The Bechtel National appeal provided the Federal Circuit with an opportunity to provide clarity to both contractors and the government on the allowability of third-party settlement costs. Unfortunately, the Federal Circuit refused to do so. Instead, its decision in Bechtel, while affirming the Tecom framework, provides little further insight when it comes to a critical question: Does every potential breach of a government contract relating to a third-party claim present risk under Tecom? The Federal Circuit chose not to answer that question.
Generally, contractor legal costs associated with third-party lawsuits are allowable if the costs are reasonable, allocable, consistent with CAS (or GAAP), are not limited by the cost principles of FAR Subpart 31.2, and comply with the terms of the contract. See FAR § 31.202-2; 31.205-47. Of course, contractor legal costs become unallowable when they fail to meet any one of these five tests. In Tecom, the Federal Circuit applied the fourth test, compliance with the terms of the contract, to address the allowability of legal defense and settlement payment costs that were incurred in connection with a Title VII sexual harassment suit. Geren v. Tecom, 566 F.3d 1037 (Fed. Cir. 2009). Pursuant to the framework established under Tecom, contractor legal defense costs associated with third-party lawsuits are unallowable if a third party’s proven claim establishes a contractor’s breach of its government contract. Additionally, contractor settlement costs associated with such a third-party proceeding (i.e., where a claim if proven would render the legal costs unallowable) will be unallowable unless the contractor can establish that the third-party claim had ‘very little likelihood of success on the merits.”
The Tecom decision left contractors to wonder whether the two-part test it announced should be construed narrowly as only applicable to Title VII sexual harassment suits that may present a breach of FAR 52.222-26, or instead, should apply more broadly to any third-party claim where there may be an alleged breach of a government contract. Additionally, the Tecom decision did not address (1) the evidentiary standard required to support a determination that a plaintiff had “very little likelihood” to succeed and (2) the circumstances where other clauses in the contract create a conflict or otherwise operate to make the legal defense and settlement costs allowable.
Last year, Dentons addressed the Court of Federal Claims (COFC) decision in Bechtel and the analysis of the Tecom standard in that case. The COFC specifically declined to endorse a broader application of Tecom beyond the circumstances presented in that case, which it found to be very similar to those in Tecom. Specifically, the COFC narrowly construed the Tecom decision as only applying to those circumstances where a third-party claim, if proven, would establish a prime contract breach in the employment discrimination context, based on the “expansive public policy” against employee discrimination. “The Court, accordingly, decline[d] to read the rationale of Tecom as applicable whenever liability costs arise out of conduct that could also constitute a breach of contract.” Bechtel Nat’l, Inc. v. United States, 137 Fed. Cl. 423, 431 (2018). The COFC acknowledged that its narrow reading may be “difficult to square” with the broad language employed in Tecom that “costs resulting from a breach of contractual obligation are not allowable under the contract.” Id. at fn 5. However, the COFC maintained that such Tecom language was dicta as opposed to the actual holding that “where a contract contains a non-discrimination clause, costs resulting from the breach of that clause are not allowable under the terms of the contract.” Id.
The Federal Circuit recently unanimously affirmed the COFC’s Bechtel 2018 decision. The Federal Circuit noted that although Tecom “recognized that the analysis for determining whether the costs are allowable could change if there was a specific provision dictating the treatment of specific costs,” in the Court’s view, the Department of Energy clause that Bechtel had relied upon was clear that costs disallowed by other provisions of the contract are unallowable (i.e. FAR 31.204 and 52.222-26). Further, the Federal Circuit concluded that the DEAR clause at issue did not override the other FAR provisions and clauses interpreted in Tecom, but merely imposed cumulative requirements on allowability. The Federal Circuit affirmed that the standard articulated in Tecom applies. Accordingly, Bechtel’s costs associated with the discrimination suits were “only allowable if Bechtel [could] show that the former employees had very little likelihood of success.” Because Bechtel abandoned its argument to the contracting officer that the plaintiffs had very little likelihood of success at the Claims Court, the costs were ruled unallowable.
Notably the Federal Circuit refused to address Bechtel’s argument that if Tecom covers the costs at issue in that case, the Tecom standard could be applied more broadly “to disallow costs associated with any and all alleged contract breaches and that such a reading would be contrary to the contract.” Because the Federal Circuit refused to address this issue, the COFC’s reading of Tecom, construing it narrowly to the employment discrimination context, can still be cited as persuasive authority on the subject. Nonetheless, the Federal Circuit’s refusal to address COFC’s narrowed construction of Tecom was a missed opportunity for the Federal Circuit. The COFC observed that a broader reading of Tecom would hinge on dicta. Certainly the Federal Circuit panel in Bechtel could have expressly validated that construction and clarified the issue for future litigants. At the same time however, the Federal Circuit left the lower court’s analysis untouched which leaves the COFC’s view on Tecom’s narrow scope the most persuasive authority on the issue.
As a practical matter, contractors are well advised to carefully assess all third-party claims under the Tecom framework and should take into account the appropriateness and risks associated with defending or settling any third-party lawsuit when an adverse final judgment would result in unallowable costs. Before entering into a settlement in connection with third-party claims, contractors should be seeking to establish, when possible, strong evidence that the plaintiff had very little likelihood of success on the merits, including the contracting agency’s concurrence with this view. Such evidence might include, for example, specific language to that effect in settlement agreements, an objective predictive outcome determination in appropriate cases, or other objective evidence that can be included in a later claim for reimbursement of the settlement costs. Finally, while the DOE clause at issue in Bechtel did not, ultimately, provide an avenue for recovery, contractors should always be attentive to their contracts and look for other clauses that may present a clearer basis for allowability.