B-120546, JULY 21, 1958, 38 COMP. GEN. 38

B-120546, JULY 21, 1958, 38 COMP. GEN. 38

CONTRACTS - COST-PLUS-A-PERCENTAGE-OF-COST PROHIBITION - ADMINISTRATIVE CONTROLS - PAYMENT BASIS A COST-TYPE CONTRACT WHICH ESTABLISHES A FEE COMPUTED ON A PERCENTAGE OF THE ESTIMATED COSTS WHICH, TOGETHER WITH THE FEE, CONSTITUTES THE CONTRACT CEILING PRICE AND WHICH PROVIDES FOR A DOWNWARD ADJUSTMENT OF THE FEE IF THE COSTS ARE LOWER THAN THE CEILING HAS THE EFFECT OF PENALIZING THE CONTRACTOR FOR EFFICIENCY IN PERFORMANCE AND REWARDING HIM FOR INEFFICIENCY AND THEREFORE VIOLATES THE COST-PLUS-A-PERCENTAGE-OF-COST SYSTEM OF CONTRACTING, NOTWITHSTANDING THAT PROVISION FOR ADMINISTRATIVE APPROVAL OF SUBCONTRACTS AND OF SIGNIFICANT ITEMS OF REIMBURSABLE COST WAS MADE. PROVISION FOR GOVERNMENT SUPERVISION OF LABOR AND MATERIALS AND FOR ADMINISTRATIVE APPROVAL OF SIGNIFICANT AND REIMBURSABLE ITEMS OF COST UNDER A CONTRACT WHICH PROVIDES FOR A FEE COMPUTED ON A PERCENTAGE OF THE ESTIMATED COSTS, WHICH TOGETHER WITH THE FEE CONSTITUTES THE CEILING PRICE, ARE NOT SUFFICIENT TO SAVE THE CONTRACT FROM BEING CONSTRUED AS IN VIOLATION OF THE COST-PLUS-A-PERCENTAGE-OF-COST SYSTEM OF CONTRACTING BUT ARE FOR CONSIDERATION ONLY IN CONNECTION WITH DETERMINATIONS OF AMOUNTS PROPERLY ALLOWABLE AS THE REASONABLE VALUE OF SERVICES OR SUPPLIES FURNISHED UNDER SUCH UNAUTHORIZED CONTRACTS. ALTHOUGH A CONTRACT WHICH HAS BEEN DETERMINED TO VIOLATE THE COST PLUS-A- PERCENTAGE-OF-COST SYSTEM OF CONTRACTING DOES NOT OBLIGATE THE GOVERNMENT TO MAKE PAYMENTS IN ACCORDANCE WITH THE TERMS OF THE ILLEGAL CONTRACT, THERE IS AN OBLIGATION UPON AN IMPLIED CONTRACT BASIS TO PAY THE REASONABLE VALUE OF THE BENEFITS ACCEPTED, AND, THEREFORE, PAYMENTS MADE UNDER THE CONTRACT CONSTITUTE UNAUTHORIZED EXPENDITURES EXCEPT TO THE EXTENT THAT THEY ARE JUSTIFIED AS REPRESENTING THE FAIR AND REASONABLE VALUE OF SERVICES AND SUPPLIES ACCEPTED BY THE GOVERNMENT, INCLUDING SUCH AMOUNT OF PROFIT AS WOULD CONSTITUTE JUST COMPENSATION UNDER THE CIRCUMSTANCES.

TO THE SECRETARY OF THE AIR FORCE, JULY 21, 1958:

BY LETTER DATED DECEMBER 5, 1957, THE ASSISTANT SECRETARY ( MATERIEL) WAS REQUESTED TO REVIEW AND COMMENT ON OUR DRAFT REPORT ON THE COST-PLUS-A- PERCENTAGE-OF-COST ASPECTS OF CONTRACT NO. AF 61 (514/ 609 WITH CURTISS WRIGHT EUROPA, N.V. OUR DRAFT REPORT CONCLUDED BASIS OF THE FACTS SET FORTH THEREIN, THAT THE CONTRACT VIOLATED EXISTING STATUTES ( SECTION 4 (B), ARMED SERVICES PROCUREMENT ACT, 62 STAT. 23, 41 U.S.C. 153 (B) (, PROHIBITING THE COST-PLUS-A-PERCENTAGE-OF-COST SYSTEM OF CONTRACTING.

