(Editor’s Note.  We received an interesting question from one of  our readers who was asking for some regulatory guidance on how to challenge DCAA’s assertion that certain legal costs charged directly to a government contract should have been charged indirectly and hence allocated to all contracts on a prorata basis.  It was particularly interesting because we had just finished challenging the opposite - an audit opinion that the same type of  legal costs should have been charged directly to commercial contracts and not included in indirect cost pools where the costs would be allocated to all contracts including government cost type work.  Both positions were put forth by the Defense Contract Audit Agency during their incurred cost audits and, not surprisingly, they took opposite positions on the same type of costs that resulted in less costs being allocated to federal reimbursable contracts.  During our client’s challenge of  DCAA’s position that the questioned costs should be allocated directly to commercial contracts rather than indirectly, the client sought a written opinion from both our firm and a well known law firm.  We thought we would summarize the arguments presented in the opinions because (1) disputes on direct versus indirect charging is common (2) the issues presented are not limited to legal costs but affect numerous other types of costs and (3) our readers would be interested in seeing “real life” legal and consulting positions in defense of  a client.  We assure our readers the legal opinion is real but we decided not to identify the law firm in case we missed a nuance of their argument that they might take exception to.)

The contractor is a rather large engineering firm working on a variety of contracts with commercial, local/state agencies and the federal government. Because of the high cost of insurance the contractor did not insure itself against third party law suits alleging errors and omissions (E&O) and/or professional negligence.  These law suits are common in the industry and typically occur years after an engineering study is complete and the structure is built or fixed where some third party might be injured and their lawyers sue everyone involved in the project. The legal costs in question were the in-house and outside legal expenses involved in defending against these third party lawsuits as well as the costs of settling them before they went to court.  The lawsuits in question happened to be related to commercial contracts that were completed several years before the legal costs were incurred.  Like most of its other legal costs, the contractor charges these costs indirectly in the period they are either incurred or the liability is known with reasonable certainty.  The contractor has a disclosure statement and written government accounting policies and procedures where criteria for charging direct and indirect charges are addressed and the manner of charging many (but not all) expenses are discussed.

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