Appendix — Boeing Co., The v. United States, (2009) (No. 1302)

No.

In

Supreme Court, U.S.

P FILED -—

091302 APR 23 200

OFFICE

oh CE OF THE CLERK

upreme Court of the HAnited tates

°

THE BOEING COMPANY,

Petitioner,

Vv.

UNITED STATES OF AMERICA,

Respondent.

+

On Petition For A Writ Of Certiorari

To The United States Court Of Appeals

For The Federal Circuit

S

APPENDIX

VOLUME II

J. MICHAEL LUTTIG

Executive Vice President

& General Counsel

GRANT M. DIXTON

LYNDA GUILD SIMPSON

THE BOEING COMPANY

100 North Riverside

Chicago, IL 60606

(312) 544-2800

April 23, 2010

.

CHARLES J. COOPER

Counsel of Record

MICHAEL W. KIRK

HOWARD C. NIELSON, JR.

DAVID LEHN

COOPER AND KIRK, PLLC

1523 New Hampshire Ave., N.W.

Washington, D.C. 20036

(202) 220-9600

(202) 220-9601 (fax)

ccooper@cooperkirk.com

Counsel for

The Boeing Company

COCKLE LAW BRIEF PRINTING CO (800) 225-6964

OR CALL COLLECT (402) 342-2831

i

TABLE OF CONTENTS

Page

Appendix Documents

Volume |

McDonnell Douglas Corporation v. United States

(“MDC 14”), 567 F.3d 1340 (Fed. Cir. 2009)........... la

McDonnell Douglas Corporation v. United States

(“MDC 12”), 323 F.3d 1006 (Fed. Cir. 2003)......... 37a

McDonnell Douglas Corporation v. United States

(“MDC 10”), 182 F.3d 1319 (Fed. Cir. 1999)......... 74a

McDonnell Douglas Corporation v. United States

(“MDC 13”), 76 Fed. Cl. 385 (Ct. Cl. 2007)......... 106a

Volume II

McDonnell Douglas Corporation v. United States

(“MDC 11”), 50 Fed. Cl. 311 (Ct. Cl. 2001)......... 258a

McDonnell Douglas Corporation v. United States

(“MDC 9”), 40 Fed. Cl. 529 (Ct. Cl. 1998)............. 299a

McDonnell Douglas Corporation v. United States

(“MDC 5”), 37 Fed. Cl. 270 (Ct. Cl. 1996)........... 369a

McDonnell Douglas Corporation v. United States

(“MDC 4”), 35 Fed. Cl. 358 (Ct. Cl. 1996)............. 4lla

McDonnell Douglas Corporation v. United States,

Nos. 2007-5111, 5131 (Nov. 24, 2009)..........0..000... 462a

258a

MCDONNELL DOUGI.AS

CORPORATION AND GENERAT.

DYNAMICS CORPORATION, Plaintiffs, v.

UNITED STATES OF AMERICA, Defendant.

No. 91-1204 C

UNTITLED STALES COURT OF FEDERAT. CT.ATMS

50 Fed. Cl. 311; 2001 U.S. Claims LEXIS 171

August 31, 2001, Filed

COUNSEL: Caryl A. Potter, [I], Elizabeth A. Ferrell,

Roger K. Heidenreich, and Allyson B. Handler, Son-

nenschein, Nath & Rosenthal, Washington, D.C., and

St. Louis, Missouri, for plaintiff McDonnell Douglas

Corporation, with whom was John W. Walbran,

McDonnell Douglas Corporation, of counsel; Linda L.

Listrom, Gregory S. Gallopoulos, and David A. Chur-

chill, Jenner & Block, LLC, Chicago, Illinois and

Washington, D.C., for plaintiff General Dynamics.

Bryant G. Snee, Robert E. Kirschman, Jr., Patricia M.

McCarthy, Alan J. Lo Re, Eric J. Nestor, and David B.

Stinson, United States Department of Justice, Wash-

ington, D.C., for defendant, with whom was George P.

Williams, of counsel.

JUDGES: HODGES, Judge.

OPINION BY: HODGES

259a

OPINION

HODGES, Judge.

The issue in this case now is whether the Navy’s

unilateral modification establishing a new schedule

for first flight was reasonable. The schedule was in

place at termination, and it was specific. McDonnell

Douglas Corp. v. United States, 182 F.3d 1319, 1332

(Fed. Cir. 1999). If it was reasonable as well, the

Circuit’s finding that the Government’s decision to

terminate for default was performance-related will

require us to rule for defendant.

The unilateral schedule was reasonable. A Con-

tracting Officer acting with discretion rationally could

have determined that the contractors would not have

achieved first flight by December 1991. In considera-

tion of these factors, we dismiss plaintiffs’ complaint

and enter judyinent for the Government.

I. BACKGROUND

The Navy introduced a program in 1984 to devel-

op a carrier-based stealth aircraft known as the A-12.

The A-12 was a full-scale engineering and develop-

ment contract. McDonnell Douglas and General Dy-

namics contracted with the Navy in 1988 to produce

eight A-12 aircraft.' The Navy could purchase four

’ For a full factual background see McDonnell Douglas Corp.

v. United States, 35 Fed. Cl. 358 (1996) (see also McDonnell

Douglas Corp., 182 F.3d 1319 (Fed. Cir. 1999)).

260a

production lots of aircraft. It exercised this option in

May 1990. Each aircraft would test different char-

acteristics of the A-12. The eighth aircraft would

possess the stealth characteristics that would serve

as the basis for the optional production lots. The con-

tract schedule called for delivery of the first aircraft

in June 1990; the remaining aircraft were to be

delivered monthly through January 1991.

Plaintiffs experienced difficulties in perforimance

of this contract from the beginning. Delivery sched-

ules and aircraft weight growth were the primary

concerns. The contractors also were aware that their

costs likely would exceed the ceiling price in the con-

tract. Everyone knew in early 1990 that a June 1990

first flight could not be achieved. The Contracting

Officer asked the contractors for an estimate of when

the first aircraft would be delivered. Negotiations

ensued, but ultimately the Navy and the contractors

could not agree on a date. The Navy issued a uni-

lateral schedule modification on August 17, 1990. The

unilateral schedule for first flight was December 31,

1991.

The contractors asked the Navy for restructure of

the contract in November 1990. The Navy issued re-

ports during November that the Navy A-12 Program

Manager was unreasonable in his conclusion that the

contract could be completed within the specified ceil-

ing price, and he failed to anticipate greater risk in

the schedule. Secretary of Defense Cheney briefed the

President of the United States in early December. He

expressed disappointment with the Navy’s handling

26 1a

of the A-12 program and promised to take corrective

action. Thereafter, Secretary Cheney directed the

Deputy Secretary of Defense to report on the status of

the A-12 program within 10 days.

Secretary of the Navy Lawrence Garrett re-

sponded to Secretary Cheney’s request on December

12. Secretary Garrett was concerned about the con-

tractors’ willingness to complete the contract as it

was then structured. The Office of the Secretary of

Defense sent a memorandum to the Navy on Decem-

ber 14, directing the Navy to “show cause by January

4, 1991 why the Department should not terminate

the A-12 program and pursue other alternatives.”

At the direction of OSD, the Navy sent a cure

notice to the contractors on December 17. The Navy

asserted in the notice that the contractors “failed to

fabricate parts sufficient to permit final assembly in

time to meet the schedule for delivery of FSED air-

craft [and] failed to meet specification require-

ments... .”

The contractors responded to the cure notice

denying they were in default of the A-12 contract.

They asserted that the unilateral schedule was un-

enforceable and that the specifications were un-

achievable. The contractors also provided the Navy

with a “Proposal for Equitable Restructure of the A-12

Contract.” They requested the contract be restructured

262a

pursuant to Pub. L. No. 85-804." In return, they

would absorb a $1.5 billion fixed loss, the contract

would be restructured to a cost-reimbursement con-

tract, and they would waive their claims for equitable

adjustment. ‘he record indicates that the Under-

Secretary of Defense for Acquisition, Mr. Yockey, would

have been willing to go forward if the contractors had

agreed to accept a $2 billion loss and other con-

cessions.”

Rear Admiral William R. Morris was the Con-

tracting Officer at the time. He met with Under-

Secretary Yockey and Navy officials on January 4.

The Chief Engineer for the Navy reported at the

meeting that technical challenges on the A-12 were

typical for this type of development contract, and that

the contractors could resolve remaining technical

challenges. The Navy and the Joint Requirements

Oversight Council re-validated the operational re

quirements.

Secretary Cheney met with Secretary Garrett,

UnderSecretary Yockey, and the Chairman of the Joint

Chiefs of Staff on January 5 and decided not to grant

* Pub. L. No. 85-804 grants the President of the United

States the power to authorize agencies or departments to pro-

vide extraordinary relief if doing so would promote national de-

fense. See 50 U.S.C. § 1431 (1994). See also McDonnell Douglas

Corp., 182 F.3d at 1323.

* This sugvests that Mr. Yuockey at least, a major decision-

maker on the scene, did not lose confidence in plaintiffs’ exper-

tise but was only haggling over price.

263a

85-804 relief. Secretary Cheney understood that the

A-12 program would be cancelled as a result, but the

Navy would decide how and whether to terminate the

contract. Admiral Morris met with Mr. Yockey and

other Department of Defense officials on Sunday,

January 6. He terminated the contract for default the

next day.

Before then, Admiral Morris did not beheve that

85-804 relief was the only way to proceed with the

contract. He wanted the opportunity to work with the

contractors. Admiral Morris had not anticipated ter-

mination of the A-12 contract.

Admiral Morris testified that under Yockey’s

guidelines he was not able to do what he wanted to

do, which was to continue the contract. McDonnell!

Douglas Corp., 35 Fed. Cl. at 368 n.13. The termina.

tion letter stated that plaintiffs were being terminated

for “inability to complete the design, development,

fabrication, assembly and test of the A-12 aircraft

within the contract schedule and the Team’s inability

to deliver an aircraft that meets contract require:

ments.” /d. at 368. The letter stated,

the Team is in default of the contract for

having failed to make progress and not meet-

ing contract requirements. The A-12 aircraft

will not be delivered within the contract

schedule nor will it meet the weight guar-

anty contained within the contract specifi

cation.

264a

The contractors sued for relief on a number of

bases, and the parties agreed to litigate a potentially

dispositive issue first. That was Count 17, which

challenged the manner in which the Navy terminated

the contract for default. We ruled that the default

te1snination was improper because we found from tes-

timony and other evidence that Admiral Morris was

not permitted to exercise reasoned discretion. /d. at

375. We found that the termination for default was

not related to performance. Jd. at 377. The Navy was

the contracting agency, and it did not believe that the

contractors’ performance justified termination for de-

fault.

The Federal Circuit found that “the government’s

default te: mination was not pretextual or unrelated

to Contractors’ alleged inability to fulfill their obliga-

tions under the contract.” McDonnell Douglas Corp.,

182 F.3d at 1326. The Circuit’s opinion states that

“the government’s decision to terminate the A-12 FSD

Contract for default was related to contract perform-

ance....” Jd. at 1326-27. It directed us to determine

whether the contractors were in default of the A-12

contract. “[IJf the government can establish that

Contractors were in default, then the termination for

default would be valid. (citation omitted). Conversely,

if the government is not able to make this showing,

then the default termination was invalid... .” Jd. at

1329.

We tried this issue for 6 weeks in May and June

2001. The Government argued that it was not limited

to the bases for default found in the cure notice. That

265a

does not matter because the only reason for default

that can be sustained happens to be in the cure

notice: schedule. As noted above, plaintiffs would not

have met the December 1991 schedule, known as

P00046. We find that this schedule was reasonable.

Il. DISCUSSION

A. Schedule

The default notice issued on January 7, 1991

stated that termination of plaintiffs’ contract was

based in part on plaintiffs’ “inability to complete the

design, development, fabrication, assembly and test

of the A-12 aircraft within the contract schedule. . . .”

The Federal Circuit stated that Admiral Morris be-

lieved the contractors could not meet the delivery

schedule, and that he “believed [the] Contractors to

be in material breach of the contract.” McDonnell

Douglas Corp., 182 F.3d at 1327.

The schedule established by the Best and Final

Offer provided that the first FSED aircraft was due in

June 1990, and the remaining aircraft would be

delivered monthly through January 1991. The con-

tractors experienced problems in performance of the

contract from its inception, “namely controlling the

growth of the aircraft weight and meeting the con-

tract schedule.” McDonnell Douglas Corp., 35 Fed. Cl.

at 362. The Navy was aware in early 1990 that the

contractors would not meet the delivery date for the

first aircraft, but it took no action to terminate the

contract then. Jd. “When a due date has passed and

266a

the contract has not been terminated for default

within a reasonable time, the inference is created

that time is no longer of the essence so long as the

constructive election not to terminate continues and

the contractor proceeds with performance.” DeVito v.

United States, 188 Ct. Cl. 979, 413 F.2d 1147, 1154

(Ct. Cl. 1969). Defendant waived its right to ter:min-

ate plaintiffs for default based on the delivery sched-

ule set forth in the original agreement. It elected to

permit plaintiffs to continue working several months

past June 1990 and thereby surrendered its right to

tersninate for that reason. 413 F.2d at 1153.

The Navy issued contract modification P00046

unilaterally on August 17, 1990, setting first flight for

December 31, 1991. McDonnell Douglas Corp., 35

Fed. Cl. at 362. The Government seeks to uphold the

default termination on the ground that the contrac-

tors were not making progress toward the December

1991 first flight schedule. Plaintiffs argue that the

Navy’s unilateral schedule was unreasonable and

therefore unenforceable. If so, legally they could not

have been terminated on that ground. Alternatively,

they argue that the new schedule was waived.

The Government may terminate a contractor for

default based on failure to make progress toward

meeting an enforceable schedule. FAR 49.402-1(a).

For a unilateral schedule to be enforceable, the Gov-

ernment must follow certain procedures when estab-

lishing the new schedule. DeVito, 413 F.2d at 1154.

The time for performance must be “both reasonable

and specific from the standpoint of the performance

267a

capabilities of the contractor at the time the notice is

given.” Id.; see also International Tel. & Tel., etc. v.

United Staies, 206 Ct. Cl. 37, 509 F.2d 541, 549 (Ct. Cl.

1975). The reasonableness requirement in DeVito is

based on what the Government “knew or should have

known. ...” 177; 509 F.2d at 550. The burden is on

defendant to show that it “reestablished a new deliv-

ery schedule reasonable in the circumstances, upon a

failure to comply with which it properly based the

termination for default.” Jack Spires & Sons Elec-

trical Co. Inc., 1987 Eng. BCA LEXIS 58, 87-3 B.C.A.

(CCH) P20,069 at 101,627 (Aug. 10, 1987).

The contractors argue that Captain Elberfeld, the

Navy A-12 Program Manager, did not establish a

reasonable schedule.* According to plaintiffs, the uni-

lateral schedule was intended to serve as a “place-

holder” because it did not provide revised dates for

flight testing or contract completion. Moreover, plain-

tiffs contend that the Navy was aware that General

Dynamics was having trouble manufacturing com-

posite parts, and that the in-house system that

General Dynamics was using for schedule projections

was unreliable.

The contractors employed a “P/2” computer sys-

tem to create an internal manufacturing schedule.

* We have no evidence that the Contracting Officer took any

part in the issuance of P00046, or even had knowledge of it. No

one argued that this was an issue, however, so we do not address

it here.

268a

Plaintiffs argue that while the P/2 system did set

a first flight schedule, the system was not reliable.

Ii did not account for manufacturing problems or

unexpected technical issues, for example. Weight re-

duction efforts and porosity problems resulted in

increased complexity in the manufacture of composite

structures, according to plaintiffs. They point out that

the Navy did not rely on the contractors’ schedule.

Admiral Cook testified that by June 1990 the Navy

had lost confidence in the contractors’ ability to

predict the schedule.

The contractors contend that even the Navy’s

first flight projections were slipping to the right, and

that the Navy program office was projecting in

August 1990 that first flight could occur in February

1992. Commander Shields’ PERT system was show-

ing a first flight in February 1992 just three days

before the issuance of the unilateral schedule.°

“Microcracking” in certain large composite wing

parts known as “big ribs” was discovered just days

before the issuance of P00046 in August 1990. Plain-

tiffs complain that Captain Elberfeld knew about the

microcracking problem but did not take that into

account when he issued the unilateral schedule.

The contractors also argue that the unilateral sched-

ule was unreasonable because it required a fully

* PERT stands for Program Evaluation and Review Tech-

nique. Commander Shields was Captain Elberfeld’s scheduling

expert.

269a

specification-compliant aircraft within 16 '/2 months

and required delivery of the Lot I production aircraft

before the FSED test aircraft. They contend that

Captain Elberfeld did not rely on the best estimates

the Navy had to produce the unilateral schedule. The

contractors complain that the Navy knew or should

have known in August 1990 that first flight of De-

cember 31, 1991 was not achievable.

A series of events led to the issuance of P00046.

Captain Elberfeld testified that in June 1990 the con-

tractors were projecting first flight to occur between

July and September 1991. The Government under-

stood that it was not possible for the contractors to

deliver the first FSED aircraft in June 1990. Mr.

