The Armed Services Board of Contract Appeals (the Board) recently issued a decision awarding Northrop Grumman Corporation (Northrop) $74 million under the Cost Accounting Standards (CAS) for the settlement of costs relating to the curtailment of Northrop's Officers Supplemental Executive Retirement Plan (OSERP). While the Board found that Northrop's accounting of taxes did not comply with the CAS, the Board ultimately sustained the appeal because it found that the non-compliance was not material under Federal Acquisition Regulation (FAR) 30.602(c)(1). Notably, the Board also opined on the role of expert witnesses in CAS cases and explained that, while expert testimony may be helpful, the Board will not necessarily accept expert opinions on the proper interpretation of the CAS. A copy of the opinion is available here.

Background

For cost reimbursement contracts with the government, the costs of pension plans are calculated as part of a company's overhead. When a pension plan is frozen or "curtailed," CAS 413 stipulates that the company must calculate the plan's assets versus the plan's obligations at the time the benefits were frozen to determine whether the government overpaid or whether the contractor is entitled to payment from the government. See 48 C.F.R. § 9904.413-50(c)(12). If the plan's assets are greater than the present value of the plan's obligations, the government effectively overpaid for the overhead and, alternatively, if the assets are less than the obligations, the contractor is entitled to a proportionate payment from the government to "settle up." 

After freezing its OSERP in 2014, Northrop calculated that the OSERP's obligations outweighed assets such that the government owed Northrop $74 million. The government denied the claim and Northrop appealed to the Board. 

Summary of Decision

The government objected to Northrop's calculations of both the value and obligations of the pension plan. The Board made the following findings on the government's three main challenges: 

• Value of the Assets to be Discounted by Future Taxes. The government objected to Northrop's calculation of the value of the plan because of the manner in which Northrop "valued the future income of its assets, taking into account taxes on such income." See Northrop Appeal, at 2. The Board found that treating future taxes as a reduction to the earnings assumption did not comply with the CAS. The Board was persuaded, however, by Northrop's materiality defense under FAR 30.602(c)(1) and concluded that the methodology, while non-compliant with the CAS, "was not material and generated an identical result." See Northrop Appeal, at 17.
• Mortality Tables. The government objected to the actuarial mortality tables used by Northrop to determine life expectancy of the plan pensioners because Northrop changed the mortality tables it used mere months before curtailment. But the Board sided with Northrop, noting the decision to implement the tables was companywide. The Board also found the use of the tables to be Northrop's "best estimate" of calculating the plan's obligations, as required by CAS 412. See 48 C.F.R. § 9904.412-40(b)(2). In so doing, the Board reiterated its holding in Gould, Inc. that CAS 412's "best estimates" requirement should apply to CAS 413 adjustments. See Gould, Inc., ASBCA No. 46759, 97-2 BCA ¶ 29,254. See Northrop Appeal, at 11-13.
• Adjustment to the OSERP's Liability for Taxes Already Owing to Northrop. The government objected to "a one-time payment of tax liability by the plan incurred before curtailment but paid afterwards." See Northrop Appeal, at 2. The Board noted that CAS 413, while not dispositive of the issue, may not allow contractors to assign prior period costs to the current accounting period as Northrop did. See 48 C.F.R. § 9904.413-50(c)(12). Yet, the Board declined to go down this "rabbit-hole" as the government failed to raise the issue and the government itself consented to non-current period adjustments that tilted in its favor. The Board cautioned against its opinion being cited as a finding on the issue. See Northrop Appeal, at 14-15.

In summary, while the Board took issue with some of Northrop's accounting methods, it ultimately found that any CAS non-compliance was not material because Northrop's approach reflected the "actual net value of the pension plan."  See Northrop Appeal, at 2.

Further, in reaching its decision, the Board provided notable commentary on the role of expert witnesses in CAS cases. According to the Board, experts "can illuminate accounting concepts" that aid the Board in avoiding interpretations of the CAS that would be "inconsistent or nonsensical." But the Board explained that it will "not take into account the experts' opinions of what the [CAS] mean." Thus, in the Northrop Appeal, the Board permitted expert testimony to explain accounting concepts, the operation of trusts, the consequences of applying different accounting concepts, and the calculations performed with respect to the OSERP, but refused to "cede [its] obligation to interpret CAS provisions to expert witnesses." See Northrop Appeal, at 7-9.

Takeaways

There are two principal takeaways for contractors from the Northrop Appeal: (1) contractors may successfully rely on a FAR 30.602(c)(1) materiality defense when there is no material cost difference due to a CAS violation, and (2) while the Board considers expert testimony helpful in deciding cases involving the interpretation of CAS provisions, the Board will not consider expert opinions directly on the interpretation of the CAS and will instead focus on the text of the CAS provisions and any guidance published by the CAS Board.

Going forward, contractors involved in a dispute with the government involving the CAS should be aware that any non-compliance may be excused if the non-compliance does not materially change a cost calculation. Additionally, contractors should consider how to best tailor any expert witness testimony in light of the Board's view that while expert testimony "can illuminate accounting concepts" that aid in the interpretation of the CAS, expert testimony directly interpreting the regulations may not be considered. 

*This alert has been updated to clarify the basis for the Board's decision.

For more information, please contact:

Alex L. Sarria, asarria@milchev.com, 202-626-5822

Jason N. Workmaster, jworkmaster@milchev.com, 202-626-5893

Elizabeth J. Cappiello*

*Former Miller & Chevalier attorney

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