This article was published in the November 2017 issue of AGC Law in Brief (Volume 3, Issue 6), Practical Construction Law & Risk Issues. It is reprinted here with permission.
Firm fixed-price contracts seem like a simple concept in practice — agreements that do not allow for the modification of the contract price after award without an express agreement between the parties. But in reality, there is very little case law guiding the practical approach to these types of contracts. Further, public entities have attempted to use audit provisions to capture contractor profits in fixed-price contracts. Some audit provisions imply that any savings discovered in an audit of a fixed-price contract should be returned to the owner. Therefore, a close examination of any audit provision in a fixed-price contract is necessary to prevent a public entity from attempting to claw back profits made on the contract.
This article examines, in brief, the definition of fixed-price contracts and cases in which the audit provision in the contract has been unsuccessfully used to assert claims for reimbursement and False Claims Act liability.
Fixed-Price Contracts — Defined
Fixed-price contracts are one of two primary types of contracts: (1) fixed-price and (2) cost-type contracts. Fixed-price contracts generally provide for a price that is not dependent on the costs incurred by contractors during performance, although some fixed-price contracts allow for price adjustments based on cost performance in relation to a target cost agreed on by the parties.
Subpart 16.2 of the Federal Acquisition Regulation (FAR) recognizes five types of fixed-price contracts: (1) firm fixed-price; (2) fixed-price with economic price adjustment; (3) fixed-price with price redetermination (both prospective and retroactive); (4) fixed-price level-of-effort; and (5) fixed-price incentive. Focusing on firm fixed-price contracts, the FAR states that “[a] firm-fixed-price contract provides for a price that is not subject to any adjustment on the basis of the contractor’s cost experience in performing the contract.” 48 C.F.R. § 16.202-1 (2012). “This contract type places upon the contractor maximum risk and full responsibility for all costs and resulting profit or loss.” Id.
Courts have interpreted the FAR to preclude adjustment or reimbursement for the value of fixed-price contracts. See Info. Sys. & Networks Corp. v. United States, 64 Fed. Cl. 599, 606 (2005). Indeed, the court in Information Systems held that the government “bore the risk of the adequacy of [the contract] price and that it was ‘fair and reasonable’ in light of all the known costs, whether they be ‘allowable’ or not.” Id. at 607.
Courts have also recognized the risk-shifting mechanism of fixed-price contracts. “Unlike the cost-reimbursement type contract in which the government bears the burden of all allowable costs, the burden is shifted entirely to the contractor in a fixed-price contract, and the government bears only the risk of over-estimating project costs (and therefore agreeing to pay an unnecessarily large fixed-price).” Id. at 606. “In a fixed price contract, if the final total costs of the agreed upon services exceed the contracted price, the contractor takes the loss; conversely, he can profit if the costs are lower than the contract price.” S & B/BIBB Hines PB 3 Joint Venture v. Progress Energy Florida, Inc., 365 F. App’x 202, 203 (11th Cir. 2010) (internal citations and quotations omitted). “A firm-fixed-price contract provides for a price that is not subject to any adjustment on the basis of the contractor’s cost experience in performing the contract. This contract type places upon the contractor maximum risk and full responsibility for all costs and resulting profit or loss.” Prime v. Post, Buckley, Schuh & Jernigan, Inc., No. 6:10-CV-1950-ORL-36, 2013 WL 4506357, at 9 (M.D. Fla. Aug. 23, 2013).
Auditing the Fixed-Price Contract
Public entities have attempted to use audit provisions to circumvent the fixed-price terms in contracts. Some have gone so far as to use the False Claims Act to claw back money when those audits demonstrate that the contractor performed the work well under the fixed-price amount. Empire Blue Cross & Blue Shield v. United States, 26 Cl. Ct. 1393, 1395-1396 (Cl. Ct. 1992), aff’d, 5 F.3d 1506 (Fed. Cir. 1993), provides an illustrative example of the government’s use of an audit of a fixed-price contract.
In Empire Blue Cross, the U.S. Claims Court held that a government contractor, Empire, was not liable to reimburse the government for increasing profits through the use of lower-cost labor. There, the contractor entered into a fixed-price contract with the government to serve as a Medicare intermediary for New York state. During the negotiations of the contract, the government requested Empire provide a “Certificate of Current Cost or Pricing Data” in support of its proposed contract price. “Included in the data . . . was a summary of expected administrative costs which listed, among other information, an estimated average manpower requirement of 433 employees to perform the contract work.” Id. at 1395.
During the contract’s initial term, there were 23 amendments to the scope of work, 11 of which involved price increases. The 11 price adjustments included $1,277,575 for increased costs of labor for such work. However, a subsequent audit revealed that Empire’s labor costs actually decreased because it reduced its staffing levels from an original 337 employees to 302 employees. This was well short of the 433 employees listed in the estimated costs section of the contract and the Certificate of Current Cost or Pricing Data.
Nevertheless, the court found that Empire’s “accomplishment of the work with fewer personnel than initially thought necessary becomes a circumstance that inures exclusively to Empire’s benefit.” Id. at 1396. “Savings in estimated costs realized by a contractor during performance of the base contract work give the Government no reprieve from the obligation to pay more for extra work.” Id. Accordingly, the court held that Empire was entitled to reap the benefits of performing its work at a lower cost and was not required to repay the government for the increased labor costs under the adjustments to its scope of work.
United States ex rel. Wilkins v. North American Construction Corp, 173 F. Supp. 2d 601 (S.D. Tex. 2001), provides another example of the government’s inability to claw back funds under a fixed-price contract. The court held that a contractor, under a fixed-price contract with the government, has no False Claims Act liability for allegedly “padding” its fixed-price proposal with extraneous cost items within its fixed price.
In Wilkins, the Army Corps of Engineers (the Corps) awarded a fixed-price contract to North American Construction Corporation (NACC) for the construction of a groundwater treatment facility. The Corps subsequently filed a False Claims Act action against NACC and its sub-subcontractor, ECE, after discovering the work agreed to in the fixed price included items that were supposed to be unit priced. The Corps argued that it “reasonably assumed that the fixed price it agreed to pay for drilling the wells did not include any costs for waste removal because the price for waste removal was separately classified” — “if it had known that the total contract price of $1,295,000 for drilling and waste management included $280,000 in costs for waste removal, it would not have agreed to pay ECE that total price” of $1,295,000. Id. at 609.
The contractors countered that, “by bidding and approving a fixed price contract, the government chose not to impose an obligation to disclose the cost basis of the fixed price bid or contract.” Id. Ultimately, the court held that, by agreeing to accept the fixed-price bid, the Corps could not protest that the fixed price should have been lower, stating, “However, the mere fact that an activity may be accomplished less expensively in a fixed-price contract falls measurably short of fraud under the False Claims Act.” Id. at 635 (internal citations omitted).
For now, it appears the courts have little appetite to change fixed-price contracts to allow public entities the ability to recover or share in profits received by contractors. But, as noted, audit provisions in contracts can be written to allow potential recovery if evidence of overpricing is discovered, and thus must be examined carefully.