Lamers, the principal program manager for the

McDonnell Douglas and General Dynamics A-12

Team, provided information to Captain Elberfeld in

June 1990, estimating first flight in July 1991.

Captain Elberfeld testified that the contractors had

additional time built into the schedule — a buffer. The

contractors presented briefing slides to the Govern-

ment that were used to provide a schedule status.

The contractors’ slides stated that they had “frozen

aircraft number 1, configuration.” Captain Elberfeld

interpreted this to mean that no further design was

needed for aircraft number 1. The slides also indi-

cated that the contractors had factored in contin-

gencies in creating span times. That is, “how long it

may take to manufacture a part [and] how many tries

270a

it would take....” The contractors added time to

cover the unknowns. The Government considered the

contractors’ P/2 system to be a tool that was working

effectively to estimate the schedule, according to Cap-

tain Elberfeld.

The Government made a reasoned assessment to

deter:inine whether the contractors could achieve first

flight in July 1991. The Navy reviewed the contrac-

tors’ estimates and added an additional 25 percent for

slippage. The Government predicted first flight to

occur in November or December 1991. Shortly there-

after, Captain Elberfeld attended a meeting with

Secretary Cann. Secretary Cann instructed Captain

Elberfeld to get a handle on the schedule. Projected

first flight kept slipping to the right and Secretary

Cann wanted to know when the contractors would be

ready for first flight. Secretary Cann instructed

Captain Elberfeld to set a “schedule with sufficient

slack.”’ Captain Elberfeld testified that he inter-

preted Secretary Cann’s words to mean

don’t go out and try to be a big hero and

have a schedule to get somewhere that is not

* Captain Elberfeld testified that span times are used in

determining the overall flow of manufacturing in the factory.

They are the “amount of time it takes to perform a particular

task.”

’ The decision to issue a wnilateral schedule modification

did not originate with the Contracting Officer or even with

Captain Elberfeld. Neither was it the idea of his boss, Secretary

Cann. Very likely the direction came from Mr. Yockey, the Acting

Assistant Secretary of Defense for Acquisition.

271la

achievable. Make sure you build in the type

of contingency and buffer time that’s neces-

sary to ensure that in going forward in a

restructuring we’ve allocated enough time

that we don’t need to go back and restructure

and reschedule again. Give yourself the room

in this first restructuring, one bite at the

apple more or less.

The Navy wanted a reasonable schedule, not an un-

achievable one. The contractors and the Navy con-

vened a strategy board to put together a realistic

schedule for first flight. Captain Elberfeld testified

that while the Navy could not achieve a “signed-up

commitment” from the contractors, he felt that they

were “moving in the right direction.” At the meeting,

the contractors agreed to work toward an aggressive

plan but they would not sign up to a schedule. Cap-

tain Elberfeld felt that most of the technical issues

affecting first flight were under control. He developed

a delivery schedule for first flight that “was meant to

be ... realistic [and] achievable.” He stated, “with all

the information we had at the time, it was an achiev-

able schedule.”

Captain Elberfeld felt that setting a unilateral

schedule was the appropriate approach because

If you don’t have a delivery schedule

that’s realistic, you’re just sort of drifting and

any schedule that — any type of an interim

schedule that you’re planning to use along

the line doesn’t have any of the weight of

contractual force behind it. It ends up being

sort of a rubber or elastic schedule and can

272a

just move to fit the events that are taking

place. Instead of trying to manage the pro-

gram, you end up being run by events

instead of proactively managing them.

Captain Elberfeld wanted a schedule that both the

contractors and the Navy felt was one they could use

to manage the program. During this period, the con-

tractors were proposing July-September 1991 for first

flight.

John Lamers, plaintiffs’ A-12 Program Manager,

spoke with Captain Elberfeld on August 14 about

problems with microcracking. Mr. Lamers told Cap-

tain Elberfeld that it could be a tooling or cure cycle

problem and that the contractors were in the process

of finding a solution. Captain Elberfeld testified that

Mr. Lamers did not seem concerned and the micro-

cracking was just one among several items he men-

tioned. Captain Elberfeld considered this problem but

decided not to change his mind about setting the

unilateral schedule for first flight for December 1991.

He felt that the contractors had identified the problem

and were working to fix it. He knew that contingen-

cies and conservatism were built into the unilateral

schedule, and he made a reasoned decision not to

adjust the December deadline. He felt that the buf-

fer was adequate to address the problems that the

contractors were experiencing. At this time, the

contractors were predicting first flight to occur before

December 1991. Mr. Lamers testified that the con-

tractors were “showing somewhere between September

273a

and November 1991” for first flight at the Design

Review Board in September 1990.

It is likely that the December 1991 date was first

mentioned by Commander Shields, Captain Elberfeld’s

scheduling expert. In any event, Captain Elberfeld

consulted with Commander Shields before he issued

P00046. Commander Shields was the Production

Readiness Officer on Captain Elberfeld’s team. One of

Commander Shields’ responsibilities was to develop

schedule estimates for the Navy. He provided Captain

Elberfeld information needed to update the schedule.

Inforination was derived from different people within

the Navy, as well as input from the contractors. Cap-

tain Elberfeld attended a meeting with Commander

Shields and others on August 14. Commander Shields

reported an inner wing problem that could lead to a

February 1992 first flight if nothing were done to

correct it. He also reported that a five-day work week

would lead to an April first flight. The contractors

were working six days a week at the time, however,

and in Captain Elberfeld’s words, there “may have

been some coverage in the overall plan for [the inner

wing issues] ... already.” The Navy started with the

information given to them by the contractors to

predict a reasonable first flight date. The Navy looked

at the contractors’ past history, evidence of progress

on the contract, estimates of delivery dates on tooling,

estimates on composite part fabrication, and the

274a

“number of parts off a tool” to create a government

estimate of first flight.”

It is important to note that once given his orders

to develop a unilateral first flight schedule, Captain

Elberfeld went about his mission in a thorough and

comprehensive manner. He did not merely accept Mr.

Lamers’ optimistic projections on behalf of the con-

tractors. He investigated the computer software that

plaintiffs were using to estimate schedules in house.

Mr. Lamers provided an explanation of his July 1991

first flight estimates by category. He noted that the

Contractors were including one month for “contin-

gency” and three months for “conservatism.”

The original contract terms required the con-

tractors to begin delivery of the Lot 1 aircraft in June

1991. POOO46 did not change the Lot 1 delivery

schedule. This meant that delivery of the first produc-

tion aircraft was required before delivery of the first

test aircraft. Captain Elberfeld testified that the

unilateral schedule did not establish a schedule for

contract completion. Captain Elberfeld conceded that

it made no sense and was not intended. The Govern-

ment did not expect the Lot 1 aircraft to be delivered

prior to the FSED aircraft. PO0O046 was intended to

set the schedule for first flight, not completion of the

contract.

* “Number of parts off a tool” refers to the number of times

it takes a contractor to manufacture a good part.

275a

The unilateral schedule was reasonable. Captain

Elberfeld relied on input from Commander Shields as

well as overall test plans made by his flight test

deputy, Colonel Nyalko. Plaintiffs argued at trial

that Captain Elberfeld did not consider Commander

Shields’ first flight estimates. However, Captain

Elberfeld knew of Commander Shields’ estimates. He

knew that the dates were flexible; they could slip to

the right or to the left. Commander Shields’ dates

were based on the assumption that nothing would be

done about the problems. Commander Shields made

hundreds of projected first flight estimates, all depen-

dent on different assumptions. His job was to be pes-

simistic.” But Captain Elberfeld obtained information

from the contractors as well. The Navy wanted to set

a schedule that the contractors could meet. Captain

Elberfeld set a schedule that took into account the

critical information that he had at the time.”

The contractors concede that they were not going

to make the December 1991 first flight. Default may

be sustained on this ground.

B. Schedule Waiver

Plaintiffs contend that even if the unilateral sched-

ule was reasonable, it was waived. This is important

* Plaintiffs did not call] Commander Shields as a witness at

trial.

’* Mr. Anderson, a contractor executive, acknowledged that

reasonable minds could disagree on a reasonable schedule in

these circumstances.

276a

because we have found that the schedule was

reasonable and that plaintiffs would not have met it.

According to plaintiffs, the Navy knew that the con-

tractors were targeting a March 1992 first flight date.

Plaintiffs point to a presentation by Captain Elber-

feld and Captain Currie at the Tailhook Convention

in September 1990, where they announced that first

flight would occur in the first quarter of 1992. More-

over, in preparation for a meeting of the Defense

Acquisition Board, Captain Elberfeld told the con-

tractors to assume a March 1992 first flight date.

According to the contractors, that is the date the

Navy expected first flight; not December 1991. The

contractors briefed the March 1992 first flight to the

Navy and to officials in the OSD office in November

1990. The contractors told the Conventional Systems

Committee in late November 1990 that a March 1992

first flight was projected. ‘he contractors assert that

they heard no objection to the March date, and relied

on statements made during the Tailhook Convention

and those of Captain Elberfeld. They continued to

perform the contract with the March 1992 date in

mind. Plaintiffs quote Admiral Johnson as stating

that the Navy would have accepted a June or even a

September first flight.'' These communications estab-

lish that PO0046 was waived, according to plaintiffs.

" This statement is true. The Navy would have accepted

dates well beyond the March 1992 projection. Admiral Johnson

was a highly credible witness and we apree that the Navy would

have been satisfied with a September 1992 first flight. In fact,

(Continued on following paye)

2774

Captain Elberfeld testified that he briefed the

Tailhook Convention on a first flight date of Septem-

ber 1992 “because of the security nature of the pro-

gram, and ... [to] not put in something overly

optimistic ... and making sure that [the aviators]

wouldn’t be disappointed [if first flight weren’t

achieved].” His statements were not intended to be

a waiver of the December 1991 first flight date.

He testified that a March 1992 first flight) was

“acceptable for a planning date, in going forward to

the Defense Acquisition Board, for the purpose of

baseline-rebaselining the program.” It is true that

Captain Elberfeld told the contractors to assume a

March 1992 first flight in preparation for a meeting of

the Defense Acquisition Board. However, the parties

were negotiating a restructured program at the time,

and that assumption was contingent upon a restruc

tured program.

we have no doubt that the Navy was satisfied with the entire

program, if somewhat frustrated with the contractors’ pace. But

the Circuit makes the point that the Government docs not relin

quish its right to terminate a contract merely because in this

case the Navy wanted the plane. We agree. The Navy's desire to

continue the contract was meant to be support for our finding

that Admiral Morris was not peruitted to exercise discretion in

deciding whether to terminate the contract and to terminate it

for default. Termination for default is a very serious sanction

that rarely is applied by the Government) These were corpora-

tions that have a history of participation in successful and

highly sensitive weapons development projects with the United

States.

278a

In any event, a key element of waiver is reliance.

We saw no evidence that the contractors relied on a

March flight deadline to their detriment. They were

obligated by contract to perform regardless of the

schedule.

C. Financial Ability

Defendant argued in its opening statement that

the only possible way to save the A-12 program was to

place additional funds into the program or into the

contract. There were only two sources from which the

money could have come, the Government or the con-

tractors. The Government chose not to put additional

funds into the contract, and the contractors did not

have the money, according to defendant. It is de-

fendant’s position that the contractors were legally

obligated to complete the contract, but “didn’t have

the funds to do so.”

The Federal Circuit expressed its view that “[t]he

cost to complete a contract — more particularly, the

inability of a contractor to perform a contract at the

specified contract price — and the ability to meet a

contract schedule are both fundamental elements of

government contracts and are related to contract per-

formance; as such, they are highly relevant to the

question of default,” McDonnell Douglas Corp., 182

F.3d at 1328. When terminating a contract for default

the Contracting Officer is required to “give the

contractor written notice specifying the failure and

providing a period of 10 days... in which to cure the

279a

failure.” FAR 49.402-3. Case law has broadened the

scope of this standard. The cure notice “need not cite

each and every failure, but it must list with enough

particularity the performance failures which have

placed the contractor in danger of termination for

default.” Composite Laminates, Inc. v. United States,

27 Fed. Cl. 310, 318 (1992) (quoting IJnternational

Verbatim Reporters, Inc. v. United States, 9 Cl. Ct.

710, 721 (1986)). “Where the plaintiff has received

prior notice of its failures, whether by telephone,

letter, or word of mouth, that information will be con-

sidered properly in conjunction with the cure notice.”

Id.

The termination letter issued by the

Navy on January 7, 1991 states that it was

terminating for default because of the Team’s

inability to complete the design, develop-

ment, fabrication, assembly and test of the

A-12 aircraft within the contract schedule

and the Team’s inability to deliver an aircraft

that meets contract requirements.... The

Team is in default of the contract for having

failed to make progress and not meeting con-

tract requirements. The A-12 aircraft will not

be delivered within the contract schedule nor

will it meet the weight guaranty contained

within the contract specification.

Neither the cure notice nor the default notice sug-

gests that the Navy thought the contractors were

280a

financially unable to complete the contract.” Admiral

Morris did not consider plaintiffs’ financial condition

when deciding to terininate the contract for default.

Admiral Morris testified that he “was not in a posi-

tion on the basis of the infos:nation [he had] to judge

the seriousness of the financial situation of either

firm. ...” He believed that problems could be solved

“within the four corners of the contract.”

At trial, the Government focused its attention on

McDonnell Douglas’ alleged financial inability. McDon-

nell Douglas’ financial capacity did not endanger

perfo:inance on the A-12 contract, however. The Gov-

ernment was provided periodic reports by the Defense

Contract Audit Agency (DCAA). The DCAA was

charged with auditing contractors’ financial status

to determine whether adverse financial conditions

existed that could jeopardize contract perfo:imance.

The DCAA concluded in September 1990 that “MDC

financial capability is weak when compared to in-

dustry standards. However, we do not believe that

contract performance is endangered.” The DCAA

audited McDonnell Douglas again in November 1990

and made the same finding that performance was

not endangered. The final DCAA audit occurred in

December 1990 with the same result. Contract per-

formance was not endangered.

" We held to the contrary, in fact. “The Contracting Officer

did not believe that the contractors would not perforiu:; he wanted

to continue the contract and address the issues without extraor-

dinary relief.”

28la

The Government called Mr. Neuman, a senior

price analyst who was the person primarily responsi-

ble for assessing the financial condition of McDonnell

Douglas during the contract period. He testified that

McDonnell Douglas’ cash flow situation was “almost a

financial crisis. ...” However, Mr. Neuman conceded

that he did not speak to Admiral Morris about the

financial condition of McDonnell Douglas prior to ter-

mination of the A-12 contract. In fact, his office was

not even consulted before the termination occurred.

He was not involved in the issuance of the cure

notice. He admitted that McDonnell Douglas was a

viable corporate entity and at all times its available

financing exceeded the amount of debt that it needed

to perform its obligations. McDonnell Douglas took

a number of steps to conserve cash. It participated

in an inventory reduction program, curtailed capital

expenditures, reduced data processing costs, cut share-

holder dividends, and sold real estate. Mr. Neuman

testified that none of McDonnell Douglas’ government

contracts were affected by its financial condition.

The Government presented evidence only with

respect to McDonnell Douglas’ financial position. It

did not determine whether General Dynamics had

the financial ability to complete the contract. Eleanor

Spector, Deputy Assistant Secretary of Defense for

procurement, testified that her “general feeling” was

that the contract could not continue without relief

under Public Law 85-804. But she conceded that in

determining financial ability one must consider both

contractors because the A-12 contract made them

282a

jointly and severally liable. The Government did not

perform this analysis. Ms. Spector testified that she

did not have enough data before termination to

determine how much cash McDonnell Douglas would

have needed to continue performance. She was not

aware of the borrowing capabilities of either cor-

poration prior to termination. She did not speak to

Admiral Morris about terminating the contract for

default. Ms. Spector’s office did not assess whether

McDonnell Douglas’ financial condition was contrib-

uting to a failure to make progress on the A-12

contract. Ms. Spector stated that the reasons for the

default termination were Admiral Morris’ and the

reasons that the program would not continue “was

wrapped up in a lot of other things.”

Evidence at trial established that plaintiffs’ fi-

nancial ability was not a concern of Admiral Morris.

He did not terminate this contract for financial in-

ability of the contractors because as he testified, he

was not in a position to judge their financial where-

withal. Moreover, plaintiffs’ financial condition was

not endangering performance of the A-12 contract.

Plaintiffs’ default termination may not be sustained

on this ground.

D. Repudiation

The Government contends that the default ter-

mination was proper because of the contractors’

“failure to provide adequate assurances that [they

had] the financial capability to perform the contract

283a

constitutes repudiation of the contract.” We ruled in

April 1996 that the contractors did not repudiate the

A-12 contract. McDonnell Douglas Corp., 35 Fed. Cl.

at 377. We stated that a contracting officer may

terminate a contract for default when the contractor

has expressed a “positive, definite, unconditional, and

unequivocal manifestation of intent ... not to render

the promised performance when the time fixed . .. by

the contract shall arrive....” ld. (quoting Cascade

Pac. Int'l v. United States, 773 F.2d 287, 293 (Fed. Cir.

