On November 4, 2016, the US Department of Defense (DoD) will publish a final rule that amends the Federal Acquisition Regulation Supplement (DFARS) to effectively render independent research and development (IR&D) costs unallowable on DoD contracts unless contractors comply with certain reporting and oversight requirements. While intended to "improve the effectiveness of IR&D investments by the defense industrial base, the final rule, by requiring contractors to engage in technical interchanges with DoD before costs are generated," appears to send the DoD down a slippery slope of curtailing the "independent" nature of contractor IR&D. Contractors should be aware of this change when establishing and/or assessing the financial viability of an IR&D project.
Historically, DoD policy has been to create "conditions that allow DoD contractors the freedom to determine the focus of their IR&D programs and especially the freedom to exploit fruitful avenues of research that, in their judgments, may provide the greatest benefits." See Dept. of Def., Directive No. 2304.1, Independent Research and Development (IR&D) and Bid and Proposal (B&P) Program (May 10, 1999) (emphasis added). Additionally, 10 U.S.C. §2372, Independent Research and Development and Bid and Proposal Costs; Payments to Contractors, requires that any regulations governing the payment of expenses incurred by contractors for IR&D "may not include provisions that would infringe on the independence of a contractor to choose which technologies to pursue in its independent research and development program."
Nevertheless, beginning in fiscal year 2017, this final rule requires that for IR&D costs to be allowable costs on DoD contracts, major contractors must: (1) report annually to the Defense Technical Information Center (DTIC), with a copy to the cognizant administrative contracting officer and the Defense Contract Audit Agency (DCAA), summary information regarding ongoing and completed IR&D projects; and (2) communicate proposed IR&D efforts to appropriate DoD personnel by means of a "technical interchange" before any proposed new IR&D costs are generated. These changes apply to every major contractor, meaning those whose covered segments allocated more than $11 million in IR&D and bid and proposal costs to covered contracts during the preceding fiscal year.
While the DTIC reporting requirements have existed for several years, the stated intent of the technical interchange requirement is to ensure that both contractors and DoD have sufficient awareness of each other's efforts and to provide industry with feedback on the relevance of proposed IR&D efforts. It is unclear, however, what purpose such awareness or feedback ultimately serves, if the IR&D projects are "independent" and the rule "does not contain a requirement for DoD to approve a contractor's IR&D efforts." Moreover, while the DoD may not "approve" IR&D projects, the rule appears to create a mechanism whereby DoD, as the gatekeeper of the technical interchange process, effectively controls the allowability of the IR&D costs.
Despite strong industry criticism, the final rule also remains devoid of certain basic information, such as what constitutes a technical interchange (email? whitepaper? in-person presentation?), who is an appropriate "technical or operational DOD Government employee," and even details on how far in advance these interchanges must be scheduled. It also remains unclear how the DoD intends to protect contractors' competition-sensitive research and development project information disclosed during these technical interchanges, given the revolving door between government and industry.
In order to manage the administrative burdens the final rule imposes and ensure IR&D cost allowability, contractors should take several immediate steps: (1) identify the DoD employees authorized to conduct technical interchanges (or in the absence of readily available DoD employees, the Office of the Assistant Secretary of Defense for Research and Engineering); (2) engage the appropriate DoD employees on what constitutes a sufficient technical interchange and discuss any potential scheduling issues; (3) assess the financial viability of their IR&D projects by recognizing that this rule provides new grounds for audit attacks, which increases the financial risk associated with IR&D costs; and (4) take steps to protect any proprietary information that may be discussed during these technical interchanges, including the use of nondisclosure agreements.
The final rule's new, and unrefined, obligations are likely to result in increased administration costs for contractors and also appear rife with cost-allowability landmines. As a result, the rule seems destined to stifle contractor creativity and reduce contractor incentives to engage in new, independent research and development efforts.
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