Buy Lines | New legislative proposals spell big trouble

Bent on meeting deadlines to pass critical authorization and appropriations legislation, Congress has let several troubling provisions slip into some bills.

For example, both House and Senate versions of the fiscal 2007 defense authorization bill contain numerous problematic amendments, including one in the Senate bill that establishes a strong preference for using fixed-price contracts for development and low-rate initial production.

To paraphrase author and former defense executive Norman Augustine, that's a strategy on which our record is unblemished by success.

The Senate version of the defense authorization bill contains a proposal that may be the most problematic of all. Section 844 would prohibit "excessive pass-through charges" on competitive, or commercial, fixed-price defense contracts or subcontracts. The provision defines an excessive charge as "a charge for overhead or profit" on work done by subcontractors when more than 90 percent of the work on the contract is subcontracted.

In those cases, in addition to the direct subcontract costs, prime contractors could charge the government only for the associated administrative costs, and minimal overhead and fee based only on those administrative costs.

This is how it works with cost-type contracts, but in a competitive fixed-price environment, this represents a sea change.

The provision is undoubtedly a response to allegations of layering of costs on some Iraq- and Katrina-related contracts. But the contracts in question were few and were awarded in emergency or contingency environments, situations in which large umbrella contracts covering scores of subcontracts often are the most efficient and effective way to meet critical mission needs.

But this provision would apply to all contracts, and that raises a number of other troublesome issues.

The legislation applies not only to prime contracts, in which a direct business relationship is inherently established between government and contractor, but also to subcontracts. In addition to raising serious questions about the privity of contracts ? the exclusive business relationship is between the prime contractor and its subcontractors, not between the government and its subcontractors ? the reach of the legislation could be very broad.

It is also unclear how it would work. Does it mean that individual parts of fixed-price contracts will be broken out and treated as a cost-type contract?

Most fundamentally, the amendment threatens to distort both the essence of competitive, fixed-price contracting and the incentive structures that drive company decisions to do work in-house or by subcontract.

In a competitive fixed-price environment, in which the contracting officer has determined that the price is fair and reasonable, there is generally little reason for the government to interject itself into individual cost elements. The company assumes the responsibility and risks for performing to the agreed level of quality and for its competitively set price, and in return is rewarded for the assumption of that risk.

This amendment makes a mockery of that risk-reward equation, which itself is a long established precept of business.

Although the government's interests lie in companies making subcontracting decisions based on the needs and interests of the customer, this amendment could generate real disincentives for any subcontracting except where it is absolutely essential. Why would a company subcontract any more than necessary, when doing so increases its costs and risks yet reduces its rewards? Doing so would be contrary to the most basic rules of commerce and fiduciary law as well.

Legislation such as this, which prescribes a cookie-cutter approach to a contracting environment that is complex and constantly changing, could do far more harm than good. As Congress races to meet its legislative deadlines, one can only hope that someone takes a deep breath and a calm look at what is being proposed, and thinks again.

Stan Soloway is president of the Professional Services Council. His e-mail is soloway@pscouncil.org.

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