1985)) (quoted in United States v. Dekonty Corp., 922

F.2d 826, 828 (Fed. Cir. 1991)). The contractors did

not fail to provide adequate assurances. The Govern-

ment did not view the contractors’ actions in this

manner. Jd. Admiral Morris did not believe that the

contractors would not perform. He wanted the oppor-

tunity to work out the problems “within the four

corners of the contract.”

Defendant argued in its post-trial brief that since

our ruling in April 1996, “the Federal Circuit has

clarified its adoption of the modern view that, in

addition to traditional forms of repudiation ... a con-

tractor’s failure to provide adequate assurances that

it has the financial capability to perform the contract

constitutes repudiation of the contract.” The Govern-

ment quotes the contractors as stating that they

“can’t get there if we don’t change the contract ... it

has got to get reformed to a cost type contract or we

cannot do it.” The contractors stated that they “could

not absorb the loss that would result from the

contract.” Defendant argues that these statements

284a

coupled with the contractors’ conduct, prove that they

would not have been able to complete the contract.

Defendant cites Danzig v. AEC Corp., 224 F.3d 1333

(Fed. Cir. 2000) for the modern rule on repudiation.

In Danzig, the Navy awarded a contract to AFC to

complete construction of a Naval and Marine Corps

Reserve Training Center. AFC fell behind and the

Navy issued a cure notice. At a subsequent meeting

with the contractors, AEC proposed a completion date

of April 16, 1991. The Navy agreed not to terminate

the contract for default if AEC continued to make pro-

gress toward that schedule. AFC submitted another

revised schedule of April 26, 1991. Navy accepted this

schedule. The project continued to progress slowly

and AKC informed the Navy that it was unable to

make progress because its surety had frozen its bank

account. The Navy issued a cure notice stating that

AEC needed to complete the work by the agreed

schedule. AEC responded by explaining that the work

would not be complete by the April deadline. Due to

financial constraints with its surety AEC could not

predict when the project would be completed. Unless

the surety released funds, AEC stated that “it is doubt-

ful that AEC will ever be able to complete the project.”

The Navy responded by asking AEC to provide another

detailed response. AFC again stated that it “cannot

cure the deficiency ... we cannot. give you any assur-

ance as to when the project will be completed.” The

Navy issued a show cause letter to AEC asking why

the contract should not be terminated for default.

AEC never responded to this request, and on April 22,

1991 the contract was terminated for default.

285a

The Federal Circuit reasoned that the termina-

tion for default was proper because AEC “failed to

give the Navy adequate assurances that it could

complete the contract on a timely basis or even that it

could continue to make progress toward completion.”

Danzig, 224 F.3d at 1337. The Federal Circuit noted

that AFC “removed the contract files and office equip-

ment from the work site and disconnected the tele-

phone at the work-site office.” /d. at 1339. AEC’s

conduct, coupled with its responses did not provide

the Navy with assurance that the project would be

completed. While AEC asserted that the Government

was at fault for some delay, it did not explain why

this caused slow progress. /d. For all these reasons,

the Federal Circuit concluded that AFC had breached

the contract.

None of those facts is present here. In response to

the cure notice issued by the Navy, the contractors

stated that they were committed to the program and

were providing a response to the concerns raised by

Admiral Morris. The contractors addressed Admiral

Morris’ cure letter and provided additiona! informa-

tion about the progress of the program. Certain

specifications and delivery schedules would not be

met, but the contractors explained why this was so.

They alleged that certain requirements were impossi-

ble to satisfy, for example. Unlike AEC, McDonnell

Douglas and General Dynamics continued to perform

until they were terminated for default. They were

spending between $ 120 and $ 150 million per month

on the A-12 contract.

286a

Ms. Spector testified that the contractors never

refused to perform. The contractors spent money

other than that provided by the Government through

progress payments. Admiral Morris testified that

McDonnell Douglas wanted to solve the problems

within the contract. He believed that it was possible

to work with the contractors to find a solution. “The

contracting officer did not believe that the contractors

would not perform; he wanted to continue the con-

tract and address the issues with the contractors

without extraordinary relief.” McDonnell Douglas

Corp., 35 Fed. Cl. at 377. Admiral Moi:is did not view

the contractors’ response to the cure notice as failing

to provide adequate assurances.

The Government points to the contractors’ request

for equitable restructure of the A-12 contract as evi-

dence that their financial situation would not permit

the contractors to complete this contract. The pro-

posal for restructure was not a response to the cure

notice. It was a request for financial assistance. It

was not included with the cure notice response but

was a separate document with a separate cover sheet.

Admiral Morris took notes at a January 2, 1991

meeting with the contractors. He records Mr. Anders,

Chairinan-Elect of General Dynamics, as stating,

“(bloth companies committed.” Yockey agreed that

contractors were “mov[ing] in the right direction.”

Failure to give adequate assurances does not appear

in the termination notice as a ground for default.

While the contractors wanted a restructured program

they did not state they would suspend work on the

287a

A-12 contract. John McDonnell, CEO of McDonnell

Douglas, testified that the contractors “weren’t about

to abandon [the A-12 contract].” Admiral Morris testi-

fied that he “would not have terminated the contract

on the 7th of January if I got the authority to give it

one more try.”

Plaintiffs did not repudiate this contract. Admiral

Morris did not terininate the A-12 contract because

the contractors did not give adequate assurances.

Default may not be sustained on this ground.

E. Weight

The termination notice includes the assertion that

the contractors’ inability to meet the weight guaranty

was a reason for default. The original weight specifi-

cation was waived by the Navy. We ruled that 7930

pounds over BAFO was acceptable to the Govern-

ment. McDonnell Douglas, 35 Fed. Cl. at 362 If the

parties argued this holding on appeal, the Circuit did

not address it.

Waiver requires that (1) the Government has

knowledge of performance that does not conform with

contract requirements; (2) the Government through

action or inaction indicates that the nonconforming

performance is acceptable; and (3) the contractor re-

lies on the acceptance and continues to perform the

contract. Gresham & Co., Inc. v. United States, 200

Ct. Cl. 97, 470 F.2d 542, 553-55 (Ct. Cl. 1972); DeVito,

413 F.2d at 1153-54.

288a

Defendant accepted the overweight condition of

the aircraft. McDonnell Douglas, 35 Fed. Cl. at 373."

The Navy knew in September 1989 that the contrac-

tors would not meet the BAFO weight requirement.

Id. The Navy encouraged the contractors in October

1989 to “stop worrying about weight and to focus on

manufacture and assembly” of the aircraft. Jd. In

May 1990, the Navy determined that the A-12 air-

craft weight would be 7930 pounds over BAFO. /d.

The Navy knew that the original predicted weight

was unachievable. Jd. The Contractors notified the

Navy in a June 1990 letter that the BAFO estimate

would not be met, and asked that the contract be

revised. Id. We held that the letter “doctrments the

contractors’ belief that the BAFO weight had been

waived.” Jd. The Navy was only concerned that it re-

ceive an aircraft that met its operational needs. Jd.

The Navy knew that the weight of the aircraft

was 7930 pounds over BAFO. The contractors con-

tinued to perform. The weight specification in the

contract was waived.

F. Other Specifications

The Government asserted at trial that the con-

tractors were in default of specifications not identified

in the cure notice or the default notice. This includes

PA Roll, the Propulsion System, and Structural

* See McDonnell Douglas, 35 Fed. Cl. at 373, fur a complete

set of factual findings.

289a

Certification. The propulsion system includes three

components: the air inlet, the engine, and the exhaust

nozzle. PA Roll is power approach roll, which refers to

the aircraft’s ability to roll its wings as it approaches

a carrier for landing. The Government also refers to

“substantial and continuous” delay by the contrac-

tors, which they assert was present throughout the

life of the A-12 contract. The Government contends

that these alleged problems endangered successful

completion of the A-12 contract.

The default notice states vaguely that the con-

tractors’ “inability to deliver an aircraft that meets

contract requirements” is a basis for default. Admiral

Morris did not terminate this contract for the con-

tractors’ inability to meet the PA Roll, the Propulsion

System, or Structural Certification. He did not even

consult with technical personnel before termination.

McDonnell Douglas Corp., 35 Fed. Cl. at 368.

More importantly, plaintiffs were not in default of

these specifications. The contractors’ Chief Engineer,

Dr. Keith Jackson testified that PA Roll met the

original contract specification. Dr. Jackson briefed

Admiral Gentz on the risk reduction efforts that the

contractors had taken with respect to PA Roll. These

efforts had the potential to improve the A-12’s roll

performance beyond that required in the contract

specifications. General Dynamics’ project pilot for the

A-12 program, Mr. Sweeney, believed that PA Roll

performance was within the specification. He believed

that the A-12 PA Roll performance would be carrier

suitable.

290a

The Contractors were inaking progress with re-

spect to the A-12 propulsion system. Mr. Squires, the

Government's A-12 Project Engineer on the pro-

pulsion system, testified that he was unaware of

termination concerns with respect to propulsion is-

sues. He testified that “|termination}] caught [him)

totally by surprise.” The Navy was aware that in sub-

freezing conditions ice could break off from the

aircraft inlet and strike the engine. The contractors

were not required to perfect anti-icing until aircraft

11. The FSED aircraft that was scheduled to fly in

December 1991 did not require the anti-icing proce-

dures. Admiral Cook agreed that the contractors had

successfully completed the Critical Design Review in

1989 on the engine. Technical risks associated with

the engine were regarded as low at termination. ‘The

contractors were solving problems with the engine

mixer. Admiral Cook reported to UnderSecretary

Yockey that resolution of the mixer problem was a

“low-tech fix.” The contractors were making progress

on the development and testing of the exhaust nozzle.

The contractors were performing tests on the nozzle

and additional testing was planned. The contractors’

problem with nozzle development was not a “show-

stopper.”

The Government contends that structural! certifi-

cation of the A-12 aircraft was another requirement

29148

that the Contractors were not meeting at termina-

tion.” However, Admiral Lockard sent. a memoran-

dum to Admiral Gentz in November 1990 reporting

that “the A-12 structural certification plan has been

agreed to by [the Navy! and the contractors. ”

Admiral Cook’s briefing to Secretary Yockey just be-

fore termination rated the overall structure status as

“low/medium risk.”

The contractors had a plan in place and they

were making progress with regard to structural

certification,

The Government cites 63 other specifications that

the contractors were failing to meet at the time of

termination. The contractors identified the 63 speci-

fications in July 1990, and the Navy elected to po

forward with the contract. The Navy did not ter-

minate the contract then. At Critical Design Review

IH (CDR ID) on October 18, 1990, Admiral Lockard

announced that the parties had “reached a technical

resolution on the airplane.” Admiral Lockard belheved

that the path to successful close out of CDR TT was in

place and “if both parties agreed to follow the path

we would ... wind up concluding CDR with

successful results.””” Soon after termination of the

* Structural certification is the process of conmfirmunp that

an aireraft is capable of withstanding loads and stresses during:

aircraft operation

“The Government contends that because the minutes of

CDR HI were not signed it was never closed out. Irrespective of

(Continued on following paye)

292a

A-12 contract for default, Admiral Cook responded to

a draft report of the Inspector General of the Depart-

ment of Defense as follows:

[While there were a number of technical

concerns identified during the third phase of

the CDR ... none were viewed as insur-

mountable. In fact, in the ensuing months

(July to November) all issues were resolved

to the satisfaction of the Navy’s technical

community.

We ruled that “the Navy believed that the aircraft

would meet operational requirements.” McDonnell

Douglas Corp., 35 Fed. Cl. at 371. The contractors

were not terminated for failure to meet these 63

requirements. The technical issues were resolved to

the satisfaction of the Navy. Default may not be sus-

tained on this ground.

Ill, CON TRACTORS’ DEFENSES

A. Superior Knowledge

We ruled in December 1996 that certain issues

related to plaintiffs’ superior knowledge defense could

not be tried because the resulting threat to national

security would not permit it. This determination

was based in part on the Government’s invocation of

the state secrets doctrine and partly on “a series of

closeout, the contractors were expected to build the aircraft as

defined during the CDR process. They did that.

293a

security breaches and discovery abuses... .” McDor.nell

Douglas Corp., 182 F.3d at 1329. The Federal] Circuit

asked us to reconsider that Order, but the circum-

stances that prompted the ruling persist. Therefore,

we must reaffirm the December 13, 1996 Opinion and

Order for the reasons states therein.

The Federal Circuit’s opinion speculated that

some of the restrictions on superior knowledge issues

would be removed by now, “because of the passage of

time and of possible intervening developments. .. .”

Id. at 1330. The Circuit questioned “whether the risk

of disclosure of state secrets will preclude adjudica-

tion, on remand, of Contractors’ superior knowledge

claim, and the issues of loss adjustment and reason-

able profit.” Jd. But after that, the parties conducted

discovery and exchanged contention interrogatories

in preparation for trial. In the course of that dis-

covery, plaintiffs issued several interrogatories that

prompted the United States to invoke again the mili-

tary and state secrets doctrines to protect infor mation

that is necessary to resolution of these issues.

We reviewed the declaration by Secretary of the

Air Force F. Whitten Peters, and determined that it

comports with the legal requirements for invoking the

state secrets doctrine as set forth by the Federal

Circuit. We also reviewed the classified version of

Secretary Peters’ declaration, and we remain satisfied

that superior knowledge issues in this case cannot be

litigated safely. This determination is based on that

294a

declaration and the warnings described, as well as

those of previous government officials.” We know

from recent briefings that all of these warnings con-

tinue to apply with full force.

We cannot establish that the information that

has been removed from this case would have bene-

fitted either party. Without extensive discovery re-

lated to this information, which will not be permitted

for years if ever, no one can know whether either

party would have been helped or harined by it. At one

time plaintiffs made a persuasive showing that they

could prove their claim without the information.

Years later, defendant made the same argument, that

it did not need the protected information to defend

the superior knowledge count of plaintiffs’ complaint.

Neither side was entirely right or entirely wrong. We

can never know enough to make a finding of fact on

this issue. That is why we could not try claims or

© See also McPeak Declaration at 2-3 (July 22, 1993) (“I

have concluded that continued inquiry into what is known as

plaintiffs’ ‘superior knowledge’ claims would necessarily require

examination and use of information that cannot be disclosed in

this litigation.”); see also Donley Declaration at 5-6 (March 30,

1993) (“LiJnadvertent, unauthorized disclosure of the information

that is described in more detail in my in camera declaration

could severely jeopardize national security.”); see also Rice

Declaration at 4-5 (November 20, 1992) (“The unauthorized

disclosure of the national security information at issue reason-

ably could be expected to cause extremely grave damage to the

national security.... this will weaken our country’s ability to

defend itself and could place at risk our aircraft and the lives of

the crews of those aircraft.”)

295a

defenses that depend on information that has been

removed from this case.

Other reasons for removing the superior knowl-

edge issues from this case are set out in McDonnell

Douglas v. United States, 37 Fed. Cl. 270 (1996). All

of those reasons apply today. The Appendix to which

we referred in earlier orders and opinions remains

classified under seal at the Pentagon. The reviewing

court may wish to retrieve that document should it

have the occasion to reach this issue again. However,

the parties do not have access to this document and it

is not included in the record otherwise.

Issues involving superior knowledge cannot be

litigated safely. Defendant’s argument that it is en-

titled to a loss adjustment pursuant to FAR 49.203

and plaintiffs’ lost profits argument are moot. Plain-

tiffs may not use superior knowledge as a defense

because we cannot know whether that argument has

merit.

B. Impossibility

Plaintiffs now argue that the Government’s invo-

cation of the state secrets doctrine has prevented

litigation of their impossibility defense. Information

withheld by the Government “bore directly on the

achievability of the weight, other technical per-

forinance, and schedule provisions of the A-12

Contract ...” according to plaintiffs, and they cannot

prove impossibility because superior knowledge is an

element of that defense. However, neither this new

296a

argument nor the cases cited by plaintiffs fit the facts

of this case.

Plaintiffs argue that the court’s ruling that the

BAFO weight was “unachievable” provides additional

evidence that the contract was impossible to perform.

Yet we did not rule that the BAFO weight was

unachievable. The Navy thought the BAFO weight

was not achievable. So did everyone else. In any

event, the BAFO weight is not an issue because we

have ruled that it was waived as a contract speci-

fication. Similarly, other specifications are not in

issue because failure to meet specifications was not a

reason that would have supported the contracting

officer’s decision to terminate for default.

Plaintiffs’ best argument is “commercial impos-

sibility” as explained by the Court of Claims in Foster

Wheeler Corp. v. United States, 206 Ct. Cl. 533, 513

F.2d 588 (Ct. Cl. 1975). A contract is commercially

impossible if it “could not be accomplished without

commercially unacceptable costs and time input far

beyond that contemplated in the contract.” Defen-

dant’s argument that plaintiffs were approaching the

ceiling price of their contract would offer support to

such a theory. That is not the argument before this

court, however, and no evidence was submitted to

support it.

The potential issue of an impossibility defense

arose in a pre-trial hearing. Defendant was concerned

that evidence of impossibility could be presented after

defendant rested its case. We ruled that if plaintiffs

297a

were to raise a defense of impossibility, defen-

dant could put on a rebuttal case to address that

evidence.” Plaintiffs did not present such evidence.

