B-136469 L/M, APR 30, 1959

B-136469 L/M, APR 30, 1959

PRECIS-UNAVAILABLE

FRANKLIN FLOOTE, ADMINISTRATOR, GENERAL SERVICES ADMINISTRATION:

REFERENCE IS MADE TO YOUR LETTER OF NOVEMBER 10, 1958, CONCERNING A REQUEST FOR REVIEW OF GENERAL SERVICES ADMINISTRATION ORDERS TO NATIONAL LEAD COMPANY, PRIME CONTRACTOR, TO WITHHOLD PAYMENT OF THE AMOUNTS OF $17,900 AND $17,673.50 DUE THE H. K. FERGUSON COMPANY, CLEVELAND, OHIO, FOR ARCHITECTURAL-ENGINEERING SERVICES RENDERED UNDER GOVERNMENT COST-PLUS -A-FIXED-FEE CONTRACTS NOS. GS-008 (D)-1516, GS-008 (D)-1504 AND QS-008- 2489 WITH THE NATIONAL LEAD COMPANY AND ITS SUBSIDIARY, THE NICKEL PROCESSING CORPORATION.

THERE WAS RETURNED WITH YOUR LETTER A COPY OF THE H. K. FERGUSON COMPANY'S MEMORANDUM OF LAW PROTESTING THE ACTION TAKEN BY THE GENERAL SERVICES ADMINISTRATION IN THE MATTER. THERE WAS ALSO ENCLOSED WITH YOUR LETTER A MEMORANDUM IN RESPONSE TO THE H. K. FERGUSON COMPANY'S MEMORANDUM, TOGETHER WITH EXHIBITS, CONTAINING THE POSITION OF THE GENERAL SERVICES ADMINISTRATION. YOU PROPOSED, WITH OUR APPROVAL, TO REQUEST THE H. K. FERGUSON COMPANY TO REFUND THE AMOUNT OF $266,265.96, CONSIDERED AS HAVING BEEN OVERPAID TO THAT COMPANY BY THE GOVERNMENT PRIME CONTRACTORS.

THE WITHHOLDING ORDERS APPEAR TO HAVE BEEN ISSUED AS THE RESULT OF AN AUDIT WHICH DISCLOSED AN APPARENTLY EXCESSIVE RECOUPMENT OF OVERHEAD EXPENSE BY THE H. K. FERGUSON COMPANY ON BILLINGS FOR LABOR COSTS UNDER ITS COST-PLUS-A-FIXED-FEE SUBCONTRACTS INVOLVED IN THE PROCUREMENT OF ARCHITECTURAL-ENGINEERING SERVICES FOR THE EXPANSION OF THE FACILITIES OF THE NICARO NICKEL PLANT, OWNED BY THE UNITED STATES AND LOCATED AT NICARO, CUBA. THE NICKEL PROCESSING CORPORATION HAD BEEN OPERATING AS THE MANAGEMENT CONTRACTOR FOR THE PLANT UNDER CONTRACT NO. GS-008 (D) 1504 AND IT APPEARS TO HAVE BEEN ENGAGED TO PERFORM OTHER WORK AT THE PLANT UNDER CONTRACT NO. GS-008-2489. A CONTRACT WAS SUBSEQUENTLY ENTERED INTO WITH THE NATIONAL LEAD COMPANY FOR EXPANSION OF THE PLANT'S FACILITIES (CONTRACT NO. GS-008 (D)-1516.) NEGOTIATIONS WITH THE H. K. FERGUSON COMPANY WERE COMMENCED IN 1952 BY THE NICKEL PROCESSING CORPORATION AND A SUBCONTRACT FOR THE MAKING OF PRELIMINARY ENGINEERING STUDIES AND THE PREPARATION OF PLANS AND SPECIFICATIONS WAS ENTERED INTO ON JANUARY 9, 1953. THE SUBCONTRACT WAS AMENDED FROM TIME TO TIME AND WAS EVENTUALLY SUPERSEDED BY A SUBCONTRACT DATED AUGUST 1, 1954, BETWEEN THE H. K. FERGUSON COMPANY AND THE NATIONAL LEAD COMPANY. BY AMENDMENT DATED JUNE 30, 1955, THE COST OF THE ARCHITECTURAL-ENGINEERING WORK, EXCLUSIVE OF THE AGREED FIXED FEE OF $50,000, WAS ESTIMATED TO BE $2,575,000. IT APPEARS THAT AT SUCH TIME IT WAS CONSIDERED BY THE PARTIES THAT THE WORK HAD BEEN COMPLETED EXCEPT FOR ENGINEERING WORK TO BE CARRIED OUT DURING THE PERIOD OF CONSTRUCTION.

