B-163058 March 17, 1975

B-163058 March 17, 1975

(no digest)

The Honorable Thomas J. McIntyre, Chairman Subcommittee on Research and Development Committee on Armed Services United States Senate

Dear Mr. Chairman:

Your letter of January 7, 1975, asked us to review the legal implications of current practices of the Department of Defense (DOD) in tacitly or explicitly authorizing contractors to spend funds in excess of Government contractual liability, with the expectation on the part of the contractors of reimbursement either from subsequent year appropriations or through claims procedures. You further requested that the matter be considered by our staff and field offices, and that our findings be reported to you. By letter dated January 6, 1975, you also requested a report from DOD on this matter.

In an interim reply dated February 24, 1975, we indicated some of the potential legal consequences in a conceptual context, and said that we would reply further when we had accumulated relevant facts for the programs involved. Your subsequent letter, also dated February 24, asked us to conduct a detailed examination of pertinent contractor and DOD records and to report our findings, comments, and recommendations to you by March 14, 1975. For convenience of reference, pertinent portions of our February 24 letter will be repeated herein as appropriate.

The Assistant Secretary of Defense (Comptroller) has furnished us a copy of his February 24, 1975, report to you, which we have reviewed and considered in the preparation of these comments. The programs identified in the Assistant Secretary's report are as follows:

Estimated Contractor Commitments in Excess of Government liability ($ in millions) Program

(1) Navy/NATO Patrol Hydorfoil Missile Ship (PHM) None

(2) Air Force B-1 Advanced Strategic Bomber (B-1) 15.2

(3) Army Utility Tactical Transport Aircraft System (UTTAS) 21.6

(4) Army Advanced Attack Helicopter (AAH) 7.9

(5) Air Force A-10 Aircraft (A-10) 1.6

(6) Air Force Advanced Medium STOL Transport (AMST) 29.8

(7) Air Force Airborne Warning and Control System (AWACS) 11.4

(8) Air Force Advanced Airborne Command Post (AARNCP) 8.0

Pursuant to your request, we asked our Regional Offices to review the status of all major weapon systems in development within their respective areas. Our Regional personnel reviewed contract fund status reports, progress billing records, contract allotment histories, and other pertinent documentation available at the System Program Office (SPO) or Project Office for each system. In addition, for each of the eight programs listed above, we instructed the Regional Offices to interview contractor management and financial personnel. The results of our field investigation are summarized in Attachment 1 through 8 which are presented in the sequence of the programs listed above. In a very few cases, it was not possible to schedule interviews within the limited time available. We will proceed to conduct interviews in these cases as rapidly as possible and will issue a supplemental report in the event our findings differ significantly from the information contained herein.

Funds for the program in question are authorized and appropriated under the heading "Research, Development, Test, and Evaluations" (RDT&E). The governing legislation for Fiscal Year 1975 is Pub. L. No. 93-365, 88 Stat. 399 (DOD Appropriation Authorization Act) and Pub. L. No. 93-437, 88 Stat. 1212 (DOD Appropriation Act). The RDT&E appropriations are lump-sum appropriations for each of the military departments, available for obligation until June 30, 1976. Amounts authorized (title II, Pub. L. No. 93-365) and appropriated (title V, Pub. L. No. 93-437) are set forth below (in millions);

Authorization Appropriation

Army $1,878.397 $1,779.339

Navy 3,153.006 3,006.914

Air Force 3,389.517 3,274.360

Since the RDT&E appropriation is not a line-item appropriation, the amounts appropriated for each department as given above represent the only legally binding limits on RDT&E obligations except as may be otherwise specified in the appropriation act itself.

Amounts recommended for each of the eight programs, taken from the various committee reports, are set forth in the following table (in millions);

Program Authorization Appropriation

(1) PHM $ 15.7 $ 15.733

(2) B-1 454.973 444.973

(3) UTTAS 54.06 52.66

(4) AAH 60.8 60.78

(5) A-10 81.405 81.405

(6) AMST 55.8 55.8

(7) AWACS 219.7 210.0

(8) AARNCP 67.7 62.74

With a few exception, the contracts involved are cost-reimbursement contracts of the cost-plus-incentive-fee (CPIF) type. In this type of contract, a target cost and target fee are negotiated initially, along with a fee adjustment formula. The actual fee, determined after performance, depends on the relationship of total allowable costs to the target cost. See Armed Services Procurement Regulation (ASPR) Sec. 3- 405.4 (1974). The initial target estimates form the basis for recording obligations against the applicable appropriation for purposes of section 1311 of the Supplemental Appropriation Act of 1955, as amended, 31 U.S.C. Sec 200 (1970), which provides in part-

"(a) * * * no amount shall be recorded as an obligation of the Government of the United States unless it is supported by documentary evidence of-

"(1) a binding agreement in writing between the parties thereto, including Government agencies, in a manner and form and for a purpose authorized by law, executed before the expiration of the period of availability for obligation of the appropriation or fund concerned for specific goods to be delivered, real property to be purchased or leased, or work or services to be performed; * * *."