In fact, plaintiffs’ position has been that building the

A-12 was not impossible; it would have flown in

March 1992.”

Vv. CONCLUSION

The United States asked two major defense con-

tractors with impeccable credentials and long histories

of government service to undertake a complex and

highly sensitive research and development project in-

volving stealth technology. It worked closely with

those contractors on a daily basis, on all aspects of

the design and manufacture. It worked through the

Navy because the Navy was the contracting agency.

For reasons that do not appear in the record of this

case in their entirety, the Government abruptly

terminated the contractors for default.

Admiral Morris, the Navy contracting officer did

not want to terminate the contract between the Navy

and contractors. He wanted to work out all the prob-

lems within the four corners of the contract, as he put

’ Plaintiffs’ counsel stated that the Government should put

on the default case, and “if we put [the irnpossibility defense] in

... he can come back and defend. If ... we don’t come forward

with impossibility, he’s got nothing to defend against.”

* We stated at trial that “plaintiffs’ position seems to be

that not only was it possible, but you were well on your way to

building this ship.”

298a

it. He was not allowed that option. We found that

Admiral Morris had no choice but to terminate the

contract. He also felt that he had to terminate for

default — a yrievous sanction. The Federal Circuit

ruled that Admiral Morris terminated the contract for

performance-related reasons, and that his actions

were products of his independent discretion. That

being the law of the case, we musi rule for defendant.

This is so because the unilateral schedule was reason-

able, and if the Contracting Officer was concerned

about whether the contractors would meet the sched-

ule, that concern is a legitimate basis for terminating

the contract for default.

The Clerk will enter judgment for defendant. No

costs.

Robert H. Hodges, Jr.

Judge

299a

McDONNELL DOUGI.AS

CORPORATION AND GENERAT,.

DYNAMICS CORPORATION, Plaintiffs,

UNITED STATES OF AMERICA, Defendant.

No. 91-1204C

UNITED STALES COURT

OF FEDERAT. Cl.ATMS

40 Fed. Cl. 529; 1998 U.S. Claims

LEXIS 61; 42 Const. Cas. Fed. (H) P77,274

March 30, 1998, Filed

COUNSEL: Cary] A. Potter, Ill, Elizabeth A. Ferrell,

and Roger K. Heidenreich, Sonnenschein Nath &

Rosenthal, Washington, D.C. and St. Louis, Missouri,

for plaintiff McDonnell Douglas Corporation, with

whom was John W. Walbran, McDonnell Douglas

Corporation, of counsel; Herbert L. Fenster, David A.

Churchill, McKenna & Cuneo, Washington, D.C., for

plaintiff General Dynamics Corporation.

Bryant G. Snee, United States Department of Justice,

Washington, D.C., for defendant, with whom was

George P. Williams, Office of the General Counsel,

Department of the Navy, of counsel.

JUDGES: Robert H. Hodges, Jr., Judge

OPINION BY: Robert H. Hodges, Jr.

300a

OPINION

OPINION AND ORDER

HODGES, Judge.

INTRODUCTION

Plaintiffs McDonnell Douglas and General

Dynamics entered into a full-scale engineering and

development (FSED) contract with the Navy in 1988

to develop the A-12, a Stealth aircraft. The Navy

ter:ninated the contract for default in 1991. We ruled

that the termination for default was improper and

converted it into a termination for the convenience of

the Government. See McDonnell Douglas Corp. uv.

United States, 35 Fed. Cl. 358 (1996). The purpose of

this opinion is to set forth our reasons for awarding

plaintiffs most of the costs that they incurred in

performing the A-12 contract.

BACKGROUND

“(l}f, after termination, it is determined that the

Contractor was not in default, or that the default was

excusable, the rights and obligations of the parties

shall be the same as if the termination had been

issued for the convenience of the Government.”

Federal Acquisition Regulation (FAR) 52.249-9(g). We

approach this situation as if the Government had

301la

terminated this contract for convenience on January

7, 1991 — the date of the default termination.’

Plaintiffs argued that the FAR entitles them to

incurred costs plus a reasonable profit, while defen-

dant urged us to adjust plaintiffs’ cost reimbursement

amount downward to reflect the loss that they would

have sustained had the contract been completed.

When the Government ter:minates a contract for its

convenience, the contractor “should be compensated

fairly for the work done and the preparations made

for the terminated portions of the contract, including

a reasonable amount for profit.” FAR 49.201.

Typically, the contractor is entitled to recover all of its

incurred costs and settlement costs, and reasonable

profits if warranted. See FAR 52.249-2(f). If it appears

that the contractor would have suffered a loss on the

entire contract, however, the contractor would not

' FAR 52.249-9(g) is a fiction that has not operated

smoothly in this case. A contracting officer who has just

terminated a contractor for default is not interested in

considering the same contractor’s claim for termination for

convenience settlement costs. Nor is the contracting officer likely

to participate in subcontractor settlements as provided by FAR

49.108-7 (“Government assistance in settling subcontracts”), if

he assumes that the contractors will be responsible for all of the

subcontractor settlements. That is what happened here. The

contracting officer declined to participate in the contractors’

settlement discussions with subcontractors, thereby giving

plaintifts an “estoppel” argument on that issue. We did not

address estoppel, but ruled that the settlements presumptively

were appropriate if the Government could not show collusion or

less than arms-length bargaining.

302a

obtain a profit, and its cost recovery is reduced

according to the rate of loss. See id; see also

McDonnell Douglas Corp. v. United States, 37 Fed. Cl.

270, 272-73 (1996). For reasons stated in a December

1996 ruling, however, we did not allow profit or

consider to what extent a loss ratio might apply. See

McDonnell Douglas Corp., 37 Fed. Cl. at 272. We

could not consider plaintiffs’ Requests for Equitable

Adjustment for similar reasons. See Id. at 272.

During trial in June and July 1997, we considered

only the costs plaintiffs incurred by performing the A-

12 FSED contract, Lots I, and II options, and “wind-

up” termination costs.

Plaintiffs presented a termination for convenience

claim for $3.992 billion, excluding profit and interest

and before application of the “funding cap.” The

$3.992 billion in costs include: $3.750 billion for the

* We determined that the incremental funding clause (H-7)

of the contract limits plaintiffs’ cost recovery to the funds

obligated at the time of termination: $3,499,793,515. See

McDonnell Douglas Corp. v. United States, 37 Fed. Cl. 295, 297

(1997), modified, 39 Fed. Cl. 665 (1997). When adjusted for

funding obligated for Incentive Price Revisions and Economic

Price Adjustments (IPR/EPA), the total funding cap is

$3,635,767,376. See McDonnell Douglas Corp. v. United States,

39 Fed. Cl. 665, 1997 WL 766001, at *8 (Fed. Cl. 1997) (finding

that additional funding was obligated to cover approximately

$135 million pursuant to an Economic Price Adjustment Clause

and an Incentive Price Revision Clause.) Lots I and II were

separate provisions in the A-12 contract that were not governed

by the incremental funding clause. Recovery under Lots | and II

is not in dispute. See McDonnell Douglas Corp., 37 Fed. Cl. at

297 n.2.

303a

FSED portion of the contract, $.212 billion for Lot 1,

and $.030 billion for Lot II.’ Plaintiffs submitted their

certified ter:inination for convenience claim on a total

cost basis in June 1991. Later updates covered costs

incurred in the interim, such as_ subcontractor

settlements.

The funding cap imposed by the court lmits

recovery to $3,499,793,515 for the FSED portion of

the contract. Additional funds obligated through the

Incentive Price Revision and Economic Price Adjust-

ment clauses raise the funding cap to $3,635,767,376.

Adding to this amount the $.212 billion for Lot I and

$.030 billion for Lot Il, which are undisputed amounts

“outside” of the cap, we arrive at $3,877,767,376, the

highest award possible with the funding cap in place.

Unless the Government’s valid challenges would

bring the amount claimed by plaintiffs below this

figure, findings detailed below have little practical

effect.

* Under the contract, plaintiffs were to produce eight FSED

aircraft. The contract also provided the Navy an option to

purchase four production lots of aircraft. Each FSED aircraft

would test different’ characteristics of the A-12; stealth

capabilities would be verified in the “fully capable, fully

equipped” eighth aircraft thal would serve as the basis for the

production lots. Under the origina) agreement, the first FSED

aircraft would be delivered in June 1990; the rest would be

delivered monthly through January 1991. The Navy exercised

its option on the first production Jot on May 31, 1990. See

McDonnell Douglas Corp., 35 Fed. Cl. 358, 362 (1996).

304a

The parties asked us to determine plaintiffs’ total

incurred costs, irrespective of the cap. If the funding

cap is higher or does not apply, plaintiffs’ reasonable,

allowable, and allocable costs total $3,978,002,676.

Otherwise, plaintiffs may recover no more than

$3 877,767,376.

Problems with the Coopers & Lybrand (Miller)

Report

The Government hired Coopers & Lybrand to

audit plaintiffs’ incurred costs. This effort was

managed by Frederic R. Miller, an auditor who was

the Government’s only witness at. trial.

The Government’s challenges to plaintiffs’ claimed

costs are based entirely upon the Miller Report.

Plaintiffs supplied proof with respect to al! of their

claimed costs to some degree, but more in some areas

than in others. Some of these costs could not be

awarded if strict accounting standards were emm-

ployed. We beheve that the FAR does not limit such

costs to a rigid application of cost accounting

standards.

Plaintiffs attacked Mr. Miller’s experience and

credibility along with the usefulness of his report.

General Dynamics contended that Miller had no

personal knowledge and experience with the program.

He was “denied access to the very government

personnel who were familiar with it,” such as the

program manager, contracting officer and class desk.

Additionally,

3058

Miller had no experience working for an

aircraft design company and no prior cx

perience with an RDT & FE program that had

been terminated. Miller had only a general

sense of what the A-12 contract required, he

did not have the necessary secunty clearances

to know what it specifically required. Miller

lacked famibhanty with the requirements,

schedule, and terminology of the A-12 research

and development contract, including such

issues as concept formulation, DEM/VAL,

IDR, PDR, CDR, concurrency, how many

radars were required, how many test aircraft

were required, how many change orders

occurred, when first flight was, and when

and how the contract schedule changed.

Despite this inexpenence, [Coopers &

Lybrand| consulted with no one in the Navy

who had been involved with the A-12. pro-

gram for technical assistance = not Cuptain

Kiberfeld, not Captain Cook, not Mr. Mutty,

and not Admiral Morris. Miller conceded that

such information could be competent evi-

dence for an auditor to consider, but observed

that he did not have access to such

people... Indeed, the government instructed

C&L not to consult with such Navy per-

sonnel

Plaintiffs’ problems with Miller's report do not

stop there. General Dynamics questions, inter alia,

Miller’s level of experience/familiarity with the “25%

rule” that applies to items being: returned to vendors

for restocking, Inventory Verification Reports, and

plant clearance” officers. According to General

306a

Dynamics, Miller “did not consider relevant FAR and

DCAA Contract Audit Manual ... provisions before

questioning plaintiffs’ post-te:mination relocation

expenses.”

Miller’s report claims to represent the “inde-

pendent and objective opinions of [Coopers & Lybrand]

regarding plaintiffs’ termination for convenience

claim.” Plaintiffs question this assessment.’ General

Dynamics observes that “{(djuring the drafting of the

May 1995 reports, Miller consulted with, and received

comments from the Department of Justice in order, in

Miller’s words, ‘to make sure we were all singing from

the same sheet of music in terms of the final report.’”

Mr. Miller’s analysis was helpful but marginally

useful in determining the proper level of incurred

costs. He acknowledged that the audit involved

making determinations that were “straight up and

down accounting type of decisions. ... We viewed our

role as providing ... only an audit report that was

advisory ... in nature, and that we wouldn't be

making ultimate deter:minations that either the TCO

or the person sitting in the place of the TCO would

have to make.” Defendant’s counsel confirmed, “Miller

has not been offered to provide opinions under |FAR]

49.201.... Mr. Miller is here to testify and we’re

offering him to testify regarding his conclusions as to

* A note contained in the auditors’ workpapers states the

following: “Limit the positive comments (actually none), we want

‘negatives.’ What is wrong with the proposal.”

307a

allowability, allocability and reasonableness under

FAR part 31.” Miller understood that his role was to

provide accounting advice and his opinion regarding

FAR Part 31, but that the court’s inquiry must

include a consideration of FAR Part 49 as well.

Tension Between FAR Part 31 and FAR Part 49

Defendant argued that FAR Part 31 should be

the focal point of the court’s analysis; plaintiffs

emphasized FAR Part 49. FAR 49.113 provides that

“(t]he cost principles and procedures in the applicable

subpart of Part 31 shall, subject to the general

principles in 49.201, ... be used.” (emphasis added).

See also Codex Corp. v. United States, 226 Ct. Cl. 693,

698-99 (1981). Part 31 generally may be described as

establishing a formulaic, accounting-based structure,

while Part 49 provides an equity-based framework.

Because Part 31 is subject to the general principles of

49.201, we do not apply strict cost accounting prin-

ciples here. “The use of business judyment, as

distinguished from strict accounting principles, is the

heart of a settlement.” FAR 49.201(a). We cannot

ignore equitable considerations and reasonable business

judy ment in our deliberations.”

* At the same time, we cannot fault Mr. Miller's emphasis

on FAR Part 31. He is a cost accountant, and he carried out the

mission that he was given. He did not have the access that he

needed, and he was not provided other necessary tools as

plaintiffs generally claim.

308a

Still, plaintiffs bear the burden of proving their

termination for convenience damages. See Lisbon

Contraciors, Inc. v. United States, 828 F.2d 759, 767

(Fed. Cir. 1987); FAR 31.201-3(a); see also Bath Iron

Works Corp. v. United States, 34 Fed. Cl. 218, 231

(1995), aff’d, 98 F.3d 1357 (Fed. Cir. 1996). The costs

considered in a termination for convenience recovery

must also satisfy the general requirements of FAR

Part 31 — that the costs be reasonable, allowable and

allocable. See FAR 49.113; see also FAR 31.201-2 to

31.201-4 (outlining the requirements of allowability,

reasonableness, allocability, respectively); 31.205-42

(providing cost principles “peculiar” to termination

situations).

Overall Lack of Evidence that Plaintiffs “Padded”

their Costs

Defendant had little evidence that plaintiffs

attempted to inflate their costs. One would expect to

find some improper charges claimed through inadver-

tence or negligence, if nothing else. But generally we

were not provided with evidence of inflated costs

claims through bad faith, negligence, or otherwise.”

* As General Dynamics argues in its post-trial brief,

“The fixed-price nature of the contract provided

the contractors with a financial incentive during

performance to incur only necessary costs, and to

control strictly the amount of those costs.... And,

because the contract was terminated for default, the

contractors were liable, with no assurance of being

reimbursed, for all the amounts they incurred after

(Continued on following page)

309a

Most of plaintiffs’ costs were incurred during a time

when they had no reason to think that the costs

would be reimbursed.

Testimony at trial supported this argument.

This opinion will show that for the most part, we

found no basis for questioning the reasonableness,

allowability, or allocability of plaintiffs’ claimed costs.

DISCUSSION

S

SUBCONTRACTOR SETTLEMENTS

FAR 49.104 provides, in pertinent part:

After receipt of the notice of termination,

the contractor shall comply with the notice

and the termination clause of the contract,

except as otherwise directed by the TCO. The

notice and clause applicable to convenience

terminations generally require that the

contractor —

(g) Settle outstanding liabilities and

proposals arising out of termination of

subcontracts, obtaining any approvals or

ratifications required by the TCO... .

termination, including all of the amounts they paid to

settle with their subcontractors.”

310a

“Contractors shall settle with subcontractors in

general conformity with the policies and principles

relating to settlement of prime contracts in this

subpart and subparts 49.2 or 49.3.” FAR 49.108-3(a).

“The use of business judyinent, as distinguished from

strict accounting principles, is the heart of a

settlement.” FAR 49.201(a). “The primary objective is

to negotiate a settlement by agreement.” FAR

49.201(b). “In appropriate cases, costs may be estimated,

differences compromised, and doubtful questions settled

by agreement.” FAR 49.201(c).

Prime contractors must terminate all sub-

contracts related to the terminated portion of the

prime contract and settle all liabilities and proposals

arising out of termination of the subcontracts. FAR

49.104(b), (g). The A-12 contract entitles the con-

tractors to the cost of settling and paying subcontractor

termination proposals. FAR 52.249-2(f(2)Gi). Such

costs are “generally allowable.” FAR 31.205-42(h);

FAR 31.205-42(g)1)(1)(B).

FAR 49.201 requires that the contractor be

compensated fairly through the exercise of judyment.

Cost and accounting data may be employed but are

not rigid measures for determining fair compen-

sation. Settlements may be executed on a “bottom

line” basis. See FAR 49.201(b) (“The parties may

agree upon a total amount to be paid the contractor

without agreeing on or segregating the particular

elements of costs or profit comprising this amount”).

