The "Three Musketeers" of Overhead Property: Motorola, Hughes, and Raytheon Cases
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The “Three Musketeers” of Overhead
Property: Motorola, Hughes, and
Raytheon Cases
Whether you agree or disagree with the reasoning of these cases, one outcome is clear
—government property is not a mundane or boring subject anymore.
BY J O H N B. W YAT T I I I
Dedicated to Charles Woodside, CPCM1, a true musketeer of the contract management profession.
In the realm of federal government contract they stay the course in their continual quest
law and management, especially in the legal to obtain justice and aid the oppressed.3 By
representation of government contractors, we analogy, in the realm of contract management
have many exciting issues that are frequently and government property, there are three state
litigated. Such “exciting litigious issues” from court cases that arguably resemble Dumas’s
a contractor’s perspective normally include three fictional characters. Our three heroes in
submitting claims for constructive changes this contract management saga are three state
and equitable adjustments, defending against appellate court decisions namely Motorola4
defective pricing allegations under the “Truth in (from Arizona), Hughes5 (California), and
Negotiations Act” (TINA), and of course, defending Raytheon6 (Texas).
against the occasional termination for default.2 These three decisions challenge the state and
Most contractor or government contract local taxation authorities’ assertion that overhead
management professionals would not include (also referred to as indirect cost) property is
in the previous “excitement litigation list” property not owned by the federal government.7
anything involving government property. The result has been that our “Three Musketeers
Government property is generally regarded as a
mundane boring subject that is rarely involved
About the Author
in litigation. However, due to some interesting
arguments being proffered in various state courts DR. JOHN B. WYATT III, PDCM, Fellow, is a full
involving the taxation of government property, professor and the coordinator of contract man-
the mundane has now taken center stage. agement programs at California State Polytechnic
In his classic 1844 novel, The Three University. He is a member of the NCMA Board
Musketeers, Alexandre Dumas introduces the of Advisors and also an advisor on the Contract
Management Certification and Accreditation
reader to three noble characters: Porthos,
Board. He also is vice president of education for
Aramis, and Athos. These three fictional
the NCMA San Gabriel Valley Chapter. Send
superheroes of yesteryear bravely confront the
comments on this article to cm@ncmahq.org.
notoriously tyrannical Cardinal Richelieu, as
Journal of Contract Management / Summer 2005 ■ 23T H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
of Overhead Property” have successfully asserted Court had declared years ago to be that federal
that overhead property is indeed owned by government-owned property that is immune from
the United States (hereafter, government), and taxation by any subordinate governmental entity.
thus immune from state taxation. An estimate
of the current cumulative effect of the “Three I. What Is Overhead Property?
Musketeers” decisions upon state treasuries
involved in this dispute has been projected at A. Types of Contracts, Financing Contractor
exceeding a billion dollars in lost revenue.8 The Performance, and Direct Versus Indirect
efforts of our heroes also resulted in an official Costs
declaration that the government does claim title
to overhead property by the Department of 1. Types of Contracts
Defense (DOD).9 Even with this official declaration, At issue in all three cases was contractor-furnished
however, another significant potential challenge property under both fixed-price and cost-reim-
may still arise to further frustrate the “Three bursable contracts that was reimbursed by
Musketeers.” Lurking in a dismal swamp is a the government as an indirect cost. As a quick
potential “soon-to-be-proposed” regulatory change review, in federal government procurement, the
that promises to muddy the waters of “govern- two general types of contracts are fixed-price
ment title to overhead property” once again. and cost-type (cost-reimbursable). In a fixed-price
This article examines the common arguments contract, the government will only pay the
and legal reasoning in the Motorola, Hughes, contractor a fixed price for its contract per-
and Raytheon decisions. I will also proffer the formance. This fixed price may arise from
identity of who (in the author’s opinion) is the negotiating a price in a competitive proposal
“real villain” (hint: not the state tax collectors) in procurement or from the contractor’s bid in a
our exciting saga of federal contract management. sealed bid procurement. Disregarding changes
After all, doesn’t a dispute involving over a billion or other grounds for a post-award equitable
dollars—and still growing—make it exciting?10 adjustment, that fixed price will be the ultimate
price that the contractor will receive for its
The Stage for the “Three Musketeers” performance under the contract, regardless of
The stage for the Motorola, Hughes, and Raytheon the amount of costs actually incurred by the
cases involves substantially similar facts and contractor in its performance. The contractor’s
common issues. In all three cases, a state or profit is derived from the difference between
local taxing authority sought to collect taxes the fixed price paid by the government and
on what was stipulated to be “indirect cost or contractor’s total cost in contract performance.
overhead property.”11 In Motorola, the Arizona Fixed-price contracts generally equate to the
Department of Revenue sought an assessment greatest potential risk—as well as potential
for delinquent use taxes;12 in Hughes, defense profit—for the contractor.