In brief, under the LOF clause, the contractor must notify the Contracting Officer in writing when he expects to incur costs within the next 60 days in excess of 75 percent of the total amount than allotted to the contract. If the Contracting Officer does not allot additional funds to the contract, the contractor is under no obligation to continue performance, and the Government is under no obligation to reimburse the contractor for costs incurred in excess of the total allotment. When and to the extent that the amount allotted to the contract is increased, any such excess costs shall be allowable "to the same extent as if such costs had been incurred after such increase in the amount allotted."

Cases involving the BOF clause before the Armed Services Board of Contract Appeals and the Court of Claims appear to support DOD's conclusion that, where the Government has strictly adhered to the terms of the contract, the contractor is not entitled to reimbursement for excess costs. Thus, reimbursement has been denied where the contractor failed to give timely notice of the overrun. General Electric Co. v. United States, 412 F.2d 1235 (Ct. Cl. 1969); Acme Precision Products, Inc., 61-1 BCA Para. 3051 (1961). Also, the notice must be given to the person with authority to act on it, i.e., the Contracting Officer. In Weinschel Engineering Co., Supra, the Board denied recovery where the contractor had continued to perform using its own funds after funds earmarked for the project had been exhausted, but failed to notify the Contracting Officer until after the overrun had been incurred, although other Government officials had knowledge of the overrun. The Board stated:

"* * * A contractor has no right to usurp the Government's prerogative to control the expenditure of public funds by violating the Limitation of Cost clause and continuing to incur costs after the funds 'earmarked' for the project have been exhausted." Id., at p. 17,236.

There are situations, however, where the contractor may be able to recover despite failure to comply with the LOF clause, for example, if the overrun was reasonably unforeseeable, General Electric Co. v. United States, 440 F.2d 420 (Ct. Cl. 1971), Magnavox Company, 74-1 BCA Para. 10495 (1974); or if the Government urged continuation of performance, Consolidated Electrodynamics Corp., 1963 BCA Para. 3806 (1963). In Thiokol Chemical Corp., 60-2 BCA Para. 2852 (1960), overrun costs were allowed despite noncompliance with the Limitation Clause where the Government had accepted and used the items involved (rocket motors) and where the Board found that the "Government here would never have permitted appellant to discontinue performance of the contract."

The fact that the Government has funded prior overruns will not alone be sufficient to override the Limitations clause. United Shoa Machinery Corp., 68-2 BCA Para. 7328 (1963). But prior funding was relevant in Clavits Ordnance, Divisions of Clavits Corp., 1962 BCA Para. 3330 (1962), and the contractor recovered where he had been assured by the Government that the overrun would be funded when new appropriations became available, the Board finding that the Government's actions constituted "constructive authorization" to proceed.

Our investigation indicated that contractors operating under the LOF clause had given timely notice of projected FY 1975 overruns. It further appears that the military department in each case has instructed the appropriate contractor that costs incurred in excess of the amounts allotted are incurred at the contractor's risk. The military departments have generally indicated to the contractors that sufficient funds would be requested in FY 1976 to provide reimbursement of any contractor-funded overruns, but that there can be no assurance that Congress will appropriate such funds. All contractors said they were aware of the risks involved in proceeding with company funds.

Our review of correspondence and interviews with contractor personnel revealed no instance of overt pressure by the Government to continue performance with company funds.

It should be noted however that all contractors emphasized that a consequences of interrupting performance for 2 or 3 months at the end of a fiscal year would be to increase the total cost of the contract. In one case, a Contracting Officer, in denying additional funds, pointed out that cost management would be "a most important factor" in evaluating contractor performance to determine the award of the production contract. Thus, while that Contracting Officer's statement is not incorrect, it could be construed, in the context in which it was made, an a subtle inducement to the Contractor to continue performance with company money.

It is apparent from the foregoing that a contractor's claim will depend on a series of complex factual interrelationships, to be developed through testimony at an adversary proceeding. The outcome of litigation, as DOD points out, is unpredictable. Based on the facts we have been available precedent would not appear to support recovery.

