Idle Facilities and the Federal Acquisition Regulation Cost Principles

HOST: KURT SMITH: Hi everyone and welcome to Cherry Bekaert’s GovCon podcast, where we discuss current government contracting trends, compliance matters, and best practices to guide federal contractors forward. My name is Kurt Smith, and I am a manager in Cherry Bekaert’s Government Contractor Services Group.

With me today is Brendan Halloran, also a member of Cherry Bekaert’s Government Contractor Services Group. Brendan is a senior manager in the group and a former Divisional Administrative Contracting Officer with the DCMA.

He was with the DCMA for 10 years, and today we are taking a look at idle facilities. Generally speaking, these idle facilities can take various forms.

For example, when I was with the DCAA, I audited a shipyard manufacturing facility. Idle facilities in that context meant there was a dry dock available for the overhaul of a destroyer or naval ship, but the Navy had not awarded a contract for an overhaul.

Consequently, that facility sits idle. There is some incentive for the government to keep manufacturing facilities of national concern—like those building destroyers, aircraft carriers, or submarines—as part of the defense industrial base.

It is very important for the government to keep those yards occupied with ongoing contracts. Another more topical type of idle facility involves Class A office space, which has suddenly become an issue due to the pandemic.

With the onset of COVID-19, everyone in both the private and public sectors was basically made to work from home. There is now an issue across the country where Class A office space is sitting unused.

Management has generally become more comfortable with employees working from home, trusting that the quality of work is the same as if the employee were in the office. This has become widely accepted.

In most cases, there is no impetus or need for employees to report to the office. This creates an issue with idle facilities, as contractors may have taken out five- to ten-year leases on space that was fully occupied prior to the pandemic.

Currently, that space may only be 25% occupied, leaving contractors in a position of paying for unused space. We should first take a look at the cost principles, as I want to get your perspective on this, Brendan.

I will bring up the appropriate cost principle, which is FAR 31.205-17. There is a time frame of one year referenced in that cost principle.

Idle capacity means the unused capacity of partially used facilities. Under FAR 31.205-17(b)(2), the government is basically willing to give contractors a year to find other uses for that space or to reduce the associated costs.

As we discussed earlier, the current environment for subleasing space is far more difficult today. Because there is so much unused Class A space, there are not many people seeking new leases.

If a contractor finds themselves in this situation, Brendan, what would be your initial response?

BRENDAN HALLORAN: Thanks, Kurt. This has always been a topic of debate between contractors and the government.

In the COVID-19 environment, the situation has greatly changed occupancy levels and the perceived need for employees to be at a physical workspace. There are a number of areas to consider.

I want to drill down into the distinction between idle facilities and idle capacity. An idle facility would theoretically be completely unused, with no employees regularly reporting and no operations occurring.

Idle capacity is a bit more vague, as it refers to a portion of a facility used at a reduced level. For example, if only 20% of a 100-person capacity is being used, there is more room for interpretation.

At what point should a contractor think about reducing its footprint or consolidating employees to another building or facility? In this day and age, that could also include moving to remote work.

If you are subject to a government review or audit, the prescribed approach is a reasonable amount of time, usually not to exceed one year. Contractors really do need to be aware of this and plan accordingly.

I believe that everyone, including the government, is in a similar situation with the shift to remote work and uncertainty regarding when or if they will return to an office environment.

Contractors would be best served by planning and evaluating their facility footprint, usage, and outlook. By being proactive, you demonstrate that you are aware of the situation and acknowledge the unused capacity or idle facility.

You should document your plans and options for that space. If you have an idle facility, you should consider if there is a future contract need or if there was an original program requirement for that space.

Documenting and demonstrating that you have met those points is important to support your case. You need to show that the space was originally required and what the forward-looking need is.

If there is no future need, you must document the actions you are taking to dispose of the space. This could include subletting or looking for options to terminate the lease and the costs associated with that.

