(Editor’s Note. Employee litigation against employers has skyrocketed. In spite of believing they have legitimate business reasons for discharging them, contractors find themselves targets of wrongful discharge actions from a variety of state, local and federal laws. At the federal level, there is no shortage of suits alleging employment discrimination, ERISA violations and suits alleging retaliatory discharge for whistleblower actions. Contractors incur costs against such suits through litigation, settlements before judgements, and payments after judgments. Thomas Lemmer, Thomas Jeter and Hugo Teufel, all from the law firm of McKenna & Cuneo, have written an excellent article in the June issue of CP&A REPORT that discusses the relevant regulations and case decisions affecting recovery ot these costs and address the best actions contractors should take to ensure they are reimbursed for these costs through their federal contracts.)

The overriding principle affecting recovery of litigation-related costs, settlement costs and costs resulting from an adverse decision is reasonableness. FAR 31.201-3 addresses reasonableness of cost. It must pass the "prudent person" rule – a cost is considered reasonable if "in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business". To determine whether a cost is reasonable, it should be (1) a type of cost recognized as "ordinary and necessary for the conduct of the contractor’s business or the contract performance" and (2) should result from "generally accepted sound business practices" arrived at from "arm’s length bargaining". Satisfying reasonableness criteria is essential for recovery of this type of cost and the contractor cannot begin too early to document that its employee-related actions are reasonable.

Allowability of Litigation-Related Costs

Litigation-related costs commonly include in-house and outside attorney’s fees, consultant fees and other inside and outside costs related to the case. In addition to reasonableness, two cost principles and a few cases determine allowability of costs related to litigation.

Professional & Consultant Services (FAR 31.205-33). This cost principle governs costs of services of outside professionals engaged to enhance a contractor’s legal, economic, financial or technical positions and applies to litigation involving both the government and third parties (e.g. employees). Unless one of the enumerated exceptions is present (which would not apply here), this cost principle generally treats litigation-related costs as allowable.

Proceedings Initiated By a Government Entity (FAR 31.205-47). This regulation sets forth specific guidelines for costs related to judicial or administrative proceedings initiated by federal, state, local or foreign governments. It generally provides that a maximum of 80% of otherwise reasonable proceedings costs are allowable if the contractor prevails in the litigation or proceedings or if it settles with a specific provision permitting allowability. If the contractor does not prevail, such costs are unallowable. Though the principle has generally been limited to proceedings initiated by governmental entities, two exceptions apply for litigation instituted by private parties: (1) when an employee brings a suit alleging reprisals for a contractor found guilty of the Major Fraud Act and (2) employee qui tam lawsuits under the civil False Claims Act unless the contractor prevails or settles under certain conditions (e.g. the government did not intervene in the action and the CO determines that there was little likelihood of winning).

Case Law. In Northrup Worldwide Aircraft Servs., Inc. two employees won a wrongful termination claim where they alleged they were discharged for refusing to participate in a fraud against the government and were awarded $900,000 in compensatory damages and $900,000 in punitive damages in a civil suit. Though the employees worked on another contract, the contractor sought recovery of attorney’s fees on a cost-type contract. The CO asserted that it would be unreasonable to reimburse the contractor for its alleged attempts to defraud the government.

The Board of Contract Appeals disagreed, finding that a litigation position may be reasonable notwithstanding an adverse verdict asserting reasonable people can differ and a quite sensible litigation position may "fail to carry the day". The Board found the legal costs both allowable and allocable as an indirect cost because it was incurred for the overall operation of the business. The authors find this decision quite favorable to contractors because it refuses to find costs associated with litigation as automatically unallowable if damages are awarded but seeks additional evidence on the reasonableness of incurring these costs.

In Hirsh Tyler Co., a contractor was found to engage in sexual discrimination in its promotion practices and forced to pay back wages and attorney’s fees in a civil suit. In spite of the adverse judgement, the contractor’s legal fees were found to be reasonable and hence allowable on a cost-type contract because defense of the lawsuit represented prudent business practices "regardless of the outcome".

In Hayes Intl Corp., the contractor incurred legal fees against employees in a racial discrimination suit brought by the Equal Employment Opportunity Commission. Because the litigation concluded by a consent decree there was no finding the contractor violated the Civil Rights Act. The Board concluded these were reasonable costs incurred by an "ordinary prudent person" and allowed the legal costs charged to its contract. Unlike the other two cases where an adverse decision did not preclude recovery of costs, the Board concluded that a finding of violation of the Civil Rights Act might have led to a different result.

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