UNDER DATE OF DECEMBER 31, 1957, THE ASSISTANT SECRETARY FURNISHED OUR OFFICE WITH HIS VIEWS AND CONCLUDED BY STATING THAT "IT IS CONSIDERED THAT THE CONTRACT INVOLVED HERE DIFFERED SO MUCH FROM THE NORMAL COST-TYPE CONTRACT CONTEMPLATED BY CONGRESS IN ITS PROSCRIPTION OF THE " CPPC" SYSTEM OF CONTRACTING THAT THE CONTRACT IN QUESTION CANNOT * * * BE CONSIDERED IN CONTRAVENTION OF THE STATUTE.'

WE HAVE CAREFULLY CONSIDERED THE ASSISTANT SECRETARY'S LETTER IN THE LIGHT OF OUR DRAFT REPORT AND THE RECORD BEFORE OUR OFFICE, AND WE ARE OF THE VIEW THAT THE CONTRACT AS WRITTEN DOES, IN FACT, VIOLATE THE STATUTORY PROHIBITION AGAINST THE COST-PLUS-A-PERCENTAGE-OF-COST SYSTEM OF CONTRACTING, AND CANNOT BE CONSIDERED AS AUTHORIZED BY THE STATUTORY SANCTION FOR COST-PLUS-FIXED-FEE CONTRACTS.

AS PART OF THE PROGRAM TO ESTABLISH PRODUCTION SOURCES IN EUROPE AND TO PROVIDED LOGISTIC SUPPORT FOR F84F AIRCRAFT FURNISHED TO NATO COUNTRIES UNDER THE MILITARY ASSISTANCE PROGRAM, CONTRACT NO. AF 61 (514/-609 WAS ENTERED INTO ON JUNE 26, 1953, WITH CURTISS-WRIGHT EUROPA, N.V. (1CWE/--- A WHOLLY OWNED FOREIGN SUBSIDIARY OF CURTISS WRIGHT CORPORATION--- FOR THE FURNISHING OF SPARE PARTS AND ACCESSORIES FOR THE OVERHAUL AND MAINTENANCE OF J-65 JET ENGINES. UNDER THE CONTRACT, CWE WAS TO SUBCONTRACT THE ACTUAL PRODUCTION OF THE SPARE PARTS AND ACCESSORIES, FURNISH TECHNICAL KNOW-HOW TO EUROPEAN PRODUCERS, SET UP INSPECTION AND QUALITY CONTROL PROCEDURES, INCLUDING A COMPLETE TESTING LABORATORY, AND ASSUME LIMITED RESPONSIBILITY TO THE AIR FORCE FOR THE QUALITY OF THE END-ITEMS. THE CONTRACT PROVIDED FOR REIMBURSEMENT OF ACTUAL COSTS (ESTIMATED AT $24,884,447), PLUS THE LESSER OF (1) A FEE OF $2,115,553 (8 1/2 PERCENT OF THAT AMOUNT), OR (2) A FEE EQUAL TO 8 1/2 PERCENT OF THE TOTAL CONTRACT COSTS REIMBURSED, COSTS AND FEE NOT TO EXCEED THE TOTAL CONTRACT COST OF $27 MILLION. THE FEE CLAUSE OF THE CONTRACT (PARAGRAPH E, PART III) FURTHER PROVIDED:

* * * IN THE EVENT THE TOTAL CONTRACT COST, INCLUSIVE OF THE AMOUNT OF COMPENSATION TO BE PAID THE CONTRACTOR HEREUNDER, AND THE AMOUNTS ALLOTTED IN ACCORDANCE WITH EXHIBIT B ATTACHED HERETO ARE INCREASED, BUT THE QUANTITY OF PARTS, SPECIAL TOOLING, EQUIPMENT AND SERVICES TO BE DELIVERED, ACQUIRED, OR PERFORMED BY THE CONTRACTOR IS NOT INCREASED, THE CONTRACTOR SHALL NOT BE ENTITLED TO ANY INCREASED COMPENSATION; PROVIDED, HOWEVER, SUCH COMPENSATION SHALL BE INCREASED AS PROVIDED IN PART IV HEREOF IF THE QUANTITY OF PARTS AND SPECIAL TOOLING TO BE DELIVERED HEREUNDER OR THE SCOPE OF THIS CONTRACT IS OTHERWISE INCREASED BY APPROPRIATE AMENDMENT OF THIS CONTRACT. NO REDUCTION IN SUCH COMPENSATION SHALL BE MADE EXCEPT AS PROVIDED IN THE CHANGES AND TERMINATION CLAUSES OF THIS CONTRACT AND THE FIRST SENTENCE OF THIS PARAGRAPH.

