Rumsfeld v. United Technologies Corp.

• Decision Date: 15 January 2003
• Docket Number: No. 02-1071.,02-1071.
• Parties: Donald H. RUMSFELD, Secretary of Defense, Appellant, v. UNITED TECHNOLOGIES CORPORATION, Pratt & Whitney, Appellee.
• Court: U.S. Court of Appeals — Federal Circuit

315 F.3d 1361

Donald H. RUMSFELD, Secretary of Defense, Appellant, v. UNITED TECHNOLOGIES CORPORATION, Pratt & Whitney, Appellee.

No. 02-1071.

United States Court of Appeals, Federal Circuit.

January 15, 2003.

Patricia M. McCarthy, Senior Trial Attorney, Commercial Litigation Branch, Civil Division, Department of Justice, of Washington, DC, argued for appellant. With her on the brief were Robert D. McCallum, Jr., Assistant Attorney General; and David M. Cohen, Director. Of counsel on the brief were William F. Reyes, Special Counsel, Office of General Counsel, Department of Defense, of Washington, DC; Stephen R. Dooley, Acting Chief Trial Attorney; and Kathleen P. Malone, Trial Attorney, Defense Contract Management Agency, of Boston, MA.

Kent R. Morrison, Crowell & Moring LLP, of Washington, DC, argued for appellee. With him on the brief were Roger N. Boyd, George D. Ruttinger, and Parul P. Desai. Of counsel on the brief was Paul L. Robert, Associate General Counsel, United Technologies Corporation, of Hartford, CT.

Before NEWMAN, LOURIE, and DYK, Circuit Judges.

DYK, Circuit Judge.

The Secretary of Defense ("the government") appeals from the July 30, 2001, decision of the Armed Services Board of Contract Appeals ("Board") in favor of United Technologies Corp., Pratt & Whitney ("Pratt"). Appeals of United Techs. Corp., Pratt & Whitney, ASBCA Nos. 47416, 50453, & 50888, 01-2 BCA ¶ 31,592 (July 30, 2001). The Board found that payments made to Pratt's foreign suppliers to acquire parts under "collaboration agreements" were not "costs" for purposes of calculating indirect cost pool (overhead) allocation bases under the Cost Accounting Standards (CAS). Id. at 1. Because we conclude that Pratt did incur a "cost" for collaboration parts, we vacate and remand for further proceedings.

INTRODUCTION

The facts underlying this case are complex, but are virtually undisputed by the parties. During the period from 1984 to 1996 Pratt had a number of cost plus contracts with the government. These contracts incorporated the Cost Accounting Standards.¹ Pratt also had a number of commercial engine contracts.

Under the government contracts Pratt was reimbursed both for allowable direct and indirect costs that were allocable to the government contracts. We have discussed the differences between allowability and allocability in our decision in Boeing North American, Inc. v. Roche, 298 F.3d 1274, 1280 (Fed.Cir.2002), where we noted that "[a]llocability is an accounting concept involving the relationship between incurred costs and the activities or cost objectives (e.g., contracts) to which those costs are charged.... The concept of cost allowability concerns whether a particular cost can be recovered from the government in whole or in part." Allowable direct costs are directly reimbursed if the particular cost is allocable to a government contract. See id. The allocation of indirect costs pursuant to CAS is more complex.

Allowable indirect costs must be allocated according to a base comprised of direct costs, so that each dollar of direct costs in the base bears the same amount of indirect costs. Indirect costs include overhead, which is calculated by grouping the costs that cannot be directly allocated (here to a particular government contract or commercial engine contract). Under CAS, the overhead pool (i.e., the aggregated indirect costs) may then be allocated across contracts and programs using the "material costs" associated with each contract or program as the basis for allocation. CAS 418-50. The larger the total material costs associated with a contract, the greater its share of the overhead pool. It is therefore in the government's interest to maximize the amount of material costs associated with commercial contracts in order to increase the value of the commercial program's portion of the overhead pool and inversely decrease the government's share of overhead; and it is in Pratt's interest to minimize the commercial program material costs, decrease the value of the commercial program's portion of the overhead pool and increase the government's share of overhead.

The dispute here concerns whether amounts paid to acquire certain "collaboration parts" for commercial engine programs constituted "material costs" under CAS that should have been included in the programs' allocation bases used to allocate overhead. The government argues that these amounts were "costs" that should have been included; Pratt argues that the amounts were not "costs" and that they were correctly excluded. The consequences of inclusion or exclusion are allegedly considerable, amounting to $250,000,000 (including interest), according to the government's calculation.