3lla

Contractors are entitled to the costs of sub-

contractor settlements provided the settlements are

“arrived at in good faith, ... reasonable in amount,

and ... allocable to the terminated portion of the

contract.” FAR 49.108-3(c). A settlement will be

approved when it is the product of “arms-length

bargaining, without collusion, and reflect[s] a sound

exercise of prudent business judgment” by the prime

contractor. General Electric Co., 1982 ASBCA LEXIS

269, 82-1 B.C.A. (CCH) P15,725, at 77,806 (March 29,

1982), aff'd on recon., 1982 ASBCA LEXIS 188, 83-1

B.C.A. (CCH) P16,207, at 80,529 (December 1, 1982).

The FAR does not encourage second-guessing of the

exercise of business judyinent. 82-1 B.C.A. (CCH)

P15,725, at 77,804.

Subcontractor settlements may comprise the

subcontractor’s incurred costs, profit or loss adjust-

ment, and the subcontractor’s settlement expenses. If

the sum is reasonable, allocable, and allowable, the

subcontractor is entitled to recovery.

We ruled that defendant could not question

plaintiffs’ business judgment or negotiating tactics,

but that it could submit evidence of investment, bad-

faith, self-dealing, or less than arins-length trans-

actions. Defendant also could show evidence of willful

neglect or wrongdoing attributable to the plaintiffs, if

applicable.

312a

A. Norden

Norden had a subcontract with General Dynamics

to provide a radar system for the A-12. General

Dynamics terminated Norden for default in April

1989, and Norden sued General Dynamics in June

1989. The parties settled this litigation in 1992 for

approximately $40 million. As part of its termination

settlement proposal to the Government, General

Dynamics claimed the $40 million amount of settle-

ment, $10 million in legal fees incurred in its defense,

and $10.7 million in reprocurement costs.

We ruled in August 1997 that General Dynamics’

decision to settle with Norden was made on the basis

of sound business judyment. The Government argued

that General Dynamics could not recover costs

associated with the Norden settlement because it

terminated Norden for default. Testimony at trial

established that (1) General Dynamics faced a

potential liability of $160 million; (2) a trial would

have been litigated before a jury in Norden’s home

state of Connecticut; (3) security problems would

have made trial dangerous and perhaps restrictive;

and (4) Norden could have raised General Dynamics’

own schedule slippage in its defense. General

Dynamics determined that it was prudent to settle

with Norden, and we declined to second-guess that

reasoned decision. See generally Nolan Brothers, Inc.

v. United States, 194 Ct. Cl. 1, 437 F.2d 1371, 1392

(Ct. Cl. 1971) (holding that costs incurred as a result

of a decision to terminate a subcontractor for default

were recoverable so long as the decision was “one that

313a

a prudent business man would take in the circium-

stances”).

B. Westinghouse

Westinghouse subcontracted with General Dy-

namics in 1988 to develop and supply the combined-

function forward-looking infrared radar system for

the A-12 aircraft. As a result of the Norden

termination in 1989, the subcontract was superseded

by a new subcontract requiring Westinghouse to

develop and supply the multi-function radar systems

also. Westinghouse began work on the new contract

late in the development phase of the project. See

McDonnell Douglas Corp. v. United States, 1997 U.S.

Claims LEXIS 318, No. 91-1204 (Fed. Cl. Aug. 21,

1997). The Government terminated the prime contract

in January 1991, and General Dynamics terminated

Westinghouse in April 1991. Westinghouse submitted

a termination settlement proposal] and request for

equitable adjustment in May. The parties negotiated

a $73 million settlement in August 1991. The Govern-

ment challenges $51,099,249 of that settlement.’

" The Government challenged costs as either “questioned”

or “pending.” Questioned costs are considered by defendant not

to be reasonable, allowable, or allocable. Costs are designated

“pending” because the Government’s audit team claims it did not

have enough information about them to make an evaluation. We

reviewed all challenged costs on the same basis.

314a

1. Expedited Settlement

The Government argues that Westinghouse and

General Dynamics colluded or engaged in less than

aiins-length dealing because of circumstances sur-

rounding their settlement. That is, General Dynamics

departed from its internal procedures and settled

with Westinghouse on an expedited basis before an

audit and claims analysis was performed. Defendant

suspects that General Dynamics expedited settlement

so that it could enlist Westinghouse’s support in this

litigation.

The Westinghouse settlement was _ allocable,

allowable, and reasonable. That the settlement was

achieved on an expedited basis does not taint its

inteyrity. Settlement was made contingent upon a

successful audit. General Dynamics settled with

Westinghouse long before the prime contract termi-

nation was converted into one for convenience, and it

faced severe litigation risk. General Dynamics had no

incentive to settle with Westinghouse on a less than

reasonable basis. Westinghouse sought $110 million;

the parties settled for $73 million.

2. Combined Loss Ratio

Defendant challenges $27,573,468 due to an

alleged improper calculation of Westinghouse’s loss

ratio. The loss ratio is impermissible, according to

defendant, because unlike those applied to other

subcontractor settlements, the loss ratio applied to

Westinghouse combined FSED, Lot I, and Lot II. This

315a

had the effect of increasing Westinghouse’s recovery

and the Government’s ultimate liability by $27,573,468.

“The impact of combining the loss ratio is to dilute

the impact [of] the loss ratio on the FSED portion of

the contract which represented 82% of the actual

costs at termination,” defendant argues.

General Dynamics states that it imposed a

combined loss ratio here because the subcontract

required it. Westinghouse subcontracted with General

Dynamics initially to supply the combined-function

forward-looking radar system only. After General

Dynamics terminated Norden, its initial subcontractor,

however, it assigned Westinghouse the additional

responsibility of developing and supplying the multi-

function radar system. In return for accepting the

multi-function radar duties late in the development

phase, Westinghouse demanded that any loss ratio

imposed combine FSED, Lot I, and Lot II. Motorola

was the only other subcontractor to extract such a

concession. General Dynamics did not impose a

combined loss ratio on Motorola because Motorola

was not in a loss position at the time of termination.

Loss ratios were segregated for purposes of

progress payments for more than a year after General

Dynamics and Westinghouse’ renegotiated’ the

subcontract, but Westinghouse insisted that they be

integrated. General Dynamics’ legal department

agreed, and sought and obtained Government

approval. The Government argues that it approved

the combined loss ratio for progress pay:inents only,

not for final settlement. We are not aware that

316a

Government approval is required in such circum-

stances. Moreover, there is no prohibition against

combining loss ratios. The application of a combined

loss ratio to the Westinghouse subcontract does not

demonstrate collusion or less than arms-length

dealing. General Dynamics believed that it was

required to combine FSED, Lot I, and Lot II for

purposes of assessing any loss ratios, and that

position was not unreasonable. The contract does not

limit the application of a combined loss ratio to

progress payments only.

Moreover, Westinghouse demanded that loss

ratios be combined as consideration for agreeing to

perform the multi-function radar contract late in the

program. The first subcontractor, Norden, was ter-

minated more than a year into contract performance

in 1989. Westinghouse’s performance period was

compressed. General Dynamics needed exceptional

performance from Westinghouse, and got it. It was

recsonable for General Dynamics to agree to a com-

bined loss ratio.

3. Low Range Estimate at Completion Value

General Dynamics engineers generated a range

of estimate at completion (EAC) values that settle-

ment negotiators could employ to compute the loss

ratio for the Westinghouse settlement. The values

ranged from low to high and General Dynamics used

a low value at settlement. Specifically, General Dy-

namics’ engineers recommended a range of possible

317a

EACs from $163 million to $175 million. The nego-

tiators actually used an EAC of $165.8 million. The

Government contends that they should have used an

EAC at the mid-point of the range. This would have

increased the loss adjustment and reduced the

Government’s liability by $3,602,687. It was unrea-

sonable for the contractor to select a lesser EAC value

within the estimated range, according to the Govern-

ment.

General Dynamics derived the estimate at

completion from a reasonable exercise of business

judyment and consideration of other information in

addition to engineering analysis. It weighed com-

peting considerations and input from financial and

business personnel. This exercise resulted in the

departure from a mid-point in the estimated range.

That General Dynamics’ negotiators employed a

value from the low end of the range does not

invalidate it. The FAR expressly permits a contractor

to employ business judyiment in reaching a settlement

with the subcontractor. See FAR 49.201(a). Engineering

was only one source of information that General

Dynamics considered before selecting its EAC; it

consulted business and financial personnel, and

weighed competing considerations. This is the essence

of the exercise of business judgment.

The Government’s solution — arbitrarily to choose

the mid-point of the engineering department’s range

— is not consistent with the cxercise of business

judyinent. We find no support for the position that it

318a

is per se unreasonable for a contractor to select a

value that is below the mid-point of an estimated

EAC range.

4. Profit on Lots I and II

General Dynamics applied a loss ratio of 84.87%

on Lot I progress payments prior to terminating

Westinghouse. Lot II progress payments’ were

suspended in December 1990. Defendant questions

certain costs because General Dynamics settled with

Westinghouse allegedly on the basis of 15-20% profit

margins. Defendant challenges $9,397,228 because it

appears that General Dynamics credited Westing-

house with profit for Lots I and II while the contract

was in a loss position. The Government argues that it

was improper to pay Westinghouse profit. General

Dynamics denies that it paid Westinghouse profit, but

that instead it applhed a combined loss ratio of

85.73% to the Westinghouse contract.

If the loss ratio is segregated, it may appear that

Westinghouse received profit for Lots I and II. We

stated that it was reasonable for General Dynamics

to combine loss ratios in the circumstances of this

case, however. ‘The combined loss ratio precluded

Westinghouse from making profits. The Government's

argument assumes that General Dynamics was

required to segregate loss ratios, but the contract did

not require segregation.

3194

5. Inventory ‘Transfer

Upon termination of its sub-contract with

General Dynamics, Westinghouse transferred inventory

originally slated for use on A-12 to non-A-12 programs

on a total cost basis. Westinghouse’s termination

settlement proposal, korm SF 1436, took into account

Transferred Costs as well as Disposals and Other

Credits. Westinghouse placed the transferred cost

amount on line 16, which accounts for disposals and

other credits, then appled au loss ratio to that

amount.

The Government argucs that the entire amount

of transferred inventory should have been included in

Disposals and Other Credits without taking into

account the loss ratio. This would have further

reduced the Government’s lability.

DCAA Contract Audit Manual § 12-311 provides

instruction as to the type of items included within the

Disposals and Other Credits line on Form SF 1436.

The section states in part:

Credit amounts included in a settlement

proposal nosmally represent (1) an offer by

the contractor to purchase inventory at less

than cost, (2) the proceeds from the sale of

termination inventory, or (3) a combination

of (1) and (2)... .

Westinghouse transferred common items at full

cost to a non-A-12 program. It did not offer to

purchase or sell inventory. Thus, the cost of the

transferred inventory should not be included at all on

320a

line 16 (Disposals and Other Credits). The plain

language of DCAM §12-311 suggests ti st the

Government’s interpretation is incorrect.

Westinghouse transferred common item: for

other uses as instructed by FAR 31.205-42 and FAR

45.606-2. Although Westinghouse included _ the

transferred costs of the inventory under Disposals

and Other Credits on Line 16, it applied a loss ratio

to the costs. This has the same effect as if

Westinghouse had included the costs on Line 7

(Transferred Costs), then applied the loss ratio to the

remainder. While it would have been proper to

include the entire amount of transferred costs on the

transferred cost line, thereby reducing total costs

before applying the loss ratio, Westinghouse essentially

removed those transferred costs from the settlement

equation by applying a loss ratio to them on the

Disposals and Other Credits line.

Moreover, according to DCAA’s training manual

(Audit of Ter:ninated Contracts, FAO Training Course

2211), removal of common items from program costs

prior to applying a loss ratio is required. While

Westinghouse did place the transferred cost amount

on the Disposals and Other Credits line, it essentially

took the cost of those transferred items out of the

settlement proposal by applying the loss ratio to

them. The Government’s liability remains the same.

32la

6. Consideration of REAs

Westinghouse submitted requests for equitable

adjustments totaling $44.5 million as part of its

termination settlement proposal. General Dynamics

settled those claims for $11 million, but it did not

deterinine who was responsible for the adjustment.

General Dynamics did not verify that REAs paid to

Westinghouse arose solely because of government

fault, but paid the REAs and claimed $10 million as

part of its termination settlement proposal. Defendant

contends that it cannot be held liable for such claims

when General Dynamics does not prove that govern-

ment conduct or inaction caused the adjustment. The

Government challenges $10,098,968° of the settle-

ment as “pending.”

This argument is essentially a reiteration of a

government motion that we denied carlier. We stated

before trial that the court would “consider the reason-

ableness of challenged subcontractor REA payments

on the same basis as other costs allegedly incurred.”

McDonnell Douglas Corp. v. United States, 1997 U.S.

Claims LEXIS 319, No. 91-1204, at 2 (Fed. Cl. June

13, 1997) (denying defendant’s motion for pre-trial

determination that plaintiffs cannot recover amounts

* The Government determined that the impact of agreeing

to pay Westinghouse $11 million in REAs is $10,098,968, after

recomputing segregated loss ratius. We stated that Westing-

house was entitled to a combined loss ratio, so the Government’s

figure is incorrect. As we did not sustain this challenge, however,

we need not determine the actual impact of the payment.

322a

claimed for their subcontractors’ requests for equi-

table adjustment). Costs are reasonable so long as

they do not result from plaintiff’s willful neglect or

wrongdoing. Jd. at 1. Settlements must be negotiated

in good faith and incorporate the exercise of business

judgment.

Westinghouse sought equitable adjustments

totaling $44.5 million. General Dynamics obtained

advice and assistance from technical, financial, and

legal representatives before settling these claims.

Engineers for General Dynamics reviewed the requests

for equitable adjustments and determined that

Westinghouse was entitled to an adjustment ranging

from $12 million to $18 million. General Dynamics’

lawyers proposed a range of adjustment from $9

million to $11 million. The actual $10 million adjust-

ment incorporated the exercise of business judyment.

Defendant has not shown that plaintiff’s willful

neglect or wrongdoing prompted the claims; nor is

there a hint of bad faith.

C. Other Subcontract Challenges

We do not reprise the legal standards described

in rulings above concerning Norden and Westing-

house. It is sufficient to state that no credible

evidence of bad faith, willful neglect, or wrongdoing

has been presented with respect to any of the

following subcontracts: General Electric Aircraft En-

gines, Allied-Signal-Torrance; Allied Signal-Teterboro;

323a

SJ & LA-Hughes; Harris Corporation; SCI Tech-

nology, Inc.; Litton Systems; Sundstrand Aerospace;

Menasco Aerospace; and Parker Hannifin. McDonnell

Douglas’ claimed incurred costs with respect to these

subcontracts may be awarded, as they are reasonable,

allowable and allocable. Plaintiff General Dynamics’

claimed incurred costs with respect to Litton Amecon;

GE-Utica; Martin Marietta; Models and _ Tools;

Teledyne Ryan; Hewlett Packard; Motorola; Arkwin;

Struthers Dunn; Parker Hannifin; and Hexce! also

are reasonable, allocable, and allowable.

Il.

SUBCONTRACTOR REQUESTS FOR EQUI-

TABLE ADJUSTMENTS

The Government challenges various subcon-

tractors’ requests for equitable adjustments, because

“it is now uncontroverted that neither General Dy-

namics [njor McDonnell Douglas even attempted to

establish Government liability for the REAs.” We

stated in June 1997 that the court would “consider

the reasonableness of challenged subcontractor REA

payments on the same basis as other costs allegedly

incurred.” Plaintiffs exercised sound business judg-

ment with regard to paying REAs to subcontractors.

A court should not second-guess contractors who

make reasoned decisions in such cirenmstances, as

noted above. Such costs claimed by plaintiffs are

reasonable, allocable, and allowable.

324a

We have even less reason to question plaintiffs’

costs with respect to requests for equitable adjust-

-ments in this area than in the Westinghouse situation,

given the evidence presented. The Government argues

that “there is a requirement that a prime contractor

evaluate a subcontractor claim to determine Govern-

ment liability.” If so, this is not a case in which the

plaintiffs blindly passed on a claim for costs by the

subcontractor to the Government. We see no com-

pelling reason for subcontractors’ requests for equitable

adjustments to be treated differently from other

subcontractor settlement costs. See FAR 49.201(b)

(“The parties may agree upon a total amount to be

paid the contractor without agreeing on or seg-

regating the particular elements of costs or profit

comprising this amount”). As Allen Broesche, a

witness for General Dynamics, testified: “It was our

money, and we reached a reasonable settlement.”

Plaintiffs had no expectation that any of these

expenses would be reimbursed by the Government

while negotiating with subcontractors over REAs or

any other settlement expenses. We cannot disallow

these costs.

III.

DIRECT MATERIAT.

[T]he audit team performed audit pro-

cedures, including sampling, to evaluate the

allowability, allocability, and reasonableness

of the [General Dynamics] and |McDonnell

Douglas] direct material line (Line 1) items

325a

in their January 1994 Update. These pro-

cedures were supplemented by Coopers’

review of the February 1997 Update, and, as

a result, Coopers questioned a total of

$14,955,000 in MDC direct material costs . . .

and $53,143,152 of GD’s proposed direct ma-

terial costs. Additionally, Coopers categorized

$9,935,196 as pending for MDC due to

MDC’s failure to perform a commonality

study. In general, the questioned direct ma-

terial costs include overpayments to vendors,

defective items that were returned and not

properly credited, items actually used or

usable for other programs, excess purchases,

purchases incurred long before required, and

inadequate or sloppy documentation.