contractor Hughes Aircraft Company sought Conversely, in a cost-reimbursable contract,
a refund of ad valorem property taxes paid to the government will pay the contractor for
Orange County, California;13 and in Raytheon, its level of effort, meaning the contractor’s
contractor Raytheon E-Systems, Inc., sought a expenditure during contract performance of its
refund for use taxes paid to the state of Texas, as allocable, allowable, and reasonable costs, as per
well as claiming the sale-for-resale exemption.14 the FAR’s cost principles.16 Also, contractor must
Our “Three Musketeers” generally assert a comply with the applicable “Limitation of Cost”
common premise as their defense to state or clause provision.17 Contractor’s “profit,” which
local taxation. That common premise is that the actually is called a fee, is based on a number of
“indirect cost or overhead property” in question mechanisms, depending on which variation of
is not able to be taxed because it is property a cost-reimbursable contract is involved (such
owned by the United States, which the Supreme as a fixed-fee, incentive-fee, or award-fee). In
24 ■ Summer 2005 / Journal of Contract ManagementT H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
a fixed-price contract, the contractor assumes in Part 31 (in particular, the reimbursement
the risk of completion that the government will standards of FAR 31.2).21 FAR 31.2 requires
accept its deliverables. Such acceptance is a allocation of costs in accordance with the Cost
condition precedent to receiving final payment Accounting Standards (CAS), which are specifically
under the contract, as well as avoiding potential designed to mandate and achieve uniformity
liability for unliquidated progress payments. and consistency in the cost accounting practices
followed by prime contractors and subcontractors
2. Contractor Performance Financing in estimating, accumulating, and reporting costs
Although the government generally prefers a under federal procurement contracts.22
contractor to use private funds to finance its Of the 19 individual CAS provisions, CAS 418
contract performance, it nonetheless provides is principally relevant to this discussion because
methods of government financing, namely it provides for the consistent determination and
progress payments in fixed-price contracts and allocation of direct and indirect costs by federal
reimbursement of costs in cost-type contracts.18 government contractors.23 In particular, CAS 418
Under the progress payments mechanism, the permits contractors to use pre-established rates
government pays the contract price in progress for its indirect costs based on either forecasted
payments (based on predetermined milestones— or actual/standard costs, which then become the
usually work completed), based on the basis for billing the overhead property purchases
contractor’s incurred costs during performance, to the government.24 These pre-established
which again is limited to the contract price. rates are used to allocate overhead cost pools
Progress payments are not given in cost reim- to all of the contractor’s federal contracts based
bursable contracts. Remember, in a fixed-price on forecasted costs, which are subsequently
contract, the contractor assumes the risk of reviewed and adjusted by the contractor to reflect
completion with no guarantee whatsoever that its actual business activity and actual costs.
its actual costs will be recovered. In fact, if the Each overhead cost pool captures those costs
government ultimately does not accept these pertaining to a given activity, such as operating
deliverables, the contractor is liable for the supplies, perishable tools, or non-capitalized
progress payments previously advanced. furniture and office equipment. These revised
When deliverables are accepted, progress pay- rates are consequently audited and approved by
ments are ultimately repaid by the liquidation the government, with the approved rates being
process. Liquidation occurs when the government applied in the accounting periods to which
deducts the amount of progress payments they pertained.25 The result is that our “Three
allocated to the deliverables received from the Musketeers” have each allocated overhead
payment due to the contractor. The Progress purchases to their government contracts (and
Payments (PP) clause found in FAR 52.232-16 their commercial ones, too), in proportion to
is required by the FAR (when the contract permits the business activity corresponding to those
progress payments) and provides that the contracts. In accordance with the allocation of
government shall obtain title to contractor’s indirect costs between government and com-
property financed by progress payments.19 To mercial work described earlier, our “Three
date, the majority of case law interpreting the Musketeers” were then reimbursed by the
“title language” of the PP clause sides with the government for those indirect costs attributable
government’s position that it does have title and to the government.
not merely a security lien.20 The FAR clause that serves as the payment
Under cost-reimbursable contracts, during mechanism for the contractor is the “Allowable
contract performance the government pays the Costs and Payment” (ACaP) clause, at FAR
contractor for its costs as they are incurred, Part 52.216-7. The “AcaP” clause establishes
plus a pro-rata share of the negotiated fee in the methodology for the submission of the
accordance with the FAR’s cost principles found contractor’s properly allocated indirect costs so
Journal of Contract Management / Summer 2005 ■ 25T H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
as to be allowable, as well as the mechanism for Below, I have included the Hughes court’s
reimbursement of those indirect costs by the assessment of what constituted overhead
government. FAR Part 16.307(a)(1) requires the property as illustrative of all three cases.
insertion of the “AcaP” clause in every cost- In Hughes, Judge Hollenhorst aptly states in
reimbursement contract and was included in pertinent part:
each of our “Three Musketeer” government
contracts. The “ACaP” clause sets up the In the performance of its government contracts,
submission procedure for the contractor to Hughes acquired certain supplies, expensed
invoice its costs incurred, so as to receive cost equipment, and office partitions. This property
reimbursement payments for its allocable, was purchased under indirect accounts, i.e., it
allowable, and reasonable costs. As will be was not charged to a particular Hughes contract
discussed infra, the “AcaP” clause provides the and, consistent with the prescribed and appli-
“indirect costs linkage” to the “all other property” cable CAS and the FAR, was allocated among
provision of Part 52.245-5(c)(3), which is a all of Hughes’s government contracts. Property
fundamental premise in our “Three Musketeers” purchased on such indirect accounts is
argument that overhead property acquired in often referred to as “overhead” property.
cost-reimbursable contracts is property owned “Supplies” includes materials consumed in
by the government. the production process, such as welding sup-
plies, plating compounds, abrasives, brushes,
3. Direct Costs vs. Indirect Costs anodes, acids, sandpaper, and emery cloth,
The FAR Subpart 31.202 defines a “direct cost” as well as artist and drafting supplies, and
as one that is tied to only one cost objective. general office supplies. “Expensed equipment”
Indirect costs, per FAR Subpart 31.203 (a), are includes durable low-cost items of equipment
costs not directly identified with a single final purchased for general use with a life expectancy
cost objective, but are identified with two or more of less than 18 months, such as low-cost
final cost objectives or an intermediate cost laboratory and test equipment, small tools,
objective. Not at issue in our “Three Musketeers” jigs, dies, molds, patterns, taps, gauges, and
litigation is the question of whether property similar manufacturing aids, as well as drafting
acquired by the contractor as a direct cost of equipment, lamps, calculators, and blackboards.
a given contract (called contractor acquired “Partitions” consists of movable office space
property, or CAP) is government property. dividers used at Hughes’s various business
Where the disagreement has arisen (the subject locations to establish work areas for per-
of which our “Three Musketeers” have cham- formance of Hughes’s contracts. All of the
pioned over the state tax collectors) is the subject supplies, expensed equipment, and
question of whether property acquired by the partitions were accounted for by Hughes as
contractor that is reimbursed by the government overhead, i.e., as indirect cost items allocated
as an indirect cost is in fact property owned by among all of Hughes’s then pending contracts,
the government. rather than directly to particular contracts.
Pursuant to its contracts with the …[U.S.]