An additional possibility for the contractor would be to attempt to develop some form of quantum meruit claim (fair value of services rendered). We denied such a claim in B-176493, October 2, 1973, because the claim presented no basis for finding a contract "implied in fact" for the contractor-funded performance, and we pointed out that grounds for recovery did not exist where the contractor appeared to be acting as a "pure volunteer." A further problem is supporting such a claim would be to establish that the Government has benefited as a result of the contractor-funded performance. Contractor opinions in this respect were extremely varied and do not enable us to form a meaningful conclusion. The question of the existence and nature of such benefit in any given contract would probably be resolved only through litigation.

The LOGO clause (Attachment 10), used in most of the Air Force contracts under consideration, presents more difficulties. The clause, developed by the Air Force and not used to our knowledge by any other department, is designed to impose cost discipline on the contractor and to protect the Air Force against a contractor's being able to stop work on abort notice.

Under LOGO, a schedule of planned fiscal year allotments covering the period of performance is agreed upon at the outset of the contract. The allotment for each fiscal year is specifically made subject to the availability of funds. If the contractor believes that his total costs through any fiscal year will exceed the cumulative obligations through that fiscal year, he must notify the Contracting Officer in writing 16 months prior to the beginning of the fiscal year in which he expects to incur such costs. A significant difference between LOF and LOGO is that, under LOGO, unless the Government fails to timely allot an initial increment of a planned fiscal year allotment, or prospectively revises the funding plan downward, the limitation of Government liability "shall not be authority for the Contractor to cease or slow the performance of work" under the contract and "may not be used as the basis for extending schedules or otherwise altering performance" (Para. (g)) DOD apparently believes that this clause would protect the Government against having to reimburse the contractor for excess expenditures.

In a report to the Chairman, Preparedness Investigating Subcommittee, Senate Committee on Armed Services, entitled "Contractual Features and Related Matters in the AWACS Aircraft Program," B-163052, June 30, 1971, we cautioned that, if the parties are unsuccessful in accurately forecasting funding requirements, "the provisions of the [LOGO] clause could prove so financially burdensome on the contractor that they could constitute the seed for contract disputes."

To our knowledge, the LOGO clause has never been interpreted or discussed in a reported decision of any court or administrative body. Thus, there is no guidance to support definitive conclusions regarding a contractor's rights thereunder. We believe, however, that there is a substantial likelihood that the clause would not be interpreted as obligating the contractor to perform in any and all events.

There is ample precedent for a court's refusal to enforce a contract provision it deems "unreasonable" under a particular set of circumstances. As one example, under construction contracts, the Government frequently furnished the contractor with boring logs intended to indicate the presence or absence of subsurface water. Through the fault of no one, the logs are occasionally incorrect and the contractor incurs additional expenses in pumping and "dewatering" operations. The Court of Claims has consistently allowed claims for additional compensation in these circumstances, despite an express provision in the contract stating that the Government does not guarantee the accuracy of the boring logs. It has been held in a long line of cases that the exculpatory clauses cannot be given its "full literal reach" and does not relieve the Government of liability for changed conditions "as the broad language thereof would seem to indicate." United Contractors v. United States, 368 F.2d 585, 593 (Ct. Cl. 1966); Woodcrest Construction Company v. United States, 408 F.2d 405, 410 (Ct. Cl. 1959); Foster Construction C.A. & Williams Brothers Company v. United States, 435 F. 2d 873, 888 (Ct. Cl. 1970); Fattora Company v. Metropolitan Sewerage Commission of the County of Milwaukee, 454 F.2d 537, 542 (7th Cir. 1971). Thus, the mere fact that the contract places a risk on the contractor is not necessarily dispositive.

It is not inconceivable that the notification period (17 months) might be deemed unreasonable in certain cases, for example, where a contractor could establish that its accounting system precluded timely discovery of the overrun. There is also, in our opinion, considerable doubt over the contractor's obligation to continue performance if the Contracting Officer denies additional funds after timely notice. To obligate the contractor to perform in this situation would, in affect, give the contract the character of a fixed-price contract. As with the LOF situation, we discovered no instance of overt pressure to use or obligate company funds in excess of amounts allotted, but if DOD in interpreting LOGO to require performance even after funds have been denied, the concept would arguably be inapplicable since the "obligation" to perform would presumably arise under the contract.

In sum, there are many questions under LOGO still to be resolved, and it is impossible to predict the outcome of a claim in the absence of precedent. At the very least, however, we believe that recovery for excess expenditures where the Government, after timely notice, has refused to allot additional funds to the contract, cannot be categorically foreclosed.