PART IV," ALLOTMENT OF FUNDS," WAS AS FOLLOWS:

A. THE CONTRACTOR IS AUTHORIZED HEREUNDER TO EXPEND OR OBLIGATE IN THE PERFORMANCE OF THIS CONTRACT INCLUSIVE OF COMPENSATION SET FORTH IN PART III, THE SUM OF $27,000,000.00. SUCH SUM SHALL BE EXPENDED OR OBLIGATED IN ACCORDANCE WITH THE AMOUNTS ALLOTTED AND SET FORTH IN EXHIBIT B, ATTACHED, AND THE CONTRACTOR SHALL NOT BE OBLIGATED TO FURNISH THE QUANTITY OF PARTS SET FORTH IN PARAGRAPH 1 OF PART I OF THIS SCHEDULE OR PERFORM THE OTHER OBLIGATIONS OF THE CONTRACTOR HEREUNDER IF THE AMOUNTS ALLOTTED TO THIS CONTRACT AS INCREASED FROM TIME TO TIME, AS PROVIDED IN THIS PARAGRAPH, ARE FULLY EXPENDED. SAID SUM MAY BE INCREASED BY THE GOVERNMENT SOLELY IN ITS DISCRETION UNLESS THE INCREASE IS DUE TO AN INCREASE IN THE SCOPE OF THE WORK CALLED FOR HEREUNDER, AND THIS INCREASE CAN BE ACCOMPLISHED ONLY BY AGREEMENT OF THE PARTIES. IN THE EVENT THE GOVERNMENT DESIRES TO INCREASE SAID SUM AS A RESULT OF AN INCREASE IN THE SCOPE OF THE WORK CALLED FOR UNDER THIS CONTRACT, EXCLUDING CHANGES MADE UNDER CLAUSE 2 OF THE GENERAL PROVISIONS HEREOF, THE PARTIES HERETO AGREE TO MEET TO CONSIDER THE TERMS AND CONDITIONS OF A CONTRACT FOR THE PERFORMANCE OF SAID INCREASED SCOPE OF WORK.

THE ASSISTANT SECRETARY CONTENDS IN HIS LETTER THAT---

* * * THE USE OF A CONTRACT CONTAINING A COST CEILING BEYOND WHICH THE FEE COULD NOT BE INCREASED, WHILE PROVIDING FOR A PROPORTIONATE DOWNWARD ADJUSTMENT OF THE FEE ON INCURRENCE OF COSTS LOWER THAN THE CEILING, COUPLED WITH GOVERNMENT SUPERVISION OVER THE USAGE OF LABOR AND MATERIALS, IS NOT A VIOLATION OF A PROHIBITION AGAINST THE COST PLUS-A-PERCENTAGE-OF- COST SYSTEM OF CONTRACTING. * * *

IN SUPPORT OF THIS PROPOSITION, THERE WAS CITED 23 COMP. GEN. 410; B 44323 DATED SEPTEMBER 25, 1944; AND B-105344 DATED SEPTEMBER 12, 1951. HOWEVER, SINCE NORMAL ADMINISTRATION OF COST-TYPE CONTRACTS REGULARLY INVOLVES APPROVAL BY ADMINISTRATIVE CONTRACTING OFFICERS OF SUBCONTRACTS AND SIGNIFICANT ITEMS OF REIMBURSABLE COST, IT IS NOT EVIDENT THAT ANY SUBSTANTIAL ADDITIONAL ELEMENT OF CONTROL EXISTED IN THE CWE CONTRACT. FURTHERMORE, THE SPECIFIC CONTRACT PROVISIONS QUOTED ABOVE CLOSELY APPROACH A VIRTUAL GUARANTY OF A FEE OF 8 1/2 PERCENT OF COSTS INCURRED UP TO THE CONTRACT CEILING OF $27 MILLION.

