T&M (unless otherwise specified T&M apply equally to LH contracts) contracts permit the government to acquire service on the basis of direct labor hours at specified hourly rates. In addition to actual employee pay rates, the fixed hourly rates include contractor overhead, G&A and profit. Materials provided in conjunction with labor hours are typically provided to the government at the prime contractor’s cost. In contrast to fixed price contracts, the government’s price will largely be based on the number of labor hours provided by the contractor and in contrast to cost reimbursement types of contracts, the labor charges are not limited to the contractor’s actual costs.

 

Because the government views T&M contracts as providing less incentive for efficient performance than fixed price contracts the FAR provides they should be used only when the scope of work or duration of performance is not defined sufficiently to allow a reasonable basis for a fixed price contract. In recent times there has been confusion over whether prime contractors could include profit in the labor rates they charged the government for subcontract labor. In guidance issued April 9, 2004 the Defense Contract Audit Agency stated it interpreted the T&M payment clause at FAR 52.232-7 as limiting the price prime contractors could charge, treating subcontract labor as essentially a pass-through cost, meaning the prime contractor could not include any profit or other added margin to the price charged to the government as subcontract labor. DCAA’s interpretation conflicted with the prevailing practice under which parties applied the clause’s limitation only to subcontracts for materials, not for labor. DCAA’s position was widely criticized as unfair because prime contractors would not be able to recoup costs incurred for administering subcontract labor or for the risk assumed for defective subcontractor work.

 

The rulemaking process started in Sept. 2004 when the FAR Council issued a proposal that would have required prime contractors to treat subcontract labor as a pass-though cost. A year later, the Council issued separate proposed FAR rules: one covering T&M contracts for commercial services and one for noncommercial services. Both proposed rules adopted a default approach where subcontract labor hours would be treated as “materials” and charged to the government at the prime contractor’s cost. Two years of discussions, fact finding and public meetings ultimately led to, on Dec. 12, 2006, three sets of regulations governing T&M contracts: (1) a final FAR rule that applies to commercial item acquisitions (2) a final FAR rule applying to noncommercial item acquisitions and (3) an interim DFARS rule applying to DOD noncommercial item acquisitions.