Proposed DOD Regulation Puts Contractor Payments in Jeopardy

On January 15, 2010, the Department of Defense ("DoD") unveiled a proposal to amend the Defense Federal Acquisition Regulation Supplement ("DFARS") to require withholding of contractor payments for contractor failure to maintain "acceptable business systems."  Business systems covered by the new rule would include accounting systems, estimating systems, purchasing systems, earned value management systems (EVMS), material management and accounting systems (MMAS), and property management systems.

As a government contractor, you know when the Department of Defense ("DoD") enacts a new DFARS regulation, the entire Federal Government doesn't take long to follow suit with a comparable Federal Acquisitions Regulation ("FAR").  Recently, the DoD unveiled a proposal that would greatly impact the government contractor community, and in particular, small to medium-sized government contractors. 

The proposal, unveiled on January 15, 2010, is keynoted as follows:

"Contractor business systems and internal controls are the first line of defense against waste, fraud, and abuse. Weak control systems increase the risk of unallowable and unreasonable costs on Government contracts. To improve the effectiveness of  . . . oversight of contractor business systems, DoD is considering a  rule to clarify the definition and administration of contractor business systems . . ."

Business systems covered by the new rule would include:

 Accounting systems,
 Estimating systems,
 Purchasing systems,
 Earned value management systems (EVMS),
 Material management and accounting systems (MMAS), and
 Property management systems.

A new contract clause would require the Administrative Contracting Officer (ACO) to:

 ". . . immediately withhold ten percent of each of the Contractor's payments . . ." once the ACO makes a final determination that a business system contains deficiencies. 

The clause further specifies:

 ".  . if the ACO is withholding payments for deficiencies in more than one business system, the cumulative percentage of payments withheld shall not exceed fifty percent . . . if the ACO determines that there are one or more system deficiencies that are highly likely to lead to improper contract payments being made, or represent an unacceptable risk of loss to the Government, then the ACO will withhold up to one-hundred percent of payments until the ACO determines that the Contractor has corrected the deficiencies".

This clause would be required in solicitations and contracts when contemplating:

A cost-reimbursement, incentive type, time-and-materials, or labor-hour contract;
A fixed-price contract with progress payments made on the basis of costs incurred by the contractor or on a percentage or stage of completion;
A construction contract that includes the clause 52.232-27, Prompt Payment for Construction Contracts.  

While the proposed regulation relies in large part on existing guidance on determining adequacy of estimating systems, EVMS, MMAS and property management systems, new clauses are proposed that cover accounting systems and purchasing systems.  These new clauses greatly codify requirements that heretofore were matters of judgment and organizational style for many contractors.

Purchasing Systems

Another proposed clause, "Contractor purchasing system administration", describes a purchasing system as follows:

" . . the Contractor's system or systems for purchasing and subcontracting including make or buy decisions, the selection of vendors, analysis of quoted prices, negotiation of prices with vendors, placing and administering of orders, and expediting delivery of materials.."

Similar to the accounting system clause discussed to the right, the clause defines a deficiency as "a failure to maintain an element of an acceptable purchasing system" and provides another list of seventeen (17) "elements" of an acceptable system:

 
1.  Have an adequate system description including policies, procedures, and operating instructions that comply with the FAR and DFARS.

2.  Ensure that all applicable purchase orders and subcontracts contain all flow down clauses, including terms and conditions and any other clauses needed to carry out the requirements of the prime contract.

3.  Maintain an organization plan that establishes clear lines of authority and responsibility.

4.  Purchase orders are based on authorized requisitions and include complete history files.

5. Establish and maintain adequate documentation to provide a complete and accurate history of purchase transactions to support vendors selected and prices paid.

6. Apply a consistent make or buy policy that is in the best interest of the Government.

7. Use competitive sourcing to the maximum extent practicable and ensure debarred or suspended contractors are properly excluded from contract award.

8. Evaluate price, quality, delivery, technical capabilities, and financial capabilities of competing vendors.

9. Require management level justification and cost/price analysis as applicable for any sole or single source award.

10. Perform appropriate cost or price analysis and technical evaluation for each subcontractor and supplier proposal or quote.

11. Document negotiations in accordance with FAR 15.406-3.

12. Seek, take, and document appropriate purchase discounts, including cash discounts, trade discounts, quantity discounts, rebates, freight allowances, and company-wide volume discounts.

13. Ensure proper type of contract selection and prohibit issuance of cost-plus-a-percentage-of-cost subcontracts.

14. Maintain subcontract surveillance to ensure timely delivery of an acceptable product and procedures to notify the Government of potential subcontract problems that may impact delivery, quantity, or price.

15. Document and justify reasons for subcontract changes that affect cost or price.

16. Notify the Government of the award of an auditable subcontract and perform adequate audits of those subcontracts.

17. Enforce adequate policies on conflict of interest, gifts, and gratuities, including the requirements of the Anti-Kickback Act.
 
Important:  This pending change to requirements will surely place increased scrutiny on contractor business systems.  And, once this change is implemented, the consequences of non-compliance could be very serious.

ECC has teamed with JTH Consulting, LLC to offer a Special Series:  Helping Government Contractors Meet Today's Challenges.  This article is our first installment in the series of articles and upcoming training sessions.  Contact info@ecohencpas.com if you would like more information on the upcoming training session.