The Contractor's Perspective

Six things to know about the DFARS Contractor Business Systems rules

Posted in Compliance, Cost Issues, New FAR Rules

Final revisions to the new DFARS rules on Contractor Business Systems were published February 24, 2012. DoD’s summary of the comments on the interim rule and a list of the changes to the interim rule are available at 77 Fed. Reg. 11355 (Feb. 24, 2012) [pdf]. Here are six of the key points contractors need to know about the final rules.

1. The Contractor Business Systems requirements do not apply to existing contracts that lack the new DFARS contract clauses.

The new Contractor Business Systems requirements apply only to new contracts awarded after the interim rules were issued in May 2011. Unless the contractor agrees to the addition of the new DFARS clauses through a bilateral modification, they do not apply to existing contracts. The DoD comments accompanying the final revisions make this point directly—”Revisions to the DFARS set forth in this rule do not affect existing contracts that do not include the business systems clause unless the contractor and the Government agree to modify the contract bilaterally.”

2. The Contractor Business Systems requirements will apply only to contracts that are subject to the Cost Accounting Standards.

The statutory requirement for the new DFARS rules on Contractor Business Systems appeared in section 893(f)(3) of the 2011 National Defense Authorization Act, which defined a “covered contract” as a “cost-reimbursement contract, incentive-type contract, time-and-materials contract, or labor-hour contract that could be affected if the data produced by a contractor business system has a significant deficiency.” Section 816 of the 2012 National Defense Authorization Act revised the definition of “covered contract.” Under the revised definition, a covered contract is one “that is subject to the cost accounting standards promulgated pursuant [41 U.S.C. § 1502] that could be affected if the data produced by a contractor business system has a significant deficiency.”

This limitation is important because many defense contracts fall under the applicable dollar thresholds or are exempt from CAS coverage altogether. Small businesses are exempt from CAS, for example, as are firm-fixed-price contracts for commercial items and firm-fixed-price contracts awarded on the basis of adequate price competition. The full list of CAS exemptions appears at 48 C.F.R. 9903.201-1.

3. Business systems are key elements of contractor responsibility and will be used to determine eligibility for covered contracts.

DoD’s commentary on the final rules specifically makes the point that maintaining adequate business systems is a “condition of contracting responsibility and, in some cases, eligibility for award.” According to DoD, establishing and maintaining an adequate business system is not merely red tape associated with performing government contracts. Complying with the business systems requirements is an important element of the work that contractors perform and is part of the price that contractors charge for their goods and services. In DoD’s view, the business systems requirements are “material terms, performance of which is required to ensure contracts will be performed on time, within cost estimates, and with appropriate standards of quality and accountability.” Contractors can expect to have business system compliance considered in connection with the award of DoD contracts, not just as an element of past performance, but as part of a responsibility determination. Even under the interim rules, we have seen DoD agencies include the requirement to pass a business systems review as a condition to the award of a contract.

4. The five-percent withholding authority in the DFARS Contractor Business Systems rules is not the only remedy available for contractor nonconformance.

The Contractor Business Systems clause at DFARS 252.242-7005 requires the contracting officer to withhold five percent of payments whenever the contracting officer makes a “final determination” that the contractor’s business system contains a “significant deficiency.” Although the clause limits the withholding to a maximum of 10 percent if there is more than one such deficiency, there is no requirement that the government prove monetary damages to justify this withholding.

But there is also no language limiting the government’s remedy to the five or ten percent withholding if it can show actual monetary damages. Think defective pricing claims, demands for repayment of unallowable costs, and allegations of fraud or False Claims. DoD’s comments on the final rules indicate that contracting officers are expected to assert larger claims if they can be proven. According to DoD, the five-percent withholding required in the business systems is intended as an estimate of the “unquantifiable” impact of unreliable information. “When the financial impact of a deficiency is quantifiable, DoD expects contracting officers to take appropriate actions to reduce fees, recoup unallowable costs, or take action if fraudulent activity is involved.”

5. DCAA’s assessment of a contractor business system isn’t final.

Under the DFARS business system rules, the responsibility for making an initial determination as to the adequacy of a contractor’s business systems, as well as the final determination that a system suffers from a “significant deficiency” falls not on DCAA, but on the contracting officer. DCAA’s role will be as an auditor, system reviewer, and advisor to the contracting officer rather than the final decision-maker.

The contractor will have a number of opportunities to make its case to the contracting officer following a DCAA report on the adequacy of its business systems. Under the rules, the contracting officer must make “an initial determination that there are one or more significant deficiencies in one or more of the Contractor’s business systems.”  DFARS 252.242-7005(d)(1). The contractor would then have at least 30 days to respond to the initial determination (the rule does not preclude the contracting officer from extending the deadline). Assuming the contracting officer deems the response insufficient, the contracting officer would make a “final determination” as to the existence of a significant deficiency and in appropriate cases would begin withholding payments. Withholding would continue until the deficiency is corrected or until the contracting officer is satisfied that the contractor is implementing a satisfactory corrective action plan.

6. Contractors are entitled to challenge an improper assessment of their business systems. 

Certainly not all contracting officer decisions are correct, and there will no doubt be some contracting officers who make erroneous determinations that compliant business systems suffer from a significant deficiency. Like other government actions, such erroneous determinations are subject to review under the Contract Disputes Act. Although a government decision announcing its decision to withhold payment from a contractor would normally be considered a government claim subject to immediate appeal, DoD’s comments on the final Contractor Business Systems rules indicate its expectation that a separate contractor claim would be required as a precursor to any litigation. In DoD’s view, “[f]inal determinations on the adequacy of the contractor’s business systems under the rule are not contracting officer’s final decisions . . . .” Thus, contractors seeking to challenge such a determination in the Court of Federal Claims or the Armed Services Board of Contract Appeals would be required first to submit a claim to the contracting officer. Appeal rights available under the Contract Disputes Act would be available after the contracting officer makes a final decision on the claim.

In addition to the negative financial impact of an improper decision to withhold five percent of a progress payment or cost voucher, it is safe to assume that such a decision would have a negative impact on a contractor’s past performance rating. Contractors have the opportunity to review and correct errors in past performance ratings and to include their substantive response to an agency’s rating of past performance even if the error itself is not corrected. According to the Federal Circuit’s recent decision in Todd Constr., LP v. United States, No. 2010-5156 (Aug. 29, 2011) [pdf], contractors may also challenge an erroneous past performance rating in the Court of Federal Claims.

Submitted by Husch Blackwell Partner Brian Waagner and attorney Dan Donohue.

[For more background on the DFARS Business Systems rules, check out our earlier posts. Our December 23, 2011 entry discusses the definition of "covered contract" in section 816 of the 2012 NDAA. Our June 21, 2011 outlines the payment withholding mechanism in DFARS 252.242-7005.  Our January 28, 2011 entry discusses the original requirements in section 893 of the 2011 NDAA.]