March 20, 2001

Multi-Million Dollar Settlement Causes Concern

Holland & Knight Newsletter
David S. Black

A leading computer retailer, Gateway 2000, Inc., recently agreed to settle a federal claim for $9 million. The settlement – and its source – is a cause for concern in the federal contracting community, and especially bodes ill for the thousands of vendors with General Services Administration (GSA) schedules contracts.

The settlement stems from a key price term allegedly included in Gateway’s GSA schedules contract. The government alleged that this price term provided that if Gateway dropped the price on an item after an order was entered but before the item was shipped, the customer – the government agency – would enjoy the benefit of that price drop. The government claimed, inter alia, that Gateway failed, for several years, to have adequate internal controls in place to ensure that government buyers gained the benefit of these rapid price drops. Although Gateway denied the government’s claims, it settled for $9 million to foreclose further litigation.

The Gateway settlement has raised concerns because it revives fears of GSA’s long-dormant weapon: the price-reductions clause, GSA Acquisition Regulation 552.238-76. On its face, the price reductions clause seems a simple provision. It requires GSA schedules contractors to ensure that their schedules prices remain below a commercial benchmark, known as the “basis of award.” While that benchmark can be narrowed by agreement, all too often the clause is broadly drawn to require that vendors’ schedules prices to government agencies must be lower than all commercial prices. If the clause is written that broadly and the vendor extends discounts only to commercial customers - and not to the government - the vendor may violate the price reductions clause.

Violations of the price reductions clause can carry very serious consequences. See generally Christopher Yukins and Michele Brown, “Strategies for Schedules Contracting,” Procurement Law Advisor (Nov. 2000). GSA has sweeping audit rights under the standard schedules contract, and claims of pricing violations can result in years of protracted, expensive investigations. As a result of an investigation, a vendor may be forced to pay thousands – or millions – of dollars for alleged pricing violations, and may face multiple damages and penalties if the government alleges that the pricing violations constituted fraud. Worse yet, these investigations can be launched even by incorrect claims of fraud, if internal “whistleblowers” mistakenly report pricing violations to government investigators.

There are at least three basic strategies for vendors to protect themselves:

Negotiate the Price-Reductions Provision Aggressively

A vendor should not allow GSA to use all the vendor’s commercial prices as the benchmark for GSA pricing; that is a recipe for disaster. Instead, the basis for award - the benchmark - should be narrowed, if possible, to one customer or group of customers.

Establish Exceptions to Price Reduction Requirement

When negotiating the price-reductions provision, a vendor should press for exceptions to the price-reductions requirement. A vendor, thus, would ensure that if it extended a special discount to a “benchmark” commercial customer - a “basis of award” customer - that special discount would not necessarily trigger parallel discounts to federal customers. For example, a vendor might urge GSA to exempt certain volume discounts from the price-reductions clause. If GSA agreed, extending those discounts to commercial customers - even if those customers were part of the contractual “basis of award” - would not necessarily trigger similar discounts to federal customers.

Establish Compliance Systems

To avoid liability, once contractors have GSA schedules contracts in place, they should establish internal compliance procedures. Contractors should ensure that those who set the vendors’ pricing - in both government and commercial markets - understand the constraints imposed by the price reductions clause. Vendors also should ensure that other obligations under the GSA schedules contracts, including the obligation to pay GSA its one-percent industrial-funding fee (IFF), will be met fully. A GSA audit is likely to occur, as a matter of course, and a vendor should be fully prepared for that audit.

A prior version of this article was published in the February 2001 issue of Procurement Law Advisor, published by Management Concepts, Inc.

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