Winstar Brief

U.S. Government may be Monetarily Liable for Imminent (1) Capping of Executive Compensation; (2) Repeal of Restructuring Cost Recoupment; and (3) Mandatory Use of "Past Performance" as an Award Evaluation Factor

Pursuant to a pivotal U.S. Supreme Court ruling this week, the Government may be monetarily liable for recently enacted, and other imminent, legislative "constrictions" targeted against government contractors. Under Winstar, the government is liable for monetary damages when it enacts legislation, or promulgates regulations, which have the "effect" of voiding, impairing, or changing existing contracts or business agreements. Imminent passage of either (1) the Senate version of the FY `97 DoD Authorization bill, which contains an amendment to cap executive compensation at $200,000 for all (not just DoD) government contracts; or (2) the House-passed FY `97 DoD Appropriations bill, which includes a provision that would repeal contractor recoupment of restructuring costs incurred since August 15, 1994, will do just that. This is in addition to the devastating adverse "effect" of recently enacted statutory requirements for "past performance" evaluations in all significant competitions to contractors who "bought in" to fixed-price development contracts. Consequently, Congress' recently enacted, and imminent, mandates are a prerogative for which DoD will pay dearly. However, understanding that customer goodwill is the contractor's "stock in trade," contractors must assist their customers in profitably restructuring existing contracts that have been, or will immediately be, detrimentally impacted by these legislative "constrictors." Crafting Divisional, Sector-wide, and Corporate strategies will enable contractors at all tiers to exhaust discrete, controllable options prior to judicial enforcement. Because of the far-reaching impact on corporate policy, finance, contracts and legal, existing production, and diminished new business capture, we are directing this Briefing Paper to you. Our belief is that existing contracts are the assets from which (1) strategies must be crafted; (2) government "inducements" must be factually reconstructed; and (3) vehicles must be harnessed to persuade customers to replace contractor losses by "investing" back into existing contracts. Time is of the essence to prepare "work around" solutions prior to Conference on the imminent legislation next week.

I. Congress has enacted legislation to repudiate the appearance of "favoritism" toward the defense community

Many of the recently enacted, and imminent, "reforms" are punitive or arbitrary in nature because they retroactively penalize contractors who reasonably relied on express government representations. Indeed, several legislative reforms are directed against all federal contractors, with severe detriment to commercial and non-commercial hardware and service contractors at all tiers. In repudiating the obligations of prior Congresses, and of previous Administrations, Congress has potentially caused the government to incur massive liability from injurious impact to contractors on existing contracts.

II. The government potentially will incur massive liability from amendments to the FY `97 Defense Authorization bill (if enacted into law after Conference next week)

Congress may incur liability if it enacts the executive compensation "cap" of $200,000 allocable to all federal contracts; or repeals contractor entitlement to all "restructuring costs" incurred after August 14, 1994 for business buy-outs or mergers. The executive compensation "cap" amendment is purportedly geared to "new contracts." However, its permanent extension, and broadened application to all federal contracts, will erode profit on existing contracts because it ignores vested compensation plans and employment contracts. Similarly, the proposed repeal of contractor entitlement to recoup restructuring costs back to 1994 will likely trigger a variety of litigation. Numerous contractors relied on restructuring "inducements" by Congress to accelerate and eliminate excess capacity, and negotiated downward forward-pricing-rate-agreements. Specifically, the DFARS Final Rule requires contractors to have removed such restructuring costs from billings, negotiated forward-pricing-rate-agreements to reflect projected savings to DoD, defend audits, and demonstrate net savings to DoD, before negotiating advance agreements to amortize or recoup incurred costs. Consequently, Congress has positioned itself to capture literally billions of dollars in savings, by disallowing billions of dollars in contractor restructuring costs, from industry bottom lines.

III. The government may also be liable for adverse "effects" from the recently enacted FASA and FARA

Certain aspects of FASA, such as mandatory evaluation of "past performance," possess grave consequences for the numerous contractors who "bought in" to developmental programs to gain competitive advantage for subsequent Full-Rate Production (FRP) competitions. Specifically, contractors who "bought in," with either customer consent or active encouragement, to fixed-price development programs did so for the opportunity to develop "technical discriminators" to win the eventual FRP competition. Statutorily imposed evaluation of past performance now retroactively penalizes prior "de facto" wholly funded R&D, such that many contractors are now eliminated from capturing the FRP award as a matter of law. Under Winstar, prior customer inducement to "invest" in a developmental program now constitutes breach of an "implied in fact" contract, rendering DoD liable for the monetary value of the original "buy in." Since as much as fifty percent of gross revenues flow through to subcontractors on major programs, it also has unsavory implications for existing teaming agreements and CRADAs. Even more ominously, it may also reduce shareholder value in recent mergers and acquisitions, because adverse past performance of the acquired entity will now taint the acquiring contractor in future competitions as a matter of law.

IV. STRATEGIES

We anticipate that contracting agencies and government lawyers will deny that their program personnel ever possessed "authority" to induce contractors. Therefore, meticulous detail must be given to factually reconstructing the collective pattern of inducement(s), prior to negotiating your resultant damages with Senior-Level Government Officials. Concurrently, strategies must be crafted from Divisional, Sector, and Corporate perspectives to maximize shareholder value by globally leveraging concessions, as opposed to inviting protracted piecemeal disputes. These include a host of fiscal and Anti-Deficiency Act issues, fiscal "color of money" issues, monetary impact assessments, subcontractor issues, pre-emption of unfounded audits and unilateral downward price adjustments, and selection of the most appropriate monetary and non-monetary vehicles, including judicial enforcement. Having anticipated such Congressional targeting, we have been coordinating the strategies and negotiations of similarly situated contractors. Please advise us if your management has an interest in exploring these options further.

This information is offered only for general informational and educational purposes. It is not offered as and does not constitute legal advice or legal opinions. You should not act or rely upon this information without seeking the advice of an attorney.

Last modified: May 2, 2001