Federal Circuit Continues to Narrow Circumstances Under Which a Contractor May Recover Legal Costs
 
August 18, 2004
 

In Rumsfeld v. General Dynamics Corporation, 365 F.3d 1380 (Fed. Cir. 2004), the United States Court of Appeals for the Federal Circuit continues to narrow the circumstances under which a contractor may recover legal costs. Specifically, the Federal Circuit held that a contractor may not apportion its defense costs between unsuccessful and successful (or settled) claims brought by the government in the one proceeding.

As background, General Dynamics incurred substantial costs in defending against government-initiated civil fraud claims based upon General Dynamics’ alleged submission of inflated and fraudulent cost estimates to the government and allegations of subcontractor kickbacks. 365 F.3d at 1382. The federal district court dismissed all of the counts against General Dynamics. Id. On appeal, the United States Court of Appeals for the Second Circuit affirmed the district court’s decision except for the dismissal of the subcontractor kickback claims, which the court reversed and remanded for further proceedings. Id. The government and General Dynamics subsequently entered into a settlement agreement in which General Dynamics agreed to pay $3.3 million to dispose of all claims in the case. Id. at 1383. The settlement agreement provided that the law suit shall be dismissed “without costs or attorney’s fees to either party,” but did not address whether the contractor’s legal defense costs were unallowable for government contract and cost accounting purposes. Id. Thus, no court found General Dynamics guilty of any wrongdoing.

General Dynamics included the costs of the fraud/anti-kickback case as overhead costs for which it sought payment by the government. 365 F.3d at 1383. The government informed General Dynamics that all of the legal expenses sought by General Dynamics were unallowable under Federal Acquisition Regulation (FAR) 31.205-47(b)(4). Id. Thereafter, General Dynamics informed the government of its belief that the costs to defend the claims, other than the anti-kickback related allegations, were allowable under FAR 31.305-47. Id. at 1384. In response, the government reiterated its decision that all of the costs incurred in the proceeding were unallowable. Id. at 1383-84. General Dynamics appealed to the Armed Services Board of Contract Appeals.

The Board agreed with General Dynamics that apportionment was permissible, stating: “Congress intended to permit recovery of legal defense costs when a contractor was successful. ... [W]e believe apportionment is required for those claims in a proceeding on which the contractor has prevailed and which do not involve the same wrongdoing as the claims compromised, unless the settlement agreement provides otherwise.” 365 F.3d at 1384.

On appeal, the Federal Circuit rejected the Board’s apportionment decision based on the terms and legislative history of 10 U.S.C. § 2324(k)(3), which was promulgated as part of the Major Fraud Act of 1988 and serves as the basis for FAR 31.205-47(c). Section 2324(k)(3) provides:

In the case of a proceeding referred to in paragraph (1) that is commenced by the United States and is resolved by consent or compromise pursuant to an agreement entered into by a contractor and the United States, the costs incurred by the contractor in connection with such proceeding that are otherwise not allowable as reimbursable costs under such paragraph may be allowed to the extent specifically provided in such agreement.

See also FAR 31.205-47(c)(1). The Federal Circuit determined that the term “proceeding” as used in the statute includes all claims or causes of action within a particular case, action or proceeding, and that Congress, by the plain terms of the statute, disallowed all costs of the proceedings (except where the settlement agreement provides otherwise). Id. at 1386. The court stated:

The language of the statute is clear: where there is a disposition of a proceeding by consent or compromise, section 2324(k) applies to make unallowable all costs associated with that proceeding unless specifically provided for in the settlement agreement. We hold that, at least in the circumstance that a settlement agreement resolves or disposes of all claims still pending in that proceeding when settlement occurs, there has been a “disposition” of that proceeding by “consent or compromise.” Because the settlement agreement between General Dynamics and the government resolved “all claims” against General Dynamics still included in the suit “without costs or attorney’s fees to either party,” section 2324(k) precludes the recovery of costs by General Dynamics.

Id. at 1387. The court concluded that any other result would amount to an improper re-writing of the statute by the court. Id.

In rejecting apportionment, the Federal Circuit also relied on the legislative history of section 2324(k). The court determined that the legislative history evidenced the intent of Congress to “curtail a contractor’s ability ... to recover legal costs for fraud proceedings, even in cases where the proceeding was resolved through settlement,” unless otherwise agreed to by the parties. Id. at 1389

In sum, based upon its reading of the Major Fraud Act and its legislative history, the Federal Circuit concluded that defense costs incurred in defending against unsuccessful claims brought by the government are tainted as unallowable if other claims brought by the government in the same proceeding are successful or settled without an express provision in the settlement agreement allowing the costs. Although the Federal Circuit was clear that in such proceedings apportionment of legal costs is not an option, the decision in Rumsfeld v. General Dynamics Corporation did not address or involve proceedings concerning claims between private parties. Indeed, the decision leaves open the question of whether a contractor in a dispute with another private party may apportion the costs of defending against successful and unsuccessful claims, and seek to recover the costs of defending against the baseless claims.

For more information, e-mail Peter McKeen at peter.mckeen@hklaw.com or call toll free, 1-888-688-8500.