If there is a question or finding in an audit, you must have justification for what you were actively doing to address it. This supports the costs for that one-year period.

In some cases, contractors run into situations where they cannot dispose of that space within a year. There are many factors and actions that need to be considered to demonstrate your position to the government.

HOST: KURT SMITH: In my experience on the audit side, I found it refreshing that the government is often open to negotiation. For example, you mentioned the government may be willing to pay for lease termination costs.

Your comments about documenting efforts to sublease, finding other uses, or winning follow-up contracts all come into play. These factors influence the government's decision to pay a claim beyond that one-year parameter.

While that year is a basic rule of thumb, it is not necessarily written in stone if you can justify the costs beyond that period. Is that right?

BRENDAN HALLORAN: I have certainly seen circumstances like that. From an audit perspective, the one-year mark will usually be the cutoff in my experience.

Anything in excess of a year would likely end up as a questioned cost or audit finding. However, certain circumstances might contribute to a contracting officer’s consideration of costs beyond that year.

We look at what the initial requirements were and if there were special requirements for that space. This could be something unique about the building, such as specific access or security requirements associated with a contract.

If those factors drove the initial contract requirement, they should be documented as part of the support case. It explains why it may not be easy to find a way to sublet or why there is not a high demand for that unique space.

These details can be proposed to the government to support consideration of reasonableness. You want to make every effort not to exceed that general rule of thumb, but being proactive about the lease and the original need can support further consideration.

HOST: KURT SMITH: As GovCon professionals, we are constantly on the lookout for the release of guidance regarding these issues. Have you seen any guidance released by the government?

The government itself is likely struggling with the same issue, so they are certainly aware of it. I am sure contractors have already complained to contracting officers across the country.

BRENDAN HALLORAN: I haven't seen any firm guidance at this point. I have talked with several people to see if there is active discussion in regulatory or audit agencies, but there is nothing firm yet.

I think everyone, including the government and contractors, is in the same boat. It is uncertain what the environment needs to be and when things might go back to the "normal" occupancy seen pre-COVID.

Because of that uncertainty, we don’t know when that one-year clock would start from an audit perspective. That is why it is good for contractors to be thinking about planning now.

Consider what a realistic occupancy looks like and if there are benefits to consolidating or disposing of some space.

HOST: KURT SMITH: I think you mentioned that in forward pricing proposals, the idea of consolidating space is being brought up.

BRENDAN HALLORAN: It is a good point. Contractors who have identified that a certain part of their workforce will be remote or use "hoteling" can reduce their footprint.

They may have the ability to move employees or operations to other existing facilities. There are certainly benefits to that in terms of reduced costs associated with facilities.

In forward pricing rates, budgets, and forecasts, there is an opportunity for contractors to consider these changes for next year and beyond. This can affect their rates and potentially provide a competitive advantage.

Contractors should be aware of these strategies while evaluating the resources and facilities they actually need.

HOST: KURT SMITH: One other thing you mentioned is that during the onset of the pandemic, some contractor employees were not allowed to report to work at all. In my mind, that would justify extending that one-year parameter.

BRENDAN HALLORAN: That is a good point, Kurt. That is likely why there hasn't been a firm directive or guidance on when audits will begin looking at this.

It would be very hard to have audit findings associated with facilities right now because, outside of very select operations, the entire contractor base has been in the same situation.

There would have to be consideration given to timing and when it is reasonable to look at the costs associated with these facilities. It is currently an unknown, but it will eventually be picked up again.

Contractors being prepared with a plan is the best course of action.

HOST: KURT SMITH: I agree that it is a wait-and-see situation. In a few months, the picture could look very different.

Maybe we can revisit this topic and introduce someone from our real estate group to comment. I am sure their landlord clients are seeing these changes effect their businesses as well.

I want to thank you for your time today, Brendan. Your comments have been very informative.

If you have any questions, please email us. You can find this and future podcasts on our website at cbh.com.