Aydin Corporation (West) v. Sheila E. Widnall, Secretary of the Air Force
Docket: 94-1441
Court: Court of Appeals for the Federal Circuit; November 12, 1995; Federal Appellate Court
Aydin Corporation appeals a decision by the Armed Services Board of Contract Appeals, which denied its claim for equitable adjustment related to costs incurred from a contracting officer's order to change its method of cost allocation and billing. The appeal also includes requests for reimbursement concerning a foreign sales commission, costs for building a demonstration radar, and certain unabsorbed overhead costs. The United States Court of Appeals for the Federal Circuit affirms in part, reverses in part, and remands the case.
The background involves a multi-year, firm-fixed-price contract awarded in 1987 by the Air Force to Aydin for the production of Multiple Threat Emitter Systems (MUTES). The contract stipulated progress payments based on incurred costs, calculated as 80% of Aydin's cumulative costs. Aydin initially allocated its total costs equally among thirteen delivery orders but faced objections from the contracting officer, who mandated segregation of costs by delivery order and separate progress payment requests. After halting payments until compliance was met, Aydin incurred significant administrative costs to implement the required changes. The contracting officer ultimately denied Aydin's claim for these additional costs, prompting the appeal.
The Board denied Aydin's claim, affirming that the contracting officer appropriately treated each delivery order as a separate contract, aligning with the contract terms and federal regulations. The Board ruled that the cost segregation requirement did not constitute a constructive change to the MUTES contract, disallowing Aydin's request for an equitable adjustment.
Additionally, the Government disallowed certain indirect costs in Aydin's progress payment requests, including substantial sales commissions related to a foreign contract, costs for a demonstration radar, and certain unabsorbed overhead costs. Aydin, which pays commissions to global sales agents and includes these in its general and administrative (G&A) expense pool, incurred approximately $3.7 million in commissions from the sale of the "SOLAR II" system to Argentina.
The Defense Contract Audit Agency (DCAA) identified a significant discrepancy between the size of the 1989 SOLAR II sales commissions and their minimal impact on the MUTES contract's overhead rate. DCAA concluded that Aydin's inclusion of these commissions in the G&A expense pool violated Cost Accounting Standards (CAS) 410 and 418, resulting in the removal of about $3.6 million from both the 1989 and 1990 G&A pools. Aydin's claim for reimbursement was denied by the contracting officer and subsequently appealed to the Board.
The Board determined that Aydin's sales commissions did not qualify as G&A expenses under CAS 410, as they were not incurred for the overall management of Aydin. It noted that while insignificant expenses can be allocated to G&A pools, Aydin's 1989 commissions were significant and their inclusion would lead to an inequitable distribution to government contracts.
The Board recognized that the SOLAR II commission, which constituted over 91% of Aydin's total commissions but only 19% of the G&A base, necessitated a special allocation to ensure a fair G&A rate for the MUTES contract. This approach was deemed consistent with CAS 410.40(d), which allows non-G&A expenses to remain in the G&A pool unless they can be specifically allocated to cost objectives based on a beneficial or causal relationship.
The Board determined that the sales commission for the SOLAR II contract could not be included in Aydin's General and Administrative (G&A) expense pool due to the ability to directly allocate it, in accordance with CAS 410.40(d). Aydin was permitted to directly assign the sales commission to the SOLAR II contract without violating CAS 402. The Board instructed Aydin to reassign this commission as a direct expense, which led to the DCAA's deduction of that amount from Aydin's G&A pool.
In 1983, Aydin engaged Prutech Research and Development to develop a three-dimensional radar system. Due to budget constraints during the development phase, Aydin invested $3.0 to $4.5 million of its own funds to create a demonstration radar in 1986-1987, treating it as a capital asset and depreciating the costs over five years, which were included in the G&A expense pool allocated to the MUTES contract. A DCAA audit in 1989 found these costs should be classified as independent research and development (IR&D) expenses, which are unallowable under FAR 31-205.18(d)(1) if incurred in prior accounting periods. Consequently, DCAA removed the demonstration radar costs from Aydin's 1988 G&A expense pool, leading Aydin to appeal the denial of full reimbursement. The Board upheld DCAA's decision, asserting that the costs should have been charged in the years they were incurred, not depreciated in subsequent years.
