ASBCA Grants $253 Million Northrop Post-Retirement Benefits Claim

David Yang

Pension and other post-retirement benefit expenses have long constituted a substantial obligation on the part of contractors under cost-type contracts and are often the subject to disputes with the government as to the calculation and allowability of such costs. While court and board decisions regarding pension-related disputes have tended to be a mixed bag, the decisions have more often sided with the government. However, the Armed Services Board of Contract Appeals’ (“ASBCA” or “Board”) July 13, 2017, decision in Northrop Grumman Corp., ASBCA No. 60190, may signal a more favorable trend for contractors in connection with such issues. In this case, Northrop filed a claim for $253 million in retiree health benefits over an 11-year period from 1995 to 2006, which the Defense Contract Management Agency (“DCMA”) disallowed because Northrop used an outdated accounting practice for accruing such costs under the relevant Federal Acquisition Regulation (“FAR”) cost accounting requirements. Specifically, DCMA asserted that during the relevant time period, Northrop was required to use the accrual method under Financial Accounting Standard (“FAS”) 106 which requires that anticipated health expenses be fully accrued at the time of a retiree’s eligibility for those benefits, rather than the non-FAS 106 method used by Northrop which does not factor in the full costs until the they are incurred. As a result, the non-FAS 106 accrual method used by Northrop to calculate retirement health benefit costs began low but increased over time, thus resulting in a $253 million claim over the period for the retirement health benefits that were ultimately incurred. Accordingly, because Northrop deviated from the accrual standard under the FAR, and did not fully fund health benefit costs from the start, DCMA denied the claim, finding the costs to be unallowable because Northrop did not comply with the FAR on these calculations.

The ASBCA rejected DCMA’s determination. Although the ASBCA agreed with DCMA that Northrop failed to use the correct cost accounting method for accruing retirement health costs, when it came time to determine quantum, which was the subject of this case, the Board found that notwithstanding Northrop’s technical noncompliance with the regulations, DCMA’s denial of Northrop’s claim was unreasonable because the government sustained no harm due to Northrop’s noncompliance. In this regard, the Board stated that “[a]lthough appellant failed to use the proper accrual methodology, there is no evidence or government contention that the amount accrued by appellant pursuant to [the Deficit Reduction Act of 1984] in the pre-transition years exceeded the amount of costs that would have been allowable applying FAS 106 … In fact, precisely the opposite is true.” Northrop Grumman Corp., ASBCA No. 60190, July 13, 2017 at 14. The Board further noted that “[f]undamentally, the government should only be concerned where the contractor claims more than permitted by regulation,” which was not the case here. Id. at 15. Thus, the Board found that, regardless of which accrual method Northrop used, because the costs were incurred, there was no dispute about their reasonableness, and nothing in the FAR prohibited recovery because Northrop did not overcharge the government, the government was required to reimburse Northrop notwithstanding Northrop’s technical noncompliance with the FAR’s accrual rules. In sum, the Board found that the “government suffered no damages as a consequence of [Northrop’s] methodology during the pre-transition years” and, thus, Northrop “has never, and will never, claim, and the government will never pay, amounts disallowed by the final decision.” Id. at 18.

In rejecting DCMA’s form-over-substance argument, the ASBCA signaled that it will take a harder look at whether a contractor’s noncompliance with a regulation was material and whether the claimed costs are valid and were incurred even if there has been a technical discrepancy in the contractor’s cost accounting practices. While contractors must still comply with cost accounting rules, the ASBCA’s decision strikes the right balance in situations where the contractor takes a good faith position that deviates from the applicable rules but the government denies a claim due to a technicality. This policy best reflects the day-to-day realities that contractors encounter during contract performance while ensuring that contractors are not unfairly or arbitrarily penalized for a technical noncompliance that has not resulted in any harm or damages to the government.