(Editor’s Note.  Subscribers and clients frequently inquire about guidelines the government uses in evaluating proposed profit.  Yes, there are guidelines and a general familiarity with them can often protect profit earned and provide opportunities for additional profit.  We recently came across an article by David Bodenheimer of the law firm Crowell & Moring LLP in the November 2001 issue of the Lyman Report that addresses these guidelines.)

In FAR 15-404-4(a)(3) there is a policy statement that we have often quoted when government buyers seek to impose the lowest possible profit on our clients: “the government and contractors should be concerned with profit as a motivator of efficient and effective contract performance.  Negotiations aimed merely at reducing prices by reducing profit … are not in the government’s interest…and do not provide proper motivation for optimum contract performance.”     

Statutory Limits.  FAR 15-404 imposes statutory restrictions on certain contracts:  (1) 15 percent for cost-plus-fixed-fee contracts for research and development (2) 6 percent for architect-engineer services (this limit, of course does not apply to engineering services) and (3) 10 percent for other cost-plus-fixed fee contracts.  In addition, regulations generally disallow profit from claims for delay under the Suspension of Work and Government Delay of Work clauses (FAR 52.242-14 and 17, respectively).  Also,  regulations provide for no-fee contracts when the contractor agrees to cost-sharing arrangements under FAR 16-303..

What’s a Fair Profit Rate?  The question “what is a fair profit” can be as elusive as reasons for or against a given profit rate.  Nonetheless, a surprising number of cases have centered on a 10 percent profit rate as the going rate for doing business with the government (Ideker, Inc. found 10% to be reasonable; Kong Yong Enter Co. found 10% to be fair and Techno Engineering & Constr. rejected 4% when 10% was normal).  For contractors looking for higher profit rates, 15 percent has been widely accepted in cases involving contract changes and breaches (Big Chief Drilling Co., Yamas Constr.) though many cases for changes have provided far less profit.

What happens to fee when a cost type contract overruns the original budget?  Does the ceiling amount cover only costs where fee can be collected in excess of the ceiling?  It depends.  Where the Limitation of Funds clause limits the government’s obligation for “costs” incurred (without reference to fee) the courts have generally held that a contractor first recovers its full costs up to the ceiling (without any reduction to fee) and then collects fee over and above the ceiling (Allied Signal, John McMullen).  Conversely, when the contract specifies that the Limitation of Funds clause includes both fee and cost, the contractor may not recover either cost or fee above the ceiling.

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