The Federal Circuit Invalidates Longstanding Advance Agreement Between Government and Contractor Under FAR 31.109 at New Contracting Officer’s Request

Earlier this month, the U.S. Court of Appeals for the Federal Circuit invalidated an agreement between the government and aircraft engine manufacturer Pratt & Whitney (Pratt), which set out the accounting treatment for certain overhead costs — referred to as “Drag costs” — following a prior dispute. The agreement at issue was entered into as part of a settlement of that prior dispute.

While recognizing “there is a strong public interest in enforcing settlements, especially in complex litigation,” the Federal Circuit concluded that the agreement was not enforceable because it violated the Federal Acquisition Regulation (FAR) requirements for advance agreements. The “Drag agreement” stated that it was executed under the authority of FAR 31.109, but “there was no evidence that the Drag agreement was incorporated into any of Pratt’s government contracts” and “the Drag agreement lack[ed] a statement of its duration,” as required by FAR 31.109(b). Because the agreement did not comply with the FAR, the Federal Circuit concluded that “the contracting officer lacked authority to bind the government” and thus, “the Drag agreement cannot be enforced against it.” The Federal Circuit remanded to the Armed Services Board of Contract Appeals (ASBCA or the Board) to assess Pratt’s argument that, even without the agreement, its accounting treatment was compliant — though not before noting its skepticism regarding Pratt’s position.

The Federal Circuit’s decision in Secretary of Defense v. Pratt & Whitney¹ is an important reminder to the government and contractors alike to track the FAR 31.109 requirements in any advance agreement invoking its authority. While the bounds of this decision will be defined over time, both by the parties to existing advance agreements and perhaps by the Boards and the Court of Federal Claims in future litigation, contractors should consider if and how the decision may subject existing agreements to scrutiny should one or both parties question whether a particular agreement meets those requirements and is thus enforceable.

Pratt’s Allocation of Overhead Costs and Long-Running Dispute With the Government

This appeal involves a long-running dispute between the government and Pratt regarding Pratt’s allocation of certain overhead costs to government contracts. The costs at issue relate to Pratt’s ongoing use of “unconventional agreements” with its commercial parts suppliers. Rather than purchase commercial engine parts directly from those suppliers, Pratt uses “collaboration agreements” to pay the suppliers a percentage share of its engine program revenue in exchange for the parts. The Drag costs represent “a portion of Pratt’s cost of supervising the commercial engine program” that is reimbursed by the suppliers. In short, the government argued that it overpaid Pratt on its cost-plus contracts because Pratt calculated the government’s share of those overhead costs in a way that violates the Cost Accounting Standards (CAS).

The Federal Circuit’s decision offers significant detail regarding both Pratt’s evolving accounting treatment of the Drag costs as well as the government’s evolving position. As is relevant here, Pratt maintained both a government and commercial engine program during the relevant period — with contracts under each. As a general matter, the government is required to reimburse Pratt for those overhead costs properly allocated to its government contracts. CAS 418 governs allocability of overhead costs. The Federal Circuit explains that pursuant to CAS 418-50, Pratt elected to allocate its overhead costs based on the proportion of material costs Pratt incurred for the government engine program as opposed to the material costs associated with the commercial engine program. Two calculations are involved in that allocation: (1) which costs are properly included in Pratt’s “overhead pool” and (2) the “allocation base” and how much of the pool was attributed to the government engine program versus the commercial engine program.

The government and Pratt have disagreed for over 30 years regarding how to calculate the cost of commercial engine parts acquired by Pratt under its collaboration agreements, including whether the Drag costs are properly included in the overhead pool as well as whether and how the material costs associated with commercial contracts should be included in the allocation base. Following earlier litigation arising from the government’s assertion of a CAS noncompliance — specifically, that Pratt’s failure to comply with CAS 418 caused a “substantial distortion in overhead allocation” between the government and commercial engine programs — the parties reached a settlement in 2006. Simultaneously, the parties entered into the Drag agreement, which explained that in the future, Pratt would include the material costs in the allocation base and would no longer reduce the overhead pool by the Drag figure.