In 1988, Aydin submitted a late Government-furnished equipment (GFE) claim related to unabsorbed overhead costs due to a Government-caused delay. A subsequent contract modification (Modification P00013) authorized payment of $1,738,850 for these costs, with a provision for immediate payment upon invoicing. The total settlement for the GFE claim amounted to $2.5 million. In May 1989, Aydin submitted another equitable adjustment claim, leading to a settlement of $21,884,400 and a further modification (Modification P00015) that increased payment under CLIN 0013 by $3 million for unabsorbed overhead costs. The contracting officer later deducted $1.6 million and $2.8 million from Aydin's indirect cost pools, reflecting unabsorbed overhead already compensated in the settlements. Aydin contested these deductions, but the Board confirmed that the contracting officer acted appropriately in reducing the indirect cost pools and progress payments based on the payments already made to Aydin.
The Board's interpretation of the MUTES contract and its incorporation of certain Federal Acquisition Regulation (FAR) provisions is subject to de novo review, as established by 41 U.S.C. Sec. 609(b) and relevant case law. The court reviews the Board's interpretation of FAR provisions with deference to the Board's expertise. The Government is required to compensate contractors for constructive changes in contracts, with the court consulting contract language to identify such changes.
The "Progress Payments" clause specifies that progress payments should be based on eighty percent of the contractor's cumulative total costs under the MUTES contract as a whole, without the need for cost segregation by delivery order. The MUTES contract distinguishes between "this contract" and individual delivery orders, affirming that "this contract" refers to the overall agreement. Consequently, Aydin is authorized to bill costs based on the aggregate of the MUTES contract.
The MUTES contract does not incorporate FAR 32.503-5, which treats each delivery order as a separate contract. Instead, it incorporates FAR 52.232-13, which addresses progress payments but does not imply a wholesale adoption of FAR Part 32 or require cost segregation. The Board’s reliance on FAR 32.503-5 to assert that Aydin must treat delivery orders as separate contracts is unfounded, as the "Progress Payments" clause does not mandate such segregation of costs.
The Board's reliance on various factors, including Aydin's practice of treating each delivery order as a separate contract, does not negate the explicit terms of the MUTES contract, which stipulate payment of "eighty percent (80%) of the Contractor's cumulative total costs." Aydin calculated progress payments based on cumulative total costs as required. The "Notice of Progress Payments" clause grants the contracting officer authority to halt payments if Aydin's accounting system is deemed inadequate, which could necessitate modifications at Aydin's expense. The Board incorrectly denied Aydin's claim for equitable adjustment.
Regarding the SOLAR II sales commission, the court assessed whether the Cost Accounting Standards (CAS) apply to the MUTES contract. CAS governs cost allocability for applicable contracts, mandating specific accounting practices to ensure a beneficial relationship between costs and contracted allocations. The MUTES contract includes FAR 52.230-3, which requires Aydin to comply with CAS unless exempted. The exemption under 4 C.F.R. Sec. 331.30(b)(9) applies only if Aydin did not submit "any cost data" when seeking the contract. The contracting officer required Aydin to provide informal cost information prior to the award to identify potential errors, which qualifies as "any cost data" under the regulation. Thus, the MUTES contract is subject to CAS, as it does not meet the criteria for exemption.
