Defense Contractors Face Withheld Payments Over ‘Significant’ System Flaws

The Pentagon is imposing a new contract provision which calls for withholding as much as 10 percent of payments to defense companies when it finds “significant” shortcomings in any of six business systems used to track performance and cost of weapons programs or services.

The measure is intended to protect taxpayers from overbilling. It focuses on the systems that companies such as Lockheed Martin Corp. (LMT), the No. 1 defense contractor, use to estimate costs for bids, purchase goods from subcontractors or manage government property and materials.

A rule, which took effect Aug. 16, requires that all new contracts include language that spells out the potential for withholding payments due to deficiencies, such as those involving the standard “Earned Value Management” system used to determine whether companies are meeting cost and schedule goals.

As initially drafted, the Pentagon would have been empowered to withhold as much as 20 percent of billings. After industry complaints, that was cut to a 10 percent maximum in the fiscal 2011 defense policy bill.

The rule resulted from an August 2009 hearing of the congressionally mandated Commission on Wartime Contracting at which major business-system deficiencies were described within companies working in Iraq and Afghanistan.

The Defense Contract Management Agency in October decertified the Earned Value system used by Lockheed's Fort Worth, Texas aircraft unit to track costs and schedules, a Pentagon spokeswoman said. Photo: Lockheed Martin Close

The Defense Contract Management Agency in October decertified the Earned Value system... Read More

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The Defense Contract Management Agency in October decertified the Earned Value system used by Lockheed's Fort Worth, Texas aircraft unit to track costs and schedules, a Pentagon spokeswoman said. Photo: Lockheed Martin

“These changes are long overdue and reflect potential risk associated with longstanding and continuing contractor business system deficiencies,” said commission Co-Chairman Michael Thibault in an e-mail.

Impact Minimal to Substantial

The regulations impact will be “minimal” on contractors with “well-documented and effective systems,” he said. The impact will be “substantial” for contractors having deficiencies, he said.

The regulation covers all defense contracts issued after Aug. 16, including those that reimburse companies for costs, pay incentive fees for hitting cost and schedule targets, payments for progress during a specified time frame or those that base payments on time, materials or labor hours.

About 20,000 contractors under the jurisdiction of the Defense Contract Management Agency “can be subject to withholds provided the clauses are in their contracts and a determination has been made that a system is disapproved,” said agency spokeswoman Jacqueline Noble in an e-mail statement.

“System disapproval will be based upon one or more significant deficiencies defined as a ‘shortcoming’ that materially affects the ability” of U.S. officials to rely on the information for management purposes, she said.

‘Significant Deficiencies’

If withholding is warranted, the government contracting officer would stop five percent of progress payments and other performance-based disbursements while directing the contractor to withhold submitting five percent of billings on vouchers for cost, labor-hours and time and materials contracts, she said.

The combined withholds would continue under the Pentagon determined the contractor “has corrected all significant deficiencies,” she said.

Professional Services Council Executive Vice President Alan Chvotkin said in an e-mail the group’s members are seeing these clauses included in new solicitations.

“Many of the attributes for some of the business systems have been in place for some time and are already being complied with by contractors,” he said. “Many others are new and require contractors to modify their systems to come into compliance -- and those actions are under way but cannot be accomplished instantly.”

“I would not expect contractors to be held accountable for instant compliance with all of these new system requirements nor to see funds withheld under this rule,” Chvotkin said.

‘Fair and Timely’

The DCMA and Defense Contract Audit Agency continue to develop a final version of their internal audit procedures and workforce guidance to align with the new rule, he said.

The Defense Department has assured the council that “updating their guidance is a top priority and is under way but may not be finished for several months,” he said.

Thibault agreed, saying the regulation will require “fair and timely audit evaluation” to assure that unnecessary contractor expenses are not incurred.

The aeronautics unit of Bethesda, Maryland-based Lockheed Martin, which makes the F-16 and F-35 jets, has a deficient “earned value” system that makes the unit candidate for potential withholds from new contracts after Aug. 16.

The contract management agency in October decertified the Earned Value system used by the Fort Worth, Texas, aircraft unit to track costs and schedules. The company’s system was deficient in 19 of 32 areas, a Pentagon spokeswoman said at the time.

Lockheed Comments

The decertification remains in effect until the company demonstrates compliance during the next review in the first four months of 2012, Noble said.

Lockheed Martin spokesman Joe Stout said in an e-mail that “we are committed to having the best and most highly rated EV system in the industry.

“We’re now well into implementing” corrective actions that include rewriting all the processes that relate to EVMS in our media library and developing new computer-based tools for our users, in addition to extensive training of employees,” Stout said.

“We expect to be ready for a re-audit in early 2012,” Stout said. “We have not been notified of any withholding or plans for withholding.”

To contact the reporter on this story: Tony Capaccio in Washington at acapaccio@bloomberg.net.

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

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