UNDER THE TERMS OF THE SUBCONTRACT DATED AUGUST 1, 1954, THE H. K. FERGUSON COMPANY WAS TO BE REIMBURSED FOR COSTS INCURRED PURSUANT TO PARAGRAPH 3.0 AND ALL SUBPARAGRAPHS THEREUNDER, SUBJECT TO THE CONTRACTOR'S AUDIT. SUBPARAGRAPH 3.1 PROVIDES, IN PERTINENT PART, THAT THE COST OF THE WORK SHALL INCLUDE SALARY RATES FOR PERSONNEL (INCLUDING OVERHEAD, TAXES AND PROPORTIONATE SHARE OF VACATION AND HOLIDAY PAY) IN ACCORDANCE WITH THE HOURLY RATE SCHEDULE MARKED SCHEDULE A. THAT SCHEDULE LISTS 43 CLASSIFICATIONS OF LABOR FOR EACH OF WHICH ARE SHOWN A MINIMUM AND A MAXIMUM HOURLY RATE UNDER COLUMNS MARKED "FROM" AND "TO." ACCOMPANYING THE SCHEDULE IS AN "EXPLANATION OF SALARY RATES FOR NICARO EXPANSION PROGRAM," WHICH STATES THAT THE RATES WERE ARRIVED AT IN THE FOLLOWING MANNER:

"BASE SALARY VACATION AND HOLIDAY DIRECT SALARY

DIRECT SALARY 75 PERCENT OVERHEAD ACTUAL COST OF

PAYROLL TAXES SALARY RATE AS SHOWN ON SCHEDULE A."

THE RECORD SHOWS THAT THE H. K. FERGUSON COMPANY PERFORMED SERVICES ON THE PROJECT BEGINNING SOMETIME IN 1952 AND EXTENDING THROUGH THE EARLY PART OF THE YEAR 1956. AN ADMINISTRATIVE REPORT ON SPECIAL OVERHEAD AUDIT LISTS TOTAL BILLINGS OF $2,636,000, INCLUDING THE FIXED FEE OF $50,000 AND $2,422,000 BILLED AT THE "CONTRACT SALARY RATES." IT WAS DETERMINED BY YOUR AUDITORS THAT THE TOTAL SUM OF $1,027,000 HAD BEEN CHARGED AS OVERHEAD EXPENSE WITH THE USE OF THE 75 PERCENT OVERHEAD RATE, AND THAT THE SUBCONTRACTOR'S ACTUAL OVERHEAD COSTS WERE APPROXIMATELY $390,000 LESS THAN SUCH AMOUNT. THE H. K. FERGUSON COMPANY WAS THEREUPON REQUESTED TO REFUND THE AMOUNT OF $390,000 TO THE NATIONAL LEAD COMPANY, AND IT THEN ENGAGED THE ACCOUNTING FIRM OF LYBRAND, ROSS BROS. & MONTGOMERY TO PERFORM AN INDEPENDANT COST STUDY. THAT FIRM AT FIRST DETERMINED THAT THE OVERHEAD INCLUDED IN BILLINGS AT SALARY RATES EXCEEDED ACTUAL OVERHEAD BY $158,586.96. HOWEVER, THE FIRM SUBSEQUENTLY ADVISED THE GENERAL SERVICES ADMINISTRATION THAT ADJUSTMENTS OF $56,991.44 AND $33,010.77 SHOULD BE MADE IN FAVOR OF THE SUBCONTRACTOR. THE GENERAL SERVICES ADMINISTRATION HAS NOT APPROVED SUCH CLAIMED ADJUSTMENTS BUT ADDED THE SUMS OF $31,116 AND $76,563 TO THE $158,536.96 FIGURE IN COMPUTING THE REVISED AMOUNT OF $266,265.96 BELIEVED TO BE CHARGEABLE TO THE SUBCONTRACTOR.