As pointed out earlier, a primary goal of contract funding procedures is to prevent the overobligation of appropriated funds. The statutory restraints in this respect are Revised Statutes Sec. 3679, as amended, 32 U.S.C. Sec. 665 (1970) (the "Antideficiency Act"), and Revised Statutes Sec. 3732, as amended, 41 U.S.C. Sec. 11 (1970), set forth in part below:

"31 U.S.C. Sec 665(a):

"No officer or employee of the United States shall make or authorize an expenditure from or create or authorize an obligation under any appropriation or fund in excess of the amount available therein; nor shall any such officer or employee involve the Government in any contract or other obligation, for the payment of money for my purpose, in advance of appropriations made for such purpose, unless such contract or obligation is authorized by law."

"41 U.S.C. Sec. 11(a):

"No contract or purchase on behalf of the United States shall be made, unless the same is authorized by law or is under an appropriation adequate to its fulfillment, except in the Departments of the Army, Navy, and Air Force, for clothing, subsistence, forage, fuel, quarters, transportation, or medical and hospital supplies, which, however, shall not exceed the necessities of the current year."

Under DOD's approach of recording obligations for the instant contracts on a target price basis for purposes of 31 U.S.C. Sec. 200, described herein- above, the obligation so recorded would not exceed amounts made available for the contracts during FY 1975, and thus would not violate the above statutes. However, we do not believe that the recording of obligations is the sole factor relevant in assessing possible violation of 31 U.S.C. Sec. 656 and 41 U.S.C. Sec. 11. Thus, in 42 Comp. Gen. 272, 275 (1962), we stated with regard to the generally accepted purpose of these prohibitions:

"These statutes evidence a plain intent on the part of the Congress to prohibit executive officers, unless otherwise authorized by law, from making contracts involving the Government in obligations for expenditures or liabilities beyond those contemplated and authorized for the period of availability of and within the amount of the appropriation under which they are made; to keep all the departments of the Government, in the matter of incurring obligations for expenditures, within the limits and purposes of appropriations usually provided for conducting their lawful functions, and to prohibit any officer or employee of the Government from involving the Government in any contract or other obligation for the payment of money for any purpose, in advance of appropriations made for such purpose; * * *." (Emphasis added.)

The question arises, therefore, whether a Contracting Officer may "commit" the Government to reimburse a contractor in advance of appropriations becoming available in the next fiscal year. We have not objected to contracts entered into subject to the availability of appropriations in certain circumstances, as long as the contract made it unequivocally clear that no Government liability could arise until the appropriations became available. 21 Comp. Gen. 864 (1942); 39 Comp. Gen. 776 (1960), B-171798, August 18, 1971. In the present context, if it were clear through judicial precedent that a given course of conduct by the Government would give rise to a valid claim for reimbursement, we might conclude that such conduct constituted involvement of the Government in an obligation (although not in the "Sec. 200" sense) for the payment of money within the scope of the Antideficiency Act and hence would constitute a violation thereof. As indicated, we would require a clear line of judicial or quasi-judicial precedent to support such a finding. Since such precedent at present does not exist, we cannot conclude that the actions of the military departments with respect to the contracts here under consideration constitute a violation of the Antideficiency Act.

It appears that contractor funding in excess of contract allotments, or at least the potential exposure to such liability, is a problem inherent in the nature of research and development contracting in the framework of an inflationary economy. As long as these contracts are incrementally funded, there may be a point beyond which money to fund overruns is simply not available in any given fiscal year. Also, as many contractors emphasized, so as not to lose the company's competitive position, there is considerable impetus on the contractor to continue performance, even if it means assuming the risk of loss. Since all contractors agreed that interruption of performance could increase total cost, and since the projects involved are of major importance, the outright prohibition of contractor funding may not necessarily be desirable or feasible. Nevertheless, the practice obviously has an impact on congressional prerogatives, and we concur with the Assistant Secretary of Defense that it should not be encouraged.

In reviewing the Attachments to this letter, it must be noted that, where the "contractor funding" figures include noncancellable commitments, this indicates contractor exposure and not actual cash flow or contractor billings to the Government. This exposure is a potential liability that would be realized in the event the contract were terminated at the end of the fiscal year without additional funding. Even in such a case, the liability would be offset, at least in part, by termination costs, and would therefore not necessarily represent out-of-pocket expenditures on the part of the contractor.

Some of the attachments hereto contain business privileged information within the purview of 18 U.S.C. Sec. 1905 and are marked "COMPETITION SENSITIVE." Such information should be safeguarded to prevent release as public information.

Pursuant to the consent of Mr. Fine of your staff, we are furnishing a copy of this report to the Committee on Armed Services, House of Representatives. We plan to make no further distribution of this report unless you consent or publicly release its contents.