Navy and Coast Guard Shipbuilding:
Navy Should Reconsider Approach to Warranties for Correcting Construction Defects
GAO-16-71: Published: Mar 3, 2016. Publicly Released: Mar 3, 2016.
What GAO Found
For five of the six Navy and Coast Guard ships GAO reviewed, guarantees did not help improve cost or quality outcomes. While the type and terms of each contract determine financial responsibility for correcting defects, the government, in most of the cases GAO examined, paid shipbuilders to repair defects. For the four ships with fixed-price incentive type contracts and guarantee clauses, the government paid the shipbuilder 89 percent of the cost—including profit—to correct these problems. This means the Navy and Coast Guard paid the shipbuilder to build the ship as part of the construction contract, and then paid the same shipbuilder again to repair the ship when defects were discovered after delivery—essentially rewarding the shipbuilder for delivering a ship that needed additional work. Navy officials stated that this approach reduces the overall cost of purchasing ships; however, the Navy has no analysis that proves their point. In contrast, the warranty on another Coast Guard ship—the Fast Response Cutter (FRC)—improved cost and quality by requiring the shipbuilder to pay to repair defects. The Coast Guard paid upfront for the warranty, which amounted to 41 percent of the total defect correction costs. The figure below shows the amount, as a portion of the millions of dollars required to address defects, shipbuilders and the government paid to correct defects for the ships GAO reviewed and the difference in defect-correction arrangements.
Comparison of Costs Borne by Government and Shipbuilder for Correction of Shipbuilder-Responsible Defects for the Six Ships GAO Reviewed
Although the Federal Acquisition Regulation (FAR) and the Department of Defense guidance instruct programs to, respectively, consider and document the use of a warranty, the use of warranties is not mandatory, and the Navy does not consider using them for ship contracts. In contrast, the Coast Guard's FRC warranty, as well as that planned for another upcoming ship class, fosters quality performance by following the FAR warranty provisions. The Navy may be missing opportunities for savings by not considering use of warranties. Further, the Navy has no stated objective for its guarantees, and guidance for contracting officers is minimal as to when or how to use a guaranty. While the FAR does not apply to guarantees, according to federal internal control standards, government programs require objectives and guidance to ensure that they achieve the desired results. Without a clear objective and guidance for using a guaranty and for determining when a warranty is appropriate in shipbuilding, Navy contracting officers do not have the information they need to make informed decisions regarding which mechanism is in the best interest of the taxpayer.
Why GAO Did This Study
The U.S. government spends about $17 billion per year building ships to support national defense and homeland security. Defects often become evident shortly after a ship is delivered. Warranties and guarantees are both mechanisms to fix defects for which shipbuilders are responsible.
- Warranties give the government a contractual right to direct the correction of defects at the contractor's expense.
- Guarantees are Navy-specific contractual mechanisms that provide for the correction of defects; but unlike warranties are not covered in the FAR.
The House report accompanying the National Defense Authorization Act for Fiscal Year 2015 included a provision for GAO to review warranties and guarantees in government shipbuilding programs. This report assesses the extent to which (1) warranties and guarantees reduce the government's exposure to additional costs and risks of poor quality and (2) how the Navy and Coast Guard use acquisition regulations and guidance to implement warranties and guarantees. GAO reviewed the Navy's and Coast Guard's guaranty or warranty practices and policies and selected six case studies, comprised of four Navy ships—representing ships built in the last five years—and two vessels the Coast Guard most recently purchased.
What GAO Recommends
DOD with the Navy should take steps to structure contracts so shipbuilders cannot earn profit for correcting defects for which they are responsible; determine whether a warranty is appropriate; and establish a guaranty objective and guidance. DOD partially concurred with the recommendations and it plans to complete a study by September 2016.
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Recommendations for Executive Action
Comments: In providing comments on this report, the Department of Defense partially concurred with this recommendation, and has completed a study reviewing our findings. The study, conducted by the CNA Analysis and Solutions, found that our recommendations were well founded and appropriate. In response to our report and the study, the Navy states it will provide written guidance by the end of 2017 to prevent shipbuilders from earning profit for correcting shipbuilder-responsible defects.
Recommendation: To improve the use of warranties and guarantees in Navy shipbuilding, the Secretary of the Defense should direct the Secretary of the Navy, in arrangements where the shipbuilder is paid to correct defects, to structure contract terms such that shipbuilders do not earn profit for correcting construction deficiencies following delivery that are determined to be their responsibility.
Agency Affected: Department of Defense
Comments: In providing comments on this report, the Department of Defense partially concurred with this recommendation, and agreed to conduct a study to determine what policy and guidance changes are necessary to provide guidance on the many factors that should be considered to effectively implement warranty and guaranty provisions. As of April 2017, this study is complete and the Navy states that it now concurs with our recommendation. In doing so, the Navy is drafting an instruction, including a decision template, laying out the considerations underlying the decision to use warranties, guarantees or other mechanisms. This instruction will help contracting officers choose an appropriate tool and document the decision in a business clearance memorandum. The Navy plans to implement the instruction by the end of 2017.
Recommendation: To improve the use of warranties and guarantees in Navy shipbuilding, the Secretary of the Defense should direct the Secretary of the Navy to establish and document a clear objective for using a guaranty, and then create guidance for contracting officers that illustrates how to implement a guaranty that meets this objective. This guidance should describe how contracting officers should use aspects of the guaranty, including determining an appropriate limitation of liability, to achieve the objective and include considerations as to when a guaranty should be a separate contract line item.
Agency Affected: Department of Defense
Comments: In providing comments on this report, the Department of Defense partially concurred with this recommendation, and has completed a study reviewing our findings. The study, conducted by the CNA Analysis and Solutions, found that our recommendations were well founded and appropriate. In response to our report and the study, the Navy states it will include separate contract line items for FAR-type warranties in at least two solicitations for ship construction. In addition, the Navy states that it plans to revise data requirements to better gather and track contractor responsible defects, and then develop analytical methods to help make better determinations in the future as to the optimal guaranty duration and limit of liability. They expect to complete these activities by December 2017.
Recommendation: To improve the use of warranties and guarantees in Navy shipbuilding, the Secretary of the Defense should direct the Secretary of the Navy, for future ship construction contracts, to determine whether or not a warranty as provided in the FAR, provides value and document the costs, benefits, and other factors used to make this decision. To inform this determination, the Navy should begin differentiating the government's and shipbuilder's responsibility for defects and track the costs to correct all defects after ship delivery.
Agency Affected: Department of Defense