THE BASIS FOR YOUR POSITION IS THAT THE SUBCONTRACT WAS IN VIOLATION OF THE STATUTORY PROHIBITION AGAINST THE USE OF THE COST-PLUS-A PERCENTAGE-OF -COST SYSTEM OF CONTRACTING (41 U.S.C. 254(B)), UNLESS IT BE INTERPRETED AS CALLING FOR ADJUSTMENT OF COSTS TO ACTUAL OVERHEAD. THE ATTORNEYS FOR THE SUBCONTRACTOR CONTEND THAT THE STATUTORY PROHIBITION DOES NOT APPLY TO SUBCONTRACTS AND, EVEN IF IT DID, THE PAYMENT PROVISIONS OF THE SUBCONTRACT ARE NOT SUCH THAT THEY SHOULD BE CONSTRUED TO BE A COST-PLUS-A -PERCENTAGE-OF-COST ARRANGEMENT OF THE TYPE WHICH THE CONGRESS INTENDED TO PROHIBIT. THEY FURTHER CONTENDED THAT THERE EXISTS NO LEGAL BASIS UPON WHICH THE GOVERNMENT COULD CLAIM REPAYMENT FROM THE H. K. FERGUSON COMPANY BECAUSE THERE WAS NO PRIVITY OF CONTRACT BETWEEN THE GOVERNMENT AND THE H. K. FERGUSON COMPANY AND THE CONTRACTUAL ARRANGEMENTS BETWEEN FERGUSON AND THE PRIVATE INDUSTRIAL CONCERNS OPERATING THE NICARO PLANT WERE IN ALL RESPECTS VALID CONTRACTS BASED UPON PROPER CONSIDERATION.

THE ADMINISTRATIVE MEMORANDUM, IN ITS DISCUSSION OF THE LEGAL ISSUES INVOLVED, CITES 35 COMP. GEN. 63 AS AUTHORITY FOR THE STATEMENT THAT IT IS A WELL ESTABLISHED PRINCIPLE OF GOVERNMENT LAW THAT, IF OVERHEAD COSTS COMPUTED IN ACCORDANCE WITH A CONTRACT PROVISION USING A FIXED PERCENTAGE OF SALARIES AND WAGES EXCEED ACTUAL OVERHEAD AS DETERMINED BY COST STUDIES, THE CONTRACTOR IS REQUIRED TO REFUND THE EXCESS PAYMENTS. ALSO CITES VARIOUS PROVISIONS OF THE SUBCONTRACT AS THE BASES FOR THE CONCLUSIONS: (1) THAT THE SUBCONTRACT SHOULD BE CONSTRUED AS MEANING THAT THE SUBCONTRACTOR WOULD NOT BE ENTITLED TO RETAIN ALL AMOUNTS PAID AT THE SPECIFIED LABOR RATES, REGARDLESS OF ACTUAL COSTS; AND (2) THAT THE DIRECT RELATIONSHIP BETWEEN THE GOVERNMENT AND THE SUBCONTRACTOR'S PERFORMANCE ULTIMATELY FOR THE BENEFIT OF THE GOVERNMENT, WITH STIPULATIONS AND CONTROLS EXERCISED BY THE GOVERNMENT, PROVIDES PRIVITY SUFFICIENT TO BE BINDING BETWEEN THE SUBCONTRACTOR AND THE GOVERNMENT AS A THIRD-PARTY BENEFICIARY.

THE ATTORNEYS FOR THE SUBCONTRACTOR WERE GRANTED AN OPPORTUNITY TO ANSWER THE ADMINISTRATIVE MEMORANDUM AND THERE IS ENCLOSED A COPY OF THEIR SUPPLEMENTAL MEMORANDUM OF LAW IN THE MATTER.

