Department of Defense Clarifies Implementation of CARES Act Section 3610 to Provide Contractors Relief for Paid Leave

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Introduction

On April 9, 2020, the Office of the Under Secretary of Defense (Acquisition and Sustainment) released guidance regarding the April 8, 2020 Defense Federal Acquisition Regulation Supplement (DFARS) class deviation, which implements section 3610 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) by creating DFARS 231.205-79.¹ This guidance, which consists of a memorandum from the Acting Principal Director, Defense Pricing & Contracting (APD, DP&C) (the April 9 Memorandum) and responses to 19 frequently asked questions (the FAQs), addresses several critical issues concerning the class deviation and DoD's approach to implementing section 3610. (Click here for the Memorandum.)

The new guidance reiterates a number of points that were already plain from DFARS 231.205-79, its accompanying memorandum (the April 8 Memorandum), and the text of section 3610 itself: relief is at the contracting officer's discretion and subject to the availability of funding; the contractor bears the burden of establishing that it qualifies for relief; a contractor's entitlement to relief is established through a contract modification; and the Department of Defense (DoD) intends to reduce the relief provided to a contractor under DFARS 231.205-79 by the amount that a contractor obtains under other programs.

The new guidance also covers various topics that DoD has not previously addressed. For instance, the FAQs state that section 3610 applies to Other Transaction Authority (OTA) contracts and that contracting offices can apply the principles from the DoD class deviation and guidance to OTAs. Perhaps most notably, the guidance provides the first indication of how DoD intends to apply section 3610 to fixed-price contracts. It also provides more granular instructions to both contracting officers and contractors on the application of section 3610 and DFARS 231.205-79 to all contract types.

This Advisory summarizes the April 9 Memorandum and the FAQs, focusing on the new guidance concerning eligibility requirements and prerequisites to relief under section 3610 and DFARS 231.205-79, the importance of segregating costs resulting from the COVID-19 public health emergency, and the application of section 3610 and DFARS 231.205-79 to fixed-price, cost-reimbursement, and time-and-materials and labor-hour contracts. The Advisory also identifies numerous issues that remain unresolved and offers practical guidance on compliance with the guidance.

Eligibility Requirements and Prerequisites to Relief

DoD's guidance is valuable on what is perhaps the most ambiguous aspect of Section 3610—the requirement that an expense result from the contractor's inability to perform work on a federally approved worksite because of a closure or restriction and its inability to resort to remote work. If interpreted narrowly, that element of section 3610 could prove restrictive. The guidance, however, suggests that DoD does not intend to do so. The FAQs state that "[t]he approved worksite is the contractor's location and any other places of performance specifically identified in the contract." Interestingly, DOD indicates that approved worksites include any facility "at which contract administration services are performed in support of those contracts . . . ." Although not perfectly clear, this apparently means that, if a contractor's or subcontractor's "approved" worksite is affected, the relief also extends to other facilities that provide administrative support, presumably including the home office.

Notably, the FAQs also indicate that a contractor may be able to recover for otherwise unallowable employee leave costs even where the contractor's facility is not closed (or where the contractor's facility is closed but remote working is possible). A contractor may be able to recover costs for paid leave that arise not because the contractor's facility is closed and remote work is infeasible, but because an employee cannot be in the workplace and cannot work remotely due to "public health reasons or family care issues." Although this interpretation is consistent with the Office of Management and Budget (OMB) March 20, 2020 guidance regarding section 3610 (OMB Memorandum), DoD still deserves credit for recognizing that a responsible contractor may extend paid leave to an individual who is unavailable to perform productive work due to the need to care for family members or other reasons associated with the COVID-19 public health emergency.² Contractors, however, should be mindful that their burden to substantiate increased costs due to paid leave during this period will be heightened where that leave is not related to facility closures and the lack of remote work options.

One aspect of eligibility that remains unclear is the concept of exhaustion of other avenues for relief, which originated in section 3610. The new DFARS 231.205-79(b)(6) provides that cost recovery must be reduced by the amount the contractor is "eligible to receive" under any other federal payment, allowance, tax, or other credit specifically identifiable with the COVID-19 public health emergency. The FAQs state that the cost principle is inapplicable where "the contractor has been or can be reimbursed for employee leave costs by other means," which seems to align with a plain reading of the cost principle. The April 8 Memorandum, however, contemplates a contractor's ability to attest that it "has not or will not pursue reimbursement of the same costs accounted for under [its] request" through other channels. Thus, a contractor should assess alternate means of recovery and be prepared to decline them in an attestation (and be prepared to comply with that declination) to seek recovery pursuant to the class deviation.

