Agencies don't always play by the rules on commercial-item contracts

Infotech and the law | Legal insights for today's market

What should a contractor do when a federal agency wants to buy the contractor's commercial product or service but does not want to use commercial-item pricing or terms? What if the agency wants to audit the contractor's proposal or performance costs?

It's a question that clients have asked repeatedly during the past few years. Agencies generally appreciate the benefits of the commercial-item contracting process but are increasingly distrustful of the pricing that comes with that process.

In most cases, the issue can be resolved by making sure that everyone - the contractor, user and contracting officials - have a common understanding of the rules applicable to commercial-item contracting. The regulations in this area, Federal Acquisition Regulation Part 12, are well drafted and have been in effect since 1995, but they are sometimes still misunderstood.

FAR expresses a strong preference for the acquisition of commercial items, stating that agencies shall acquire commercial items when they are available to meet the needs of the agency. Thus, if a contractor can demonstrate that a product or service is a commercial item, the streamlined terms of FAR Part 12 ? as may be tailored for a particular acquisition ? would typically apply.

FAR 2.101 includes a detailed definition of the types of goods and services that can be classified as commercial items. Generally, it includes items of a type customarily used by the general public that are sold, leased or licensed to the general public. It also includes commercial services of a type offered and sold competitively in substantial quantities, based on catalog or market prices and under standard terms and conditions.

The definition is intentionally broad and, as a result, covers a wide range of commercial products and services. Contractors should be prepared, however, to document their market prices under standard commercial terms and conditions because the agency must make a determination that the price is fair and reasonable.

To state the obvious, it is critical to distinguish between the terms price and cost. Commercial-item contracts are awarded on the basis of price - not cost - analysis. Agencies are specifically prohibited from seeking cost or pricing data, as that term is defined in FAR, in connection with commercial items.

Additionally, cost accounting standards do not apply to contracts for commercial items on a firm fixed-price basis, and the cost principles (FAR Part 31) do not apply when price, rather than cost, analysis is performed in connection with a contract award.

So except in rare circumstances, an agency is off base if it requests a cost-based justification for a contractor's commercial-item proposal. Competitive pricing information, not cost information, is clearly an adequate and preferred basis for price analysis under FAR.

FAR Part 15, which governs negotiated procurements, specifically exempts commercial-item contracts from the broad audit clause (FAR 52.212-2) contained in cost-type contracts. Instead, commercial-item contracts contain FAR 52.212-5, which provides for access to books and records by the Comptroller General - a rare occurrence - but does not give broad audit rights to the contracting agency.

The reason for limited audit rights in the commercial-item context is clear: They are not necessary. A commercial-item contract should be negotiated on a price basis (i.e., what the item sells for in the commercial market, which is verifiable), not on a cost basis (i.e., what the item costs the contractor to provide).

In short, price reasonableness should be determined by an analysis of the external market, not the contractor's internal books and records. Cost audits rarely have a place in commercial-item contracts.

Richard Rector is chairman of the government contracts practice at DLA Piper US LLP.

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