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Hi,

Wondering how to process a wage escalation REA for a CPIF contract before actual costs have incurred. When issuing the option we incorporated a new CBA WD. We were going to wait to process the REA to adjust Target Cost based on actuals but management wanted us to adjust the cost based on estimated cost.

As long as the new CBA rates result in an allowable cost, why would we base an REA on estimated cost vs. actual cost when adjusting the Target Cost?

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dkubis, I am assuming that you are referring to estimated cost of performance vs. actual cost of performance, not estimated vs. actual labor RATES.

I would think that you want to establish the target prior to performance or as early as possible, so that other factors related to performance are not affecting or clouding the objective of adjusting the TARGET cost due to a change in labor rates..

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As long as the new CBA rates result in an allowable cost, why would we base an REA on estimated cost vs. actual cost when adjusting the Target Cost?

If you set the Target Cost to the actual costs being incurred, what makes this a CPIF contract and not a CPFF contract? You set the target cost in advance, which is used as the baseline to measure the actual costs against.

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If you don't adjust the target cost, you will likely penalize the contractor because the incentive fee is based on performance against the target cost.

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I'm thinking I dont want to overcompensate the contractor for performance not incurred. I don't want hours not used to be calculated at the higher rate.

An REA is to make the contractor whole again, not to put them in a better position than they were. The contractor does not suffer until the end of the year because their target cost should be adjusted to actual costs incurred due to the rate increase. During the year they're covered because they're paid allowable cost.

What I was thinking of doing was raising the estimated cost based on the increased wages and estimated performance and have the contractor submit an REA at the end of the year to adjust target cost to account for actual hours affected by the CBA WD.

That seems most fair.

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Where is the incentive in this? The purpose of an incentive fee is to encourage the contractor to get the job done cheaper by allowing the contractor to earn a higher fee by cutting cost. How does your proposal accomplish that?

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have the contractor submit an REA at the end of the year to adjust target cost to account for actual hours affected by the CBA WD.

Adjusting the Target Cost to account for actuals performed is not an incentive contract. You're essentially adjusting the target cost to reflect the actual cost. What is the incentive in that? You're making this a CPFF contract by adjusting the target cost to reflect the actual cost.

A CPIF contract is supposed to be used to incentivize the contractor to perform at levels lower than the expected cost. That way they can earn a higher fee. You need to adjust the target cost before the costs are incurred, not after they've already been incurred.

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FAR 22.1006, Solicitation provisions and contract clauses, calls for a price adjustment clause to be used in fixed-price, T&M and LH contracts only, so why are we discussing application of price adjustments to cost-reimbursement contracts? Wouldn't it take a FAR deviation to include such a clause in a cost-reimbursement contract?

When offerors come up with their target cost, aren't they supposed to make allowance for any expected increases in labor rates (as opposed to in fixed price contracts subject to SCA in which they must warrant "that the prices in this contract do not include any allowance for any contingency to cover increased costs for which adjustment is provided under" the price adjustment clause)? With the government assuming the risk of increased labor rates, by agreeing to pay for the contractor's actual reasonable costs, why would one agree to a price adjustment?

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The contractor can make allowances for expected increases but not for SCA WDs or CBA WDs. Those are hard to predict. However, when a new WD comes out it should not be tied to fee. They should just be compensated for the increased wages. They should not be in a worse or better position than before the wage increase.

The REA for CBA rate increases should be tied to actual costs performing the change IAW DFARS 252.243-7002 Requests for Equitable Adjustment.

You cannot compensate the contractor for higher rates due to a new CBA for performance never accomplished.

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I don't understand where you are coming from. DFARS 252.243-7002 does not require that the equitable adjustment be based on actual costs incurred. All it requires is a good faith belief in what the cost of the equitable adjustment will be. Also, by adjusting the target cost, you are not compensating the contractor for costs never incurred. The contractor only receives its allowable incurred cost. If the incurred costs are below the target cost, the contractor is not paid the difference.

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The contractor can make allowances for expected increases but not for SCA WDs or CBA WDs. Those are hard to predict. However, when a new WD comes out it should not be tied to fee. They should just be compensated for the increased wages. They should not be in a worse or better position than before the wage increase.

The REA for CBA rate increases should be tied to actual costs performing the change IAW DFARS 252.243-7002 Requests for Equitable Adjustment.

You cannot compensate the contractor for higher rates due to a new CBA for performance never accomplished.

I think your reliance on DFARS 252.243-7002 is misplaced. I don't see where it says anything about whether the adjustment should be prospective or retrospective, but to me there's an implication that it should be prospective. Otherwise, how do you interpret this language from paragraph (a) of the clause?

