CBCA Permits Agency Auditors Access to Firm Fixed-Price Cost Data

A major benefit of firm fixed-price contracts to many contractors is a greater ability to protect sensitive cost, pricing, and profit information from scrutiny. Fixed-price contracts are just that — fixed at “a price that is not subject to any adjustment on the basis of the contractor’s cost experience in performing the contract,” which “places upon the contractor maximum risk and full responsibility for all costs and resulting profit or loss.” FAR 16.202-1. In exchange, the contractor receives certain flexibilities, including lesser government scrutiny of its cost information. Having firm-fixed-price (FFP) elements of a contract does not necessarily mean, however, that a contractor can escape any government scrutiny of the cost data related to the FFP portion, according to a recent decision by the Civilian Board of Contract Appeals (CBCA or the Board). The CBCA held that because the cost reimbursement portion of the contract required a year-end incurred cost audit (to establish indirect rates and verify claimed costs), the government may reasonably audit the FFP contract portion as well to ensure the contractor is not improperly claiming reimbursement for costs covered by FFP line items or trying to recoup FFP losses through indirect costs. This case serves as an important reminder of the far-reaching nature of government audit rights, and offers the interesting suggestion that contractors attempt to negotiate the scope of audit clauses before entering into contracts should they wish to limit government auditor access to highly proprietary cost or pricing information.

In HPM Corporation v. Department of Energy, CBCA 7559, the contractor (HPMC) held a hybrid cost reimbursement and fixed-price contract with the Department of Energy (DOE). That contract contained three clauses giving DOE the ability to audit relevant records:

• The FAR audit clause (52.215-2, which applies to a “a cost-reimbursement, incentive, time-and-materials, labor-hour, or price redeterminable contract”)
• The Allowable Cost and Payment clause (FAR 52.216-7, expressly noted in this contract as “Applies to Cost-Reimbursement”)
• The DOE Acquisition Regulation (DEAR 970.5204-3) clause titled “Access To and Ownership of Records” (paragraph (d) of which requires the contractor to make records “acquired or generated by the Contractor under this contract” available to DOE for audit)

The contract also contained a disputes clause requiring the parties to negotiate any dispute in good faith. As part of a yearly incurred cost audit, DOE requested the contractor provide data regarding the fixed-price portion of the contract (specifically, details regarding the contractor’s actual labor costs charged under a FFP line item), to which the contractor objected, arguing the audit clause only gave DOE the right to access data regarding the cost reimbursement part of the contract. DOE declined to participate in ADR on this issue, which the contractor also contended violated the disputes clause requirement to negotiate in good faith. The contractor presented a two-count nonmonetary claim requesting a contract interpretation of both the audit and the disputes clause.

Regarding the disputes clause, the CBCA held it had jurisdiction to interpret the clause yet found that DOE had not breached it. DOE clearly did not agree with the contractor’s interpretation of the contract’s various audit clauses; it was unclear what the contractor thought ADR would accomplish. The contractor’s real complaint was that “DOE does not agree with and has not capitulated to HPMC’s position on DOE’s audit rights.” The CBCA reasoned that the contractor “appears to want to pull the Board into the minutiae of contract administration and have the Board direct the positions that DOE must take in the negotiation process,” which “is not the purpose of the CDA’s nonmonetary claim review process.”

The CBCA also held it had jurisdiction to interpret the audit clause, over DOE’s objection. The CBCA explained that although the contractor could wait until the conclusion of an audit (in which it declined to provide documentation) and then file a monetary claim challenging any resulting indirect cost reductions, the contractor “is not obligated to wait until DOE takes such action in order to seek a decision interpreting its audit production obligations under the contract.” Rather, where “[r]esolution of that contract interpretation issue may assist HPMC in its continuing contract performance,” the CDA permits the contractor to submit nonmonetary claims for early resolution, even if they may later have monetary impacts.

On the merits, CBCA disagreed with the contractor’s arguments that the contract’s various audit clauses “only authorize DOE and its auditors to access information regarding the cost-reimbursement CLINs [Contract Line Item Numbers] in its contract and that information associated with the FFP CLINs are completely off-limits.” While the Allowable Cost and Payment (FAR 52.216-7) clause was expressly tied to the cost-reimbursement portions of HPMC’s contract, the audit clause (FAR 52.215-2) had no such limitation and clearly provides for audits of “cost-reimbursement contracts.” The CBCA found it unnecessary to decide whether FAR 52.215-2 “applies only to the cost reimbursement CLINs … or to the contract as a whole” because “DOE’s auditors have not requested documents that would fall outside the context of a normal incurred-cost audit.” DOE explained in briefing that “[a] well-known audit risk is misallocation and/or cost shifting between fixed price, cost reimbursable, and indirect work/costs,” and that “[t]he audit in question is being undertaken to ensure that indirect costs being charged to the cost-reimbursement CLINs are appropriately allocated to those CLINs and have not been, through some type of accounting mechanism, moved away from FFP CLINs.” Given this holding, the CBCA reads the FAR audit clause as permitting the government to fully audit FFP portions of hybrid contracts, so long as there is any cost reimbursement portion to which the contractor could improperly be shifting costs.

Even without FAR 52.215-2, the CBCA found that the DOE-specific audit clause (DEAR 970.5204-3) had no limitation to only cost-reimbursement contracts or CLINs, giving DOE full authority to request the information. The Board concluded it “is in no position to impose some type of myopic limitation on the scope of documentation that auditors need to support an audit of the cost-reimbursement aspects of this contract or of HPMC’s indirect cost rates.”

The contractor’s apparent concern with providing DOE with the requested FFP information is understandable: DOE had requested information regarding its FFP labor costs, which the contractor presumed that DOE planned to make use of in its development of the follow-on solicitation for the same FFP services the contractor was performing. It is easy to see why a contractor would not wish to disclose its profit and cost information in advance of such a competition. But, the CBCA dismissed these concerns regarding “inappropriate use of its proprietary information” as “wholly speculative,” and said that DOE was contractually entitled to the information.

So, what is a contractor to do? The CBCA offered a likely difficult-to-implement solution: negotiate the scope of the government’s audit rights before signing a contract. The CBCA cited a forty-year-old Court of Claims precedent proclaiming that “[i]f plaintiff desires to keep the contracting officer in the dark as to the identities of its suppliers [or about other information in its accounting files], … it should not have contracted with the Government on a cost-reimbursement basis necessitating audit of plaintiff’s … costs.” SCM Corp. v. United States, 645 F.2d 893, 902 (Ct. Cl. 1981). The CBCA agreed, and opined that had the contractor here “wanted to create some kind of clear limitation on DOE’s audit rights or demarcation of what documents could be requested under this hybrid FFP/cost-reimbursement contract, it should have insisted on those limitations, written in clear language, before it executed the hybrid contract.” Whether the government would have been receptive to such concerns before signing this contract is, of course, open to debate.

In sum, while the CBCA agreed that “the Government’s audit rights under these clauses are not limitless and do not provide a basis for wide-ranging document requests for corporate records unrelated to the verification of actual costs,” the contractual audit clauses here provided more than sufficient authority for DOE to request access to the contractor’s incurred cost information for FFP CLINs. This is an important practice point to remember both when analyzing the scope of a contractor’s risk when signing up for a hybrid cost-reimbursement/FFP contract, or any contract with expansive audit rights, and when deciding how to respond to government audit requests (see our best practices here). While there may be a good argument that FFP data is outside of a necessary audit scope, the relevant tribunals may find broad audit clauses to nonetheless give the government the right to access such data.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.