Federal Circuit Decision Addressing Salary Costs Associated with Lobbying Activities Has Broad Implications

The FAR defines an “expressly unallowable cost” as “a particular item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable.” (See 48 C.F.R. § 31.001 and 48 C.F.R. § 9904.405-30(a)(2).) The ASBCA has long held that the Government bears the burden of proving that a cost is unallowable, and, with regard to costs that the Government claims are expressly unallowable, the burden is a difficult one. To meet its burden of proving a cost is expressly unallowable, the Government must “show that it was unreasonable under all the circumstances for a person in the contractor’s position to conclude that the costs were allowable.” (See e.g., General Dynamics Corp., ASBCA No. 49372, 02-2 BCA ¶ 31,888, rev'd in part on other grounds, Rumsfeld v. General Dynamics Corp., 365 F.3d 1380 (Fed. Cir. 2004).) (“Congress adopted the ‘expressly unallowable’ standard to make it clear that a penalty should not be assessed where there were reasonable differences of opinion about the allowability of costs” so the “Government must show that it was unreasonable under all the circumstances for a person in the contractor’s position to conclude that the costs were allowable.”) Some costs are clearly unallowable—for example, the cost of alcoholic beverages (FAR 31.205-51)—and are, therefore, considered expressly unallowable under the regulations and case law. These costs rarely—if ever—ignite dispute. Other categories of costs, however, are not so clear.

One such nuanced cost—lobbying and political activity costs—was the subject of the recent decision from the U.S. Court of Appeals for the Federal Circuit in Raytheon Co. v. Sec. of Def., 2018-2371 (Oct. 18, 2019). FAR subsection 31.205-22, “Lobbying and political activity costs,” disallows costs “associated with” certain types of identified lobbying activities. (See 48 C.F.R. § 31.205-22.) But subsection 31.205-22 does not explicitly state or name compensation or salary costs as unallowable. Thus, there was arguably some room to disagree about whether the salary costs of employees engaged in unallowable lobbying activities are “expressly unallowable costs” and therefore subject to penalties under FAR paragraph 42.709-1(a)(1). In fact, a fairly recent ASBCA decision had reached the opposite conclusions with regard to compensation. (See Raytheon Co., ASBCA No. 57576. et al., 15-1 BCA ¶ 36,043.) (Bonus costs and compensation costs are not specifically named in FAR 31.205-22 and, therefore, are not expressly unallowable costs.)

Earlier this month, the Federal Circuit affirmed a 2017 ASBCA decision holding that the salary costs of employees engaged in unallowable lobbying activities are “expressly unallowable costs” and therefore subject to penalties under FAR paragraph 42.709-1(a)(1). (See Raytheon Co., ASBCA No. 57743, 17-1 BCA ¶ 36724.) In so doing, the ASBCA had found that costs that are directly associated with expressly unallowable costs are also expressly unallowable.

The Federal Circuit affirmed the ASBCA without reaching the “directly associated” issue. Instead, the court found that the “associated with” language of FAR 31.205-22 necessarily identified employee compensation as unallowable. The Federal Circuit reviewed the historical development of the cost principle, tracing the current regulation making unallowable “[c]osts associated with the [enumerated lobbying] activities unallowable” to the predecessor language in the Defense Acquisition Regulation and the Federal Procurement Regulations, which each included “the applicable portion of the salaries” of individuals engaged in lobbying activities. (See Slip Op. at 7.) The court found that the regulatory changes removing the references to salaries and instead substituting the term “costs associated with” did not create any ambiguity about the allowability of salaries. Thus, the court held these costs expressly unallowable.

It is troubling that, in reaching this conclusion, the court did not apply the relevant expressly unallowable test—“unreasonable under all the circumstances”—required by longstanding precedent. Instead, it found that salaries of corporate personnel involved in lobbying are “unambiguously costs associated with lobbying.” Moreover, it determined that FAR 31.001’s definition of expressly unallowable costs includes compensation costs “unambiguously falling within a generic description of a ‘type’ of unallowable costs.” (See Slip Op. at 6.) The court thereby renders meaningless the qualifying requirement of FAR 31.001, that, in addition to being of “a particular item or type of cost,” an expressly unallowable cost must also be “specifically named and stated to be unallowable.” The Federal Circuit simply concludes that a cost need only fall unambiguously within the ambit of “a type” of unallowable cost—ignoring the requirement that it be “specifically named.” Notably, the Federal Circuit flatly rejects Raytheon 2015. The court states that this “decision is not binding on this court, and in any event, is contrary to the plain language of Subsection 22 to the extent that it concludes that salaries in the form of bonus and incentive compensation for lobbying and political activities are not ‘expressly unallowable.’” (See Slip Op. at 9.)

What does this mean for contractors? First, the Federal Circuit’s decision requires that contractors, who previously had relied on the 2015 Raytheon decision, now must scrub their incurred cost proposals and exclude these types of salary costs or risk penalties, interest, and system deficiencies. Second, the Federal Circuit’s decision also suggests that other categories of FAR Subpart 31 costs that are “unambiguously” within a “type” of disallowed cost also are at risk. Because this decision holds that a cost need not be designated by a regulation as “expressly unallowable” in order to reach that conclusion, this precedent seems poised to broaden the scope of expressly unallowable costs of all types.

For more information about how to avoid cost disallowances or to respond to proposed disallowances or assessment of penalties, please contact the authors or your regular Pillsbury contact.