REGARDING THE QUESTION OF PRIVITY OF CONTRACT, THE GENERAL RULE IS THAT THERE EXISTS NO PRIVITY OF CONTRACT BETWEEN THE GOVERNMENT AND FIRMS ENGAGED BY ITS CONTRACTORS TO PERFORM PORTIONS OF THE WORK COVERED BY THE GOVERNMENT CONTRACTS. THERE MAY BE CIRCUMSTANCES WHERE THE GOVERNMENT COULD BE CONSIDERED TO BE A THIRD-PARTY BENEFICIARY UNDER A CONTRACT BUT WE DO NOT FEEL THAT THE GOVERNMENT, UNDER THE NATIONAL LEAD CONTRACT, ACQUIRED ANY ENFORCEABLE RIGHTS AGAINST THE H. K. FERGUSON COMPANY SO FAR AS THE RECOVERY OF OVERPAYMENTS MADE BY THE PRIME CONTRACTOR TO THAT COMPANY MIGHT BE CONCERNED. THE ADMINISTRATIVELY CITED CASE OF MANEALY V. UNITED STATES, 68 C. CLS. 623, WHEREIN THE PLAINTIFF WAS HELD TO BE A THIRD-PARTY BENEFICIARY OF AN AGREEMENT RELATING TO THE SETTLEMENT OF CLAIMS UNDER A TERMINATED GOVERNMENT CONTRACT, IS CONSIDERED TO BE OF DOUBTFUL APPLICATION TO THE FACTS OF THE INSTANT CASE.

THE PROHIBITION AGAINST THE USE OF THE COST-PLUS-A-PERCENTAGE-OF COST SYSTEM OF CONTRACTING HAS BEEN INCORPORATED IN OTHER FEDERAL STATUTES RELATING TO THE NEGOTIATION OF GOVERNMENT CONTRACTS. IT WAS STATED IN 21 COMP. GEN. 858, THAT "IT IS EVIDENT THAT THE PROHIBITION AGAINST THIS FORM OF CONTRACTING COULD BE SUBSTANTIALLY EVADED AND THE PURPOSES THEREOF DEFEATED WERE IT NOT APPLIED TO THE PERFORMANCE OF THAT PART OF THE CONTRACT WORK SUBLET BY THE PRIME CONTRACTOR TO OTHERS." ALSO, 41 U.S.C. 254(B) AND CORRESPONDING PROVISIONS OF LAW CONCERNING CONTRACTS OF THE ARMED FORCES (10 U.S.C. 2306), REQUIRE COST CONTRACTS AND COST-PLUS-A- FIXED-FEE CONTRACTS TO PROVIDE FOR NOTICE TO THE PROCURING AGENCY OF CERTAIN KINDS OF SUBCONTRACTS. COST-PLUS-A PERCENTAGE-OF-COST TYPE SUBCONTRACTS ARE NOT THERE MENTIONED, AND IN OUR OPINION, THE FAILURE TO MENTION SUBCONTRACTS OF THAT TYPE IN REGARD TO THE ADVANCE NOTICE REQUIREMENT MUST BE CONSIDERED AS A CLEAR INDICATION THAT THE CONGRESS DID NOT CONTEMPLATE THAT SUCH SUBCONTRACTS WOULD BE USED, BUT INTENDED SUBCONTRACTING TO BE COVERED BY THE PROHIBITION AGAINST THE USE OF THE COST-PLUS-A-PERCENTAGE-OF-COST SYSTEM OF CONTRACTING.

THE CONTRACTS CONSIDERED IN 35 COMP. GEN. 63 CONTAINED PROVISIONS WHICH WERE CLEARLY TO THE EFFECT THAT OVERHEAD COST ALLOWANCES WOULD ORIGINALLY BE MADE ON THE BASIS OF A PERCENTAGE OF SALARIES AND WAGES REIMBURSABLE UNDER THE CONTRACTS, BUT THAT SUCH ALLOWANCES WOULD BE SUBJECT TO ADJUSTMENT TO ACTUAL OVERHEAD COSTS AS DETERMINED BY COST STUDIES MADE BY THE GOVERNMENT. IN REGARD TO CERTAIN CONTENTIONS MADE BY THE CONTRACTOR, THE DECISION INDICATED THE VIEW THAT THE CONTRACTS WOULD HAVE VIOLATED THE PROVISIONS OF 41 U.S.C. 254(B) IF THEY HAD NOT PROVIDED FOR RETROACTIVE ADJUSTMENTS IN THE EVENT THAT THE OVERHEAD COST ALLOWANCES EXCEEDED ACTUAL OVERHEAD COSTS.

