Sec'y of Def. v. Northrop Grumman Corp.
| Citation | 942 F.3d 1134 |
| Decision Date | 15 November 2019 |
| Docket Number | 2018-1945, 2018-1990 |
| Parties | SECRETARY OF DEFENSE, Appellant v. NORTHROP GRUMMAN CORPORATION, Appellee Northrop Grumman Corporation, Appellant v. Secretary of Defense, Appellee |
| Court | United States Courts of Appeals. United States Court of Appeals for the Federal Circuit |
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, Crowell & Moring LLP, Washington, DC.
Before Prost, Chief Judge, Bryson and Reyna, Circuit Judges.
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.
This dispute concerns Northrop Grumman Corporation’s ("Northrop") accounting of costs for providing postretirement 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 accounting2 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 (). 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 government’s disallowance, Northrop has deducted the disputed $253 million from its annual PRB cost reimbursement submissions since 2007, amortized over a 20-year period—approximately $12.7 million annually.
Northrop appealed DCMA’s denial to the Armed Services Board of Contract Appeals ("the Board"). The Board bifurcated the proceedings into two phases—entitlement and quantum. The Board held an evidentiary hearing in each phase.
During the entitlement phase, the Board determined that Northrop’s use of the DEFRA method was not in compliance with FAR 31.205-6(o). J.A. 12. The Board pointed to Northrop’s concession that "there is no dispute that the DEFRA method did not comply with GAAP requirements," as required by the FAR. Id. The Board also found that by not using the FAS 106 method, Northrop did not timely fund its PRB obligations to the full extent permitted by the FAR. Id. According to the Board, this rendered $253 million of Northrop’s transition obligation unallowable under FAR 31.205-6(o)(3). J.A. 12–13. The Board rejected several of Northrop’s arguments, including its contention that the FAS 106 method only set a ceiling for allowable costs under the FAR and any costs up to that amount should be allowable notwithstanding Northrop’s failure to fund those costs. J.A. 13–16. The Board explained that "no such language is contained" in FAR 31.205-6(o)(3), and thus the plain language of that regulation contradicted Northrop’s arguments. J.A. 13.
The Board determined, however, that it could not resolve Northrop’s argument that the government’s disallowance was improper because the negative amendment to Northrop’s PRB plans ensured that the $253 million in disputed PRB costs "have never been and will never be claimed or incurred." J.A. 16. The Board explained that there was inconsistent testimony as to whether Northrop included the unallowable costs in its reimbursement submissions in 2007 and subsequent years, and those submissions were not in the...
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