IT IS TRUE THAT IN A NUMBER OF OUR EARLIER DECISIONS WE TOOK THE VIEW THAT ABSOLUTE COST LIMITATIONS, AND PROVISIONS FOR GOVERNMENT SUPERVISION OF COSTS AND EXPENDITURES, WOULD SUFFICIENTLY PROTECT THE UNITED STATES AGAINST THE EVILS AT WHICH THE COST-PLUS-PERCENTAGE PROHIBITION WAS DIRECTED, EVEN WHERE A FEE OR PROFIT ON A PERCENTAGE BASIS WAS PROVIDED FOR. HOWEVER, SINCE B-46232 OF MARCH 28, 1945, WE HAVE ADHERED TO THE RULE THAT SUCH CONTROLS OR DUBIOUS COST LIMITATIONS ARE NOT SUFFICIENT TO SAVE SUCH CONTRACTS FROM VIOLATING THE PROHIBITION, BUT ARE FOR CONSIDERATION ONLY IN CONNECTION WITH DETERMINATIONS OF AMOUNTS PROPERLY ALLOWABLE AS THE REASONABLE VALUE OF SERVICES OR SUPPLIES FURNISHED UNDER SUCH UNAUTHORIZED CONTRACTS. SEE 33 COMP. GEN. 291, 292. DECISION B- 105344, REFERRED TO ABOVE, HAD REFERENCE TO A CONTRACT ENTERED INTO BY THE DISTRICT OF COLUMBIA UNDER A STATUTE WHICH DID NOT EXPRESSLY PROHIBIT CONTRACTING ON A COST-PLUS-A PERCENTAGE-OF-COST BASIS, AND HENCE SUCH DECISION IS NOT PERSUASIVE HERE. THE DECISION OF THE SUPREME COURT IN MUSCHANY V. UNITED STATES, 324 U.S. 49, 61-62, IS ALSO CITED AS RECOGNITION OF THE FACT THAT EFFECTIVE CONTROLS OVER COSTS RENDERS THE PROHIBITION INAPPLICABLE. WE CANNOT AGREE THAT THE COURT'S DECISION GAVE RECOGNITION TO THE ABOVE FACT; INSTEAD, THE RATIONALE OF THE DECISION WENT TO THE CONTRACTOR'S INCENTIVE TO INFLATE HIS COSTS AND THEREBY INCREASE HIS PROFIT SINCE THE GOVERNMENT WAS ALREADY BOUND CONTRACTUALLY TO PAY ANY FUTURE COSTS. IN THAT CONNECTION, THE ASSISTANT SECRETARY STATED FURTHER THAT HAD THE CONTRACT BEEN DRAWN AS AN ORDINARY COST-PLUS-A-FIXED-FEE CONTRACT UNDER CURTISS-WRIGHT'S ORIGINAL PROPOSAL FOR A 10 PERCENT FEE, SUCH FEE WOULD HAVE BEEN COMPUTED ON THE SAME ESTIMATED COST FOR THE SAME QUANTITY OF WORK PROVIDED FOR IN THE ORIGINAL CONTRACT, AND THAT, THEREFORE, A SAVING IN FEE RESULTED FROM ENTERING INTO THE CONTRACT HERE INVOLVED. HOWEVER, THAT POSITION FAILS TO RECOGNIZE THE FACT, POINTED OUT BY THE AIR FORCE REPRESENTATIVES DURING THE NEGOTIATIONS, THAT CWE HAD LITTLE OR NO INCENTIVE TO KEEP COSTS DOWN AND THEREBY DECREASE ITS COMPENSATION PROPORTIONATELY. IT WAS WITH RESPECT TO SUCH A SITUATION THAT THE CONGRESS DIRECTED ITS PROHIBITION TO PRECLUDE ANY TEMPTATION OR POSSIBILITY THAT A CONTRACTOR MAY INCREASE HIS PROFIT BY CARELESSLY OR DELIBERATELY INCREASING HIS COST AT THE EXPENSE OF THE GOVERNMENT UNDER A REIMBURSABLE CONTRACT.

THE PREAWARD NEGOTIATIONS WHICH CULMINATED IN THE EXECUTION OF THIS CONTRACT, AS REPORTED IN THE CONTRACT REVIEW BOARD MINUTES, RECOGNIZED THAT THE COST ESTIMATES SUBMITTED BY CWE WERE SUBSTANTIALLY HIGH. ALSO, THE BOARD STATED IN A MEMORANDUM OF THE CHIEF PROCUREMENT AND PRODUCTION DIVISION, THAT "THE ESTIMATED COSTS MAY APPEAR EXCESSIVE, BUT DUE TO THE OVERWHELMING INTANGIBLES, NO BETTER ESTIMATE CAN BE OFFERED.'