The history surrounding section 331.30(b)(9) indicates that "any cost data" should not be limited to data used for price negotiations, as clarified by the Cost Accounting Standards Board (CASB). Initially, the CASB suggested such a restriction but later rejected it, confirming that "any cost data" applies broadly. The court, having determined that Cost Accounting Standards (CAS) apply to the MUTES contract, must evaluate the Board's decision to deny Aydin reimbursement for SOLAR II sales commission costs excluded from progress payments. The Government can mandate changes to a contractor's accounting practices to prevent inequitable results but cannot require actions that violate CAS 402, which mandates consistent classification of similar costs as either direct or indirect. CAS 402 prohibits charging similar costs differently across contracts. If equitable distribution of similar costs is not achievable through indirect allocation, a contractor must reassign these costs equitably or directly assign them to specific contracts. The Board's ruling, which allowed all sales commissions except for SOLAR II to remain classified as G&A expenses, violates CAS 402. The court finds no justification for treating the SOLAR II sales commission differently from other sales commissions. By excluding the SOLAR II costs from the G&A pool, the Government imposed a requirement that contradicts CAS 402's principles, as it cannot narrowly define costs to exclude only one significant item without violating equitable treatment standards.
The court addresses several key issues regarding Aydin's claims related to sales commission costs, demonstration radar expenses, and unabsorbed overhead costs. It notes that if the SOLAR II sales commission costs had been incurred under different circumstances or purposes, they might have been directly assigned to the SOLAR II contract in compliance with CAS 402. However, the court could not determine a valid basis for treating these costs differently from other sales commission costs, prompting a remand for clarification from the Board.
Regarding the "Progress Payments" clause, the court emphasizes compliance with generally accepted accounting principles (GAAP). Aydin’s costs for building the demonstration radar were classified as IR&D expenses under GAAP and must be expensed when incurred, not depreciated. Consequently, the Board rightly denied Aydin's claim for these costs.
On the issue of unabsorbed overhead, the court affirms the Board's decision that Aydin cannot claim payment for costs already settled directly with the Government by including them in indirect cost pools, as Aydin did not demonstrate that the Board erred in this regard.
In conclusion, the court reverses the Board’s denial of Aydin's equitable adjustment claim for costs related to changing its accounting system, categorizing this adjustment as a constructive change to the contract. The court remands for further explanation of the SOLAR II sales commission costs while affirming the denial of claims for the demonstration radar and unabsorbed overhead costs. Each party will bear its own costs. The decision is affirmed in part, reversed in part, and remanded for further proceedings.
Affirmation of the board's decision is expressed, with dissent from Parts I and II.A. In Part I, the court finds that the contracting officer effectively modified the MUTES contract by mandating Aydin to segregate costs by delivery order, contending that the contract did not incorporate FAR 32.503-5. The contract's "Progress Payments" clause stipulates that progress payments are 80% of the contractor's cumulative costs, while FAR clause 52.232-13 necessitates compliance with subpart 32.5 regulations for progress payments on multiple-order contracts. This regulation specifies that such payments should be managed as separate contracts for each order. The board accepted the contracting officer's testimony, which highlighted a standard practice of requiring cost segregation by delivery order, leading to the conclusion that each order should be treated as distinct.
In Part II.A., the court remands for clarification regarding the distinction between SOLAR II sales commission costs and other sales commissions, without resolving whether Aydin was rightfully required to exclude foreign sales commissions from progress payment requests. Although agreement exists on the contract's coverage by the Cost Accounting Standards (CAS), there is disagreement on the necessity for a difference in purpose or circumstance for SOLAR II commissions compared to others, arguing that size alone is a relevant factor in their allocation. The board found that SOLAR II commissions constituted over 91% of total sales commissions for 1989 but only 19% of Aydin's general and administrative (G&A) costs. Thus, Aydin failed to demonstrate that it was equitable to allocate these commissions to the contract. Even if FAR 32.503-5(c) were applicable, it does not mandate cost segregation and only establishes a preference for it, which is not strictly required unless specific conditions, which do not pertain to the MUTES contract, are met.