BACKGROUND

A. Pratt's Collaboration Agreements

The parts in question were produced for Pratt by foreign parts suppliers for three commercial aircraft engines (the PW2000, PW4000, and JT8D-200 engines) pursuant to "collaboration agreements" between Pratt and these foreign parts suppliers beginning in 1977. The PW2000 engine program (originally named the JT10D engine program), which was representative in all relevant aspects of the three engine programs, included collaboration agreements between Pratt and Motoren-und Turbinen-Union Muenchen GmbH (MTU) of Germany and Fiat Aviazione Societa Per Azioni (Fiat) of Italy, dated July 12, 1977. Pratt had similar agreements for the PW4000 and JT8D-200 engine programs with other foreign parts suppliers.

Pratt was the only entity that had a direct contractual relationship to the purchasers of the engines. The foreign parts suppliers had no direct relationship to the purchasers. However, under the collaboration agreements between Pratt and each parts supplier there was a complicated agreement that involved substantial risk sharing. Pratt did not pay a preset price for the collaboration parts. Instead, under the agreements, each collaborator was assigned a percentage share of the engine program ("program share"). Substantially all of the collaboration agreements required each collaborator to pay to Pratt a substantial up-front "program entry fee" directly related to its program share. The collaborator was to receive its program share of the revenues derived from the engine sale by Pratt "in consideration of the parts manufactured." United Techs., 01-2 BCA ¶ 31,592, at 15 (citation omitted). The collaborator was to supply parts with an "equivalent engine value" based on its "Manufacturing Target Cost" (MTC), i.e., parts with a particular combined value in relation to the total value of the engines produced by Pratt (the relative value of the parts being equal to the program share). The MTC of a part was "the estimated cost of each part if Pratt were to manufacture the part." (Appellee's Br. at 6 n. 3.) The collaborators also shared in certain costs that Pratt incurred for the engine programs, because a fee called "Drag" was subtracted from their revenue shares, the Drag representing Pratt's "disproportionate program expenses," which include "overhead for the program management and administration, marketing and sales, product support, material handling, and other administrative functions." United Techs., 01-2 BCA ¶ 31,592, at 14. The amount of "Drag" was based on a negotiated agreement between Pratt and each collaborator. The express language of the collaboration agreements also provided that the relationship between Pratt and the foreign collaborators was that of independent contractors and not as partners. Id. at 16.

The collaboration parts were used by Pratt either directly to construct engines or as spare parts. The name of the form used by Pratt to request the parts was "purchase order." Id. at 13. The Board described Pratt's treatment of the collaboration parts by Pratt as follows:

[The] parts ... are ... received, stored and moved through the Manufacturing Division (MD), like other purchased parts (R4, tab 307 at 2515). The collaboration parts are intermingled with and are not segregated from Pratt's other purchased and manufactured parts (R4, tab 407 at ¶ 4).

Id. After the parts were received by Pratt, "[t]he collaboration agreements provide[d] that title to the parts furnished to Pratt remain[ed] with the collaborator until the parts [were] delivered to [an engine or spare part] customer." Id. According to the collaboration agreements, title to the parts was transferred to Pratt immediately prior to delivery. Thus, Pratt became the owner of the parts before delivery in order to pass title of the engine or spare part to the engine or spare part customer.

The collaboration agreements included a number of other risk sharing aspects not generally found in contracts for the acquisition of materials. Examples of these risk sharing aspects included: sharing in the risk that the engine program would lose money; sharing in the administrative expenses for the engine programs; sharing in price discounts and rebates to customers; sharing in liability to third parties; and sharing the risk that due to a change in circumstances, e.g., a redesign of the engine, the equivalent engine value of the parts produced by another collaborator might change, altering the percentage share of the parts contributed by the collaborator and therefore its program share.

Pratt also acquired engine parts under subcontractor agreements with parts suppliers that were both more traditional and less complex. Pratt agreed to purchase parts from these suppliers for a fixed price per part, and took title on the delivery of the parts.

B. Cost Accounting Standards

Many government contracts, like the government contracts here, are structured as "cost-reimbursement" contracts, requiring the government to reimburse the contractor for "allowable" costs incurred to perform the contract. As noted above, costs are characterized by both their allowability (whether the government is required to reimburse the costs) and allocability (whether the costs are to be allocated...