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ASBCA Reverses Course and Holds that the $10,000 Penalty Waiver of FAR 42.709-5 Applies to Individual Cost Elements

November 4, 2011

On October 19, 2011, the Armed Services Board of Contract Appeals (Board or ASBCA) issued a decision clarifying whether the $10,000 waiver threshold in FAR 42.709-5(b) applies to individual unallowable costs or the sum of all unallowable costs.  See Thomas Assocs., Inc., ASBCA No. 57126, 2011 WL 5142513 (Oct. 19, 2011).  The Board, on a motion for reconsideration, reversed an earlier decision and held that the mandatory $10,000 waiver only applies if the sum of the individual unallowable cost elements included in an indirect cost rate proposal does not exceed $10,000.

In the motion for reconsideration, the Government argued that the Board erred as a matter of law in holding that the contracting officer was required to waive FAR 42.709-1 penalties because the individual unallowable cost elements did not exceed $10,000.  In particular, the contractor included $2,400 of life insurance premiums, $6,080 for employee morale, $776 for boat title taxes and $3,866 for a business meeting in its final indirect cost rate proposal.  Because each individual cost element was less than $10,000, the Board originally held that the contracting officer was required to waive penalties for each cost.  See Thomas Assocs., Inc., ASBCA No. 57126, May 17, 2011, 11-1 BCA ¶ 34764.

In the motion for reconsideration, the Board reversed its earlier decision and held that the $10,000 threshold applies to the sum of the unallowable costs.  The Board examined the original intent of the drafters and concluded that while the language in FAR 42.709-5 may have been more explicit, the original intent of the clause was to only exempt from penalties situations where the total amount of unallowable costs did not exceed $10,000.  In this case, the total individual unallowable costs exceeded $10,000, and thus the costs were not exempt from penalty pursuant to FAR 42.709-5(b).

In general, a contractor is subject to penalties if expressly unallowable costs are included in an indirect cost rate proposal.  See FAR 42.709-1.  The amount of the penalty is equal to the amount of the expressly unallowable costs allocated to government contracts, plus interest.  FAR 42.709-1(a)(1).  However, if the indirect cost was determined to be unallowable before the submission of the indirect cost rate proposal (e.g. pursuant to a DCAA Form 1), the amount of the penalty is doubled.  FAR 42.709-1(a)(2).  In assessing the penalty, the FAR requires the contracting officer to waive the penalty when the "amount of the unallowable costs under the proposal which are subject to the penalty is $10,000 or less . . . ."  See FAR 42.709-5(b).  As clarified in Thomas Associates, the mandatory waiver only applies if the total amount of unallowable costs does not exceed $10,000.