JV partner - fee on fee issue

[shultzm]

If a Joint Venture has one of the non-controlling JV partner's division, Division A, purchase material, can Division A include fee on the material when it is quoted to the JV? Can the JV also include fee on the material? Are there any FAR / DFAR rules that would apply?

[joel hoffman]

If a Joint Venture has one of the non-controlling JV partner's division, Division A, purchase material, can Division A include fee on the material when it is quoted to the JV? Can the JV also include fee on the material? Are there any FAR / DFAR rules that would apply?

So, you are essentially saying that a member of a joint venture would purchase materials as a subcontractor to the JV entity of which it is a member, marking it up once, then essentially selling it to itself as a JV ? The JV would sell it to the government and the firm will share again in the profit. Would the pyramiding of profit by simply assigning one or more of the firms the role of a subcontractor to furnish itself with materials or services be considered unreasonable? There may be some coverage elsewhere, but see 31.205-26(e) and 52.215-23.

"(e) Allowance for all materials, supplies, and services that are sold or transferred between any divisions, subdivisions, subsidiaries, or affiliates of the contractor under a common control shall be on the basis of cost incurred in accordance with this subpart. However, allowance may be price when--

(1) It is the established practice of the transferring organization to price interorganizational transfers at other than cost for commercial work of the contractor or any division, subsidiary, or affiliate of the contractor under a common control; and

(2) The item being transferred qualifies for an exception under 15.403-1( and the contracting officer has not determined the price to be unreasonable.

(f) When a commercial item under paragraph (e) of this subsection is transferred at a price based on a catalog or market price, the contractor--

(1) Should adjust the price to reflect the quantities being acquired; and

(2) May adjust the price to reflect the actual cost of any modifications necessary because of contract requirements."

Now, if the transaction passed the first smell test, clause 52.215-23 ? Limitations on Pass-Through Charges could apply. I believe that this would preclude the JV charging fee or G&A type overhead for the material, except for the value added by the JV to the materials, if any.

I might have the wrong substantiation here but the principle to me would be not allowing a scheme for individual JV members to perform contract functions at a full markup, essentially acting as a sub to the JV, then the JV takes a full markup on the members' contributions to the contract effort.

[shultzm]

Thanks. Those were the only two regulations that I could find.

[here_2_help]

Joel,

I don't think the cost principle you cited (31.205-26(e)) would apply in this situation.

Note that the original question stated that "one of the non-controlling JV partner's division, Division A" was purchasing the material. Assuming that the description "non-controlling" was correctly applied, then Division A would NOT be considered to be an affiliate under common control. Thus, the cost principle would not be applicable.

The other rule on excessive pass-thru costs might apply; but we don't know the percentage of subcontracting by the JV and we don't know whether the solicitation and contract contained the restrictions, and we don't know whether the JV already addressed the issue in its proposal.

Hope this helps.

[joel hoffman]

Joel,

I don't think the cost principle you cited (31.205-26(e)) would apply in this situation.

Note that the original question stated that "one of the non-controlling JV partner's division, Division A" was purchasing the material. Assuming that the description "non-controlling" was correctly applied, then Division A would NOT be considered to be an affiliate under common control. Thus, the cost principle would not be applicable.

The other rule on excessive pass-thru costs might apply; but we don't know the percentage of subcontracting by the JV and we don't know whether the solicitation and contract contained the restrictions, and we don't know whether the JV already addressed the issue in its proposal.

Hope this helps.

Here, I agree that we don't know if either cost principle applies to the situation. We also don't know why or if it is necessary for one of the firms to purchase materials for this contract outside of the JV's role as the prime contractor.

[here_2_help]

Here's the thing. There is no one, right, way for a JV to operate. Some JVs are run as independent entities, with full employee populations and full direct/indirect accounting. Others are run more like co-producers, with the JV being a shell and acquiring all necessary labor and goods from subcontractors--some of which may also be JV members. And there are other possible scenarios as well--including hybrids of the foregoing two I described.

We don't know how this JV operates (though we do know that it has acquired material from a subsidiary division of a non-controlling JV member). That means that it is incumbent on the JV to explain to the cognizant CO what's going on and how the JV operates. One would think the proposal would have been the place to do that, but perhaps the solicitation didn't require this issue to be addressed, or at least not addressed to the level of detail now thought to be necessary.

I believe the lesson to be learned here is that the CO needs to know how the JV will operate. The JV should propose in a manner consistent with how it will operate--including providing a narrative regarding cost accounting and cost build-up. And then it needs to operate in a manner consistent with how it proposed (CAS 401 requires this, if nothing else).

There's an article on this site (in the analysis section) dealing with one poor JV who ran into auditors and at least one CO who didn't understand (or wouldn't accept) how it would be operating. I would recommend that article to those interested in pursuing this topic. It was also addressed to some extent, long ago, in the ABA publication "Strategic Alliances and Teaming on Government Contracts: Winning Combinations for the Next Century". (Published by ABA in 2000.)

Hope this helps.

[Guest Vern Edwards]

help:

That was an informative post. Thanks.

Vern

[joel hoffman]

help:

That was an informative post. Thanks.

Vern

I agree that it is informative.

Regardless of what the JV says it is "going to do", I believe that a JV agreement is generally valid for one contract at a time. So many practices are not the recurring, standard, consistent, customary practice - set in stone, take it or leave it. Thus, it is possible that "how the JV operates" in charging the customer for materials purchased from its members should be at least negotiable, if they don't seem to be reasonable.

I'm assuming in the case here that these aren't materials that the member firm normally produce or sell commercially. I know there are exceptions for that. For instance, many of the big construction companies have learned the trick of renting equipment from their equipment rental subsidiaries or affiliates, who also rent commercially, at the commercial rates, so they or their parent organization can legally collect twice, so to speak.

Of course, if it identified the intended practice in its proposal, as Here mentioned, then the government had the opportunity to negotiate or challenge the practice.

[Guest Vern Edwards]

I agree that it is informative.

Regardless of what the JV says it is "going to do", I believe that a JV agreement is generally valid for one contract at a time.

It ain't necessarily so. Stick to what you know.

[joel hoffman]

It ain't necessarily so. Stick to what you know.

There are joint venture agreements to pursue contracts. A joint venture as a contractor entity is generally on a contract to contract basis.

[Guest Vern Edwards]

That may be, but your statement was more general than that. In any case, a JV agreement is valid for the purposes and period for which it says it is valid. Period.

The question was: "Can the JV also include fee on the material?" here_2_help's two posts provided a good answer. You did not make the answer clearer or more accurate by going on about negotiating. People should read help's posts and ignore speculative, prognosticatory, and confusing responses that don't cast any light on the matter at hand.