Our consulting practice has been preparing numerous termination settlement proposals lately.  The rules are unique but if you understand them you can generate significant dollar recoveries.  In the case study discussed below, we were able to increase the original estimated amount of the proposal more than tenfold by carefully analyzing the contract and facts of performance and applying the termination rules to identify numerous cost recovery opportunities. The case study below is a real proposal we prepared for a client and accurately describes the process we followed to assemble the entitled costs submitted in the proposal. (The identity of our client is not given and dollar amounts have been changed.)  We would strongly recommend obtaining expert advice if you are planning on preparing a termination settlement proposal since all such help is almost always a reimbursable cost of the termination.

Our client had a cost type professional services contract and asked us to prepare a termination proposal as soon as they received their termination notice.  Following a 10 month period after award that included some performance work, a protest and an unsuccessful rebid of the contract, the contract was terminated and our client decided to seek the maximum dollars they were entitled to.  We began the process by asking them to provide all of the costs that were chargeable to the contract. We received some accounting data that included some direct labor and equipment costs that was approximately $100,000. We observed there were several categories of costs that probably should have been included but were not and decided to assemble the termination costs from scratch.  First, we developed a time line of events for the ten months, next identified types of effort and expenditures that might potentially be included in the proposal, then identified those activities that should be included and quantified the amounts and finally presented the costs in a manner most likely to be accepted by the government.

• Establish Timeline

Before formal award, Contractor was verbally notified of award and held a major kick of meeting bringing in personnel from all over the country.  After the award was made, Contractor secured space for additional employees and equipment and prepared the facilities for occupancy, ordered a variety of equipment such as desktops, servers and telecommunications and incurred significant labor costs to get ready to “go on-line.” Once the protest and rebid process was initiated, direct project work ceased but several activities had to continue in order to be ready to perform.  Finally, after receiving the termination, certain activities continued.

• Identify Potential Types of Costs
Detailed inquiries into the types of activities that occurred during this period revealed that significant effort by normally indirect labor was expended for equipment (e.g. receiving, inspecting, installation, software, maintenance) and other labor intensive activities (project management and organizational readiness - status meetings, recruiting, training, preparing written policies and procedure, etc.). In addition several other expenses continued – rent, a law suit, idle labor that could not be laid off without permanently loosing them, severance payments, subcontractor payments, returning government owned equipment, getting other equipment and facilities ready for other uses, etc. Our inquiries included a trip to the Contractor where two intensive days were spent with key individuals probing their memories which, in turn,generated recollections of several other activities related to the contract. Once all potential activities were identified, we distinguished between those that were clearly identifiable with the terminated contract and those that were likely not or were questionable.

• Quantify Results
Once those activities clearly related to the terminated costs were identified, we began quantifying the costs related to them. Costs we considered to be direct labor– already billed, IT (they maintained their own separate timekeeping system) and project management (they were dedicated full time to the project) were distinguished from indirect labor e.g. support from HR, contracts, finance and accounting, project heads. We asked all employees who do not normally prepare timesheets to estimate time spent on their relevant activities and asked them to be prepared to document as much as possible the basis for these estimated hours (e.g. personal journals, emails, expense reports, etc.). Hours were then multiplied by hourly rates.  Facilities that were and were not usable on other projects were distinguished and the rental costs for the unusable facilities were computed for the remaining period of lease. (Though estimates of related utilities costs could be justified we chose not to do so.)  We determined that equipment usable for other purposes could, on average be ready in six months after termination and we computed six months of depreciation to be charged to the terminated contract.  Costs of purchasing and installing other equipment not usable for other purposes (e.g. telecommunications) were computed. Subcontracts and consulting expenses were included at invoiced amounts for costs incurred while estimates of future costs for consultants and in-house finance were estimated for liaison with auditors and negotiations. Overhead and G&A rates were computed, making sure that normally indirect costs charged to the termination were deducted from the respective overhead and G&A cost pools.  Finally, a fee was proposed which coincided with expected profit rate.

• Presentation
Allowability and allocations issues related to terminations are complex and most auditors and COs have little experience with terminations.  We realized certain categories of costs are an “easier” sell than others so assigned all of the allocable costs we computed into “buckets” we believed could be most easily defended.

Indirect costs charged direct. Since there is long case history, authoritative texts and even DCAA recognition of charging certain indirect costs as direct termination costs, we charged all labor costs, whether normally classified as direct or indirect, as direct labor costs of the termination.

Unexpired leases and settlement with subcontractors. These costs are relatively noncontroversial and we assigned unusable facilities costs.

Idle capacity. Though more controversial yet still defensible, we used the category of “idle capacity” (underutilized resources) as the category for assigning both the depreciation costs of the hardware and software costs of the equipment that would eventually be used for other purposes. We also assigned the three months of costs incurred by two idle employees who were hired to support the terminated contract and could not be assigned to other work until they were eventually laid off.

Special equipment. The telephone communications costs were charged to this category that provides for “special tooling, test equipment and special equipment.” This category was used for that equipment not classified as “common items” e.g. not usable for other work.

Settlement costs. The costs related to preparing a termination are probably the least controversial and both consultant and in-house financial costs were charged here.

Initial Costs. Costs related to getting ready for the contract before it was formally awarded is a normally allowable precontract cost when it would be an otherwise allowable cost of the contract. We charged the costs associated with the initial kickoff meeting to this category.

Other costs continuing after termination. These include severance pay and projected legal costs associated with a lawsuit brought by an employee who was laid off.

Indirect costs. Indirect cost rates, adjusted for the costs charged direct on this contract, were applied to the respective costs they normally are charged to – overhead to labor, G&A to all other costs except settlement costs.

Unrealistic documentation requirements. To preempt the common practice of inexperienced auditors questioning labor costs as unsupported costs if no timesheet is provided, we educated the auditors on certain key provisions of FAR Part 49 that deemphasizes “strict accounting records” and pointed out it would be unreasonable to expect indirect labor that do not normally use timesheets to do so on this contract in expectation of a termination.  We are prepared to cite relevant supporting decisions if we need to.

Once the costs were grouped in the above categories, they were regrouped into the cost categories identified in the specific termination proposal form used.

However, the cost data and categories identified above will be the basis on which auditors will conduct their review. Of course, auditors and contracting officers are usually motivated to challenge proposed costs and they will likely have something to say about the proposed costs but a clear understanding of the rules and proper presentation of the costs can go a long way to maximizing recovery of your costs.

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