A. General Dynamics — Direct Material

1. Sample Testing of General Dynamics’ Costs

Coopers & Lybrand’s audit team “reviewed doc-

umentation to verify necessity, cost, payment, receipt,

physical existence, and disposition.” Mr. Miuiller

testified that General Dynamics did not provide the

audit team with appropriate termination inventory

schedules. Robert Wright” generally agreed that

* Wright had primary responsibility for the preparation of

General Dynamics’ termination for convenience claim. A long-

time employee of General Dynamics in the financial cost

accounting area, he had served as the deputy program director

of business management for the A-12 program since 1984. Allen

Broesche, John Lamers, and Ron Hancock also had worked on

the A-12 program during perfo:mance of the contract.

326a

General Dynamics’ inventory schedules were not

available. According to Defendant, General Dynamics’

‘accounting system’ was incapable of providing the

audit team with termination inventory schedules, as

required by the FAR, which would have identified the

current physical location and estimated costs of

material that GD purchased from vendors. As a

result, the audit team used an accounts payable

system and statistically selected transactions for

further testing.

Using audit sampling procedures, the audit team

selected for review 47 items by vendor and purchase

order number. Mr. Miller testified that in developing

the sample to be tested, the audit team received

technical assistance from the DCAA office in Memphis,

Tennessee. After testing the “sampled items,” the

audit team met with General Dynamics personnel to

seek additional explanation or further documentation

as appropriate. After evaluating the responses the

audit team either would withdraw the preliminary

exceptions or leave them in place, depending on the

documentation available.

“Dollar unit sampling” focuses on the dollars in a

given accounting population. The audit team used

this method for review of General Dynamics’ incurred

direct costs. According to the DCAA Contract Audit

Manual, dollar unit sampling is a valid technique to

account for the reasonableness of costs incurred for

direct material. See DCAM B-503.1. We agree with

the Government that audit sampling is recognized by

327a

the accounting and auditing profession as being a

proper and appropriate method for review.

Miller testified that in dollar unit sampling “you’re

not Jooking at every dollar in the population, you’re only

looking at certain dollars in the population, but those

are representative and will be representative of the

rest of the population.” When errors in the sample

population are found, an error proportion is calcu-

lated and used to determine the extrapolation

percentage. “Of approximately 22 million [dollars]

reviewed, Coopers identified $6.36 million of ques-

tioned costs within the sample. Using dollar unit

sampling procedures, Coopers projects the total

amount of questioned direct material costs to be

approximately $53,143,152.”

While we recognize that the audit team’s

methods applied proper sampling techniques, we do

not agree with all of their findings and extra-

polations. Mr. Miller questioned many direct costs

incurred on the grounds of allocability and allow-

ability. Where sufficient evidence of allowability,

allocability and reasonableness of costs are found,

however, the court must sustain those costs as

incurred.

2. Lack of Documentation

a. Bell Helicopter

General Dynamics purchased a tool for the wing-

fold of the A-12 from Bell Helicopter. Defendant

328a

claims that General Dynamics paid Bell Helicopter

“over and above the price listed in the purchase order

reviewed.” The audit team questioned $2,671 of

$23,055 paid to Bell Helicopter because it was not

satisfied that General Dynamics’ documentation

supported the costs claimed. General Dynamics

explained that it “could not locate the change order

that would have explained the precise reason for the

second of two increases in the purchase price of the

tool, which increased the price from $20,384 to

$23,055.” The audit team extrapolated a challenge of

$885,135 in costs from the $2,671 figure.

Other documentation supports General Dy-

namics’ position. It paid Bell Helicopter $23,055

pursuant to an invoice for the manufacture of an A-12

tool. Before issuing a check to Bell Helicopter,

General Dynamics’ accounts payable clerk made a

notation on the check indicating that she had verified

the invoice amount against the final purchase order

amount that had been entered by the buyer in the

procurement file. Mr. Miller acknowledged the

existence of documentation indicating that the

change was for “rework.” General Dynamics contends

that it is common for rework to be done during the

manufacture of tools developed for a RDT & E; here

there is no dispute that Bell Helicopter was providing

tooling work.

The court’s role is to determine whether General

Dynamics incurred the cost, whether it did so for the

A-12 contract, and whether it did so for a legitimate

purpose. Although Mr. Miller did not find these

329a

factors sufficient to document the increased cost,

evidence presented at trial satisfied the court that the

entire cost was allowable, allocable and reasonable.

See, e.g., FAR 49.201(c).

b. Cohn and Gregory

The audit team challenges the entire $7,714 the

General Dynamics paid to Cohn & Gregory for PVC

piping and valves. After extrapolation, this becomes a

challenge of $7,640,132.

The audit team sought a “requirements listing”

to determine whether the items purchased from Cohn

& Gregory were required for the A-12. General

Dynamics provided no such list, but submitted the

declaration of an employee, Steve Wells. Mr. Miller

testified that this representation was not sufficient to

make a determination of allowability, allocability, or

reasonableness. General Dynamics acknowledged

that it could not produce much documentation other

than the declaration. However, Mr. Wright testified

that the PVC pipes and valves were purchased for an

environmental control test stand for the A-12. Mr.

Wells was the buyer of the material. His declaration

stated that “[t]he fittings and other hardware was

purchased to build the test setup shown in the

drawings.” An invoice from Cohn & Gregory, signed

by Wells, contains a unique A-12 work order number.

This cost is properly awardable.

330a

c. Fiber-Resin Corporation

General Dynamics claims costs for tooling foam

boards that were shipped to Cadillac Motor Car

Division as furnished material to be used _ to

manufacture a tool for A-12 (Tool # R15649). Coopers

questioned $30,774 associated with this item for lack

of documentation “and an inability on the part of GD

to demonstrate the use, location, or disposition of this

material.” Cadillac was not a General Dynamics A-12

vendor, but it was a vendor to Models & Tools, an A-

12 subcontractor. Using its sampling technique,

Coopers & Lybrand extrapolated a challenge of

$7,640,132 from the $30,774 questioned item.

Mr. Miller testified that General Dynamics did

not provide sufficient documentation to support this

cost item. Coopers & Lybrand reviewed an internal

General Dynamics audit of Models & Tools and found

that General Dynamics’ own analysis concluded that

Models & Tools’ cost accounting system was inadequate.

The cost accounting system failed to identify the

tooling foam boards, for example.

Payment was made to Fiber-Resin, the producer

of the foam board, while the board was shipped to

Cadillac. The type of foam board ordered is consumed

during the production of a tool. After termination,

General Dynamics issued an abandonment certificate

to Models & Tools for Tool # R15649. This indicates

that the tool, which was classified as work-in-process,

had no value. DCAM 2-202(a) provides that because

“audits frequently require a wide variety of skills, an

33la

auditor may need technical assistance from other

disciplines such as legal, engineering, and production/

quality control. The auditor should make arrange-

ments to secure any needed technical assistance from

the ACO/plant representative or responsible acqui-

sition agency.” General Dynamics argues that Miller

should have sought technical assistance in such a

circumstance.

Plaintiff's documentary evidence and its

testimony concerning consumption of the foam board

material justify award of its costs.

3. “Expediting Charges”

Coopers questioned certain of General Dynamics’

direct material costs because General Dynamics paid

premium prices for expediting delivery of items “long

before they were actually required »y GD.” The

Government points out that many of the materials in

issue still were on hand when the contract was

terminated.

a. Stanley Aviation

The audit team challenged $70,077 in expediting

charges paid to Stanley Aviation for providing parts

for the A-12 full-scale mock-up. Miller questioned this

amount at trial “duc to the fact that the item was not

used at termination, yet it had been expedited

earlier.” The sampling technique here creates a

$6,626,207 challenge.

33Za

The minutes of a meeting of the General Dy-

namics “Procurement Ad Hoc Committee” on Sep-

tember 21, 1989 include the following entry concerning

the Stanley Aviation order: “Schedule: The A-12

program schedule dictates the requirement for pro-

curement to initiate an expediting fee to authorize

the supplier to perform to an expedited schedule that

supports the A-12 program needs.” According to

General Dynamics, “the parts still were on hand at

termination because the A-12 delivery schedule was

extended by 18 months in 1990, after these parts

were ordered.” The full-scale mock-up was affected by

this schedule change.

The Government did not establish that when the

purchase order was placed with Stanley Aviation,

Gencral Dynamics should have known it did-not need

to expedite delivery. General Dynamics points out

that this is another area in which Miller could have

benefited from technical and contract assistance. See

DCAM 2-202(a)."°

General Dynamics made a reasonable business

judyinent at the time the purchase order was made.

The fixed-price nature of the contract and the

attendant cost risks undertaken by General Dy-

namics, along with credible testimony at trial that

'’ Mr. Miller acknowledged, for example, that he did not

know the first flight date. He maintained that he did not

necessarily need to know anything about the contract schedule

to challenge a cost related to an expediting charge.

saa

General Dynamics did not make the decision to incur

expediting charges lightly, support this conclusion.

See, e.g., Boeing Aerospace Operations, Inc., ASBCA

Nos. 46274, 16275, 94-2 BCA P26,8U02, at 133,282,

1994 WL 96970 (March 21, 1994) (reasonableness is

judged by considering “all of the relevant circum-

stances existing at the time of the incurrence of the

costs”) (citing FAR 31.201-3), aff’d on recons., ASBCA

Nos. 46274, 46275, 94-3 BCA P27,281 at 135,908,

1994 WL 651887 (November 9, 1994).

b. Standard Pressed Steel & Kamatics

Coopers & Lybrand challenges $3,007 in expe-

diting charges to Standard Pressed Steel — extra-

polated to arrive at a $2,792,498 challenge. The

entire amount of a $2,059 acquisition of ball bearings

from Kamatics is questioned as well. This amount is

increased to a challenge of $7,640,132. Mr. Wright

testified that in both of these situations, “expediting

was done to meet a schedule of a subassembly, an

indentured-type system for manufacturing.” As

mentioned above, General Dynamics had to consider

carefully any decision to incur expediting charges.

The charges incurred here are properly awardable.

4. Other Direct Material Challenges

a. Sierra Alloys

Coopers & Lybrand challenges $220,924 of a

$421,764 purchase of 42 pieces of titanium from

Sierra Alloys, to be used for the inner wing engine

334a

bay doors and the inner wing. The audit team could

account for only 20 of the 42 pieces at termination,

and it challenged the cost of the other 22 pieces. The

$220,924 challenge is extrapolated to $4,001,974.

According to General Dynamics, even if 22 of the

pieces somehow were “lost,” its termination claim

should be reduced only by the fair market (salvage)

value of those 22 pieces. See FAR 49.204 and DCAM

12-304.10 (with respect to termination inventory that

is undeliverable to the government because it was

damaged, destroyed, or lost, the fair value of such

undeliverable material should be deducted from the

termination settlement proposal). General Dynamics

points out that proceeds from the sale of 12 pieces of

scrap garnered $ 17,765 — approximately $1,480 each.

Applying this average price to the 22 “lost” pieces, the

value of the challenged pieces totals $32,560.

We find that a $32,560 deduction is appropriate

because that is the fair value of the lost material.

Extrapolating from that figure, we deduct $589,815

from plaintiffs’ claim.

b. Stewart-Warner

This challenge is to $36,315 of a $435,780 pur-

chase of 12 instrument landing systems from

Stewart-Warner. The audit team could account for

only 11 of the 12 items at termination, so it

challenged the entire acquisition cost of the twelfth

item. Using its sampling methodology, the audit team

extrapolates a challenge of $636,678.

335a

General Dynamics argued that because records

were available for the other eleven items, it should be

entitled to a credit because “all parts have been

accounted for.” The Government contends, that “|t)he

fact that GD was able to provide adequate docu-

mentation regarding the eleven that went to salvage

suggests that the twelfth was not salvaged.”

General Dynamics ordered, received, and paid for

12 items for use on the A-12 contract. It rejected one

of the 12 items and returned it to the vendor. The

vendor later shipped the twelfth item directly to the

A-12 manufacturing facility in Tulsa, Oklahoma.

General Dynamics attempted to return the items to

Stewart-Warner after the contract was terminated,

but Stewart-Warner refused to accept them. General

Dynamics salvaged eleven of the items for little

value. We have no documentation concerning

disposition of the twelfth item, but these facts are not

in dispute.

General Dynamics argues that “it is reasonable

to rely on the termination procedures established by

the contractors, which reasonably attempted to

account for and dispose of all A-12 inventory.” It notes

further that the contract had been terminated for

default, so “at. the time GD disposed of the A-12

inventory it had no guarantee it ever would recover

its incurred costs, and the company thus had an

obvious incentive to dispose of its inventory in a

manner that would recover as much of the cost of the

item as possible.”

336a

We cannot find sufficient grounds for awarding

the value of the twelfth item as an incurred cost. As

mentioned above in the Stewart-Warner context, the

FAR and DCAM contemplate that when inventory is

lost, the fair value of that material should be

deducted from the termination settlement proposal.

That could be accomplished here by considering the

value of the eleven items sold for salvage to arrive at

a value for cach item, and then applying that value to

the twelfth item. We did not hear evidence of the

salvage value of those items, other than testimony

that they had very little value. We therefore cannot

impute a salvage value to the twelfth part, and

instead must deduct the acquisition cost of the

twelfth item from General Dynamics’ proposal. This

method is consistent with the Government's challenge.

We therefore sustain the extrapolated challenge

argued by the Government, $636,678.

ce. Universal Alloy

Coopers questions certain costs for ma-

terials in excess of the requirements of the A-

12 FSED contract and Lots I and II options.

For example, GD purchased aluminum from

Universal Alloy for use on various programs,

including the A-12. GD originally charged

the costs of a small portion, only 24 feet, to

the A-12 contract; in fact, the purchasing

document specifically stated that the remain-

der of the aluminum was for “various prime

contracts.” However, more than two years

after termination, GD charged an additional

337a

262 feet of the aluminum to A-12. As there is

no evidence that the A-12 program required

aluminum in excess of 24 feet, Coopers

questions all costs for aluminum in excess of

that amount.

The challenge based upon these costs is

$7,640,132 — extrapolated from an initial figure of

$1,670.

We are persuaded that allocation to the A-12

contract was reasonable. FAR 31.205-42(a) defines

common items as those “reasonably usable on the

contractor’s other work.” Testimony from Mr. Wright

indicates that although some aluminum may have

been available for use on other programs if needed, no

such need developed. The aluminum had been

acquired originally for the A-12 program. Because the

aluminum did not prove to be useful on another

program, General Dynamics transferred an additional

262 feet of aluminum (at a cost of $1,670) into the A-

12 program on February 13, 1993. At the time of the

transfer, the contract. was considered to be in default.

Thus General Dynamics had no incentive to transfer

the costs to A-12 when reimbursement by the

Government was unlikely. We find that this cost is

properly awardable to General Dynamics.

d. Voi-Shan Manufacturing

Defendant challenges a $1,902 purchase of 46

bolts from Voi-Shan Manufacturing — extrapolated

to arrive at a challenge of $7,640,132. Defendant’s

338a

position is that these items should have been re-

turned to the manufacturer, likely for full credit.

Plaintiff points out that FAR 45.605-2 perinits a

contractor to recover from the Government a restocking

charge of up to 25% of the cost of the returned items, as

well as transportation and handling costs associated

with the return. See also DCAM 12-304.8 (“The

contractor may not include the cost of returned

property in the settlement proposal but may include

the transportation, handling, and restocking charges

for the returned property”). Mr. Miller conceded that

the cost of returning the bolts may have met or

exceeded the entire $1,900 purchase price.

General Dynamics judgment not to return the

bolts was sound, given the doubtful economic value of

returning them.

B. McDonnell Douglas — Direct Material

The Government divides McDonnell Douglas’

direct material costs into three categories: (1) con-

tractor furnished equipment; (2) subcontract costs;

and (3) manufacturing material. In _ reviewing

McDonnell Douglas’ claimed direct material costs, the

audit team tested the “control, physical existence,

and disposition or termination inventory on hand at

the time of the audit.”

Unlike General Dynamics’ accounting system,

McDonnell Douglas’ records permitted the audit team

339a

to review incurred direct costs through non-statistical

sampling means:

MDC’s records permitted the Audit Team

to conduct physical inventory verification

testing with regard to termination inventory

on hand in August 1994. Mr. Miller testified

that, as a result of these procedures, the

Audit Team found discrepancies in quantity,

description, or location in nearly one-third of

the 76 items that the Audit Team selected for

verification. Coopers could not project the

results of this sample to the entire population

because MDC did not provide priced inventory

schedules. Therefore, Coopers questions only

$75,042, which represents the specific items

quantified.

Physical inventory verification testing is a proper

sampling method. If sufficient evidence sustains a

claimed cost, however, the cost should be awarded.