"The request shall not include any costs that already have been reimbursed or that have been separately claimed."

And I disagree with you that increases for SCA WDs or CBA WDs are any harder to predict than any other future event that contractors have to estimate all the time. Particularly with CBA WDs, the contractor is partly in control, since it's a party to the negotiation of the CBA.

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dkubis, how would the Limitation of Cost or Limitation of Funds clause, whichever is relevant, be applied in your situation? Also, how do you interpret "target cost" as that term is defined in FAR 52.216-10? Finally, do you interpret 52.216-10(d) to only permit equitable adjustments after final costs have been determined?

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Retreadfed, limitation of cost/funds would not apply unless running out of value or funding in which case the estimated cost might have to be increased. Target cost as defined in FAR 52.216-10. I interpret 52.216-10(d) to allow for equitable adjustments as needed.

Let me try to shed more light on the situation. CBA WD incorporated when option exercised. The WD has no affect on LOE, contractor efficiencies, nor fee.

Let's say no WD went into effect and the contractor underan the contract by $1M with a 60/40 split share ratio, 60% to the government, 40% to the contractor. Contractor made an additional $400K in fee for his efficiencies and underrunning the contract.

Let's say the CBA WD goes into effect and an REA submitted within the first 30 days. You are only able to make a best guess estimate on target cost so early in the beginning of the option year. In this scenario, let's say the contractor underrun the contract by A) $1.5M B) $1M or C)$500K. Which amount would be most fair in this situation? If you select A, what did the CBA do that was so spectacular to underrun the contract by so much more? How could it have? That means they were given more credit for their underrun because the LOE was worth a lot more at the higher rate. If you select C, that means the contractor gets screwed because they're punished even more for each hour they spend on the contract. The only fair answer is B, at the same 60/40 split giving the contractor an addition $400K in fee.

The equitable adjustment should neither put the contractor in a worse nor better position than before. It's only to make the contractor "whole" again. That is why it should not be considered until after the actual costs come in so you can calculate your adjusted final fee. From month 1-12 the contractor isn't out anything and does not experience any "harm" because actual costs are being paid. Month 13 is a different story when AFF is being calculated. With the increased rates from the CBA, it could look like the contractor overran the contract and thus suffers on final fee. That is why the target cost is adjusted after the REA is submitted.

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Guest Vern Edwards

The contractor is entitled to an adjustment to the target cost. It is not reasonable to demand that the contractor predict the outcome of CBA negotiations and what the Department of Labor will do in issuing a new wage determination and include a contingency in its proposed target cost. In fact, such a contingency would probably be inappropriate pursuant to FAR 31.205-7( c)(2).

Since the agency awarded a CPIF contract subject to the Service Contract Act, the CO should have included a special clause stating how the target cost would be adjusted for new wage determinations. If the CO did not do that, then the agency is going to have to work something out with the contractor. It could be done prospectively based on an estimate or retroactively based on an audit.

The agency cannot increase the minimum wages and fringes without compensating the contractor, and it cannot just impose an adjustment of its choosing. I would not call it an equitable adjustment. I would call it simply an adjustment. Equitable adjustment is a term of art that includes an adjustment to fee, and the target. minimum, and maximum fees should not be increased in this case for what I hope are obvious reasons. The adjustment should be limited to the effect of the new wage determination on wages and fringes.

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Vern,

I'm concerned with adjusting the TC prospectively since the TC is tied to fee through the incentive and share ratio. If TC is underestimated the contractor will receive an increased fee, if it's overestimated they'll receive a reduced incentive fee. The CBA WD should not have any influence on fee at all. The contractor should receive the same fee at the end of the year no matter if there was a CBA change or not.

Or, am I missing something?

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The contractor is entitled to an adjustment to the target cost. It is not reasonable to demand that the contractor predict the outcome of CBA negotiations and what the Department of Labor will do in issuing a new wage determination and include a contingency in its proposed target cost. In fact, such a contingency would probably be inappropriate pursuant to FAR 31.205-7( c)(2).

How is predicting the outome of labor negotiations or estimating the impact of new WDs substantively different from predicting labor rate increases as a result of inflation, and including increased costs to cover that contingency? Why wouldn't this contingency fall under FAR 31.205-7( c)(1)? If the FAR Council considered a price adjustment in this situation to be appropriate, don't you think the FAR would include CPIF contracts in the prescription for the price adjustment clause?

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Regardless of method used or not used to adjust the target cost, I recommend that dkubis check to see if the Contractor had already considered wage escalation in its price for the option

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Delete - accidental duplication.