OUR REVIEW OF THIS CONTRACT REASONABLY ESTABLISHES THAT THE AIR FORCE REPRESENTATIVES WERE DISSATISFIED WITH THE COST ESTIMATES, NOT ONLY AS TO THESE RESPECTING SPARE PARTS, BUT ALSO AS TO THOSE PERTAINING TO INSPECTION EQUIPMENT, TOOLING, AND OPERATING COSTS. THE RECORD FURTHER ESTABLISHES THAT AIR FORCE REPRESENTATIVES INVOLVED IN THIS PROCUREMENT CONSIDERED THE RATE OF PROFIT TO BE EXCESSIVE. THE CONTRACT AS WRITTEN PROVIDED NO INCENTIVE TO CWE TO ENCOURAGE EFFICIENT AND ECONOMICAL OPERATION. ON THE CONTRARY, SINCE THE CONTRACT ESTABLISHES A FEE COMPUTED AT 8 1/2 PERCENT OF THE ESTIMATED COST, WHICH, TOGETHER WITH THE FEE, CONSTITUTES THE CONTRACT CEILING, AND PROVIDES FOR A PROPORTIONATE REDUCTION IN THAT FEE FOR ANY UNDERRUNS IN THE ACTUAL COST, THE CONTRACTOR IS ACTUALLY PENALIZED IN TERMS OF ITS FEE FOR EFFICIENCY IN PERFORMANCE OF THE CONTRACT AND, CONVERSELY, THE CONTRACTOR IS REWARDED FOR INEFFICIENCY. IT IS THIS VERY SITUATION WHICH THE PROHIBITION SOUGHT TO AVOID.

THE RECORD DISCLOSES THAT THE CONTRACT WAS EXECUTED WITH CWE ON THE BASIS THAT THE PARENT ( CURTISS-WRIGHT) WAS THE SOLE SOURCE FOR SPARE PARTS FOR J-65 JET ENGINES. ON THE BASIS OF OUR REVIEW OF THE PREAWARD NEGOTIATIONS, IT SEEMS APPARENT THAT THE ESTIMATED COSTS STATED IN THE CONTRACT WERE NOT INTENDED TO REPRESENT AN APPROXIMATE ESTIMATE OF THE FINAL COST OF THE CONTRACT TO THE GOVERNMENT, BUT THAT THOSE COSTS WERE MADE HIGH ENOUGH TO INSURE THAT CWE WOULD RECEIVE IN ANY EVENT NO LESS THAN 8 1/2 PERCENT OF ACTUAL COST AS ITS FIXED FEE. ESPECIALLY SIGNIFICANT IN THAT REGARD IS THE FOLLOWING EXCERPT FROM THE MINUTES OF THE CONTRACT REVIEW BOARD.

THE BOARD CONSIDERED THE FUNDS ALLOTTED TO THE CONTRACT TO BE MORE THAN AMPLE FOR THE QUANTITY OF SPARE PARTS REQUIRED TO BE DELIVERED. THE CONTRACT AUTHORIZES AN INCREASE IN FIXED FEE IF THE WORK CALLED FOR UNDER THE CONTRACT IS INCREASED. HOWEVER, SUCH INCREASE IN FEE WOULD LIKEWISE BE SUBJECT TO THE LIMITATION OF 8 1/2 PERCENT TOTAL COSTS. THERE WAS, THEREFORE, NO OBJECTION TO THE POSSIBLE UNDERESTIMATION OF THE AMOUNT OF WORK THAT COULD BE PERFORMED AND THE VOLUME OF PARTS THAT COULD BE DELIVERED WITHIN THE FUNDS OBLIGATED BY THE CONTRACT. * * *