Segregation of Costs is Critical

DFARS 231.205-79 calls for contractors to segregate their paid leave expenses. DoD's guidance underscores why segregating costs resulting from the COVID-19 public health emergency is so important. As FAQ 8 states, "[s]ome paid leave is an allowable cost under the cost principles of FAR 31.2, specifically FAR 31.205-6(m)," but "it is likely contractors may not have an established provision in their compensation plans for granting leave for the specific purposes stated in section 3610 of the CARES Act and, without such a provision, leave of that kind normally would not be an allowable cost." In other words, DoD's implementation of section 3610 renders allowable certain costs that normally would be unallowable. That is one of the reasons why DoD's guidance emphasizes the importance of the ability to trace costs to the COVID-19 public health emergency and specifically to the impacts that Congress intended to address with section 3610. To that end, the April 9 Memorandum states that these costs should be "identified, segregated, recorded, invoiced, and reimbursed." The segregation guidance is consistent with the recommendations in our prior Advisory addressing performance delays and disruptions related to COVID-19. The memorandum specifically instructs contracting officers to document the dates when the applicable conditions begin and end, the extent of the conditions, the specific reasons why reimbursement under section 3610 applies, impact on cost/pricing, and the effect on contract performance. And the guidance puts the onus on the contractor to make sure that the contracting officer possesses the requisite information to paper the file on each of these points.

Fixed-Price Contracts and Contract Line Items

FAQ 13 states that "[f]ixed-price contracts and [contract line item numbers ('CLINs')] remain fixed-price." The guidance, however, contemplates that contractors will seek, and DoD may provide, relief through modifications to fixed-price contracts and CLINs. The April 9 Memorandum specifically anticipates that contractors will submit requests for equitable adjustments (REAs) under the terms of their fixed-priced contracts to seek relief for impacts resulting from the COVID-19 public health emergency and includes guidance for contracting officers who receive those REAs.

The memorandum directs contracting officers to establish separate CLINs for section 3610 payments under fixed-price contracts. This is intended to enhance traceability and avoid the possibility that these payments could be deemed to constitute acceptance of products or services under other CLINs. The guidance also directs contracting officers to coordinate (generally through the administrative contracting officer (ACO)) where necessary to allocate costs across multiple affected contracts.

The memorandum states that adjustments to fixed-price contracts should compensate the contractor "only for the costs of providing paid leave as permitted by section 3610, for maintaining the workforce, and shall not increase profit." Interestingly, however, the guidance suggests that this special CLIN should compensate the contractor on the basis of a fixed rate (a "fixed price per appropriate unit of measure, e.g., 'Hours' or 'Days,' exclusive of profit") on a monthly basis.³ The invoice, according to the guidance, should contain supporting documentation to "identify and explain why claimed hours could not be worked, along with a statement that these costs are not being reimbursed under other authorities." The guidance indicates that the contracting officer will verify the existence of conditions entitling the contractor to invoice for the paid leave. While DFARS 231.205-79 is not directly applicable to firm-fixed-price contracts, the guidance is not perfectly clear whether DoD expects contracting officers to at least apply the principles in that cost principle in negotiating adjustments to fixed-price contracts. It is unclear, for instance, whether contracting officers must apply the same test for "affected contractor status" that is prescribed for cost-reimbursement contracts, as discussed below. Additionally, the guidance indicates that payments made to compensate contractors under section 3610 and DFARS 231.205-79 should not be considered when measuring a contractor's performance against cost incentives, at least under fixed-price-incentive contracts. This makes sense, as the contractor should not be penalized for increased costs that resulted strictly from the COVID-19 public health emergency.