1. Damaged and Defective Inventory

The Government asserts that after the physical

inventory procedures, McDonnell Douglas supphed

documentation as to the location of several missing

“CFE/major subcontracts items selected for physical

inventory.” McDonnell Douglas had also returned

certain of these items to its vendors or labeled them

as defective, damaged or rework items. According to

the Government, “[McDonnell Douglas] provided no

satisfactory evidence that it took credit for these

damaged or defective components as a part of the

340a

subcontractor settlement process and, accordingly

Coopers questions $1,439,405 in associated costs.”

Mr. Hancock testified that the costs to repair

such items were added to increase subcontractors’

estimates at completion. This would have the effect of

reducing the subcontractors’ recovery. On the record

before the court, we cannot say that these costs are

unreasonable.

2. Common Inventory

The Government also contends that during phys-

ical inventory testing, the Defense Plant Repre-

sentative Officer’s technical representatives identified

material that could be used on other programs. “The

costs of items reasonably usable on the contractor’s

other work shall not be allowable unless the

contractor submits evidence that the items could not

be retained at cost without sustaining a loss.” FAR

31.205-42(a). Additionally, “lalny acceptance of

common items as allocable to the terminated portion

of the contract should be limited to the extent that

the quantities of such items on hand, in transit, and

on order are in excess of the reasonable quantitative

requirements of other work.” /d. Additional pro-

cedures were performed by the Coopers & Lybrand

audit team “to identify amounts of termination stores

material that MDC actually used in other programs

and, in some cases, purchased from vendors after

te: mination.” Based on these procedures, the Govern-

ment questions a total of $764,282 as “common

34la

inventory” because the costs claimed may not be

included in termination costs if the inventory could be

used on other programs, as alleged here.

Mr. Miller acknowledged that the contracting

officer should make a determination whether inven-

tory is common, but that the Government did not do

so in this case. He further acknowledged that the

Government did not provide an inventory verification

report, did not appoint a plant-wide clearance officer,

and did not make an assessment of commonality at

the time of termination. He stated that with respect

to post-termination inventory, the Government’s posi-

tion was that “they wouldn’t do anything in terms of

dealing with the contractors on inventory, other than

to let them know that there had been a termination

for default.”'' He stated that “in general, my under-

standing is that they didn’t get involved or want to be

involved in that particular process because it was a

termination for default.” Mr. Hancock testified that

all of the direct material costs in the company’s claim

were in excess of its needs. He detailed McDonnell

Douglas’ procedure for transferring common items.

We cannot question McDonnell Douglas’ claims in

this area.

3. Panstock Cost Transfer

The audit team conducted a review of pre- and

post-termination journal vouchers, and discovered a

'' See supra note 1.

342a

February 22, 1991 entry allocating $2,611,179 of

panstock to the A-12 program. The Miller report

questions the $2,611,179 as a common item unallow-

able under FAR 31.205-42.

As McDonnell Douglas uses the term, panstock

describes low-value, high volume material. Michael

Cromer” testified that panstock can be either

common and used for multiple programs, or unique

and used on a single program.

Hancock and Cromer testified that McDonnell

Douglas systematically moved panstock and other

inventory to other programs where it could, and that

its incurred costs do not include any “common items,”

for which the Government is entitled to credit under

FAR 31.205-42(a). In short, McDonnell Douglas

sought to mitigate its costs related to panstock.

Panstock should not be treated differently from

any other cost challenged as a common item. McDonnell

Douglas tried to limit the amount of panstock

attributable to the A-12 contract by attempting to

find a use for it on other contracts. The remaining A-

12 panstock exceeds McDonnell Douglas’ needs; it

remains a cost to which McDonnell Douglas is

entitled.

* Mr. Cromer was McDonnell Douglas’ manager of govern-

ment accounting.

343a

4. Fixtures Loaned to Other Programs

The Government maintains that Coopers identified

six significant test fixtures of physical inventory that

reportedly were being used on other McDonnell

Douglas programs. The costs for these items, how-

ever, remained in McDonnell Douglas’ January 1994

termination settlement proposal update. According to

the Government, “McDonnell Douglas would not

quantify the costs of the fixtures prior to Coopers’

issuance of its May 8, 1995 incurred cost audit

report.” After the incurred costs audit report was

issued, the Government learned through discovery

that McDonnell Douglas had “quantified the costs of

five of the test fixtures at $10,065,599.” Coopers

questioned this entire amount.

Special test equipment is an allowable and

recoverable A-12 contract cost under FAR 31.205-40.

Mr. Miller admitted that the six test fixtures were

built specifically for the A-12 contract. Miller argued

that the costs nevertheless should be recovered under

other contracts because the test equipment had been

loaned occasionally after te: mination. In McDonnell

Douglas’ view, this simply mitigated costs to the

Government. McDonnell Douglas points out that “no

contracting officer on any other program has agreed

to accept or pay any portion of the costs of the special

test equipment.” It concludes based on the foregoing

that there is no basis to disallow this $10,066,000 in

special test equipment costs under FAR 31.205-40. To

344a

do so would mean that it “could not recover its

incurred costs under the A-12 or any other contract.”

We agree. These costs are awardable to Mc-

Donnell Douglas.

C. Other Costs — General Dynamics and McDonnell

Douglas

1. Unabsorbed Overhead

The Government argues that McDonnell Douglas

cannot recover unabsorbed overhead costs:

Coopers’ identified and questioned

$12,538,718 in costs transferred, after

termination of the prime contract, from

overhead pools to the Termination Proposal.

These costs were for facilities and were

charged to overhead pools during the per-

formance of the A-12 contract. However, after

termination MDC attempted to charge these

costs specifically to the A-12 contract, even

though prior to January 8, 1991, other

contracts absorbed these costs pursuant to

MDC’s overhead allocation policies. Neither

Mr. Hancock nor Mr. Cromer, the two

witnesses proffered by MDC to testify to this

issue could explain why the accounting basis

of the treatment of these overhead costs was

different after termination than before.

Significantly, MDC presented no _ expert

evidence to rebut Mr. Miller’s testimony that

the costs in question were “by their very

nature, overhead costs.” Indeed, MDC

questioned these same types of costs in

345a

settling with its subcontractor, SJ & LA-

Hughes.

‘These alleged costs were, in actuality,

claims for unabsorbed overhead, inasmuch

as they represented overhead costs that

MDC allegedly could not be |sic] recover,

using the post A-12 business base for

allocating its overhead costs. As such, the

law proscribes their recovery in a termi-

nation for convenience. See DCAAM P12-

305.7(b)-(c); F. Alston, M. Worthington, & L.

Goldsman, CONTRACTING WITH ‘l'HE: FED-

ERAL GOVERNMENT 360-61 (3d ed. 1992).””

McDonnell Douglas disputes the Government’s

characterization of this expense as unrecoverable

unabsorbed overhead. Mr. Cromer testified that the

$12,539,000 amount was specific to the A-12 contract

and that it represented the cost of idled A-12 facilities

accounted for exactly as DCAA has required on two

other terminated contracts.

The issue is whether it was proper for McDonnell

Douglas to remove such costs from the company’s

overhead pools, and include them in the termination

proposal as incurred for the A-12 program.”

Cf. P. Trueger, ACCOUNTING GUIDE FOR GOVERN-

MENT CONTRACTS (10th ed. 1991) 713-25 (discussing court

and board cases on recovery of unabsorbed overhead).

* The Government pressed Cromer on cross to explain why

the $12.6 million in costs were transferred:

(Continued on following page)

346a

Cromer and Hancock testified that the idle facil-

ity costs were specific to the A-12 contract, but were

charged to overhead pools until termination. Accord-

ing to Cromer, the practice of assigning depreciation

Q: Okay. And prior to the te:mination of the A-

12 contract, where were those costs reflected?

A: They were reflected in capital assets and

then the depreciation went into overhead.

@: So those costs were allocated among all con-

tracts at McDonnell Douglas, or at least government

contracts, including the A-12, right?

A: That is correct.

Q: Can you explain why you decided to move the

costs out of the overhead pools to the A-12 termi-

nation?

A: Because that was our policy at McDonnell

Aircraft Company relative to assets that related to a

terminated contract.

Q: Can you tell me why you did it, though? I

mean, theoretically, what was the underpinning of

that decision?

A: The basis for that was that these assets were

acquired for a particular program, and they were

capitalized and depreciated. And when a program was

terminated, it is part of the cost associated with that

program. I guess that’s basically all 1 can describe it

as.

@: But you would agree with me, sir, that prior

to the termination, even though the assets had been

acquired for a specific program, you were recovering

those costs by charging them to all contracts, A-12

and others?

A: They were included in the depreciation and

the overhead expenses, yes, sir.

347a

into an overhead pool — without regard to whether it

was a program-specific asset or a_ general

administrative cost — was standard for McDonnell

Douglas. In other words, the fact that an asset was in

an overhead pool did not necessarily identify that

asset as a yeneral, administrative type of asset. Mr.

Hancock testified that McDonnell Douglas attempted

to find alternative uses for the facilities that were

specific to A-12. He stated that after the facilities

remained idle for some time, however, “we decided

that we would claim these costs.”

Mr. Cromer testified that claiming these costs in

the A-12 termination proposal was not an aberration.

He described two prior incidences of adjusting over-

head depreciation pools following a convenience

termination. Cromer testified that after the ‘Tacit

Rainbew Program was terminated for convenience,

the DCAA “specified in their audit report that it

should be charged directly to the termination claim.”

Similarly, with respect to the Atlas program, costs in

the overhead pool were “moved from the overhead

pool and charged directly to the termination claim on

the Atlas program.”

These assets were program-specific; their costs

were incurred in performing the A-12 contract. Asset

costs assigned to overhead pools nevertheless can be

program-specific, and included in a cost proposal

associated with the termination of that program.

Based on its prior experience with the DCAA,

McDonnell Douglas sought to recover incurred costs

inextricably associated with the A-12 program. We

348a

find that these costs are reasonable, allowable, and

allocable.

2. Material Handling Expense

Coopers and Lybrand questioned $6,700,000 in

material handling expense charges at General

Dynamics related to unliquidated progress payments.

Material handling charges are incurred when material is

handled as it arrives. According to defendant, General

Dynamics is “attempting to charge the Government for

costs that were not and could not possibly have been

incurred.”

The base used to calculate its material handling

expenses includes the amount of unliquidated pro-

gress payiments paid by General Dynamics to its

subcontractors. Mr. Miller testified that he challenged

these costs because “they were payments included in

the termination for convenience proposal for material

handling expenses, overhead expenses fur material

handling, that were applied to progress payments

that didn’t represent deliveries and shipments.”

General Dynamics notes that the costs related to

material handling are principally labor, such as “the

costs of paying people to move items in and out of

warehouses and to help procure material.””

’* General Dynamics provides the following additional

explanation in its post-trial brief:

(Continued on following page)

349a

At GD'’s Ft. Worth division, a pool of people at one

end of the factory waited to receive material, which

would pass through inspection and be delivered to the

place on the factory floor where it was needed. These

expenses were incurred whether or not material was

being handled. GD divided the expenses for this labor

between the various contracts at the Ft. Worth

division. To divide the costs between the contracts, a

“base” was established, and a rate that was negotiated

with the ACO was applied to the base to determine

the amount to be charged to each contract. The base

that GD used for all of its contracts, including the A-

12, included both liquidated and wnliquidated

progress payments. GD had used this method for

years, with disclosure to, and approval by, the govern.

ment.

Nevertheless, [Coopers] challenges the use of this

method because it appears to allow GD to recover

material handling on materials-represented by

unliquidated progress payments — that were never

handled. This challenge ignores the fact that the base

is merely a method to estimate the proper allocation

of actually incurred overhead between various contracts.

The challenge in fact would have the effect of denying

GD reimbursement of material handling expenses

actually incurred. Because GD — with full knowledge

and approval of the government — divided its pool of

costs among its various contracts using a calculation

that included unliquidated progress payments,

removal of those payments from the A-12 base after

the fact would result in underestimating the A-12

contract’s pro rata share of those actually incurred

expenses. The government cannot retract retro-

actively its approval of a contractor’s established

accounting method to the detriment of the contractor.

See Litton Systems, Inc. v. United States, 196 Ct. Cl.

133, 449 F.2d 392, 394, 399-401 (Ct. Cl. 1971).

350a

We find that the material handling costs noted by

General Dynamics were incurred. It had used the

same accounting system before with Government

approval. The system provided a method whereby

General Dynamics could allocate material handling

costs to different contracts, thus accounting for A-12

expenditures properly. General Dynamic’s accounting

system was not unreasonable. We see no reason to

impose a new allocation method upon plaintiff

retroactively. See Litton Systems, Inc. v. United

States, 196 Ct. Cl. 133, 449 F.2d 392, 399 (1971).

3. Excessive Overtime

a. General Dynamics

Coopers listed as pending $3,829,421 of General

Dynamics’ overtime expenses because the company

apparently could not explain adequately why it expe-

rienced overtime hours in excess of that estimated in

its Best and Final Offer.

No legal authority mandates that overtime

cannot exceed the target estimates made in a BAFO.

This was an incentive contract. Plaintiffs point out

that Mr. Miller lacked the technical expertise to

appreciate the need for significant overtime in

General Dynamics’ performance of the contract. See

DCAM 2-202(a).

The standard that we employ to determine

the awardability of the overtime expenses claimed

here is whether they are allowable, allocable, and

35la

reasonable. See, e.g., Worsham Constr. Co, 1985

ASBCA LEXIS 733, ASBCA No. 25907, 8502 B.C.A.

(CCH) P18,016, at 90,369 (March 22, 1985). Testi-

mony at trial established that the overtime was

incurred in performance of the A-12 contract. The

overtime did not exceed an amount that would have

been incurred by a prudent business person, and

therefore is allowable. See, e.g., FAR 31.201-2, -3, -4.

b. McDonnell Douglas

The contract did not limit overtime. Additionally,

it was not necessary for the contracting officer to

approve overtime before McDonnell Douglas could

incur the expense. We find that $11,605,000 challenged

by the Government here is properly awardable to

McDonnell Douglas.

4. General Dynamics Offload

General Dynamics transferred a number of tasks

to McDonnell Douglas for completion during the

course of performance. The audit team grew con-

cerned about costs related to such tasks. “Because the

potential duplication of effort has not been quantified

by either MDC or GD, Coopers determined that costs

associated with this effort may represent costs that

GD experienced as overruns.” According to defendant,

this establishes that plaintiffs did not meet their

burden of proving entitlement to these costs: “Neither

plaintiff presented evidence as to whether the work in

question was a duplication of effort which might be

352a

unreasonable for the plaintiffs to recover from the

Government.”

Mr. Hancock’s explanation of the transfer of

certain tasks was simple: “McDonnell Douglas could

build them quicker than General Dynamics could.”

He testified that he knew of no duplication of

function, even though “|t]Jowards the latter part of

1990, the issue was discussed at almost every

meeting.”

We have no basis to suspect duplication of efforts

between plaintiffs other than, as Miller termed it

during trial, “healthy auditor skepticism.” We found

no evidence of duplication. This cost is properly

awardable.

5. Relocation Expenses

a. General Dynamics

The Government challenges relocation costs of

$2,931,977 incurred by General Dynamics. Defendant

states that the “benefitting” contract should be

charged for the relocation expenses and not the A-12

contract. That is, “if an employee is transferred to

another program, for example, the F-16 or the F-18,

then those programs and not the A-12 should pay for

those costs.” Defendant invokes FAR 31.205-35(e),

which provides that “costs of family movements and

of personnel movements of a special or mass nature

are allowable. The costs, however, should be on the

basis of work (contracts) or time period benefited.”

353a

General Dynamics argues that these relocation

expenses benefitted the A-12 contract within the

meaning of FAR 31.205-35(e). Further, the costs are

properly allocable to the A-12 contract as continuing

costs after termination, pursuant to FAR 31.20542(b).

To perform the contract, General Dynamics relocated

employees from Ft. Worth to assignments in other

locations, such as St. Louis, Tulsa, Patuxent River,

and Alamogordo. These employees returned to Ft.

Worth after termination. General Dynamics included

the costs of returning such employees to Ft. Worth in

its Best and Final Offer, which makes these expenses

an “explicit premise of the contract.”

FAR 31.205-42(b) provides that “costs which

cannot be discontinued immediately after the

effective date of termination are generally allowable.”

The DCAM provides, in illustrating this FAR

provision:

For example, the contractor may have

contract personnel at a remote or foreign

location or there may be personnel in transit

to or from these sites. The cost of their

salaries or wages would be allocable to the

terminated contract for a reasonable period

required to transfer the personnel to sites for

termination or used on the contractor’s other

work.

DCAM 12-305.7(a)(1).

“No principled distinction can be drawn between

the cost to relocate an employee after termination

354a

and the cost of that employee’s salary while he

relocates,” according to General Dynamics. We agree,

especially because the BAFO included a reference to

relocation. The costs incurred to return the

contractors’ employees to their home base after

termination are allocable to the A-12 contract. They

are properly included in plaintiffs’ termination for

convenience recovery.

b. McDonnell Douglas

The Government challenges $78,000 in relocation

costs claimed by McDonnell Douglas. Relocation costs

were included in the contractors’ proposals. As stated

above, FAR 31.205-42(b) recognizes that “costs which

cannot be discontinued immediately after the

effective date of termination are generally allowable.”

