Kearfott Guidance & Navigation Corporation v. Donald H. Rumsfeld, Secretary of Defense

Citations: 320 F.3d 1369; 2003 U.S. App. LEXIS 3400; 2003 WL 456533Docket: 02-1039

Court: Court of Appeals for the Federal Circuit; February 24, 2003; Federal Appellate Court

Combined Opinion SummaryCombined Opinion Original

EnglishEspañolSimplified EnglishEspañol Fácil

The case involves Kearfott Guidance Navigation Corporation appealing a decision from the Armed Services Board of Contract Appeals regarding a government contract payment claim. The central issue is whether Kearfott can use a 'stepped-up' asset valuation, based on the purchase method of accounting, to support its payment claim. The Board ruled that the 1990 Federal Acquisition Regulation (FAR) provision prohibits this valuation method, rejecting Kearfott's arguments that the FAR regulation should not apply to a business combination that occurred prior to its effective date and that it conflicted with the Cost Accounting Standards (CAS). The court affirmed the Board's decision. 

Historically, prior to 1987, the assets of Kearfott were part of the Singer Company’s KGN Division, which included defense contracts. In December 1987, Singer created Kearfott as a wholly-owned subsidiary, transferring all assets and liabilities. In August 1988, Astronautics Corporation of America (ACA) acquired Kearfott, subsequently merging it with a newly formed subsidiary and commissioning an appraisal that increased the asset valuation. The transaction was treated for tax purposes as a purchase and constructive liquidation. The relevant FAR provision, FAR 31.205-52, implemented on July 23, 1990, limits allowable amortization, cost of money, and depreciation to amounts that would have been permitted had the business combination not occurred.

In May 1992, the Navy awarded Contract No. N00030-92-C-0043 to Kearfott, which subsequently submitted a progress payment request for $91,278 on September 3, 1992. This request included $15,763 related to an asset valuation increase following KGN Sub's purchase of Kearfott, which the Navy refused to pay, deeming it non-allowable. Kearfott persisted in including these amounts in future requests, leading to a dispute. Kearfott appealed to the Armed Services Board of Contract Appeals (ASBCA) against the Navy's refusal.

The government sought summary judgment, arguing that FAR 31.205-52 prohibited Kearfott from recovering costs based on the asset write-up. The Board granted this motion, referencing a prior ruling in Appeal of BAE Systems, which held that FAR 31.205-52 disallowed the use of stepped-up asset values for allowable amortization, cost of money, and depreciation. The Board clarified that the purchase method of accounting encompasses not only the initial value increase but also ongoing post-acquisition reporting.

Additionally, the Board ruled that the 1990 version of FAR 31.205-52 was not retroactively applied and did not conflict with CAS 404 and 409, as FAR addressed allowability and CAS addressed allocability. A dissenting opinion argued that FAR 31.205-52 conflicted with CAS 404 and should not bar Kearfott's claims.

Both parties acknowledged that FAR 31.205-52 was incorporated into the 1992 contract and accepted the use of the purchase method of accounting for asset valuation. The primary issue on appeal is whether the Board erred in applying FAR 31.205-52 to Kearfott's claim based on an asset write-up from a business combination that occurred before the regulation's effective date. Kearfott contends that the regulation's language indicates it should not apply retroactively, as the present tense "is used" implies the regulation only applies to business combinations occurring after its effective date of July 23, 1990.

Kearfott's interpretation of FAR 31.205-52 is rejected on the grounds that the regulation's language is temporally neutral and does not imply exclusivity to business combinations post-July 23, 1990. The regulation addresses the use of the purchase method of accounting for business combinations, indicating that 'when' should be understood as 'in the event that' rather than 'at the time that.' This means that FAR 31.205-52 applies based on the cost claim submission date, not the timing of the triggering condition. Thus, if a claim for amortization, cost of money, or depreciation is based on a valuation resulting from the purchase method, the regulation prohibits such claims.

The regulatory history reinforces this interpretation, showing that FAR 31.205-52 formalizes a long-standing tradition in government contracting to protect the government from being disadvantaged by changes in business ownership. Objections regarding the regulation's retroactive application were dismissed, affirming that its inclusion would not be unfair and would align with the established 'no-write-up' policy. The regulation is intended to apply uniformly, avoiding a dual system where combinations before the regulation's effective date could bypass its restrictions, creating inconsistencies in cost accounting practices.