The April 9 Memorandum reminds contracting officers and contracting officers' representatives to accept only completed services under fixed-price contracts. The COVID-19 public health emergency will give rise to scenarios where there is a question surrounding whether the contractor fully "completed" the required services. Such scenarios may present a host of issues, one of which is whether the contractor is entitled to bill at the full contract prices or only at the special COVID-19 rates drained of profit. For instance, under a fixed-price level-of-effort contract, a contractor that is idled by the pandemic could invoice under a special CLIN tied to costs resulting from employees on paid leave, but the contractor likely could not invoice for the level-of-effort CLIN if it is not actually providing the level of effort required under the contract. The upshot is that even if the contractor is able to recover its costs for the additional paid leave provided during the COVID-19 public health emergency and, importantly, retain its workforce, the contractor may not be able to realize profit for this time period unless it is performing under other CLINs.⁴

Cost-Reimbursement Contracts and Contract Line Items

The April 9 Memorandum also includes guidance for contracting officers administering cost-reimbursement contracts. Importantly, the FAQs make clear that DFARS 231.205-79 will not apply automatically. Rather, each contractor will need to submit a request, demonstrating how it qualifies as an "affected contractor" under the cost principle. While DFARS 231.205-79 does not define that term, the FAQs provide insight. The guidance indicates that in applying for relief, a contractor must (1) describe the actions the contractor has taken to continue performing contract work; (2) describe the circumstances that necessitated granting employee leave (at prime contract or subcontract level); (3) explain why it was not feasible for employees to continue performing remotely; (4) explain how the leave served to keep the employees in a "ready state," which is defined to mean "a contractor's ability to mobilize and resume performance in a timely manner." FAQs 1, 2, 7, 18. Additionally, if the contractor is part of the critical infrastructure workforce, as defined by DoD,⁵ or directed to implement a contract's Continuation of Essential Services Plan, the contractor must demonstrate that it made "all reasonable efforts" to continue contract performance. Importantly, determinations of "affected contractor" status will be made on a case-by-case basis considering "the particular circumstances of each contract." This seems to leave open the question of whether a contractor can secure a global, DoD-wide determination of "affected contractor status."

The FAQs indicate that costs for which a contractor is seeking relief under section 3610 and DFARS 231.205-79 should be charged to a separate account. DoD expects contracting officers to work with contractors to establish cost procedures, adjust estimated costs (with the section 3610 costs segregated), and provisionally approve and pay interim vouchers. The memorandum directs contracting officers to retain the contractor's supporting documentation for audit.

DoD's guidance is unclear on whether increased costs associated with paid leave resulting from the COVID-19 public health emergency should be charged as direct or indirect costs under cost-reimbursement contracts. The memorandum notes that contractors usually treat costs associated with employee leave as indirect costs. In FAQ 9, however, DoD leaves open the possibility that "[t]here may be circumstances in which the cost can be directly identified with particular contracts." And, in fact, the April 9 Memorandum recommends that contracting officers ask contractors to charge these paid leave costs under a new cost category named "Other Direct Costs (ODC) COVID-19." Yet, despite the name, the guidance indicates that when such costs in this category can be allocated to applicable contracts "based on some reasonable, agreed upon allocation" and that "in some situations," charging through indirect cost pools may be more appropriate. FAQ 10 states that "[b]y creating a new category of costs, any potential issues with disclosed accounting policies and procedures, cost accounting standards, or a contractor's cost accounting standards disclosure statement may be avoided." While it may be wishful thinking to suggest all issues will be avoided, the segregation and separate handling of such costs will no doubt ease the administrative burden on both contractors and contracting officers.⁶

Time-and-Materials Contracts

The April 9 Memorandum also includes limited guidance on time-and-materials (T&M) and labor-hour (LH) contracts and suggests that they should be treated similarly to cost-reimbursement contracts. The memorandum indicates that contractors are expected to submit interim vouchers for payment of increased paid leave costs and that the contracting officer will review and, if acceptable, provisionally approve and pay them. Given the hybrid nature of T&M and LH contracts, contractors might consider asking their contracting officer for permission to treat the adjustment to those contracts and CLINs along the lines outlined for fixed-price contracts, with the addition of a fixed-rate CLIN dedicated to compensation for the COVID-19 impact to their workforces.

Remaining Questions

Notwithstanding the DFARS class deviation and DoD's efforts to clarify its approach to implementing section 3610, numerous questions remain.

Does DoD intend to extend reimbursement (cost allowability) beyond the limits of section 3610? In justifying the allowability of paid leave that is not directly caused by a facility closure and inability to work remotely, FAQ 3 states that "section 3610 provides considerable discretion to treat paid leave as an allowable cost." This guidance reflects sound policy—not only from a procurement standpoint but also from a public health perspective. Contractors, however, should consider seeking contract modifications that memorialize agreement on these points, especially given the risk that DoD's approach could become more restrictive over time. The importance of seeking written concurrence from the contracting officer is particularly acute for costs that do not fall squarely within DFARS 231.205-79.

