Appeals from the Armed Services Board of Contract Appeals in
Nos. 57625, 60190, Administrative Judge Robert T. Peacock.
Daniel
B. Volk, Commercial Litigation Branch, Civil Division, United
States Department of Justice, Washington, DC, argued for
Secretary of Defense. Also represented by Joseph H. Hunt,
Robert Edward Kirschman, Jr., Patricia M. McCarthy; Robert
Lyn Duecaster, Contract Disputes Resolution Center, Defense
Contract Management Agency, Chantilly, VA.
Donald
B. Verrilli, Jr., Munger, Tolles & Olson LLP, Washington,
DC, argued for Northrop Grumman Corporation. Also represented
by Ginger Anders; Charles Baek, Stephen John McBrady, Nicole
J. Owren-Wiest, Crow-ell & Moring LLP, Washington, DC.
Before
Prost, Chief Judge, Bryson and Reyna, Circuit Judges.
Reyna,
Circuit Judge.
The
Secretary of Defense appeals a final decision of the Armed
Services Board of Contract Appeals finding that the United
States Government improperly disallowed certain retirement
benefits costs that Northrop Grumman Corporation asserts are
eligible for reimbursement. Northrop Grumman Corporation
conditionally cross-appeals the Armed Services Board of
Contract Appeals' finding that the retirement benefit
costs are unallowable under the applicable regulations
because they were calculated using an improper accounting
method. Because substantial evidence supports the Armed
Services Board of Contract Appeal's finding that Northrop
Grumman Corporation never claimed and will never claim any of
the disputed retirement benefits, we affirm and do not reach
the cross-appeal.
Background
I.
Post-Retirement Benefits Costs
This
dispute concerns Northrop Grumman Corporation's
("Northrop") accounting of costs for providing
post-retirement benefits ("PRB"). PRBs are
non-pension benefits that are made available to employees
upon their retirement. Examples of PRBs include
post-retirement health care, life insurance, disability
benefits, and other welfare benefits. Relevant to these
appeals is that PRBs can be modified or eliminated entirely,
unlike pension benefits which cannot be modified by the
employer.
The
Federal Acquisition Regulation
("FAR")[1] permits contractors such as Northrop to
seek reimbursement from the federal government for its PRB
costs. Only those PRB costs that are "allowable,"
however, may be reimbursed by the government. Effective July
25, 1991, the FAR was amended to add FAR 31.205-6(o), which
governed allowability of reimbursement of PRB costs in
government contracts. This amendment required PRB costs
assigned to a given year to be funded by that year's tax
return deadline in order to be allowable. While the amendment
permitted the use of accrual accounting[2] methods for PRB
costs, it did not expressly require that any specific
accounting standard be used. However, effective February 27,
1995, the FAR was amended again, this time to require the use
of the accounting standards set out in the Statement of
Financial Accounting Standards 106 ("FAS
106")[3] to determine allowable PRB costs in
government contracts.[4]
At the
time of the 1995 FAR amendment, Northrop accounted for its
PRB costs using an accounting method that conformed to the
requirements established by the Deficit Reduction Act of 1984
("DEFRA") rather than FAS 106. Following the 1995
FAR amendment, Northrop continued to account for its PRB
costs for government contracting purposes using the DEFRA
method, even though that method was no longer in compliance
with the FAR.
The
DEFRA and FAS 106 both require the use of accrual accounting
methods, but the actuarial assumptions underlying each method
are different. The primary difference between the DEFRA
method and the FAS 106 method is that the DEFRA method
calculates PRB costs based on current medical costs, while
the FAS 106 method calculates PRB costs to include future
increases in medical costs. J.A. 32. As a result, annual PRB
costs computed using the DEFRA method typically start lower
and increase over time whereas annual PRB costs computed
using the FAS 106 method typically start higher and decrease
over time. J.A. 2.
Between
1995 and 2006, Northrop filed disclosure statements with the
government on numerous occasions, disclosing its continued
use of the DEFRA method. The government was aware that
Northrop was not in compliance with the FAR, but it did not
object to Northrop's continued use of the DEFRA method
because its use resulted in lower reimbursement costs to the
government. J.A. 99. Indeed, had Northrop used the FAS 106
method between 1995 and 2005, the government would have paid
an additional $253 million during that period. See
J.A. 32; Oral Arg. at 15:18-15:34; see also J.A.
1000 (member of DCAA testifying that the government saved
$253 million between 1995 and 2006). In addition, both the
Defense Contract Management Agency ("DCMA") and the
Defense Contract Audit Agency ("DCAA") informed
Northrop during these years that the agencies found "no
instances of noncompliance with applicable Cost Accounting
Standards or with FAR Part 31 cost principles." J.A. 4;
see also J.A. 3-6. Although not reflective of
official policy, DCMA even used Northrop's continued use
of the DEFRA method in its internal training documents as an
example of acceptable accounting methods under the FAR. J.A.
10, 33.[5] At the time, DCMA members interpreted the
FAR's requirement that FAS 106 method be used as setting
a ceiling on allowable costs under the regulations,
concluding that the difference between the DEFRA and FAS 106
calculations would not become unallowable even if not
assigned and funded within a given year as required by FAR
31.205-6(o)(3).[6] Id.
Because
PRB cost calculations under the DEFRA method increase over
time, and calculations using the FAS 106 method decrease over
time, Northrop predicted that its PRB cost calculations using
the DEFRA method would exceed those allowable under the FAR
and FAS 106 in 2015. To avoid this eventuality, Northrop in
2006 switched from using the DEFRA method to using the FAS
106 method. As part of the switch, Northrop was required to
calculate its "transition obligation"-the
difference between the PRB costs that would have accrued had
Northrop adopted the FAS 106 method in 1995 and the PRB costs
that actually accrued due to its continued use of the DEFRA
method. See 56 Fed. Reg. 41, 738, 41, 739 (Aug. 22,
1991); FAS 106, ¶ 110. Northrop's transition
obligation in 2006 would have been approximately $305
million.
At the
same time it adopted the FAS 106 method, Northrop amended its
PRB plans. The amendment capped the annual amount Northrop
would contribute to the PRB plans independent of future
healthcare cost increases, thereby limiting the benefits
available to its employees under those plans. As a result of
this "negative plan amendment," Northrop's PRB
cost obligations were reduced by approximately $307 million.
Northrop subtracted these savings from its transition
obligation, as required by FAS 106. Northrop notified DCMA of
its PRB plan amendment and its switch to the FAS 106
accounting method on October 23, 2006, and November 3, 2006,
respectively.
On July
26, 2007, DCMA issued a notice of its intent to disallow
costs. DCMA took the position that Northrop's transition
obligation was unallowable in future accounting periods
because Northrop did not measure or fund its PRB plans
between 1995 and 2006 using the required FAS 106 method, and
therefore failed to timely assign the unfunded difference
between the higher FAS 106 amount and the lower DEFRA amount
to those years. J.A. 27. DCMA issued a Final Determination on
April 9, 2008, disallowing approximately $253 million of
Northrop's PRB costs from its post-2006 reimbursement
submissions.[7] Northrop submitted a certified claim for
these funds on May 20, 2010. DCMA denied Northrop's claim
on February 18, 2011. As a result of the ...