B. The Parties’ Factual Stipulation government, Hughes was reimbursed by the
RE: “Overhead Property” government for that portion of the supplies,
In each of our “Three Musketeer” cases, the expensed equipment and partitions used in
relevant contractor and the taxing authority the performance of the government contracts.
entered into an agreed stipulation of facts as to After completion of contract work, any
what constituted “overhead property.” Because remaining expensed equipment or partitions
these descriptions are long and potentially boring, were sold by Hughes at bid sale and the
I have listed the stipulated factual descriptions proceeds credited back to the government.27
for Motorola and Raytheon in the endnotes.26 (Emphasis added)
26 ■ Summer 2005 / Journal of Contract ManagementT H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
The common items of “overhead property” creating a single governmentwide homogenous
in all three cases are supplies and expensed procurement regulation. OFPP’s goal was to create
(non-capitalized) equipment, much of which, a “Bible” of federal procurement that would be
depending on the case, was consumed during well organized, relatively easy to understand,
contract performance.28 As Judge Patterson in and still be able to fulfill the essential mission of
the Raytheon decision concluded: “Raytheon providing regulatory guidance and instruction to
was obligated by contract to consume the government procurement personnel and govern-
overhead items in the course of performing ment contractors. OFPP’s goals were arguably
the government contracts, and the stipulation well met when the FAR went into effect in 1984.
of facts stated that Raytheon did consume the By design, the FAR’s various provisions are
overhead items in the course of performing the interconnected and meant to be read together.
contracts.”29 A common format is used throughout the FAR,
As noted above, the Hughes case includes which reaffirms the premise just mentioned. The
some expensed equipment and partitions which FAR is organized into parts, subparts, sections,
were not consumed during contract perfor- subsections, paragraphs, and subparagraphs.
mance but which were sold at bid sale after The numbering system is designed to permit the
completion of the contract work with the pro- discrete identification of every FAR provision.
ceeds credited back to the government. The number to the left of the decimal point
represents the “part” number. The first number
II. Common Reasoning in “The Three to the right of the decimal point represents the
Musketeers” Decisions Declaring “subpart.” The second and third digits to the
That Overhead Property Is Owned by right of the decimal identify the “section.” The
the United States number to the right of the hyphen is the “sub-
section.” Any notations that are in parentheses
A. Cost-Reimbursable Contracts and follow the section or subsection number
The most important legal determination in all the represent “paragraph” and “subparagraph”
“Three Musketeer” cases is that the government numbers. For example, a citation to FAR
has title to overhead property. To understand §44.201-1(d)(1) refers to FAR Part 44, Subpart
the legal reasoning supporting that premise 2, Section 01, Subsection 1, Paragraph d, and
relating to cost reimbursable contracts, one Subparagraph 1.
must understand the origin and history of the Of particular importance in reaffirming the
FAR, as well as employ one of the fundamental reasoning in our “Three Musketeer” cases,
rules of interpreting its regulatory provisions. is FAR Subpart 52.2. Subpart 52.2 contains
specific clauses that are required or can be
1. History and Fundamental Rule of incorporated into federal procurement contracts.
Interpretation of the Federal Acquisition For example, FAR §45.106(f) requires §52.245-5
Regulation to be incorporated into every cost-reimbursement
Prior to the FAR’s enactment, three principal contract. The next two digits after 52.2 correspond
regulations governed federal procurement: the to the FAR subject part in which the provision
Defense Acquisition Regulations (DAR), the or clause is prescribed. The FAR clause number
Federal Procurement Regulation (FPR), and a is then completed by a hyphen and a sequential
NASA procurement regulation. These regulations number assigned within each section of Subpart
proved to be unworkable. Not only was the size 52.2. Any notations that are in parentheses
of each regulation unmanageable, the regulations after the clause number represent paragraph
lacked uniformity and often conflicted with each and subparagraph numbers of that clause.
other. Because of this, Congress commissioned For example, FAR 52.245-5(c)(3) refers to
the Office of Federal Procurement Policy (OFPP) “FAR 52.2” (the reserved Subpart for all clauses),
to create uniformity in federal procurement by “45” (keyed to subject matter—namely “Part
Journal of Contract Management / Summer 2005 ■ 27T H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
45–Government Property”); “-5” (sequential paying costs of contract performance in the
clause number within 52.245); and “(c)(3)” ordinary course of business, costs incurred,
(paragraph and subparagraph numbers within but not necessarily paid, for–
the clause). Lastly, each part begins with a “000”
provision, which defines the scope of that part. (E) Properly allocable and allowable indirect
This is followed by a definitions section, often costs, as shown in the records maintained
designated as “101,” which contains important by the contractor for purposes of obtaining
definitions to aid the reader in understanding reimbursement under government contracts.”30
the subsequent regulations of that part. (Emphasis added)
The FAR’s organizational scheme outlined
here supports the premise that provisions in Per the above, it is clear that Paragraph (b)
the FAR are meant to be interpreted as a whole, acknowledges the government’s affirmative duty
unless otherwise indicated. This rule of inter- to pay for a contractor’s allocable, allowable and
pretation was either expressly or implicitly reasonable indirect costs when submitted in
accepted and applied by the appellate courts in accordance with the ACaP clause’s procedures,
our “Three Musketeers” decisions. the FAR and the CAS. More importantly, it also
signifies that in the government’s mind that it
2. The Indirect Costs Linkage of 52.216-7 has bought something through its payment of
and 52.245-5 Declaring that Indirect Cost these properly allowable and allocable indirect
Property Arising from Cost-Reimbursable costs. As will be discussed in the next paragraph,
Contracts Is Owned by Government FAR 52.245-5 answers this question: “What has
the government bought?”
a. FAR 52.216-7 “Allowable Costs and Payment” The answer to the previous question is quite
(ACaP) Clause Reaffirms That Government is simple. The government bought the indirect
Buying “Something” cost property at issue, when it reimbursed our
“Three Musketeers” contractors through the
Previously, we discussed the “Allowable payment of their individual indirect costs
Costs and Payment” (ACaP) clause at FAR Part properly allocated and allowable under the
52.216-7. This important clause establishes the contractors’ federal government contracts. FAR
methodology for the submission of the contractor’s §52-216-7(b)(1)(ii) reaffirms this premise by
properly allocated and reasonable indirect costs stating in subsection: (E) that “Properly allo-
so as to be allowable, and thereby able to be cable and allowable indirect costs . . . [are
reimbursed by the government. reimbursable] under government contracts.”
