Federal Circuit Maintains That Contractors Must Read between the Lines to Determine Expressly Unallowable Costs

Scott Arnold and Carolyn Cody-Jones

A recent Federal Circuit decision has sustained an expansive judicial reading of what constitutes an expressly unallowable cost under FAR Part 31. This decision, reached in the context of lobbying expenses, provides the potential for expansive precedent for future disputes regarding what expenses constitute expressly unallowable costs. Including expressly unallowable costs in submissions to the government can result in penalties up to two times the amount of the disallowed cost. Taking into account this decision as well as the Defense Contract Audit Agency’s (“DCAA”) expressly unallowable cost guidance released earlier this year, contractors should review their policies and procedures for identifying and excluding unallowable costs from invoices and proposals on government contracts, and consider whether to broaden their policies.

The decision, Raytheon Co. v. Sec’y of Def., Case No. 18-2371, 940 F.3d 1310 (Fed. Cir. 2019), was issued October 18, 2019. The Court upheld a decision by the Armed Services Board of Contract Appeals, and held that salary costs of the contractor’s employees who participated in lobbying activities were considered expressly unallowable costs under FAR Part 31 and subject to the penalty provisions at FAR 42.709-1. In reaching this decision, the Court rejected the argument that “an item of cost must be ‘mentioned or identified by name’” to be expressly unallowable under FAR 31.205-22 (which addresses six categories of lobbying and political activity costs, but is silent on salaries). Instead the Court maintained that an “‘expressly unallowable’ cost includes more than an explicitly stated ‘item,’” by relying on the reference in FAR 31.001’s definition of expressly unallowable cost to “a particular item or type of cost” and FAR 31.205-22’s “[c]osts associated with” preamble to the six listed categories. (Emphasis added.) The Court explained its interpretation that “[c]osts unambiguously falling within a generic description of a ‘type’ of unallowable cost are also ‘expressly unallowable.’”

The DCAA’s May 14, 2019 Audit Alert on Identifying Expressly Unallowable Costs revises prior guidance based on recent board and court decisions (including the predecessor ASBCA decision in the above-discussed Raytheon decision). See DCAA MRD 19-PAC-002(R) (May 14, 2019), available at dcaa.mil/content/Documents/mmr/19-PAC-002.pdf. It provides lists of 91 “expressly unallowable costs.” This list can assist contractors in focusing on the cost clauses that DCAA may more closely scrutinize going forward. Notably, in the portion of the list discussing FAR 31.205-22, the DCAA guidance distinguishes between lobbying salaries and incentive compensation, such as bonuses, which the Armed Services Board of Contract Appeals held in 2015 did not constitute an “expressly” unallowable cost, even though such incentive compensation was also unallowable. Because the Federal Circuit’s subsequent Raytheon decision maintained that that decision was “contrary to the plain language” of FAR 31.205-22, this aspect of the DCAA guidance will likely be changed.

Government contractors should note several takeaways from the Federal Circuit’s Raytheon decision in conjunction with DCAA’s new guidance. First, although the Raytheon decision addressed lobbying costs, the Court still opines on the power of the FAR 31.001’s definition of expressly unallowable costs and emphasizes that “types” of costs may be subsumed into that FAR part’s definition. Therefore, to preempt potential DCAA audits and investigations, government contractors should review their policies and procedures to ensure that reviews identify expressly unallowable costs under this broad standard. This is especially important considering that the Government may compute interest from the date of overpayment through the demand for payment, and a backlog of DCAA audits could potentially cause findings from previous fiscal years to have a snowball effect. Ideally, contractors will want to have established polices to ensure that expressly unallowable costs—as interpreted broadly by the Federal Circuit—are not included in final cost proposals.