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Guest Vern Edwards

How is predicting the outome of labor negotiations or estimating the impact of new WDs substantively different from predicting labor rate increases as a result of inflation, and including increased costs to cover that contingency? Why wouldn't this contingency fall under FAR 31.205-7( c)(1)? If the FAR Council considered a price adjustment in this situation to be appropriate, don't you think the FAR would include CPIF contracts in the prescription for the price adjustment clause?

The examples used in FAR 31.205-7( c)(1) are costs of rejects and defective work. In many if not most manufacturing processes those are highly predictable and largely under the control of the contractor. Whether inflation and legislation-driven fringe benefits are as predictable will depend on many factors, but on the whole I would say that they are not (entirely) under the contractor's control and are less predictable than rejects and defective work. Of course, you and I can disagree on that, and it appears that we do.

As for what the FAR councils may or may not have considered, I have no idea and don't care. This problem is not significant under CPFF contracts, and it simply may be that no one expected CPIF contracts to be used for the kind of work to which the Service Contract Act applies. What I know is that If the government is going to force the contractor to increase its costs, the contractor should not lose fee because of that. The cost incentive could have no effect on such costs, since they are imposed by the government. To me, it is unreasonable to expect that the contractor could have predicted the increase "so precisely as to provide equitable results."

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Guest Vern Edwards

Vern,

I'm concerned with adjusting the TC prospectively since the TC is tied to fee through the incentive and share ratio. If TC is underestimated the contractor will receive an increased fee, if it's overestimated they'll receive a reduced incentive fee.

Then do it retroactively.

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Let's go back to a fundamental question. dkubis, can you tell us what, if any, FAR clause is being relied upon as granting the contractor a right to an equitable adjustment in this circumstance?

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Guest Vern Edwards

In Federal Electric Corp., ASBCA 9476, 65-1 BCA para. 4747, the Armed Services board dealt with a case in which a Canadian wage determination increased the wage rates under a CPIF contract and there was no adjustment clause. The board held that the contractor was entitled to have the fee payable calculated without including the cost of the wage adjustment in the total allowable cost. The board said (I apologize for the long quote):

The parties thus entered into a contract under which the provisions for appellant's compensation over and above its expenses were ‘designed to provide an incentive for maximum effort on the part of the contractor to manage the contract effectively’. (ASPR 3–405.4(a)). Moreover, they must have considered that they had agreed on ‘a high maximum fee’ for they provided as a corresponding minimum fee ‘a ‘negative’ fee', which the Armed Services Procurement Regulation considers a ‘rare’ case. (ASPR 3.405.4(B). In arriving at the figures embodying this scheme, the parties used the cost figures embodied in appellant's price proposal and agreed that on the basis of this cost (some $17,000,000) a fee of just over $1,000,000, subject to the adjustment described above in general terms, was the proper compensation for appellant's managerial effort, barring spectacular success manifested by additional savings or dismal failure demonstrated by expenses far in excess of estimated target cost.

The Board concludes, therefore, that the parties, in entering into the instant, contract, did not intend that the target fee and the calculation of the fee actually payable to appellant should be affected by the action of the Canadian Department of Labour in approving wage rates other than those set forth in the contract. In the Board's opinion, it is the meaning and intent of the contract that the amount of any wage increase (or in theory: decrease) in wage costs resulting from Canadian approval action in regard to the proposed wage rates, should not lead to any adjustment whatever either in target cost or target fee and should be treated independently.

The instant dispute is thus to be resolved, not by adjusting the contract price equitably because of any change, as defined in the contract provisions, or because the Government has failed to meet any of its contractual obligations, but by effectuating the true contractual intent of the parties as implied from the terms of their agreement.

It is a well-established rule that contracts are to be given the meaning intended by the parties and that the principal apparent purpose of the contract must be given great weight in determining its meaning. Randolph Engineering Company, ASBCA No. 4872, 58–2 BCA par. 2053; Patterson, The Interpretation and Construction of Contracts, 64 COL, L. REV. 833, 854 (1964). Applying this rule of contract interpretation to the facts of the instant dispute, it is clear that the parties intended that appellant's compensation should be reduced below the target fee only as cost increases were within its general managerial control or risk. The wage cost increase which was here imposed on appellant by Canadian governmental action at the threshold of performance, was not such an increase. Accordingly, appellant is entitled to computation of its incentive fee under the contract without downward adjustment because of the Canadian wage determination. On the other hand, it is similarly not entitled to any increase in target fee or target cost because of this event.

In my opinion, the contractor in dkubis' case is entitled to the same. The parties should agree that at the end, the fee payable will be calculated without including the increased costs due to the wage determination in the total allowable cost for fee calculation purposes only. That should be an easy solution.

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