Relevant to this discussion is the following (Emphasis added) As noted beforehand, the
language from the “ACaP” clause at 52.216-7 “Three Musketeers” were so reimbursed by the
provides: government, as reflected in the each of their
agreed-upon “Stipulation of Facts.”
(b) Reimbursing costs. (1) For the purpose of Section 52.216-7(h) further reinforces the
reimbursing allowable costs . . . the term government’s intent (the nexus) to take title
costs includes only— under §52.245-5(c)(3) to indirect cost property
that it has purchased through reimbursement of
(i) Those recorded costs that, at the time of the indirect costs as follows:
request for reimbursement, the contractor
has paid by cash, check, or other form of (h) Final payment.
actual payment for items or services
purchased directly for the contract; (2) The contractor shall pay to the government
any refunds, rebates, credits, or other amounts
(ii) When the contractor is not delinquent in (including interest, if any) accruing to or
28 ■ Summer 2005 / Journal of Contract ManagementT H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
received by the contractor or any assignee (ii) Commencement of processing of the
under this contract, to the extent that those property for use in contract performance; or
amounts are properly allocable to costs for
which the contractor has been reimbursed (iii) Reimbursement of the cost of the property
by the government.” by the government, whichever occurs first.
The above proposition is reflected in the (4) All government-furnished property and all
portrayal of the facts in the Hughes stipulation property acquired by the contractor, title
supra. As stated therein, upon completion of the to which vests in the government under
contracts, Hughes did credit to the government this paragraph (collectively referred to as
the proceeds obtained from the bid sale of any “government property”), are subject to the
remaining expensed equipment or partitions. provisions of this clause. Title to government
property shall not be affected by its incor-
b. FAR 52.245-5, “Government Property poration into or attachment to any property
(Cost-Reimbursement, Time-and-Material, not owned by the government, nor shall gov-
or Labor-Hour Contracts) Clause Provides ernment property become a fixture or lose its
Answer That “Something” the Government identity as personal property by being attached
Bought Is Overhead Property to any real property.” (Emphasis added)
As stated above, FAR 52.245-5 answers the Section 52.245-5(c) discusses title passage of
question under the “ACaP” clause of “what is three types of property, such as (1) government-
the “something” that the government thinks it furnished property; (2) property the contractor
has bought?” The “something” that the govern- purchases for which he is entitled to be reim-
ment has in fact bought is overhead property. bursed as a direct item of cost (CAP); and (3)
FAR 45.106(f) requires the incorporation of title to all other property, the cost of which is
§52.245-5 in all cost-reimbursement contracts reimbursable to the contractor, such as indirect
and in relevant part, Section 52.245-5(c) states cost items (emphasis added). There are only two
as follows: kinds of costs under the FAR cost principles—
direct and indirect. Government-furnished
(c) Title. property is not reimbursable to the contractor
for the obvious reason that the contractor has
(1) The government shall retain title to all not incurred any costs in obtaining that property.
government-furnished property. Equally as obvious is the fact that property a
contractor purchases for which it is entitled
(2) Title to all property purchased by the con- to reimbursement as a direct item of cost is
tractor for which the contractor is entitled direct cost property. What, then, does the third
to be reimbursed as a direct item of cost category of property refer to? Clearly, the third
under this contract shall pass to and vest in category of property, “all other property, the
the government upon the vendor’s delivery cost of which is reimbursable to the contractor,”
of such property. refers to indirect cost property.
(3) Title to all other property, the cost of which B. Fixed-Price Contracts With Progress
is reimbursable to the contractor, shall pass Payments
to and vest in the government upon– The fixed-price contracts at issue in our ‘Three
Musketeer” decisions all contained the “Progress
(i) Issuance of the property for use in contract Payments” clause. The PP clause, at FAR Section
performance; 52-232-16(d) (which is incorporated into all
fixed-price contracts with progress payments by
Journal of Contract Management / Summer 2005 ■ 29T H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
§32.502-4(a)) provides as follows: III. The Excalibur and the Villain with the
“Wandering Eye”
(d) Title. (1) Title to the property described in With all due respect to Dumas, our “Three
this paragraph (d) shall vest in the government. Musketeers” saga will now take a different twist
Vestiture shall be immediately upon the date of than what was portrayed in the original novel.
this contract, for property acquired or produced In our saga, the “Three Musketeers” have pulled
before that date. Otherwise, vestiture shall from the “stone of confusion” (regarding the
occur when the property is or should have been issue of whether the government intended to
allocable or properly chargeable to this contract. take title to overhead property) the magnificent
(2) “Property,” as used in this clause, includes sword, Excalibur. The “Excalibur” is the affidavit
all of the below-described items acquired or of Carol Covey, deputy director of cost, pricing,
produced by the contractor that are or should and financing for the director of procurement in
be allocable or properly chargeable to this the Office of the Under Secretary of Defense for
contract under sound and generally accepted Acquisition, Technology, and Logistics.32
accounting principles and practices: This affidavit is extremely important because
it completely undercut previously rendered
(i) Parts, materials, inventories, and criticisms directed against “Three Musketeer”
work-in-process; decisions,33 by unequivocally stating that the
government takes title to the overhead property
(ii) Special tooling and special test equipment both in cost-reimbursement contracts and
to which the government is to acquire title fixed-price contracts with progress payments.
under any other clause of this contract; This affidavit also provides official governmental
acknowledgment and adoption of the logic and
(iii) Non-durable (i.e., non-capital) tools, jigs, reasoning of the “Three Musketeers” decisions.34
dies, fixtures, molds, patterns, taps, gauges, The Covey affidavit was admitted into evidence
test equipment, and other similar manu- and became part of the record in the Raytheon
facturing aids, title to which would not be trial court decision and was repeatedly referenced
obtained as special tooling under subpara- by the court in the Raytheon appellate decision.