THIS STRENGTHENS OUR CONCLUSION THAT THE TERMS OF THE CONTRACT, READ AGAINST THE BACKGROUND OF THE NEGOTIATIONS WHICH PRECEDED IT, PROVIDE, IN SUBSTANCE AND EFFECT, FOR A PERCENTAGE-OF-COST FEE OF 8 1/2 PERCENT AND ARE THEREFORE IN CONTRAVENTION OF THE STATUTORY PROVISION. THIS CONCLUSION IS FURTHER STRENGTHENED BY THE FACT THAT AS LATE AS JULY 1956, THE UNREALISTIC AND OVERESTIMATED CHARACTER OF THE MAXIMUM COST CEILING WAS EVIDENCED BY SUPPLEMENTAL AGREEMENT NO. 11 WHICH ADDED AN ESTIMATED $12 MILLION IN SPARE PARTS WITHOUT EXCEEDING THE $27 MILLION MAXIMUM COST CEILING. WE ACCORDINGLY CONCLUDE THAT THE SUBJECT CONTRACT VIOLATES THE COST-PLUS-A-PERCENTAGE-OF-COST SYSTEM OF CONTRACTING.

THE AUTHORITY OF AN OFFICER OF THE UNITED STATES TO ENTER INTO A CONTRACT BINDING UPON THE GOVERNMENT MUST BE FOUND IN SOME LEGALLY ENACTED PROVISION OF LAW. THAT RULE HAS BEEN LONG RECOGNIZED. SEE THE FLOYD ACCEPTANCES, 7 WALL. 666; HOOE V. UNITED STATES, 218 U.S. 322; EASTERN EXTENSION TEL. CO. V. UNITED STATES 251 U.S. 355; UNITED STATES V. GOLTRA, 312 U.S. 203; FRIES V. UNITED STATES, 170 F.2D 726; NEW YORK MAIL AND NEWSPAPER TRANSPORTATION CO. V. UNITED STATES, C.1CLS. NO. 162-54, DECIDED JULY 31, 1957. EVERYONE IS REQUIRED TO TAKE NOTICE OF THE EXTENT OF AUTHORITY CONFERRED BY LAW ON A PERSON ACTING IN AN OFFICIAL CAPACITY AND THIS IS TRUE FOR THE REASON THAT THE GOVERNMENT IS NOT BOUND BY AN ACT OF ITS AGENT UNLESS HE WAS ACTING WITHIN THE SCOPE OF HIS AUTHORITY. AM.JUR., PUBLIC OFFICERS SECTION 256. HOWEVER, WHILE THE GOVERNMENT IS NOT ORDINARILY BOUND BY AN INVALID CONTRACT, WHERE GOODS OR SERVICES ARE FURNISHED ON THE REQUEST OR ORDER OF AN OFFICER AUTHORIZED TO CONTRACT ON BEHALF OF THE UNITED STATES, BUT THE CONTRACT FOR A QUANTUM MERUIT. SEE PACIFIC MARITIME ASSOCIATION V. UNITED STATES, 123 C.1CLS. 667; 33 COMP. GEN. 533; CF. BALTIMORE AND OHIO RAILROAD COMPANY V. UNITED STATES, 261 U.S. 592.

IT HAS BEEN THE SETTLED PRACTICE OF OUR OFFICE SINCE 1945 TO REGARD CONTRACTS EXECUTED IN CONTRAVENTION OF THE STATUTORY PROHIBITION AS NOT IMPOSING AN OBLIGATION UPON THE GOVERNMENT TO MAKE PAYMENTS IN ACCORDANCE WITH THE TERMS OF SUCH ILLEGAL CONTRACTS. INSTEAD, WE HAVE ADHERED TO THE GENERAL RULE OF LAW THAT THE GOVERNMENT, LIKE ANY MUNICIPAL BODY, MAY BECOME OBLIGATED UPON AN IMPLIED CONTRACT TO PAY THE REASONABLE VALUE OF THE BENEFITS ACCEPTED OR APPROPRIATED BY IT AS TO WHICH THE UNITED STATES HAS THE GENERAL POWER TO CONTRACT. SEE 84 A.L.R. 936; 110 ID. 153; 154 ID. 356. COMPARE, IN THIS CONNECTION, THE PROVISIONS OF 41 U.S.C. 117 RESPECTING THE SETTLEMENT OF CLAIMS BASED ON IMPLIED CONTRACTS. HENCE WE ARE CONSTRAINED TO HOLD THAT ANY PAYMENTS MADE TO CWE UNDER THIS CONTRACT CONSTITUTE UNAUTHORIZED EXPENDITURES OF PUBLIC FUNDS, EXCEPT TO THE EXTENT THAT SUCH PAYMENTS MAY BE JUSTIFIED AS REPRESENTING THE FAIR AND REASONABLE VALUE OF SERVICES AND SUPPLIES ACCEPTED BY THE GOVERNMENT, INCLUDING SUCH AMOUNT OF PROFIT THEREON AS WOULD CONSTITUTE JUST COMPENSATION UNDER THE CIRCUMSTANCES. SEE MATTER OF SHADDOCK V. SCHWARTZ, 158 N.E. 872; AND THE ANNOTATIONS IN 84 A.L.R. 936.

