The plaintiff’s motion for summary judgment in its breach of contract claim is denied, where the court identified genuine factual disputes regarding whether the plaintiff’s accounting practices were compliant with cost accounting standards and generally accepted accounting principles and practices.
The court rejected the plaintiff’s contention that the government’s affirmative defense of illegality could succeed only if the costs were plainly and palpably illegal, explaining that a contracting officer cannot bind the government to contractual payment provisions that are contrary to statute or regulation, and therefore the plaintiff could not succeed on its breach of contract claim. The court also explained the FAR expressly provides that contractors cannot use one contract to recoup losses incurred on a separate contract, regardless of the agency’s agreement to do so.
The Boeing Company moved for summary judgment on its breach of contract claim alleging the government failed to pay certain costs incurred by the company prior to the restructuring of its current contract for rocket launch services. The government opposed, arguing that factual disputes remain to be resolved.
Boeing and its successor, United Launch Services LLC, alleged the Air Force breached certain agreements entered in 2006 and 2008, when the parties restructured Boeing’s Delta IV rocket launch contracts. The agreements obliged the government to make payments related to two sets of costs that Boeing incurred prior to 2006. For accounting purposes, Boeing had deferred these costs when it incurred them for allocation to anticipated future launches by holding them in inventory as an asset.
The government asserted that these agreements cannot be enforced because they are contrary to the government’s cost accounting standards, which apply to the restructured contracts, and to the FAR. The government argued that the accounting practices Boeing employed in deferring the costs did not comply with generally accepted accounting principles and practices.
When the original contract was awarded, Boeing adopted a “lot accounting” method to account for the hardware production costs it would incur for the launchers. In short, this practice would average the costs Boeing incurred producing the launchers required over all the expected missions. Boeing expected to incur higher costs early in the contract, when it was standing up its production facilities and “learning” how to build the launchers, and believed later devices would be less expensive. In so doing, Boeing hoped to smooth out the costs it would incur.
Of importance to this dispute, Boeing incurred common support costs, traceable to certain kinds of direct labor, as it produced Lot 1’s major end items. Boeing classified these costs as “program management” and “hardware support” costs. Boeing included these common costs in Lot 1 and treated them as though they were separate end items. Under Boeing’s lot accounting practice, the company did not realize the costs incurred to produce the Lot 1 end items (including the PM&HS costs) as liabilities on its balance sheet at the time they were incurred. Instead, they were classified as an asset in the form of work-in-progress inventory.
Later, Boeing realized the costs as liabilities on a “mission-by-mission basis” when missions were launched. Specifically, for each mission, it would tally the proportional costs associated with the end items used in that mission’s launch vehicle (including a proportional measure of the PM&HS costs); add in other costs associated with that mission to arrive at a “cost of sale”; and match the cost of the sale (a liability) against the revenue received for the mission.
When the commercial market for launch services failed to materialize, Boeing reduced the number of expected launches, which extended the period of time required to consume Lot 1’s end items. Further, because of the dearth of commercial opportunities, most of Lot 1’s end items would be devoted to government contracts—for which Boeing had already fixed prices.
These changes, however, had no effect on the cost to complete the items in Lot 1. Further, contrary to its expectations, Boeing found that its costs for developing the launch system increased over time, rather than decreased. This combination of circumstances led Boeing to record significant losses on its “definitized” contracts in the second quarter of 2003. Complicating Boeing’s situation, the Air Force found the firm violated the Procurement Integrity Act during the initial procurement, transferred seven ILS contract launches away from Boeing, and temporarily suspended Boeing from participation in further launch procurements. As a result, Boeing again reduced the number of expected launches by 2020.
In 2005, the Air Force adjusted its acquisition strategy for space launch services, and decided to award two contracts: a cost-reimbursement contract for launch capability services that would provide contractors with an assured funding stream, and a firm fixed-price contract for launch services, under which the government would pay separately for specific mission needs, including launch hardware and mission hardware.
Notably, under this contract structure, when Boeing incurred new costs of the type it had characterized as PM&HS costs under the ILS contract, such costs would be reimbursable under the launch capability contract, not the launch services contract. Further, the Air Force announced that losses incurred under the 1998 contracts would not be recoverable under the restructured contracts. Further, because the new contracts would be governed by FAR Part 15, the government’s cost accounting standards would apply.
When preparing its proposals for these contracts, Boeing realized that after the restructuring, the types of costs it had characterized as PM&HS costs would fall under the rubric of the launch capability contract, not the launch services contract.