graph (2) above; and
A. Excalibur: The Covey Affidavit
(iv) Drawings and technical data, to the extent The significance of the Covey affidavit is that the
the contractor or subcontractors are required DOD has now formally stated the government’s
to deliver them to the government by other position and intent as a matter of published
clauses of this contract.” (Emphasis added) public policy that it takes title to overhead
property, in accordance with the reasoning of
Using either plain meaning or a simple the “Three Musketeers” decisions. Carol Covey
match-up of words (see the areas emphasized was designated under Part 97 of Title 32 of the
above in the PP clause), it is obvious that the Code of Federal Regulations to state the official
overhead property described in the various position of DOD in a duly sworn affidavit relevant
Stipulations of Fact falls squarely within its pur- to the taking of title in overhead property. Because
view. Judge Hollencost concurred with this view this document is so important, I am quoting
in the Hughes decision by stating: “[l]ooking at relevant pertinent parts in the text of this article
the above language, Hughes’s overhead property rather than in the endnotes. I have italicized, for
clearly falls within the categories of property emphasis, certain portions so as to aid the reader.
contemplated.”31 (Emphasis added) Covey, under oath, by affidavit, states as follows:
5. I am familiar with this case [Raytheon]
as I have been advised by counsel for the
30 ■ Summer 2005 / Journal of Contract ManagementT H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
Department of Defense of the nature of the described in the clause vests in the government
issues the parties have raised….I have been immediately upon award of the contract for
designated to state the official position of the property acquired or produced before the
Department of Defense on the issues raised… date of award. For all other property described
in the clause, title vests when the property is
6. The statements in this affidavit are based on or should have been allocable or properly
my personal knowledge and experience as chargeable to the defense contract. Upon
an official of the DOD, my expert opinions completion of all obligations under the
concerning matters within the sphere of my contract, the government is deemed to have
professional responsibilities and information received all property in which it was vested
provided to me in my official capacity.” title. This property was (i) delivered to an
accepted by the government under the defense
11. The current policy of the Department of contract; (ii) incorporated in items delivered
Defense regarding title passage to the to and accepted by the government under
government includes the following: the defense contract; or (iii) consumed in
the performance of the defense contract.
a. The passage of title under defense contracts Indirectly charged property is normally
is addressed in part by FAR 52.232-16(d) considered to be consumed during the year
for Fixed-Priced Contracts with Progress in which it was charged to the contract.
Payments, FAR 52.245-2(c) for fixed-price
contracts in general, and FAR 52.245-5(c) for f. FAR 52.245-2(c) applies to direct material, when
Cost-Reimbursement Contracts. the defense contract directs the contractor
to purchase material and provides that the
b. The title vesting provisions of three FAR government will reimburse the contractor for
clauses are intended to protect the government’s that material as a direct item of cost under the
interest in government-furnished property defense contract. If the contractor purchases
and in contractor purchased property. The that material from a vendor, title vests in the
government has a title interest in all property, government upon the vendor’s delivery of such
the cost of which is allocated or properly property to the defense contractor. Otherwise,
chargeable to the contract. title vests in the government on the earliest
occurrence of (i) issuance of the material for
c. The title vesting provisions of these three use in contract performance; (ii) commence-
FAR clauses allow the government to acquire ment of processing the material or using it in
title to all property directly charged to the contract performance; or (iii) reimbursement
contract and to the allocable share of all of the cost of the material by the government.
property indirectly charged to the contract.
g. Under FAR 52.245-5(c), if the contractor is
d. These three FAR clauses do not specifically entitled to be reimbursed for property purchased
designate each type of property for which from a vendor as a direct item of cost under
title passes to the government or each type the defense contract, title to that property
of property for which title remains with the vests in the government upon the vendor’s
defense contractor. The determination of the delivery of that property to the defense con-
title passage rests on whether the property tractor. The second type of property identified
is directly charged to the contract or on in FAR 52.245-5(c) includes property that is
whether an allocable share of the property is charged indirectly to the contract, such as
indirectly charged to the contract. when the cost of the property is included in
an overhead rate applicable to performance
e. Under FAR 52.232-16(d), title to property of the contract. Title to an indirect cost item
Journal of Contract Management / Summer 2005 ■ 31T H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
of property passes to the government on the eye” of these councils?
earliest of the following three events: the
property is (i) issued by the contractor for 1. FAR Case 2004-025: Mega-Government
use under the contract, or (ii) processed or Property Clause
used by the contractor in performing the con- Relevant to this article, FAR Case 2004-025
tract; or (iii) reimbursed by the government sets up a new all-inclusive “Mega-Government
as an item of cost to the contractor. Indirect Property” clause. This new Mega-Government
property is deemed to be issued, processed, Property clause would replace all of the current
or used during the year in which it is prop- contract specific clauses (such as the cost-reim-
erly allocated or charged to the contract. The bursement government property clause) as it
government is vested with title to all reim- proposes to: “[c]ombine the requirements of
bursable property under FAR 52.245-5(c). FAR Subpart 45.5 and the [following] clauses:
(Emphasis added) 52.245-1, Property Records; 52.245-2 Government
Property (Fixed-Price Contracts); 52.245-4,
In a nutshell, the Covey affidavit, as a mat- Government-Furnished Property [Short Form];
ter of DOD published policy, clearly establishes and 52.245-5, Government Property (Cost-
that it is the government’s intent to take title Reimbursement, Time-and-Material, or Labor-Hour
to overhead property (property that is charged Contracts) into a single contract clause.36
indirectly to the contract) in cost-reimburse-
ment contracts under FAR 52.245-c and in This new Mega-Government Property clause
fixed-price contracts with progress payments may prove to be the “Three Musketeers” most
under FAR 52.232-16(d). And, it would appear formidable opponent. The clause (relevant to
to put to rest any arguments critical of the the question of the government acquiring title
“Three Musketeer” decisions. But are the to overhead property) would read as follows:
“Three Musketeers” now done with their quest?
