.,,5

         In contrast to the emphasis in the Interim Rule on excessive pass-through
charges on the amount of work subcontracted out, which could impact the use of
subcontractors, the Memorandum provides a reason to look outward and add non-
affiliated subcontractors. This is an inconsistency in policy and a mixed message
on the subject of subcontracting. The Section recommends a reconciliation of these
conflicting positions by noting (i) that the assembly of strong and capable teams
remains the goal and that the Interim Rule does not seck to discourage the
formation of strong teams and (ii) in order to avoid excessive pass-through charges,
the DoD must be assured that the prime contractor or higher tier subcontractor is
providing value commensurate with the pass-through charge.

Guidance is Needed to Assist Contracting Officers

        As noted above, the Section believes that the objective of this Interim Rule
is beneficial. To ensure that the Interim Rule is implemented in an effective
manner, and not employed merely to reprice contracts, guidance is needed to assist
contracting officers.

        In Senate Report No.1 09-254 for the National Defense Authorization Act
for Fiscal Year 2007, the Senate Armed Services Committee recommended a
provision that would require the Secretary of Defense to modify 000 regulations to
prohibit excessive pass-through charges on contracts and subcontracts because a
subcommittee "identified a potential problem with pass-through charges by
contractors responsible for major defense acquisition programs.,,6 The

4 Federal Trade Commission and Department of Justice, Antitrust Guidelines/or Collaborations
Among Competitors (April 2000).
5    Id. at I.
t.   S. Rep. No. 109-254, at 363 (2006).
Defense Acquisition Regulations System
June 25, 2007
Page 5




subcommittee "[was] particularly concerned by the possibility that the Department
could be paying unnecessary pass-through charges to lead-system integrators on
major weapon systems for which the integrator provides no value added, but that
are acquired as a part of a system-of-systems.,,7 000, however, is taking a
procurement-wide approach; the Interim Rule does not focus on lead-system
integrators. Unfortunately, the Interim Rule also does not address an important
reality in today's market: a strong prime contractor must actively search,
administer, and integrate the work of many subcontractors in order to provide to the
DoD the best solution and best value to fulfill the DoD's needs. In such a situation,
the prime contractor or higher-tier subcontractor should not be penalized for
finding best-in-class support, and the 000 should avoid the implication that would
drive contractors to decide to "make" rather than ~'buy" - the exact concern that
gave rise to the Wynne Memorandum.

        Another issue covered in Senate Report No.1 09-254 is the press coverage
of a Hurricane Katrina-related contracting problem, notably a situation where a
company received a contract and passed work down to a subcontractor that then
passed the work down further. In testimony before the Subcommittee on Readiness
and Management Support of the Senate Armed Services Committee on April 5,
2006, the Comptroller General, when asked his view on pass-through charges,
stated that '''one of the things that we need more visibility over is: I--Iow many
layers, how many players, how many margins are in here?",g

        The Section notes that contingency contracting, whether in response to a
natural disaster such as Hurricane Katrina or as a result of a contingency military
operation, carries with it numerous contracting issues. These contracting issues,
however, should not drive overall DoD policy with respect to subcontracting. The
Interim Rule contains a fundamental and beneficial goal -- the avoidance of
excessive pass-through charges -- but there is the potential for mischief in the
Interim Rule's procedure, which provides for price reductions and disallowances.
This Interim Rule is no substitute for adequate contract planning and administration
on the part of the Government. Without adequate guidance, this potential for
mischief could become an issue.

Conclusion

       The Section supports the goal of the Interim Rule on excessive pass-through
charges, but is concerned with the conflict between the Interim Rule and the Wynne

7   Id.
s Id. at 364 (quoting Comptroller General testimony).
Defense Acquisition Regulations System
June 25, 2007
Page 6




Memorandum. Recognizing the value in locating subcontractors that provide the
Government with the best solution and the best value, the Section also believes that
the DoD should create guidance to assist contracting officers in the implementation
of the rule.

        The Section appreciates the opportunity to provide these comments and is
available to provide additional information or assistance as you may require.




                                             Michael A. Bordell
                                             Chair, Section of Public Contract Law



cc:    Patricia A. Meagher
       Michael W. Mutek
       Karen L. Manos
       Carol N. Park Conroy
       Mary Ellen Coster Williams
       John S. Pachter
       Robert L. Schaefer
       Patricia 1-1. Wittie
       Council Members, Section of Public Contract Law
       Strategic Alliances, Teaming and Subcontracting
       Committee, Chair(s) and Vice-Chaires)
       Scott M. McCaleb

								
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