How will DoD implement section 3610 for commercial item contracts and subcontracts? It remains to be seen. DoD has stated that guidance on this issue is forthcoming.

When will the unavailability of appropriated funding excuse an agency from reimbursing a contractor for increased costs that meet all of the elements set forth in section 3610 and DFARS 231.205-79? All of the guidance, and the class deviation itself, subject relief to appropriations. Contractors should be especially diligent in tracking obligations under FAR 52.232-20, Limitation of Cost, and FAR 52.232-22, Limitation of Funds. Increased costs from COVID-19 will likely accelerate eclipse of the limitations, the need to provide notice, and the direction from the government of whether the contractor should continue to proceed in performing the contract. Failure to do so could create substantial risk for contractors.

Does DoD really intend for reimbursement to be discretionary where the elements of the DFARS class deviation clause are satisfied and funding is available? As noted, DoD's guidance reinforces the discretionary nature of reimbursement under section 3610. Yet where a DoD contract provides that DoD will reimburse a contractor for all allowable costs, this arguably limits the contracting officer's discretion to decline to reimburse the contractor for costs that meet the elements DoD has laid out.

What will occur if the impact of the pandemic extends beyond the end of September? Section 3610 dictates that expenses must be incurred between January 31, 2020 and September 31, 2020. This time period is reflected in DFARS 231.205-79. If the public health emergency extends beyond September 30, which federal officials have indicated is possible in light of a potential reemergence of the virus in the U.S. during the fall season, contractors will not be able to rely on DFARS 231.205-79 as it is currently constituted for costs incurred in October and beyond. Even prior to September 30, if the government lifts its social distancing guidance and states lift their state-at-home orders, contractors are likely to face a higher burden in demonstrating that paid leave is allowable after those restrictions end.

How will DoD handle other increased costs resulting from the COVID-19 public health emergency beyond paid employee leave? Section 3610 addresses what may be the most significant element of increased costs to contractors due to the fallout from our nation's fight against COVID-19. Many contractors will experience increased costs in other areas, including rent on idle facilities, unabsorbed overhead, broadband access, and IT security. It remains to be seen how DoD intends to address these costs, but contractors may (depending on their circumstances and the terms of their contracts) be able to recover these additional costs through other contract clauses, including FAR 52.242-15, Stop-Work Order; FAR 52.242-17, Government Delay of Work; the various changes clauses; and DFARS 252.237-7023, Continuation of Mission Essential Functions.

Does the DFARS cost principle apply to a contract that is not formally modified? FAQ 4 states that "[t]he deviation is effective immediately and could apply to contracts in place from January 31, 2020, through September 30, 2020." Cost reimbursement contracts generally provide that the government will reimburse the contractor for costs that are allowable based on the provisions in FAR subpart 31.2 in effect on the date of the contract.⁷ Changes to the FAR and DFARS, including class deviations, normally do not apply to existing contracts unless those contracts are modified to incorporate the changes. In some cases, that requires a bilateral modification, and in all cases, the contractor can seek additional compensation insofar as a change affects its cost of performance. The DFARS class deviation clause was not in effect prior to April 9 and thus was not incorporated into any contract entered into before that date. Given the mandate from Congress, the White House, and DoD leadership to maintain the Defense Industrial Base and provide relief to contractors, and clear direction from ADP, DP&C to apply DFARS 231.205-79 to existing contracts, this issue may prove to be academic and not one that limits the ability of contractors to recover costs. Nevertheless, it remains a best practice for contractors to memorialize their right to relief through contract modifications.

Closing

The biggest outstanding question surrounding the implementation of section 3610 concerns how civilian agencies will implement the law and address the increased costs that contractors experience as a result of the COVID-19 public health emergency. DoD has now provided relatively extensive guidance on the implementation of section 3610 for DoD contracts. That guidance addresses many of the thorny questions that the statutory language presented. The FAR Council, OMB, and the General Services Administration have lagged behind in issuing rules and guidance for civilian contracts, even though a greater percentage of employees under these contracts are likely idled as a result of the public health emergency.

We will continue to track these open questions and developments in this area. In the meantime, we encourage companies to consider the best practices that we described in this and prior advisories. It is critical for contractors and subcontractors to be mindful that neither section 3610 nor the DoD class deviation modifies any existing contracts or entitles a contractor to relief under any specific contract. Contractors and subcontractors should take affirmative steps to secure relief to address increased costs resulting from the COVID-19 public health emergency.

© Arnold & Porter Kaye Scholer LLP 2020 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.