Far from it—now they must face the real villain. (e) Title to Government Property Acquired by
the Contractor
B. The Villain with the “Wandering Eye”
Unfortunately for our heroes, some in the (1) Title to all property purchased by the
government appear not to be content with the contractor, for which the contractor is
20/20 vision of Covey in her public declarations entitled to be reimbursed as a direct item of
of DOD policy that the government claims title cost (see the “Allowable Cost and Payment”
to overhead property. Like a “wandering eye,” clause of this contract), under this contract,
the Civilian Agency Acquisition Council shall pass to and vest in the government upon:
(CAA Council) and the Defense Acquisitions
Regulations Council (DAR Council) are looking (i) a vendor’s or supplier’s delivery of such
beyond the Covey affidavit. These councils are property to the contractor;
now considering a new “Title to Government
Property Acquired by the Contractor” clause (ii) issuance of the property for use in contract
in FAR Case 2004-025 (which should be pub- performance, including installation of parts
lished in the Federal Register for comment very through normal maintenance;
soon),35 which negates the government taking
title to overhead property in regard to cost- (iii) commencement of processing of the
reimbursement contracts. property for use in contract performance; or
The question now is what is the U.S. focus,
relevant to the question of its intent to claim (iv) reimbursement by the government for the
title to overhead cost items? Will it be the 20/20 cost of the property, whichever occurs first.
vision of the Covey affidavit or the “wandering
32 ■ Summer 2005 / Journal of Contract ManagementT H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
(2) Paragraph (e)(1) of this clause shall not By referencing the FAR 52.216-7 “Allowable Cost
apply to property purchased by the contrac- and Payment” clause right after the words “direct
tor for performance of fixed-price contracts item of cost,” it arguably attempts to eliminate
or fixed-price line items. an indirect cost linkage between the new Mega-
(Emphasis added, ibid at 21) Government Property and the “AcaP” clauses.
Stated another way, the intent of the new
2. Potential Ramifications of FAR Case 2004-025 Mega-Government Property clause is that its
and “Mega-Government Property” Clause sole linkage with the “ACaPs” clause would only
involve property acquired as a direct cost item.
a. Eliminates the Indirect Cost Linkage Between In a nutshell, under cost-reimbursement con-
FAR 52.216-7 and FAR 52.245-5 tracts, by this new wording, the government
This Mega-Government Property clause directly would not be able to take title to indirect cost
conflicts with the DOD policy affidavit of Carol items. It completely conflicts with the Covey
Covey, that the government wants and obtains affidavit’s declaration that DOD policy is to
title to overhead property in cost-reimbursement acquire title to contractor acquired indirect cost
contracts. Its potential language (as I have items under cost-reimbursement contracts.
emphasized in italics), would, in two ways, Interestingly enough, the wandering eye of
destroy the “indirect costs linkage” between the these councils has limited vision. The Mega-
current FAR 52.245-5(c)(3) and FAR 52.216-7 Government Property clause does not address
(b)(ii)(E) (see discussion supra at Section III A 2). FAR 52.232-16(d) and the question of the gov-
First, this clause eliminates the current ernment obtaining title to indirect cost property
“Government Property” (Cost-Reimbursement, in fixed-price contracts with progress payments.
Time-and-Material, or Labor-Hour Contracts) Therefore, it this Mega-Government Property
clause currently found at FAR 52.245-5. As per clause should be enacted, the Covey affidavit’s
my previous discussion, the wording, “title to all pronouncements relevant to progress payments
other property” (in current FAR 52.245-5(c)(3)), indirect cost property would still remain intact.37
played a key role in our “Three Musketeer”
decisions because that language answered the b. A Call to Arms
question of what the “something” was that A word to the wise for those who, like myself,
government had in fact bought under the are advocates of the proposition that the “Three
“Allowable Cost and Payment” clause” (ACaP) Musketeer” cases were correctly decided and
at FAR 52.216-7. reflect the government’s intent (as Carol Covey
The nexus between these two clauses (FAR so aptly stated) that it does acquire title to over-
52.245-5(c)(3) and FAR 52.216-7(b)(ii)(E)) is head property. We must be diligent in providing
the “indirect costs linkage,” which is critical to sufficient quality and quantity of comments
the determination that the government takes title that convince the CAA and DAR Councils of the
to overhead cost property in cost reimbursement potential error of their ways in proposing the
contracts. Stated another way, the new Mega- Mega-Government Property clause. It boggles
Government Property clause destroys that nexus my mind to understand why these councils in
(the “indirect costs” linkage) by killing off one this rule change would ignore the Covey affida-
of the two linking clauses—namely FAR 52.245-5. vit with no reference or any explanation made.
Simply, there cannot be a nexus or linkage if Almost by stealth, it attempts to partially negate
one of the two linking clauses is missing. (if this rule is proposed) a previously issued
Second, the proposed Mega-Government public policy declaration by a designated agent
Property clause (again, it would take the place of the DOD.38 And, they do this while declaring in
of current FAR 52.245-5) specifically limits the a section of FAR Case 2004-025, “Supplementary
government to obtaining title only when the Information” (in pertinent part) that
property is acquired as a direct item of cost.
Journal of Contract Management / Summer 2005 ■ 33T H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
The primary objectives of this rule are to com- plating a retreat from the clear pronouncement of
prehensively address the operative principles of the Covey affidavit? Inquiring minds want to know.
property management; assure consistency with In summary, whether you agree or disagree
the government’s other regulatory and/or policy with the reasoning of the Three Musketeer deci-
requirements;…[and]…eliminate obsolete and/or sions, one outcome of those cases is abundantly
conflicting requirements… (Emphasis added, at 5) clear. Government property is not a mundane
or boring subject anymore. JCM
I must question whose “policy” these councils
are attempting to “assure consistency with,” Endnotes
and “what conflicting requirements” they are
1. This article is dedicated with deep gratitude to
attempting to eliminate—certainly not the Charles “Chuck” Woodside for his selfless, lauda-
Covey affidavit. If anything, this soon-to-be- tory efforts in NCMA leadership and particularly
proposed Mega-Government Property clause in in promoting contract management education
the rule will potentially create major conflict and certification. My students and I thank you.
because it fails to negate the Covey affidavit’s 2. 10 U.S.C. § 2306 (a), et seq. (2005); 41 U.S.C. §
statement of policy that the government takes 254(b) (2005).
title to overhead property acquired in fixed-price 3. In Dumas’s novel, the musketeers are united in
contracts with progress payments, while order to defend the honor of Anne of Austria
clearly negating that policy in regards to cost- (The Queen of France) against the evil schemes of
reimbursable contracts. the notorious Cardinal Richelieu.