The Board correctly ruled on the MUTES contract but mistakenly applied the cost principles of FAR Part 31 to the "Progress Payments" clause, as the contract only referenced FAR 31.205-10, which does not deal with capital asset depreciation or expensing. The contract also included FAR 252.231-7000, which stipulates that cost allowability must comply with Subpart 31.2 of the Federal Acquisition Regulations and Subpart 231.2 of the DoD Supplement, but does not fully incorporate FAR Part 31. Consequently, FAR Part 31 does not dictate the treatment of Aydin's radar costs.
Aydin’s development costs for the demonstration radar were classified as research and development (IR&D) expenses under Generally Accepted Accounting Principles (GAAP), which mandate that such costs be expensed in the year incurred, disallowing depreciation. Therefore, Aydin appropriately expensed the radar development costs in 1986 and 1987, and could not charge these costs to the Government in subsequent years.
Regarding unabsorbed overhead costs, the Government had directly compensated Aydin for these costs, and the Board ruled that Aydin could not claim these costs again through indirect cost pools. The court found that Aydin failed to demonstrate any reversible error by the Board in this determination.
The court reversed the Board's denial of Aydin's claim for equitable adjustment related to changing its accounting system, ruling that this adjustment constitutes a constructive change to the contract requiring Government compensation. Additionally, the court remanded the issue of Aydin's claim for SOLAR II sales commission costs for further explanation regarding their differentiation from other sales commission costs. The court affirmed the Board's denial of Aydin's claim for demonstration radar costs, confirming they were improperly treated as expenses.
Aydin's claim regarding the improper deduction of CLIN 0013 settlement amounts from its indirect cost pools was denied by the court, affirming the Board's decision. Each party will bear its own costs. The court's ruling is affirmed in part, reversed in part, and remanded for further explanation. Circuit Judge Mayer concurred in part and dissented in part, advocating for the complete affirmation of the Board's decision.
The court found that the contracting officer constructively changed the MUTES contract by requiring Aydin to segregate costs by delivery order. It ruled that the contract did not incorporate FAR 32.503-5, focusing instead on the "Progress Payments" clause, which specifies that progress payments should reflect 80% of cumulative total costs. The contract includes FAR clause 52.232-13, which supports the need for customary progress payments in accordance with subpart 32.5, requiring administration of progress payments under multiple orders as if each were a separate contract. The board accepted the contracting officer's testimony on the necessity of cost segregation, concluding that each delivery order should be treated as a distinct contract.
In the remand regarding SOLAR II sales commission costs, the court sought clarification on how these differ from other sales commission costs without determining if Aydin needed to exclude them from progress payment requests. Judge Mayer agreed with the assessment of whether the contract falls under the Cost Accounting Standards (CAS) but disagreed with the notion that the SOLAR II commissions must differ in purpose rather than in size. The burden lies on Aydin to demonstrate reasonable allocation among government contracts and commercial work, especially given that SOLAR II commissions constituted a significant portion of total commissions but a smaller percentage of Aydin's general and administrative base. The Board concluded that Aydin did not adequately prove equitable allocation of these commissions to the contract. Additionally, even if FAR 32.503-5 were applicable, it does not mandate cost segregation but suggests a preference.
The regulation prohibits progress payment requests based solely on total contract costs in two specific instances: when delivery orders have different liquidation rates or are managed by different payment offices. However, these conditions do not apply to the MUTES contract. While the Board's ruling was correct, it mistakenly applied the cost principles of FAR Part 31 to the MUTES contract's "Progress Payments" clause. The contract only explicitly incorporated FAR 31.205-10, which does not pertain to the depreciation and expensing of capital assets. Additionally, the MUTES contract includes FAR 252.231-7000, titled "Supplemental Cost Principles," which dictates that cost allowability must adhere to Subpart 31.2 of the Federal Acquisition Regulations, while also requiring compliance with Subpart 231.2 of the DoD Supplement effective at the time of the contract. However, FAR 252.231-7000 does not fully incorporate FAR Part 31, meaning it does not dictate the treatment of Aydin's radar costs under this contract.