The Cost Principles Committee likely did not intend to create a system that differentiates between business combinations based on their timing relative to regulation promulgation, as evidenced by a proposed but unadopted regulation in 1987. The Board's reliance on its interpretation of APB 16 and 'purchase method of accounting' is acknowledged, yet these interpretations are not central to the understanding of the FAR. Kearfott argues that applying FAR 31.205-52 retroactively creates legal issues, asserting that it disallows an asset write-up from a business combination occurring two years prior to the regulation's effective date. However, the document clarifies that a regulation does not operate retroactively merely because it considers past conduct. A truly retroactive law would need to impair vested rights or create new obligations regarding past transactions. Since Kearfott entered into the contract in 1992, the FAR did not affect any vested rights, as Kearfott had no right to reimbursement. The relevant transaction is the 1992 defense contract, not the earlier business combination. Consequently, FAR 31.205-52 applies only to government contracts executed after 1990 where the purchase method condition is met. Kearfott's rights stem from its contract, and it consented to abide by FAR provisions, recognizing the legal interpretation of these provisions was an open question at the time of contracting.

The application of FAR 31.205-52 to claims related to a pre-promulgation business combination was seen as a reasonable interpretation of the contract rather than a retroactive alteration of Kearfott's rights. The government's treatment of the 1988 business combination, leading to the application of this regulation in the 1992 contract, did not constitute an impermissibly retroactive effect. Kearfott argues that FAR 31.205-52 conflicts with CAS 404 and 409, suggesting that this conflict would invalidate FAR 31.205-52 not only for pre-promulgation business combinations but for all purposes prior to 1995, when CAS was amended to align with FAR. CAS 409 states that the depreciable cost of a tangible asset is its capitalized cost minus its estimated residual value, while CAS 404 outlines criteria for the capitalization of tangible assets. Kearfott contends that these CAS provisions require the purchase method for asset valuation, while FAR mandates using the seller's net book value. Kearfott asserts that FAR operates as an allocability rule rather than an allowability rule, which would imply that CAS regulations take precedence in cases of conflict. The resolution of Kearfott's argument hinges on whether FAR 31.205-52 is classified as allocability or allowability. Kearfott draws parallels to United States v. Boeing Co., where a court determined that a regulation was allocability-based when it made cost treatment contingent on a specific measurement and allocation method, conflicting with CAS requirements.

The court deemed the Defense Acquisition Regulation (DAR) invalid due to its conflict with Cost Accounting Standards (CAS) regulation. The government likened the case to *Rice v. Martin Marietta Corp.*, where DAR 15-203(c) required general and administrative (G.A.) expenses to be allocated to individual costs, conflicting with CAS 410, which mandated allocation only to final cost objectives. The court outlined a six-step process for cost allocation: 1) allocate direct costs, including unallowable costs per CAS 405; 2) allocate indirect costs, including G.A., following CAS 410 and 418; 3) sum direct and indirect costs; 4) identify unallowable direct costs per procurement agency policies; 5) calculate unallowable G.A. costs using the G.A. allocation rates; and 6) exclude unallowable costs from total contract costs. The court concluded that DAR 15-203(c) was an allowability provision, aligning with CAS since it involved subtracting disallowed G.A. expenses from the total contract price, rather than dictating cost allocation.

Furthermore, FAR 31.205-52 functions similarly to the DAR provision in *Martin Marietta*, permitting the government to disallow costs as part of procurement policy without affecting the measurement and allocation of costs under CAS for commercial contracts. FAR acts as a ceiling on allowable costs post-allocation, without mandating a specific cost allocation method. In contrast to the Boeing case, where the DAR required cost allocation to specific periods for allowance, FAR 31.205-52 does not impose similar allocation requirements, thus maintaining its status as an allowability provision that does not conflict with CAS regulations.

The document emphasizes the presumption of harmony between regulations addressing similar subjects, referencing the Martin Marietta case and others. It highlights that the Cost Principles Committee, in the administrative history of FAR 31.205-52, considered potential conflicts with Cost Accounting Standards (CAS) but concluded that FAR serves as an allowability rule. Kearfott failed to demonstrate a conflict with this presumption. The interpretation of FAR 31.205-52 indicates that the purchase method of accounting is essential for its application, leading to the conclusion that costs from Kearfott's asset write-ups related to a 1988 business combination are disallowed. Furthermore, the application of FAR in this context does not present retroactivity issues and does not conflict with CAS 404 or 409. Consequently, the decision by the Armed Services Board of Contract Appeals is upheld.