The plain meaning is that if this rule change 4. Motorola, Inc. v. Ariz. Dept of Revenue, 993 P. 2d
(with the Mega-Government Property clause) 1101 (Ariz. 1999).
is enacted, there will be one rule for fixed-price 5. Hughes Aircraft Co. v. County of Orange, 117 Cal.
contracts with progress payments (government Rptr. 2d 601 (Cal. Ct. App. 2002).
title to overhead property) and another rule for 6. Strayhorn v. Raytheon E-Systems, Inc., 101 S.W.
cost-reimbursement contracts (no government 3d 558 (Tex. App. 2003).
title to overhead property). Furthermore, this 7. The Three Musketeer cases of Motorola, Hughes,
proposed rule has the potential to re-ignite the and Raytheon do not stand alone. The reasoning
fires of those believing (despite the Covey affidavit) in two other previous cases likewise supports
that the government never really intended to the proposition that the federal government
take title to overhead property in the first place.39 has title to overhead cost property. McDonnell
Douglas Corp. v. Dir. of Revenue, 945 S.W.2d
437 (Mo. 1997); Aerospace Corp. v. State Bd. of
IV. Conclusion Equalization, 267 Cal. Rptr. 685 (Cal. Ct. App.
As early as 1999, Professors Nash and Cibinic 1990). Contra TRW Space & Def. Sector v. County
called for an indication from the government of Los Angeles, 58 Cal. Rptr. 2d 602 (Cal. Ct. App.
that it intended to obtain title to all items the 1996). (The author plans to address the various
costs of which are included in indirect expense shortcomings and erroneous conclusions reached
by the TRW court in a future article.)
(overhead property) allocated to its contracts.40
It took the government until February 2002 to 8. In “Postscript III: Title to Overhead Items,”
issue the Covey affidavit, which unequivocally 18 N&CR ¶56 (2004), Ralph C. Nash and John
Cibinic, professors emeriti of law of the George
provided that indication. Now, this affidavit and
Washington University, have characterized the
the clarity of governmental intent that it has overall common reasoning as well as the impact
provided is threatened by FAR Case 2004-025— of the “Three Musketeers” decisions as follows:
at least as it pertains to title to overhead cost “[s]o far, this curious and strained interpretation
property under cost-reimbursement contracts. of these clauses has cost the states over $1 billion
Nash and I agree that this appears to be a in revenue, and the amount will continue to
classic example of “government property double grow.”
speak.”41 Why is the government now contem- 9. See infra note 33.
34 ■ Summer 2005 / Journal of Contract ManagementT H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
10. See supra note 9. 12. Motorola, Inc., 993 P.2d 1101.
11. The types of property at issue in Motorola, 13. Hughes Aircraft Co., 117 Cal. Rptr. 2d 601.
Hughes, and Raytheon are arguably substantially 14. Raytheon E-Systems, Inc., 101 S.W. 3d 558.
similar. In Motorola, the court recognized that
15. See United States v. New Mexico, 455 U.S 720
Generally, [Motorola’s] overhead and IRAD [indepen-
(1982).
dent research and development] purchases include,
but are not limited to, indirect costs such as parts 16. See FAR pt. 31, 48 C.F.R. pt. 31 (2005).
(e.g., batteries, resistors and transistors), materials 17. See FAR 52.232-20, “Limitation of Cost.”
(e.g., metal, plastic) and inventories which are con-
18. See FAR 32.104(a); see also FAR 52.232-23 (In
sumed in operations and are not incorporated into
this provision, “Assignment of Claims,” the
a final product delivered to a customer; equipment
government expressly encourages banks and
and materials (e.g., test tubes, chemicals) used in
other financial institutions to fund contractor
Motorola’s laboratories; low value plant equipment
performance by providing that the right to pay-
(e.g., timers, meters, amplifiers), the cost of which is
ment can be assigned by the contractor to such
not capitalized; perishable tools (e.g., hammers, drills,
institutions.) For a discussion of the public policy
screwdrivers, maintenance and repair supplies); office
reasons underlying the Assignment of Claims
equipment (e.g., typewriter stands, card files), the cost
clause and the Assignment of Claims Act of 1940;
of which is not capitalized; and office supplies (e.g.
see also Continental Bank v. United States, 189
,stationery, printed forms, paper clips). [Motorola’s]
Ct. Cl. 99 (1969).
overhead purchases also include items such as glue,
solvents, nuts, bolts and screws, which may be incor- 19. 48 C.F.R. § 45.106(f)(1); see especially, FAR 52.232-
porated into a final product… [Motorola’s] overhead 16(d).
and IRAD purchases also include employee retirement, 20. See In re American Pouch Foods Inc., 769 F.2d
recognition, incentive and birthday awards, pins, and 1190 (7th Cir. 1985), cert denied, 475 U.S. 1082
plaques, including cakes and refreshments served (1986); United States v. Lindberg Corp., 882 F.2d
at the occasions where these items are presented. 1158 (7th Cir. 1989); In re Double H Products,
(Motorola, Inc., 993 P.2d at 1103-04) 462 F.2d 52 (3rd Cir. 1972); In re American Boiler
In Raytheon, the Stipulation of Facts of the parties Works, 220 F.2d 319 (3rd Cir. 1955); In re West
provided that Elec.,Inc., 128 B.R. 905 (Bankr. D. N.J. 1991); In re
Windham Power Lifts, Inc., 91 B.R. 598 (Bankr.
Raytheon allocated all of its indirect costs to one or
M.D. Ala. 1988); In re Wincom Corp., 76 B.R. 1
more [indirect] cost pools, based on the type of costs
(Bankr. D. Mass. 1987); In re Reynolds Mfg. Co.,
involved. Each pool captures those costs related to a
68 B.R. 219 (Bankr. W.D. Pa. 1986); In re Econ.
particular activity, such as operating supplies, perish-
Cab and Tool Col, Inc., 47 B.R. 708 (Bankr. D.
able tools or non-capitalized furniture and office
Minn. 1985). But see Marine Midland Bank v.
equipment. Raytheon allocated indirect costs relating
United States, 231 Ct. Cl. 496 (1982), cert denied ,
to overhead supplies and materials, including IR&D
460 U.S. 1037 (1983).
purchases, to one or more pools when it received
the materials and supplies. These cost pools are then 21. See 48 C.F.R. § 31.00 and particularly FAR
allocated on a pro rata basis among all the contracts 31.103(b)(1)–(2), which require the incorporation
on which Raytheon was working. Raytheon further of FAR’s cost principles in Subpart 31.2 to ascer-
allocated the costs collected in the overhead pools to tain allocable, allowable, and reasonable costs so
specific contracts on a pro rata basis. as to be reimbursable.
