Recent Developments in IR&D/B&P Do you know the difference between direct and indirect costs? Stephen D. Knight

2. Recent Developments in IR&D/B&P Do you know the difference between direct and indirect costs? Stephen D. Knight Attorney Smith Pachter McWhorter & Allen P.L.C. December 7, 2004

3. “Required in the performance of a contract” • Definition – there is none. • CAS 420 • IR&D “means the cost of effort which is neither sponsored by a grant, nor required in the performance of a contract, and which falls within” basic and applied research, development, and systems and other concept formulation studies.

4. “Required in the performance of a contract” • CAS 420 • B&P “means the cost incurred in preparing, submitting, or supporting any bid or proposal which effort is neither sponsored by a grant, nor required in the performance of a contract • Requires allocation of IR&D/B&P according to CAS 403 and 410. • If effort is “required in the performance of a contract,” it is not IR&D/B&P and will not be so allocated.

5. “Required in the performance of a contract” • FAR 31.205-18 • IR&D “means a contractor’s IR&D cost that consists of projects falling within [basic research, applied research, development, and systems and other concept formulation studies].” • IR&D “means a contractor’s IR&D cost that consists of projects falling within [basic research, applied research, development, and systems and other concept formulation studies].”

6. “Required in the performance of a contract” • Basic research “means that research directed toward increasing knowledge in science. The primary aim [is] fuller knowledge. . .rather than any practical application. . .” • Applied research – to determine potential of scientific discoveries, or improvements in technology, materials, processes, methods, devices, or techniques.

7. “Required in the performance of a contract” • Applied research – attempts to advance state of the art. • “does not include efforts whose principal aim is design, development, or test of specific items or services to be considered for sale; these efforts are within the definition of the term ‘development’.”

8. “Required in the performance of a contract” • Development • the systematic use. . . Of scientific and technical knowledge in the design, development, test, or evaluation of a potential new product or service (or of an improvement in an existing product or service) for the purpose of meeting specific performance requirements or objectives.” • Includes design engineering, prototyping, and engineering testing.

9. The Problem: • US v. Newport News Shipbuilding, Inc., 276 F. Supp. 2d 539 (E.D. Va. 2003) • “The practical effect of this reading on the ‘required in the performance of a contract’ exclusion is to create a temporal dividing line between IR&D and direct work that must be billed to a contract at the point the contract requiring the effort is signed. Prior to such a contract, the research and design effort is independent, and is eligible to be charged as IR&D, provided it otherwise fits the IR&D

10. The Problem: definition. Once a contract is signed, however, research and design efforts that are explicitly or implicitly required in the performance of that contract may no longer be charged as IR&D.”

11. The Problem Continues: • Government briefs in Alliant Techsystems, Inc. v. US, No. 99-440C (COFC) • Rely on NNS and interpret “required in the performance of a contract” without regard to whether the costs were otherwise required. • “. . . ‘required in the performance of a contract’ [means] as a practical matter, in order to perform a contract”

12. Analysis: • IR&D is a continuum of effort. • Most complex issue is “development.” • Government position is that development “required in the performance of a contract,” i.e., required as a practical matter to perform the contract, is not IR&D. • But FAR 31.205-18 says development, as part of IR&D, includes design engineering, prototyping, and engineering testing, and requires indirect allocation of such costs.

13. Analysis: • Government position would require costs that benefit more than one final cost objective to be treated as “direct costs.” • CAS 402, FAR 31.202, FAR 31.203 • Direct cost: any cost that can be identified specifically with a particular final cost objective. • Indirect cost: any cost identified with two or more final cost objectives. • See FAR 31.201-4

14. Analysis: • Government position would: (1) effectively preclude customer from buying fruits of IR&D without all of related development; (2) predicate IR&D on strict sequential development before sale of product or improvement. • Would precontract development become unallowable precontract costs? • Effect on technical data rights?

15. Analysis: • Government position ignores reality that development occurs in parallel with sales of product and product improvements. There is no “temporal dividing line.”

16. What is a “contract” for B&P purposes? • TRW, Inc., ASBCA No. 51530, 02-2 BCA para. 31,944. • MOA – parties agreed to form limited partnership for marketing purposes. • MOA required TRW to prepare and submit proposal. • Costs to prepare proposal were not B&P, but costs of the “contract.”

17. What is a “contract” for B&P purposes? • “The fact that the MOA did not provide therein for compensation for TRW’s proposal preparation costs does not exclude that MOA from the FAR definition of a ‘contract’. . . The MOA, whose material terms ‘constitute a legally binding contract,’ is a ‘contract’ within FAR 31.205-18(a)’s B&P cost exclusionary provision.” • Current effort to recognize teaming B&P as allowable.

18. Conclusions: • Scrutinize SOW to analyze what government may argue is “required as a practical matter” to perform. • Disclose specific IR&D/B&P practices. • Scrutinize all teaming and marketing arrangements to distinguish from “contracts.”