However, Boeing’s inventoried costs included PM&HS costs that it had already incurred and associated with anticipated future missions. The parties refer to these costs as deferred support costs (DSC). Boeing had expected to recover these costs (or realize losses on them) on its launch services contracts, and those launches would now take place during the period covered by the launch capability contract. To ensure that it could recover the inventoried DSC costs on the launch capability contract, Boeing sought an advance agreement providing that it would continue to use lot accounting, except the DSC costs, which Boeing proposed to recover by charging directly to final cost objectives of the launch capability contract.
During negotiations, the Defense Contract Audit Agency took issue with Boeing’s plan to roll forward $333 million in previously incurred PM&HS costs to its new contract, in a manner that might not comply with the government’s CAS. However, a later audit of Boeing’s revised proposal did not cite any potential CAS violations. After further negotiations, the parties executed a memorandum of understanding in which they agreed that the contract would include a fixed price CLIN devoted to paying deferred support costs, the total value of which would be calculated over an estimated 8-year period. Further, the parties provided that the execution of the launch capabilities contract could be contingent upon the execution and approval of advance agreements concerning lot accounting and DSC costs. Further, in November 2006, the agency’s contract management board of review expressed concern that if the costs under the prior contract were transitioned to the restructured contract, the government would in effect be subsidizing Boeing for past losses. However, the board ultimately concluded that Boeing was not attempting to transfer period costs to a later accounting period via the DSC advance agreement, but attempted to recover legitimate costs within the scope of government accounting and contract rules.
During this time, Boeing and Lockheed Martin entered into a joint venture agreement creating United Launch Alliance, of which ULS is a subsidiary. The JV elected to use Lockheed Martin’s practice “Annual Production Cycle (APC)” accounting, which Lockheed had used for the Atlas program, rather than Boeing’s lot accounting practice. The firm’s vice president and controller suggested that ULA could not adopt lot accounting because the process did not conform to GAAP.
This change caused a complication with the DPC costs Boeing had incurred prior to 2006. Under APC accounting, the costs incurred to produce particular items of hardware would be allocated entirely to those units in production during the year the cost was incurred. However, prior to 2006, Boeing had inventoried those costs using lot accounting and associated a portion with units to be produced/sold in future years under anticipated launch contracts, rather than to units in production during the years the costs were incurred. This change would have prevented these costs from being allocated to future missions.
In 2008, ULS and the government executed the DPC advance agreement, under which DCAA would audit the amount, allowability, and allocability of proposed costs. Following the audit, the parties would negotiate a reasonable value representing the total DPC that were incurred and placed in inventory before 2006, but were neither allocable nor payable under obligations on contracts entered into or performed prior to that date. Further, they agreed to allocate the negotiated costs to future Delta IV launch service missions until the total negotiated value was liquidated.
In 2008, GAO criticized DCAA for not documenting CAS compliance issues in their workpapers, and a DoD OIG report recommended the Air Force suspend potentially improper payments under the launch vehicle program and to reevaluate any advance agreements. In response, DCAA conducted a new audit which concluded that Boeing was in non-compliance with several cost accounting standards in relation to its DSC. In June 2011, the responsible administrative contracting officer issued a final decision finding that Boeing’s Lot Accounting practice was CAS noncompliant and asserting a claim of $89,235,167 in improper payments to Boeing. After an additional audit, DCAA concluded the DPC advance agreement was not valid, based on its noncompliance with government CAS.
Boeing submitted a certified claim seeking relief, which was denied. Boeing sued. In Count I, Boeing argued the government breached its contract by demanding repayment of DSC and refusing to make additional payments, as nothing in CAS or federal law or regulation precludes the recovery of DSC. In Count II, Boeing asserted that the government has breached the ELS contract by failing to negotiate a reasonable value for the DPC costs and allocate it among missions under the ELS contract, as it allegedly promised to do.
As an affirmative defense, the government alleged that Boeing’s claims were barred by illegality as the procurement contracting officer had no authority to agree to pay DSC or DPC, and any agreement to pay DPC or DSC violates Cost Accounting Standards and the Federal Acquisition Regulation. After a lengthy discovery process and attempt at mediation, Boeing moved for summary judgment.
In opposition, the government argued there is a genuine factual dispute regarding whether the government’s refusal to pay the DSC CLINs and to negotiate and make DPC payments constitutes a breach of the ELC and ELS contracts. The government asserted that the DSC and DPC costs are not allowable unless Boeing’s lot accounting practice (from which they are unquestionably derived) complied with GAAP, and that Boeing’s GAAP compliance is a genuinely disputed question of fact.
In response, Boeing argued that the government’s affirmative defense of illegality can succeed only if paying the DSC and DPC costs would be “plainly and palpably” illegal—i.e., if the costs were plainly and palpably unallowable. And, it asserts, there is no genuine dispute that they were not. Further, Boeing argued that its GAAP compliance is not relevant to the allowability of the DSC and DPC costs under any standard; and that, even if it were, GAAP allows for a range of reasonable accounting practices, and the government has not shown that Boeing’s accounting choices could be considered unreasonable.
