Despite the Government’s View to the Contrary, It is Still Legal for Government Contractors to Make a Profit

When it comes to Time and Material or Labor Hour contracts many contractors might not know all of their rights concerning what is an acceptable amount of profit. The Federal Acquisition Regulation (FAR) defines hourly rates in Section 52.232-7, but little case law exists when it comes to interpreting reasonable amounts of profit under Labor Hour or Time and Material contracts. Contractors are not the only ones who may not be aware of what constitutes reasonable profits under these types of contracts. As the following Armed Services Board of Contract Appeals (“ASBCA”) case illustrates, the Government is also not always privy as to what a contractor can bill. It is of the utmost importance for contractors to know what is acceptable when it comes to billing under Time and Material or Labor Hour contracts. A recent holding from an ASBCA case bodes well for government contractors.

In GaN Corp., ASBCA 57834, 2012 WL 2997037 (July 17, 2012), the ASBCA was tasked with interpreting the meaning of the “Payments Under Time-and-Materials and Labor Hour Contracts” clause in FAR 52.232-7. The underlying issue was whether a government contractor could charge the Government for “unexpensed and uncompensated” hours worked by the contractor’s exempt employees. In other words, could a contractor charge the government hourly rates for employee time when it was paying its employees a salary.

In GaN, the U.S. Army Engineering Support Center, Huntsville (“USACEH”) entered into a contract with the GaN Corporation (“GaN”). In the contract (“the Contract”) executed between the parties, the payment provision, Section A, stated that “task orders will be Labor Hour (“LH”) and/or Firm Fixed Price (“FFP”).” GaN’s employees assigned to work under the contract were salaried exempt workers. Thus, GaN paid its employees a fixed salary that did not fluctuate based on additional hours worked. However, when GaN billed the Government, it charged by the hour, including any hours worked in excess of a standard 40 hour work week. In other words, even though GaN paid its employees a fixed salary, it billed the Government by the hour, including hours worked by its employees that exceeded its employees’ base 40 hour work week. In doing so, GaN relied on the provision in the Contract that stated task orders could be LH.

The Government contested the billing method, alleging that GaN could not recover for hours worked unless its employees were actually paid on an hourly basis. GaN countered that even though it paid its employees a salary, it was entitled to bill the Government for hours worked based on the language of the Contract. The Government contended that allowing GaN to bill on an hourly basis would permit GaN “to pocket undue windfall profits at taxpayer expense” and that it should only be charged for costs incurred. In support of its argument, the Government reasoned that Time-and-Materials (“TM”) and LH contracts are essentially cost reimbursement contracts. As the ASBCA determined, this was incorrect. The Government all too conveniently “read out” portions of the Contract with GaN, and misinterpreted FAR 52.232-7.

The Pricing Schedule (Section B in the Contract, cross referenced with sections (a)(2) and (3) of FAR 52.232-7) stipulated that “the amounts shall be computed by multiplying the appropriate hourly rates prescribed in the Schedule by the number of direct labor hours performed.” Furthermore, the Payments clause stated that the Government would pay the contractor for all hours performed by the contractor. The Government basically ignored these clauses, relying only on other sections of the Payments clause that would have an uninformed party believe that employees would have to be hourly workers in order for GaN to be reimbursed for the hours they worked. Relying on well established contract principles, the ASBCA looked to the plain language of the Contract and determined the Government’s interpretation to be without merit. As the ASBCA stated: “The Government appears to think that the various references to actual payment and cost mean that the contractor cannot recover for hours unless the employees were paid on an hourly basis. We disagree.” The Contract made clear that task orders could be based on LH, and it made clear how to calculate payment amounts.

FAR 52.232-7 (a)(4) provides that rates under a TM or LH contract shall include wages, indirect costs, general and administrative expense, and profit. (emphasis added). FAR 16.601(c)(2), a TM provision, reflects the same. Additionally, pursuant to FAR 52.216-7, an “allowable cost and payment” provision, states with regards to billing rates that “until final annual indirect cost rates are established for any period, the Government shall reimburse the Contractor at billing rates established by the Contracting Officer or by an authorized representative, subject to adjustment when the final rates are established.” These billing rates “(1) shall be the anticipated final rates, and (2) may be prospectively or retroactively revised by mutual agreement… to prevent substantial overpayment or underpayment.” (emphasis added). Clearly, the FAR supports contractors making a reasonable profit from their efforts, and not limiting profits in TM or LH contracts unless there is a specific agreement imposing a limit. In following with these provisions, the ASBCA upheld this precedent, and held the Government to the contract they entered into with GaN.

GaN was largely a case of first impression, but the issues discussed are hardly novel. Contractors have always been entitled to reasonably profit from their work. What the Government attempted in GaN was to disregard the clear import of FAR 52.232-7, and strip that right away from GaN Corp. As one of the first cases of its nature, GaN serves to assert contractors’ rights, while holding the Government accountable for the contracts it enters into.

Also germane to the topic of government contractor profits is Empire Blue Cross and Blue Shield v. United States, 26 Cl.Ct. 1393 (Oct. 14, 1992). Empire, though distinct from GaN, addresses when contractors are entitled to reimbursement for cost incurred. In this case the Government sought reimbursement of added costs paid to an intermediary under a government contract. The primary issue the court resolved in Empire was whether additional charges for new work preformed should be reimbursed to the Government because the work was carried out with resources that already existed under the original contract. As in GaN, the Government in this case took the stance that it would only pay for costs incurred by the contractor.

The ASBCA found against the Government, and did not require the contractor to return the additional payments. In arriving at this conclusion, the court reasoned: “a contractor’s cost may be increased by a change even though he makes no additional expenditure or incurs no additional obligation. Costs are considered to be incurred when the contractor is deprived of something of value.” However, in this case, the contractor actually was deprived of something of value by performing the additional work for the Government—the contractor was deprived of its employees’ labor.

Empire, like GaN, helps to draw the line between reasonable and unreasonable profits for contractors. Both cases address reimbursements and point out that contractors can profit even if they incur no additional cost. These cases implicitly recognize that obligating a contractor’s labor to work less has its own consequences. In other words, a contractor is allowed to make a profit being efficient with its personnel.

It is important to know your rights under the FAR when engaging in a government contract so that you can maximize your profits. Though the Government in these cases would have us believe that it is improper, the FAR tells us otherwise. It is axiomatic that government contractors engage in contracts to derive a profit. What is not always so clear is what exactly constitutes a reasonable or acceptable profit. Empire is instructive in answering that question, while GaN further elucidates the answer to what constitutes fair profit under TM and LH contracts. If there is one lesson to be learned from these cases, it is that profiting from a government contract is still not a crime.

Bryant S. Banes
Managing Shareholder
Neel, Hooper & Banes, P.C.
Houston, Texas

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