While the federal contracting community knows the basic types of legal contracting methods pretty well, lurking among them is a type the federal government expressly prohibits. Called the cost-plus-percentage-of-cost (CPPC) contracting method, participants often sign them without knowing it.

Federal Acquisition Regulation (FAR) 16.102(c) prohibits CPPC provisions within contracts, and it puts the onus on prime contractors to prohibit CPPC provisions in agreements with subcontractors. As regulators begin to penalize FAR violations more harshly, it’s particularly important to watch out for provisions that fall into the CPPC contracting methods category now. Penalties could range from lawsuits to remedy the financial ramifications of such contracts to direct penalties from the federal government, such as withholding payment for contracted work.

Contractors who know what defines a CPPC contract and how to spot provisions that fall into this category will be best equipped to avoid the ramifications of being caught in violation of the CPPC prohibition. For guidance, let’s look to the Defense Acquisition University’s (DAU) definition of a CPPC, the Government Accountability Office’s (GAO) four criteria on what constitutes a CPPC violation, and previous government rulings.

What’s a CPPC Contracting Method?

While the FAR isn’t clear on what constitutes a CPPC contracting method, the DAU provides some helpful guidance. Its glossary defines a CPPC contract as:

“A form of contract formerly used but now illegal for use by the Department of Defense (DoD) that provided a fee or profit as a specified percentage of the contractor’s actual cost of accomplishing the work to be performed.”

During World War I, the government frequently used CPPC contracts as a way to encourage contractors to perform R&D work to support the war effort. These contracts compensate manufacturers for such work, making them a useful incentive. However, their downfall is they provide no incentive for contractors to control costs. As a result, the cost-plus-fixed-fee (CPFF) method was introduced as an alternative in 1940.

However, even contracts that fall under the CPFF category for time and materials can contain elements that meet the definition of CPPC. That’s why it’s important to know which types of contracting provisions land the contracts in this illegal category.

How to Spot a CPPC Provision

Put simply, contract provisions fall into the CPPC category if a fixed payment rate is applied to actual costs. For example, a contract where a fixed “material handling” or “general and administrative” rate is applied to actual costs often constitutes a CPPC agreement. For further guidance on this, the GAO classifies contracts as CPPC if the following conditions exist:

• Payment is at a predetermined rate.
• This rate is applied to actual performance costs.
• The contractor's entitlement is uncertain at the time of contracting.
• The rate increases commensurately with increased performance costs.

Based on government rulings, the provision that trips the alarm bell for regulators is when a predetermined fee is applied to actual costs. A classic example is the 1980 Comptroller General of the United States file B-196556 ruling, which found a violation of the CPPC prohibition in two fixed-price contracts from the Agency for International Development (AID). The provisions found in violation of the CPPC provision allowed for a predetermined management fee to be recovered on a sliding scale of 6 percent to 13.5 percent, depending on costs incurred for the subcontract effort.

Another government ruling shows that—if the contract contains provisions that violate the CPPC prohibition—including a cost limitation doesn’t negate the violation. In the 1979 file B-195173, the GAO said that portions of grants awarded to state and local governments by the Federal Aviation Administration (FAA) constituted CPPC violations. These portions authorized payment at a predetermined percentage of 15 percent of actual direct labor and overhead costs, and the contract’s “not to exceed” cost limitation didn’t negate this violation.

Individual task orders are also subject to scrutiny under CPPC prohibition rules. One example is a GAO decision found in file B-211213, dated April 21 of 1983. In it, the GAO found violation of the CPPC prohibition when three individual task orders awarded by the Department of Labor (DOL) included a provision for payment of predetermined percentages of 7.5 percent to 10 percent to “cover overhead and profit” on materials, subcontracts, travel, and other expense items.

Fortunately, having a predetermined percentage for additional payment that is not subject to adjustment for actual costs isn’t the same as billing a customer at provisional indirect rates and adjusting to actuals at the end of the billing period or end of the contract term. FAR 31 contains the provisions that allow recovery of indirect costs relative to final cost objectives.

What’s the Impact to My Business?

Evaluating the financial impact is an important first step if you find a provision in your contract that meets the GAO’s four criteria for a CPPC violation. Although we have not found an example of financial penalties for being caught with a CPPC contract, the adjustments needed to remove provisions that violate the CPPC prohibition come with financial repercussions. These can range from overpayments to underpayments to payment delays.

The good news is that, in many cases, the contract can be adjusted to comply with the CPPC prohibition without any material change to the payment amounts resulting from the contract. For instance, in the AID case discussed above, the report states that although the GAO found the subject grant provisions were illegal, it also recognized that the government is obligated to pay for the services that provide benefits. As another example, in the FAA case, the contracting officer determined that although the price may have been calculated using an inappropriate method, the total costs in question were actually fair and reasonable.

Similarly, in the DOL case, the GAO applied the same logic and allowed the contracting officer to determine if the amounts already paid were fair and reasonable for services rendered. As the contract was still in progress at the time of the ruling, the illegal provision of the contract was considered void. However, the department could delete the provision and negotiate a fixed fee instead.

Next Steps

Although illegal, contracts with CPPC provisions are often discovered. The good news is that the contracting officer can settle the matter with limited financial impact to the contractor, but this takes preparation. It’s important for contractors to understand which provisions land contracts in the CPPC category.

The red flags to watch for are provisions stating a predetermined, fixed percentage or fee on actual costs incurred, as well as the GAO’s four criteria for determining if a provision is in violation. If you think you may have a CPPC provision in a federal contract, contact a federal contracting consultant for assistance in identification of the provision and assessment of financial impact for presentation to your contracting officer.