IN THAT CONNECTION, WHILE IT MAY BE ARGUED THAT THE 8 1/2 PERCENT PROFIT PROVIDED FOR IN THE UNAUTHORIZED CONTRACT CONSTITUTES A FAIR AND REASONABLE MEASURE OF PROFIT, WE ARE OF THE VIEW THAT SUCH PERCENTAGE OF PROFIT SHOULD BE REEXAMINED IN THE LIGHT OF THE FOLLOWING CONSIDERATIONS.

1. CONTRACTS NEGOTIATED WITH THE ITALIAN FIRMS OF AERFER AND FIAT DURING 1952 FOR THE PRODUCTION OF F84G AND J-35 SPARE PARTS PROVIDED FOR A PROFIT OF 6 PERCENT OF ALLOWABLE COSTS, WHEREAS CWE SUBCONTRACTED ALL OF THE ACTUAL PRODUCTION OF SPARES TO AERFER AND FIAT AS THE ACTUAL PRODUCERS. UNDER THE TERMS OF THE CWE CONTRACT THE COSTS OF DEFECTIVE PARTS ARE BORNE BY THE GOVERNMENT; IN THE CASE OF THE ITALIAN CONTRACTS SUCH COSTS ARE BORNE BY THE CONTRACTOR.

2. DURING NEGOTIATIONS, THE DIRECTOR OF PROCUREMENT, AMC, STIPULATED THAT A PROFIT OF 5 PERCENT OR 6 PERCENT WOULD BE ACCEPTABLE AND IN A LAST DITCH STAND 7 PERCENT WAS PERMISSIBLE. HE RECOGNIZED THAT THE PROCUREMENT COMMITTEE AT AMC HAD INDICATED THAT 4 PERCENT WOULD BE SUFFICIENT PROFIT FOR A STATESIDE PROJECT.

3. THE ARMED SERVICES PROCUREMENT REGULATION LIMITS PROFIT ON COST PLUS CONTRACTS TO 7 PERCENT UNLESS THE SECRETARY OF THE AIR FORCE APPROVES A GREATER AMOUNT. AN AIR STAFF STUDY MADE FOR YOUR PREDECESSOR TO EVALUATE THE PROFIT BEING ALLOWED CWE CONCLUDED THAT THE CONTRACTOR MAY RECEIVE IN PROFIT ABOUT $400,000 MORE THAN WAS CONSIDERED REASONABLE UNDER NORMAL CIRCUMSTANCES.

ACCORDINGLY, WE RECOMMEND THAT A FAIR AND REASONABLE RATE OF PROFIT BE DETERMINED, COMMENSURATE WITH THE RISKS INVOLVED, THE CAPITAL INVESTMENT OF CWE, AND THE CONSIDERATIONS SET FORTH ABOVE.

WE FURTHER RECOMMEND THAT A THOROUGH REVIEW BE CONDUCTED OF THE COST REIMBURSEMENTS TO CURTISS-WRIGHT EUROPA TO DETERMINE WHETHER THEY WERE INCIDENT TO, AND NECESSARY FOR, THE PERFORMANCE OF THE UNAUTHORIZED CONTRACT. IN THIS CONNECTION, SPECIAL CONSIDERATION SHOULD BE GIVEN TO THE PROPRIETY OF PAYMENTS TO THE PARENT CORPORATION OF $451,000 FOR GENERAL AND ADMINISTRATIVE EXPENSES; THE INCLUSION OF INTERCOMPANY PROFITS ON SALES BY THE PARENT CORPORATION TO CWE AND POSSIBLE EXCESSIVE COSTS INCURRED AS A RESULT OF SUBCONTRACTING FOR GROUPS OF ITEMS RATHER THAN FOR INDIVIDUAL ITEMS.