Stipulation of Facts ¶ 39 Raytheon E-Systems, Inc. v. 22. See Donald P. Arnavas, Government Contract
Carole Keeton Rylander, Comptroller of Public Guidebook, 4th edition (2004), pp. 9-28.
Accounts of the State of Texas, and John Cornyn, 23. 48 C.F.R. §§ 9904, 401-420.
Attorney General of the State of Texas, No.
24. 48 C.F.R. § 9904.418–50(g); see Raytheon
GN-101511 (Dist. Ct. Travis Cty., Tex. 2002)[here-
Stipulation of Facts, supra note 12, at ¶¶ 34–35.
inafter Raytheon Stipulation of Facts]. Author
expresses special thanks to Raytheon counsel 25. Ibid.. at ¶ 35, 39.
Doug Sigel, Esq., of Scott, Douglass & McConnico, 26. See supra note 12.
L.L.P., Austin, TX, who provided a copy of
27. Hughes Aircraft Co., 117 Cal. Rptr 2d at 603.
the Stipulation of Facts as well as the Covey
Affidavit. See, Covey Affidavit, infra note 33. 28. See Covey Affidavit, infra note 33. (Carol Covey
Journal of Contract Management / Summer 2005 ■ 35T H E “ T H R E E M U S K E T E E R S ” O F O V E R H E A D P R O P E R T Y
notes that “[i]ndirectly charged property is nor- items may be used by personnel whose time is
mally considered to be consumed during the year charged directly because their effort involves
in which it was charged to the contract.”). Ibid., only a single cost objective or by those whose
at 3. time is charged indirectly because they are
performing functions benefiting two or more
29. Raytheon E-Systems, Inc., 101 S.W. 3d at 566. The
cost objectives. However, it is not the effort of
word “consume” both as used in the Raytheon
the user that determines whether the items
opinion and in the Raytheon Stipulation of Facts
are classified as indirect costs. Nor is it the fact
has been strictly scrutinized. See “Postscript II:
that the full cost of the item can be charged
Title to Overhead Items,” 17 N&CR ¶57 (2003),
off in the year of purchase as opposed to being
where Professor Emeritus John Cibinic notes:
capitalized and charged through depreciation.
• Consumables—In one reference, the court The item is charged indirectly only because is
appears to have been referring to direct considered to benefit two or more cost objec-
cost items that had been charged to indirect tives. FAR 31.203(a). Vesting title to “overhead
expense when it stated: [The contractor] was items “ that are not used up or exhausted dur-
obligated by contract to consume the over- ing performance to the purchasers of goods
head items in the course of performing the and services is wrong headed (Emphasis added,
government contracts, and the stipulation of at 167)
facts stated that [the contractor] did consume
30. FAR 52.217-7 (2005).
the overhead items in the course of perform-
ing the contracts. In another similar reference, 31. Hughes Aircraft Co., 117 Cal. Rptr 2d at 609.
the court stated: An agreed stipulation of fact 32. Affidavit of Carol Covey, Strayhorn v. Raytheon
stated that all of the overhead items charged E-Systems, Inc., 101 S.W. 3d 558 (Tex. App.
to the federal contracts “were consumed by 2003) (No. 03-02-00346-CV) [hereinafter Covey
[the contractor] in performing its government Affidavit].
contracts and government subcontracts and not
incorporated into any final product delivered to 33. See infra notes 9 and 12.
the federal government.” (Emphasis added) 34. Covey Affidavit, supra note 33, at 3.
This brings another question of interpretation. What 35. Source is a telephone message left on May
is meant by the term “consume?” We interpret 5, 2005, by the author for Jerry Zafos, GSA
it to mean use up or exhaust, not merely to Acquisition Policy. The case manager is Jeritta
make use of. If it is the former, and the item Parnell, at 202/501-4082. A draft of FAR Case
is exhausted, we have no problem with the 2004-025 can be found online at www.acq.osd.
Government taking title to the item. If that is all mil/dpap/UID/FARCASE2004-025.pdf.
that the advocates for title to overhead items
36. Ibid., at 3.
meant, we have no disagreement with them.
The item would satisfy the definition of direct 37. The author can surmise why this is the case. FAR
costs. The only justification for including such an Case 2004-025 is a proposed rewrite of FAR Part
item of direct cost in overhead would be that it 45. Progress payments inventory is not govern-
is of minor dollar amount. Such treatment for ment property within the purview of FAR Part
“reasons of practicality” is permitted under FAR 45. See FAR 45.000 where by express language it
31.202(b). Otherwise the cost must be charged excludes from the application of that part “prop-
directly. FAR 31.202(a). We presume that the erty to which the government has acquired a
contractor’s accounting system complied with lien or title solely because of partial, advance, or
these basic requirements. Thus, the cost should progress payments . . . .” FAR 45.000 (2005).
not be such a substantial sum to warrant the 38. Professor Ralph Nash in ”Postscript III: Title to
amount of litigation that has resulted from the Overhead Items”, supra note 9, aptly recognized
views espoused by the title to overhead items this major potential inconsistency in Department
advocates. of Defense (DOD) policy by stating that FAR Case
• Nonconsumables—It is the “nonconsumables” 2004-025 “leaves DOD officials in a very strange
that make the title to overhead items posi- position. They are pushing for a clarification of
tion untenable. Indirect expense includes the the ‘Government Property’ clause at the same
cost of many such items. They range from time [that] they are telling state courts that the
the contractor’s plant and equipment to such current clauses take title to property purchased
mundane items as pens and pencils. These with overhead money.” (at 176)
36 ■ Summer 2005 / Journal of Contract ManagementYou can also read
