Federal Circuit Decision Spells Further Trouble for Allowability of Legal and Settlement Costs
In Geren v. Tecom, Inc., No. 2008-1171 (Fed. Cir., May 19, 2009), the Federal Circuit expanded the basis for disallowing costs related to the defense and settlement of a Title VII sex discrimination lawsuit by a private party. The decision, however, has even more potentially adverse consequences for the allowability of defense and settlement costs generally. This decision requires that contractors carefully consider any decision to settle Title VII lawsuits and any other lawsuit that involves contractor conduct alleged to be in violation of any clause in a contract.
In a split decision, the Court held that the defense and settlement costs in question were unallowable based upon an expansion of its prior decision in Boeing N. Am., Inc. v. Roche, 298 F.3d 1274 (Fed. Cir. 2002). Specifically, the Court used the following two-step test for allowability of defense and settlement costs in private party lawsuits: (1) whether the defense and settlement costs would have been unallowable if a judgment had been rendered; and (2) if yes, did the lawsuit have “very little likelihood of success on the merits.” The significance of the Court’s decision is that the universe of potential unallowable legal costs is now much broader and, as a result, strategies for resolving litigations need to be rethought.
When it applied the first step, the Court held that costs incurred defending the sexual harassment lawsuit, had the lawsuit resulted in a judgment against the contractor rather than settlement, would have been unallowable. The Court did not perform a “similar or related to” analysis as in Boeing, because the costs in question were not similar or related to fraud, which is the focus of FAR § 31.205-47. Rather, the Court found that the defense and settlement costs would have been unallowable because the costs would not have complied with the “[t]erms of the contract.” See 48 C.F.R. § 31.201-2. The Court explained that the contract required the contractor to, among other things, not discriminate on the basis of sex. See 48 C.F.R. § 52.222-26. If the contractor were found guilty of sexual harassment, therefore, the Court reasoned that any costs related to such a breach would be unallowable.
Regarding the second step in the Boeing analysis, that legal and settlement costs are allowable only if the private action had “very little likelihood of success on the merits,” the Court held that this standard applies “to all private settlements where defense and judgment costs would be disallowed if the case went to final judgment against the contractor.” The Court rejected the Board’s interpretation that the standard only applies to situations that involve fraud or similar misconduct, explaining that Boeing “clearly adopted a broader rule.” The Court returned the appeal to the Board to apply the “likelihood of success” test.
This case has several meaningful impacts. First, it ignores numerous past decisions finding settlement costs allowable because settlements are reasonable business decisions. If such prior decisions were by the United States Court of Appeals for the Federal Circuit (“CAFC”) or its predecessor, a new contrary decision was required to be by an en banc court.
Second, the decision expands FAR § 31.205-47 well beyond fraud issues, and reverses the Board’s determination that the same costs were allowable. In Tecom, Inc., ASBCA No. 53884, 07-2 B.C.A. ¶ 33,674, the Board applied the first step in the Boeing analysis and held that because the costs were not specifically addressed in FAR § 31.205-47, they would be unallowable only if they were “similar or related” to costs expressly unallowable under FAR § 31.205-47. In determining that the costs were not “similar or related” to costs expressly unallowable under FAR § 31.205-47, the Board emphasized that “there were no charges of criminal conduct, fraud, or similar misconduct . . . .” Finding that the costs would have been allowable, the Board did not apply the second step in the Boeing analysis.
The Court’s reversal of the Board’s holding means that all defense and settlement costs relating to any private lawsuit may be unallowable even though no fraud or “similar or related” conduct is involved. Rather, all that is required is a conclusion that if the lawsuit had resulted in a judgment against the contractor, the contractor would be in breach of contract. Undoubtedly, auditors will aggressively use this standard to challenge more legal costs, including challenges based upon contractual requirements relating to, among others: (1) environmental compliance; and (2) affirmative action. Auditors also may now argue broadly that any lawsuit based upon any type of “unreasonable” contractor conduct renders all related costs unreasonable under FAR § 31.201-3, and that costs associated with the settlement of any private lawsuit are allowable only if the contractor establishes that the lawsuit had “very little likelihood of success on the merits.”
Second, contractors should carefully consider what is to their best advantage in any given situation: (a) try the issue before the relevant federal or state court in which the action was filed; or (b) settle the issue and have a government contract forum effectively try to determine the merits of the case? Also, when challenging a government cost allowability determination on settlement and related defense costs, the contractor must decide what forum is best suited to determine whether the underlying action had “very little likelihood of success on the merits,” either a Board of Contract Appeals (“BCA”) or the Court of Federal Claims. The Court’s decision to apply the “very little likelihood of success on the merits” standard broadly to the settlement of all private lawsuit means that these forums must rule on the merits of various non-government contract lawsuits, such as Title VII sex discrimination lawsuits. The Court of Federal Claims is more adept at handling legal issues involving non-government contracts than a BCA, so that court is likely the logical choice of forum. Of course, although neither forum is equipped to address the merits of many types of private lawsuits, these forums may well offer an opportunity for a more fair assessment of the merits than would a jury in the plaintiff’s chosen forum.
Finally, the Court’s decision simply reflects, consistent with many recent decisions, bad policy. Settlements are a favored means to resolve litigation, as shown by the efforts courts exert to achieve settlements. Because of this policy of encouraging settlements, settlement costs long have been found to reflect reasonable business judgments, creating reasonable and allowable costs. The Court, however, clearly ignored this longstanding, and sensible, policy.
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