Regulatory Notes: Cost and Pricing Data for Noncommercial Modifcations to Commercial Items

On June 8, 2005, the Department of Defense, General Services Administration, and National Aeronautics and Space Administration issued an interim rule implementing Section 818 of Public Law 108-375, the Ronald Reagan National Defense Authorization Act for FY 2005 ("Act"). Section 818 amends 10 U.S.C. § 2306a, which provides exceptions to the requirements for the submission of cost and pricing data, one of which is an exception for "commercial items." Section 818 explains that the commercial items exception does not apply to noncommercial modifications to a commercial item that are expected to cost, in the aggregate, more than $500,000 or more than 5 percent of the total price of the contract. These changes are reflected in revisions to Federal Acquisition Regulation ("FAR") Part 15.403-1(c)(3), which outlines the "commercial item" exception to the requirement that contractors submit "cost and pricing" data under certain circumstances.

One of the more burdensome aspects of contracting with the government is complying with various regulatory and statutory requirements. One of the more onerous of these requirements, the requirement to submit "cost and pricing" data, arises when contracting by negotiation under FAR Part 15. The requirement to submit cost and pricing data comes from the Truth in Negotiations Act ("TINA"). If the contract price for a negotiated contract exceeds $550,000, unless otherwise exempt from this requirement, the contractor is required to submit cost and pricing data before the government may award such contract or modification. A contractor is further required to "certify" that this data is "accurate, complete and current" as of the date the price negotiations were concluded or when the price agreement was reached. If it is determined later that this cost and pricing data was "defective," the government may reduce the price by the amount the price was increased by the defective pricing.

Cost and pricing data is defined under TINA as "all facts that, as of the date of agreement on the price of a contract (or the price of a contract modification)… a prudent buyer or seller would reasonably expect to affect price negotiations significantly." This information includes all of the cost information (e.g., overhead, general and administrative costs) that is combined in order to develop the final price. The government will also include certain audit rights by contract that will allow government auditors access to the contractor’s accounting records and all of the cost elements that are used to develop a particular price. Through these audits, the government will determine whether the cost and pricing data are accurate or defective. The term "defective cost or pricing data" is defined under TINA as "cost or pricing data which, as of the date of agreement on the price of the contract (or another date agreed upon between the parties), were inaccurate, incomplete, or non-current."

There are four exceptions to the requirement to submit cost and pricing data. These exceptions are:

• When prices are based on adequate price competition.

• When prices are set by law or regulation.

• When acquiring a commercial item (or modifying a commercial item contract or subcontract).

• When a waiver has been granted by the head of the contracting activity (usually only granted in exceptional cases).

Commercial items, as defined at FAR Part 2.101, includes both supplies and services of a type customarily sold in the commercial marketplace that is customarily used by the general public for non-governmental purposes. The fundamental premise underlying the commercial item exemption from the submission of cost and pricing data is that the government acts as any other actor when it enters the commercial marketplace. While the government may command large-scale discounts based on volume, there is no incentive for commercial companies to sell to the government if they are required to disclose all of the costs elements to the government. This does not mean, however, that a contractor selling a commercial item may arbitrarily propose a price and that the government must then accept that price because it is a "commercial item." To ensure that the price the government is paying for commercial items is "fair and reasonable," commercial item solicitations require the submission of "other than cost and pricing data," such as catalog pricing.

When linked together, the commercial item exemption and the requirement for the submission of other than cost and pricing data make inherent sense. Using an example from the information technology marketplace illustrates these concepts clearly. For example, there is no reason for the government to request the submission of cost and pricing data for commercial-off-theshelf computer software or even for computer hardware. On the other hand, it is entirely reasonable for the government to review the contractor’s catalog pricing to ensure it is getting the best deal possible. In fact, in some types of government contracts, the government includes a price reduction mechanism that requires the contractor to monitor its sales to a defined class of commercial customers, and to provide discounts in the event this defined class receives a better price than the one offered to the government.

The language in Section 818 was inserted into the Act in part because of concerns surrounding the Air Force’s 2002 contract to lease 100 Boeing KC-767A aerial-refueling tankers. This lease agreement was structured as a commercial items transaction, but following an investigation into the particulars of the contract, the Department of Defense Office of Inspector General ("DOD-IG") found that the Air Force used "inappropriate procurement strategy and demonstrated neither best business practices nor prudent acquisition strategy to provide sufficient accountability for the expenditure of $[omitted in report] billion for the KC-767A tanker program." DOD-IG Report No. D-2004-064, March 29, 2004 at i. The DOD-IG also explained that the KC-767A program as a whole did not meet the statutory definition of a commercial item, and that using this strategy did not provide the Air Force with the information required to make multi-billion dollar decisions.

As explained in the Senate Report to the Act, less than one-third of the contract amount was directed toward the acquisition of the basic, commercial item 767 aircraft, with the remaining value of the contract allocated for development costs, non-commercial modifications, logistic support, training, and lease costs. As a result, the Air Force did not have the access to the necessary cost and pricing data to determine whether Boeing’s price to the government was fair and reasonable.

The changes to FAR 15-403-1(c)(3) do not modify the existing exemption from the requirement to submit cost and pricing data for commercial items that meet the statutory definition contained within FAR Part 2.101. The intent of Section 818 and the revisions to FAR 15-403- 1(c)(3) appear to prevent the acquisition of clearly non-commercial, custom development items using the commercial items exception with substantial post-acquisition non-commercial modifications. Provided any non-commercial modifications do not exceed the $500,000 or 5 percent of the contract price, there is no need to submit cost and pricing data for these modifications.

This article is presented for informational purposes only and is not intended to constitute legal advice.