First, the court held that Boeing’s reliance on the “plain and palpable” standard was misplaced, explaining first that COs lack the authority to bind the government to contractual payment provisions that are contrary to statute or regulation, and that such provisions are therefore not enforceable. Thus, Boeing cannot recover breach of contract damages based on the government’s refusal to pay those costs. Boeing argued that even if the payment terms violated certain regulations, they could still be enforced through a breach of contract action, unless they were plainly and palpably illegal. However, the court explained the government is not required to prove the “plain and palpable illegality” of the payment provisions at issue in order to prevail on its defense to Boeing’s breach of contract claim.
Next, the court held that Boeing’s accounting for DSC and DPC costs was required to be GAAP-compliant to be considered allowable. Specifically, the board found that CAS 406 required Boeing’s practice of deferring costs for expensing in later cost accounting periods to be GAAP-compliant. Boeing argued that CAS 406 does not apply to the DSC payments because the CAS apply only to cost accounting practices. According to Boeing, the payment of an agreed sum of costs is not itself a cost accounting practice. The court disagreed, finding Boeing distorted regulatory language stating that the determination of an amount pad for a unit of goods or services is not a cost accounting practice. The court found it clear that “an agreed sum of costs” is not the same as “a unit of goods and services.” And the court found no question that the agreed-upon amounts of DSC resulted from the measurement of costs, nor that Boeing’s deferral of the costs involved the assignment of costs to cost accounting periods, both of which are defined as cost accounting practices.
Boeing argued that the DSC payments are neither an “accumulation” nor an “allocation” of costs on the ELC contract under CAS 406, but the court disagreed.
When Boeing deferred its costs by placing them in inventory, it listed them as an asset on its books, not a liability or expense. And, after the commercial launch market collapsed, it apparently expected to record the costs as expenses in years covered by the ELC contract—i.e., as costs-of-sale for launches in those years. CAS 406–40(b) and 406–50(b) contemplate precisely this sort of practice. The court found that it reasonably followed that to meet the requirements of CAS 406, Boeing had to employ GAAP-compliant practices.
Next, the government noted that FAR 31.205-23 disallows any excess of costs over income under any other contract. The government cannot use the contractor’s profits on another contract to reduce its costs on the current contract and the contractor cannot use losses experienced on another contract to justify a higher price. In response, Boeing did not dispute the government’s contention, but suggested the government was permitted to pay the DSC costs even if they constituted losses on other contracts because the government agreed to pay those costs via fixed-price CLINs. Boeing cited FAR 31.102, which provides that when the FAR’s cost principles apply in the pricing of fixed-price contracts, the government’s objective is to negotiate prices that are fair and reasonable, cost and other factors considered.
The court found this argument meritless. Under the circumstances, where cost was essentially the sole factor in determining price, the court concluded it would not be “fair and reasonable” for a CO, when considering “cost and other factors,” to simply ignore the fact that the relevant costs were, in fact, losses on other contracts. Boeing’s interpretation would allow FAR 31.102 to override other FAR language barring a contractor to use one contract to recover losses from another. Further, despite the fixed-price label, Boeing consistently described the DSC payments as intended to “reimburse” it for the costs it incurred prior to December 2006. The court found that Boeing itself understood the government’s agreement to pay DSC as akin to reimbursement on a cost-type contract, rather than a pure fixed-price arrangement.
Accordingly, the court concluded that Boeing’s GAAP compliance is genuinely disputed, and denied its motion for summary judgment. Specifically, the court found factual disputes exist regarding whether Boeing’s lot accounting practice was a permissible accounting practice under SOP 81-1; whether combining two types of contracts suggests that Boeing was actually employing “program accounting,” which is expressly excluded from SOP 81-1; and whether Boeing’s lot accounting practice complied with the applicable GAAP directives that govern when deferred costs may be held in inventory.
United Launch Services LLC is represented by Carl J. Nichols, Wilmer Cutler Pickering Hale and Dorr LLP, with whom were Christopher E. Babbitt, Wilmer Cutler Pickering Hale and Dorr LLP, Karen L. Manos, Gibson, Dunn & Crutcher LLP, and Matthew J. Thome, von Briesen & Roper, s.c., Of Counsel. The government is represented by Corrine A. Niosi, Senior Trial Counsel, and David M. Kerr, Trial Attorney, Commercial Litigation Branch, Civil Division, Department of Justice, with whom were Patricia M. McCarthy, Assistant Director, Robert E. Kirschman, Jr., Director, and Chad A. Readler, Acting Assistant Attorney General.
