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

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA43085015_0591%3A03

## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 2009

## Text

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 d

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA43085015_0591%3A03. Public record. Not legal advice.