SUBSEQUENTLY, IN A DECISION DATED JANUARY 27, 1956, TO THE SECRETARY OF DEFENSE, 35 COMP. GEN. 434, IT WAS ANNOUNCED THAT, AFTER CONSIDERABLE STUDY OF THE PRACTICES OF THE MILITARY SERVICES WITH RESPECT TO PAYMENT OF INDIRECT COSTS UNDER COST-TYPE CONTRACTS, WE HAD REACHED THE CONCLUSION THAT CONTRACTS WHICH PROVIDED FOR PAYMENTS FOR OVERHEAD BASED ON FIXED PERCENTAGES OF DIRECT LABOR OR OTHER COSTS, AND WHICH CONTAINED NO PROVISION FOR THE MAKING OF RETROACTIVE ADJUSTMENTS TO ACTUAL COSTS, VIOLATED THE PROHIBITION IN SECTION 4(B) OF THE ARMED SERVICES PROCUREMENT ACT OF 1947. THE SECRETARY OF DEFENSE WAS ADVISED THAT THE PRACTICE SHOULD BE DISCONTINUED, BUT IT WAS NOT REQUIRED THAT ANY ACTION BE TAKEN WITH RESPECT TO CONTRACTS ENTERED INTO PRIOR TO THAT DECISION, WHICH CONCLUDED WITH THE STATEMENT THAT "PROVISIONS FOR THE PAYMENT OF OVERHEAD IN FUTURE COST-TYPE CONTRACTS, OR IN MODIFICATIONS OF RATES STIPULATED IN SUCH EXISTING CONTRACTS, MUST BE CONSISTENT WITH THE DECISION HEREIN." FOLLOWING FURTHER CONFERENCES WITH OFFICIALS OF THE MILITARY DEPARTMENTS, WE AGREED WITH THE PROPOSAL OF THE SECRETARY OF DEFENSE THAT FIXED OVERHEAD RATES WOULD NOT BE ACCEPTED IN PROPOSALS RECEIVED AFTER APRIL 15, 1956, OR BE INCORPORATED IN CONTRACTS EXECUTED AFTER JUNE 30, 1956.

ASSUMING, WITHOUT DECIDING, THAT THE H. K. FERGUSON COMPANY'S SUBCONTRACT WAS ILLEGAL, IT APPEARS THAT THE COMPANY WOULD NEVERTHELESS BE ENTITLED TO THE REASONABLE VALUE OF THE SERVICES WHICH IT PERFORMED, WHICH WOULD NOT NECESSARILY BE LIMITED TO ITS ACTUAL COSTS PLUS $50,000. SEE 33 COMP. GEN. 533; 38 ID. 38. IN ANY EVENT, SINCE MOST OF THE SUBCONTRACT WORK WAS PERFORMED BEFORE THE DATE OF OUR DECISION TO THE SECRETARY OF DEFENSE, INDICATING THAT ONLY CORRECTIVE ACTION WAS REQUIRED IN THE MATTER OF EXISTING CONTRACTS AND THE NEGOTIATION OF FUTURE CONTRACTS OF THE ARMED SERVICES, IT WOULD SEEM UNFAIR TO THE NATIONAL LEAD COMPANY AND THE H. K. FERGUSON COMPANY TO ASSERT A CLAIM AGAINST EITHER COMPANY FOR RECOVERY OF AN ALLEGED OVERPAYMENT BASED ONLY UPON THE ALLOWANCE OF OVERHEAD ON A BASIS TO WHICH NO EXCEPTION HAD PREVIOUSLY BEEN RAISED.

IN THE CIRCUMSTANCES, WE ARE OF THE OPINION THAT THE GENERAL SERVICES ADMINISTRATION SHOULD NOT REQUEST THE H. K. FERGUSON COMPANY TO REFUND THE SUM OF $266,265.96, AND THAT THE WITHHOLDING ORDERS ISSUED TO THE PRIME CONTRACTOR SHOULD BE CANCELLED.

THE EXHIBITS FORWARDED WITH YOUR LETTER ARE RETURNED HEREWITH.