The DCAM provision illustrating FAR 31.205-42(b)

provides examples of allowable termination costs, but

they are not meant to be exhaustive. When a contract

is terminated, the DCAM contemplates that the

salary or wages of a worker may be charged to the

terminated contract for a reasonable period, while he

is transferred to perfoiin other work or for ter:mination

activities. The cost of relocating McDonnell Douglas’

employees is similar to the example provided by the

DCAM. McDonnell Douglas’ relocation costs are

properly awarded.

355a

6. Application of Overhead Rates to Unal-

owable Costs

The Government notes that “to the extent that

unallowable cost is identified, a corresponding adjust-

ment to the amount of overhead costs needs to be

made. In essence, if the direct costs are reduced then

overhead costs must also be reduced by the approved

rate to reflect the proper amount of overhead cost.”

We agree. The adjustment stemming from our

sustaining the Sierra Alloys challenge is $80,144. The

deduction in overhead costs resulting from the

Government's Stewart-Warner challenge is $86,511.

Thus, an additional $166,655 will be deducted from

plaintiffs’ incurred cost total.

7. Miscellaneous Costs

a. McDonnell Douglas Helicopter Corpora-

tion Purchases

During audit field work at the McDonnell

Douglas Helicopter Corporation (MDHC),

Coopers identified $785,370 in inventory

which was common to other programs and

which MDC was attempting to charge to the

A-12 in violation of FAR 31.205-42. MDHC

was unable to provide documentation to sup-

port the incurrence of $166,000 of direct

material costs. There was also $84,865 in

costs based on the use of billing rates rather

than proposed rates. Finally, Coopers ques-

tioned $41,441 for incorrectly applied ma-

terial handling charges. The total amount of

356a

costs challenged relating to MDHC is

$1,077,976.

We are generally satisfied with the measures

taken by plaintiffs in dealing with common inventory.

An earlier discussion describes the testimony that we

heard from Mr. Miller and Mr. Hancock relating to

common inventory. While the common inventory

portion of this challenge is not a concern, we are not

satisfied that McDonnell Douglas has proven its

entitlement to the other costs challenged by the

Government. The Government’s challenge is sus-

tained in the amount of $292,306.

b. Douglas Aircraft Company Purchases

and Common Bomb Racks

Coopers identified and questioned $1,087,141 in

direct material cost for which Douglas Aircraft Com-

pany could not provide proper accounting documenta-

tion to support the purchase. The costs incurred were

for bomb racks that were built initially for the A-12 at

Douglas Aircraft Company. Prior to termination, the

task of building the racks was transferred to

McDonnell Douglas Helicopter Corporation. Sepa-

rately, Coopers challenged $224,516 in costs incurred

by Douglas Aircraft Company related to common

bomb rack materials. Mr. Miller testified that the

audit team was not provided with adequate docu-

mentation as to the propriety of these costs.

Mr. Cromer offered testimony supporting these

costs. While documentation of the costs may not have

357a

been ideal, the costs were documented nevertheless.

Two sets of data were provided; they more or less

supported each other. The first was McDonnell

Douglas’ cost analysis reports reflecting amounts

billed by Douglas Aircraft Company. The second

consisted of Douglas Aircraft’s cost incurrence

records, including requisition forms and “purchase

order activity forms.”

These costs may not be documented sufficiently

to satisfy the rigorous accounting standards employed

by Mr. Miller. We find, however, that these costs are

reasonable, allowable, and allocable.

c. Loss on Sale of Office Furniture

Mr. Miller questioned the cost of office furniture

as common items because such costs are expressly

disallowed by FAR 31.205-42. In its termination for

convenience proposal, McDonnell Douglas claimed a

$1,262,000 loss on the sale of Tulsa facility furniture.

Mr. Hancock testified that except for a _ limited

amount of furniture that was transferred for the

Government’s credit, the furniture was in excess of

McDonnell Douglas’ needs, and could not be used

elsewhere after termination despite efforts § by

McDonnell Douglas to find an alternative use.

Testimony at trial established that the furniture

was purchased for the A-12 contract, and that it was

sold at auction after te: mination. McDonnell Douglas

claims the resulting loss. The costs appear to have been

reasonable, allocable, and allowable. See generally FAR

358a

31.205-16(a) (gains and losses from the sale, retire-

ment, or other disposition of depreciable property

shall be included in the year in which they occur).

d. Termination Training

Coopers & Lybrand challenges $198,000 for

termination training provided by Petersen & Co.

because it was not specific to the A-12 program. Mr.

Hancock’s testimony, however, established that this

training was provided because the A-12 contract was

terininated, and was not attended by non-A-12

personnel. We cannot conclude that these costs were

not reasonable, allocable and allowable. These costs

are properly considered settlement expenses under

FAR 31.205-42(g).

e. Non-Standard Overhead Rate

Coopers & Lybrand disallowed $29,000 because

McDonnell Douglas used “an incorrect rate for non-

standard overhead applied to termination labor.” Mr.

Miller testified that the use of that rate was not in

compliance with the Cost Accounting Standards

(CAS) incorporated by FAR Part 31.

Mr. Cromer testified that the $29,000 figure

“represents the difference between the nonstandard

forecasted rate being applied at September ’93 when

the initial claim was prepared, versus the year-end

rate that was ultimately booked into the accounting

records.” The correct rate was substituted for the

359a

non-standard overhead rate in the 1997 update when

the correct rates became available. We do not

question Mr. Cromer’s credibility on this point."

f. Robotic Paint and Assembly Pump

Coopers questioned $2,978,763 in costs related to

a robotic paint and assembly pump. Mr. Miller

testified that during the audit inquiry, McDonnell

Douglas told the audit team that costs associated

with this robotic paint and assembly pump were to be

removed from the termination proposal because

another program could use it. Instead of removing

* Additional testimony provided as follows:

Q@: When the 1994 update was prepared, it used

September 1993 data?

A: That is correct.

Q: And as of September 1993, were there final

nonstandard overhead rates for the year 1993?

A: No, there was not.

Q: Are there currently rates for 1993 like that?

A: Yes, there are.

Q: Final rates?

A: Yes.

Q: Are there also final rates for 1994, ’95 and

96?

A: Yes, there are.

Q@: Are those final rates used in the 1997

update?

A: The final nonstandard overhead rate is used

for all of those years, yes.

360a

these costs from its claim, however, McDonnell

Douglas increased the costs claimed for this equip-

ment. The Government challenges these costs as

being related to common items that are disallowed

under FAR 31.205-42(a). Miller’s challenge is “based

solely on his erroneous belief that the sprayer could

be used on another program,” according to McDonnell

Douglas. Mr. Hancock testified that McDonnell

Douglas tried to find a use for the sprayer elsewhere

— for a while, it appeared that the sprayer could be

used in the F/A-18 program — but ultimately no need

for the sprayer arose. This testimony was undisputed.

The costs associated with the robotic paint

sprayer are allowable, allocable and reasonable. Costs

of idle facilities are allowable if they are necessary

when acquired and are idled because of changes in

requirements that could not reasonably have been

foreseen. See FAR 31.205-17.

8. Miscellaneous Costs

a. Computer Sciences Corporation Depreciation

Charges

Coopers & Lybrand challenged $54,879 “related

to depreciation expenses of computer equipment.”

The audit team sought documentation from General

Dynamics supporting these costs, but these efforts

were unsuccessful, according to the Government.

General Dynamics responds that “the total

amount of CSC depreciation was over $4 million, all

but $54,879 of which had been reconciled.” General

361la

Dynamics contends that it could have easily spent

more than $54,000 trying to resolve the remaining

$54,000. This would have resulted in potential

Government liability not only for the $54,879 in

depreciation, but also for the cost of the reconciliation

effort. Settlement expenses might include “accounting,

legal, clerical, and similar costs reasonably necessary

for ... the preparation and presentation, including

supporting data, of settlement claims to the con-

tracting officer.” FAR 31.205-42(2)(1)0), (G)(A). Because

the Government did not assist with close out of this

contract, General Dynamics had to determine on its

own the proper level of expenditure to undertake to

substantiate its claims. See generally FAR 49.20 1(c)."’

The Government challenges only a small amount

of CSC depreciation expense. Virtually all of the

depreciation was properly reconciled (almost 99%),

and we agree with plaintiff that chasing the remain-

ing few dollars would not have been in the

Government's interest. The total amount claimed is

allowable, allocable, and reasonable.

b. Retention Bonuses

Coopers challenged $1,196,000 related to retention

bonuses because it said that General Dynamics did

not have a “preestablished policy” for viving such

bonuses. Mr. Miller testified that retention bonuses

17 '

See supra note |

362a

were paid by General Dynamics to non-General

Dynamics employees.

FAR 31.205-6(a) provides, inter alia:

Compensation for personal services is

allowable subject to the following general

criteria and _é additional requirements

contained in other parts of this. cost

principle:

(3) The compensation must be based

upon and conform to the terms and

conditions of the contractor’s established

compensation plan or practice followed so

consistently as to imply, in effect, an

agreement to make the payment.

The Government relies on the wrong FAR

provisions, according to General Dynamics. It had to

retain certain key employees to assist in contract

close-out, to maintain program security, and to assist

with subcontractor settlements. The retention

bonuses for such purposes are awardable under FAR

31.205-42(g)\1)(i)-(iii), + governing post-terinination

settlement expenses. This section provides that such

settlement expenses are allowable, such as

(i) Accounting, legal, clerical, and

similar costs reasonably necessary for —

(A) The preparation and presentation,

including supporting data, of settlement

claims to the contracting officer; and

363a

(B) The terinination and settlement of

subcontracts.

(ii) Reasonable costs for the storage,

transportation, protect.on, and disposition of

property acquired or produced for the

contract.

See also FAR 52.249-2(f)(3).

FAR 31.205-6(a) applies by its terms only to

payinents made for services rendered during the

period of contract performance, General Dynamics

argues. The provision applies only to employees,

rendering it inapplicable to those former General

Dynamics employees to whom the company paid

retention bonuses. General Dynamics argues that

even if FAR 31.205-6 did apply, the applicable

subsection would be FAR 31.205-6(f)(1). This sub-

section requires an established policy just as 31.205-

6(f(1) does, but General Dynamics maintains that it

set up such an established policy before paying any of

the bonuses.

General Dynamics’ argument is persuasive. FAR

31.205-42(g)(1)(G)-Giii) appear to contemplate the

situation at hand. The Government benefitted from

General Dynamics’ retention of key employees, at

least indirectly. For example, Mr. Broesche negotiated

effectively with subcontractors, resulting in settle-

ments for about half the amount sought by the

subcontractors. Although General Dynamics’s argu-

ment that it had an “established” policy of paying

such bonuses is somewhat tenuous, the decision to

364a

retain key employees served the best interests of the

Government as well as those of General Dynamics.

We do not question that judgment.

c. Loss of Useful Value-Material Transfer

Credit

The audit team tested a small sample of “trans-

actions involving the transfer of A-12 equipment to

the F-16 program” for General Dynamics’ “loss of

useful value claim.” The auditors noted that General

Dynamics transferred A-12 equipment to the F-16

program at less than net book value. Net book value

at the time was $35,859. The A-12 program was

credited only $7,100. The audit team had concerns

about and questioned “the difference between the net

book value of the item transferred and the credit

given to the A-12 program consistent with CAS 409

[Capitalization of Equipment].”. The Government

chailenges $28,759 in costs.

General Dynamics responds that “the $28,759 in

equipment was not A-12 equipment, but was

company-wide equipment charged to an indirect cost

pool.” It therefore “would have been improper to

credit the A-12 contract with costs associated with its

transfer because the value of the equipment (unlike

the value of the $7,068.82 in equipment that was

credited to [the] government) had never been charged

io the A-12 contract, as Miller erroneously assumed.”

The record before us does not dispute General

Dynamics’ claim in this regard.

365a

d. Certification Costs

General Dynamics charged the Government

$13,000 in certification costs for its updated ter-

mination for “convenience proposal,” even though this

proposal was not certified, according to defendant.

Coopers and Lybrand questioned the $13,000 claimed

by General Dynamics as unreasonable.

General Dynamics argues that these costs are

allowable settlement expenses under the FAR. See,

e.g., FAR 31.205-42(g)(1)(i)(A) (relating to costs neces-

sary for preparing and presenting settlement claims).

It “expended these costs as part of a due diligence

review of the McDonnell Douglas portion of the

termination for convenience proposal.” Mr. Wright

testified that the claim of which the Government

complains was certified both by McDonnell Douglas

and General Dynamics after a review of their June

1991 termination for convenience claim. We do not

question these costs.

e. Unsettled Subcontractor Progress Pay-

ments

Coopers & Lybrand determined that $1,653,406

in costs “representing unliquidated progress payments

made to unsettled subcontractors” is still pending.

“The ultimate settlement of these remaining sub-

contractor claims could result in the repayments of

some or all of the outstanding unliquidated amount to

General Dynamics,” according to the Government.

366a

This challenge deals entirely with unliquidated

progress payments made to Harris Corporation. Mr.

Wright, who was involved in settlement negotiations

with tiarris at the time of trial, testified that Harris

is entitled to retain at least the $1,653,406 amount,

and perhaps more. This amount is not contingent or

speculative, therefore, and it is properly awarded to

General Dynamics. Wright’s testimony is undisputed.

This amount is awarded to General Dynamics.

IV.

YET TO BE INCURRED COSTS”

We ruled last year that plaintiffs are entitled to

reimbursement of costs that must be incurred in the

interest of national security. The “To-Go” portion of

costs claimed by General Dynamics for program

security through June 1999 is estimated to be

“ Defendant notes in its post-trial brief:

The Government challenges plaintiffs’ claim for

approximately $26 million in contingent costs not yet

incurred. These contingent costs are primarily for

program security costs, settlement expenses, and

settlement with remaining subcontractors. These costs

are unallowable. “Pursuant to FAR 52.249-2. Termi-

nation for Convenience of the Government (Fixed-Price)

the contractor may recover costs incurred in the

performance of the work.” Sterling Millwrights, Inc. v.

United States, 26 Cl. Ct. 49, 112 (1992) (emphasis

added). Moreover, cost principles expressly prohibit,

in FAR Part 31, recovery of non-incurred, contingent

costs. See FAR 31.205-7(a) and 7(b).

367a

$2,489,915. McDonnell Douglas’ estimate is $1,910,416.

These costs are awarded pursuant to the earlier

ruling. McDonnell Douglas has reached a settlement

with SCI since the time of trial.” Thus, $5 million is

no longer a cost yet to be incurred.

McDonnell Douglas’ obligation to pay General

Dynamics $3.2 million for its efforts in building a

turntable is not contingent, and it is therefore

included in the judyinent. McDonnell Douglas’ claim

for $2,367,175 for administrative/settlement expenses

is denied. Neither the $10,153,895 claimed by

General Dynamics for four unsettled subcontractors

nor $246,072 claimed for settlement expenses is

allowable. We sustain defendant’s challenge in the

amount of $12,767,142.

CONCLUSION

Plaintiffs claim a total of $3,992,455,272 in

reasonable, allocable, and allowable costs. We estab-

lished a cap on plaintiffs’ recovery of $3,499,793,515

for the FSED portion of the contract. Adjusted for

funds obligated through the IPR and EPA clauses, the

funding cap becomes $3,635,767,376. Adding the

undisputed amounts of $.212 billion for Lot I and

$.030 billion for Lot II, we arrive at a figure of

$3,877,767,376. Taking into account progress pay-

ments of $2,677,634,556 held by plaintiffs, the amount

'* McDonnell Douglas agreed to pay $8 million pursuant to

the settlement, but its claim remains $5 million.

368a

due plaintiffs is $1,200,132,820, plus statutory interest

on that sum from June 26, 1991 until paid.

The parties asked us to rule on the total amount

of plaintiff’s reasonable, allowable, and allocable

incurred costs, irrespective of the cap. The total

amount of reasonable, allowable, and allocable costs

incurred by plaintiffs is $3,978,002,676. The judg-

ment that we enter today, however, is $1,200,132,820.

The opinion and order of February 20, 1998 is

VACATED. The clerk is directed to VACATE the

judyment entered February 23, 1998 as well, and to

enter judyinent for plaintiffs in the amount of

$1,200,132,820, plus statutory interest from June 26,

1991 until paid. No costs.

Robert H. Hodges, Jr., Judge

369a

McDONNELL DOUGLAS

CORPORATION AND GENERAT.

DYNAMICS CORPORATION, Plaintiffs, v.

UNITED STATES OF AMERICA, Defendant.

No. 91-1204C

UNITED STATES COURT

OF FEDERAT. CI.AM™MS

37 Fed. Cl. 270; 1996 U.S. Claims LEXIS 207;

41 Const. Cas. Fed. (CCH) P77,035

December 13, 1996, Filed

COUNSEL: Cary] A. Potter, III, Sonnenschein, Nath

& Rosenthal, Washington, D.C., for plaintiff Mc-

Donnell Douglas Corporation, with whom was John

W. Walbran, McDonnell Douglas Corporation, of coun-

sel; Herb

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