When negotiating the price of changed work, federal government contractors are keenly aware of the bottom line. They know the benefits associated with a successful negotiation, as well as the risks of heading down the path of a protracted dispute. Contractors are also mindful of potential legal and consultant costs that may be incurred throughout the price negotiation process. The United States Court of Appeals for the Federal Circuit recently provided additional clarity to contractors regarding the allowability of these costs, holding that contractors may be compensated for costs related to pricing and negotiating changed work, as long as the costs were not incurred in an effort to prosecute a claim against the government.

The Case

In Tip Top Construction, Inc. v. Donahoe, the Federal Circuit set forth the applicable test to determine whether legal and consultant costs incurred by a contractor due to negotiations over the price of changed work were recoverable as increased costs of contract administration. 695 F.3d 1276 (Fed. Cir. 2012). According to Court, the outcome of such a determination turns on “the distinction between costs incurred in connection with the administration of a contract and costs incurred in connection with the prosecution of a [Contract Disputes Act (“CDA”)] claim, the former being recoverable, but the latter not.” Id. at 1283. Put simply, legal and consultant costs are recoverable as long as they were incurred “for the genuine purpose of materially furthering the negotiation process.” Id. at 1284.

Tip Top had entered into a contract with the Postal Service for the renovation and alteration of postal facilities in the United States Virgin Islands. The contract established the procedure for the issuance of new work orders, and, upon the issuance of such an order, the parties engaged in a series of price negotiations. To help determine the cost of the out-of-scope work, Tip Top employed an outside consultant to review the new requirements and estimate the total cost to perform the work.

When negotiations between the parties proved unsuccessful, Tip Top submitted a claim to the Postal Service for the price of the change, its claim preparation costs, and its legal costs. After considering Tip Top’s claim, the contracting officer issued a final decision granting the majority of direct costs related to the new work, but rejecting a substantial portion of Tip Top’s costs stemming from the price negotiations, including the majority of Tip Top’s legal and consultant costs.

Tip Top appealed the contracting officer’s final decision to the Postal Service Board of Contract Appeals (“Board”). There, the Board similarly ruled that the vast majority of Tip Top’s consultant costs and related overhead were not recoverable because the estimated costs developed by the consultant to price Tip Top’s claim “had nothing to do with performance of the changed work or genuine contract administration and were solely directed at trying to convince the contracting officer to accept [Tip Top’s] figure for the change and maximizing [Tip Top’s] monetary recovery.” Id. at 1280 (citation to Board decision omitted). The Board also found that Tip Top had not adequately documented its consultant’s hours.

Before the Federal Circuit, Tip Top argued that, based on that Court’s decision in Bill Strong Enterprises, Inc. v. Shannon, 49 F.3d 1541 (Fed.Cir.1995), the Board below committed legal error by holding that Tip Top’s consultant and attorney costs associated with the negotiations were not recoverable. In Bill Strong, the Federal Circuit held that, under the Federal Acquisition Regulation (“FAR”), “consultant costs incurred by a contractor in connection with negotiations relating to the additional compensation to which the contractor was entitled by reason of government-caused delay were allowable as contract administration costs, even though the negotiation’s eventually failed.” Id. at 1281 (emphasis added); see also FAR 31.205-33 (establishing the allowability of certain professional and consultant services).

Relying on the holding in Bill Strong, Tip Top contended that the legal and consultant fees it incurred in negotiating the price of the change order were recoverable as contract administration costs – even though its contract was not governed by the FAR – because its contract contained a change order provision substantially similar to the FAR’s changes clause. In response, the government countered that attorney fees are not recoverable because costs to prepare and document a claim for equitable adjustment are not recoverable, and argued that Tip Top failed to support its claim for all of its consultant costs.

The Federal Circuit agreed with Tip Top, and remanded the case back to the Board with an instruction to award Tip Top its entire claim. The Court reasoned that, “if a change order requires a contractor to incur contract administration costs, those costs are recoverable to the extent they are reasonable. Thus, the dispute depends on whether the costs are classified as general contract administration costs or claim preparation costs.” 695 F.3d at 1282-83.

To determine whether claimed costs are related to contract administration costs or claim preparation costs, the Federal Circuit leaned on its prior holding in Bill Strong. Quoting that decision, the Court observed that:

In the practical environment of government contracts, the contractor and the [Contracting Officer (“CO”)] usually enter a negotiation stage after the parties recognize a problem regarding the contract. The contractor and the CO labor to settle the problem and avoid litigation. Although there is sometimes an air of adversity in the relationship between the CO and the contractor, their efforts to resolve their differences amicably reflect a mutual desire to achieve a result acceptable to both. This negotiation process often involves requests for information by the CO or Government auditors or both, and, inevitably, this exchange of information involves costs for the contractor. These costs are contract administration costs, which should be allowable since this negotiation process benefits the Government, regardless of whether a settlement is finally reached or whether litigation eventually occurs because the availability of the process increases the likelihood of settlement without litigation. Additionally, contractors would have a greater incentive to negotiate rather than litigate if these costs of contract administration were recoverable.

Id. at 1283 (citations and quotation omitted).

In order to classify a particular cost as either a contract administration cost or a cost incidental to the prosecution of a claim, the Court instructed “contracting officers, the Board, and courts [to] examine the objective reason why the contractor incurred the cost.” Id. Then, if it is determined that a “contractor incurred the cost for the genuine purpose of materially furthering the negotiation process, such cost should normally be a contract administration cost allowable under FAR 31.205–33, even if negotiation eventually fails and a CDA claim is later submitted.” Id. at 1283-84. In contrast, “if a contractor’s underlying purpose for incurring a cost is to promote the prosecution of a CDA claim against the Government, then such cost is unallowable under FAR 31.205–33.” Id. at 1284.

The Lesson

The Tip Top Construction decision reinforces the framework for recovering legal and consultant costs related to pricing, negotiating, and administering changed work. In response to this guidance, contractors should take necessary steps to properly account for their negotiation-related costs and present the costs in an acceptable format to the contracting officer. Contractors should track and clearly describe its legal and consultant costs, and ensure that the costs are incurred to further the negotiations – and not to develop or prosecute a claim. Taking such actions can increase the likelihood that contractors will be able to recover these costs and protect the bottom line.