A New Contracting Officer’s Position and the Latest Development

As the Federal Circuit notes, the Drag agreement “did not resolve the dispute.” In 2013, a new contracting officer adopted a new position — concluding that Pratt’s accounting treatment once again violated CAS and that, contrary to the agreement, Pratt was required to remove Drag costs from the overhead pool. In support of that position, the contracting officer asserted that “the Drag agreement was not valid and therefore was not binding on the government.” Pratt appealed to the ASBCA, which concluded that the Drag agreement was valid, but that Pratt had improperly calculated its material costs under CAS 418 by using “Manufacturing Target Cost” to estimate the costs where the contracting officer instead used gross revenue share. On this latter issue, the Board remanded quantum to the parties in the first instance.

The government appealed the ASBCA’s decision, and Pratt cross-appealed, to the Federal Circuit. As to the calculation of material costs, the Federal Circuit concluded that it did not have jurisdiction because the Board’s decision, which only addressed liability and not quantum, was not final. The Federal Circuit, however, agreed with the government that it had jurisdiction over the question of the validity of the Drag agreement because the ASBCA’s decision as to that issue was both separate and final.

The Federal Circuit’s Assessment of the “Drag Agreement” Against FAR 31.109

Turning to the merits, as the decision notes, the parties agreed that the plain language of the Drag agreement permitted Pratt to cease reducing its overhead pool by the Drag figure. However, the government argued that the agreement was “invalid and unenforceable against the government because it violated the FAR.” The Federal Circuit agreed.

The Federal Circuit explained that the contracting officer must have actual authority to bind the government to a contract — “a government official lacks actual authority to enter into a contract that violates the FAR.” Without specific authorization, a deviation from the FAR is beyond the authority of the contracting officer. Thus, the Federal Circuit assessed whether the Drag agreement violated the FAR.

The Federal Circuit underscored that it is “undeniable that the Drag agreement is an advance agreement” — it was “a negotiated agreement to ‘prospectively’ agree to the treatment of costs,” i.e., Pratt’s inclusion of Drag costs in the overhead pool, and the agreement even explicitly invoked FAR 31.109, stating “on its face, … that it was executed under the authority of § 31.109, the advance agreements provision.” The Federal Circuit then looked to FAR 31.109(b), which states in relevant part: “The agreements must be in writing, executed by both contracting parties, and incorporated into applicable current and future contracts. An advance agreement shall contain a statement of its applicability and duration.” Yet, according to the Federal Circuit, the Drag agreement was neither incorporated into the applicable current and future contracts nor did it contain a statement of its duration. Accordingly, FAR 31.109 “was the source of the contracting officer’s authority,” and because the Drag agreement did not comply with FAR 31.109(b), as a matter of law, “the contracting officer lacked the authority to execute the Drag agreement on behalf of the government” and thus, “the Drag agreement cannot be enforced against it.”²

In reaching this decision, the Federal Circuit disagreed with the Board’s holding that, although the Drag agreement did not comply with FAR 31.109, the agreement was valid and enforceable as long as it satisfied the general requirements for forming a contract. The Federal Circuit noted: “We are aware of no holding that gives the contracting officer authority to disregard the FAR restrictions because a settlement agreement is involved.” The Federal Circuit recognized a “strong public interest in enforcing settlements, especially in complex litigation,” but held that “a settlement agreement is a contract, so its enforceability first turns on basic principles of contracting, such as whether there was authority to bind the parties.” And here, because the “FAR was the source of the contracting officer’s authority and did not authorize the agreement,” the Drag agreement is not enforceable against the government.

In closing, the Federal Circuit recognized Pratt’s argument that, even without the agreement, it was not required to reduce its overhead pool by the Drag figure. The government argued that the Drag costs must be excluded because they were reimbursed by the suppliers, pursuant to the credits provision at FAR 31.201-5. The Federal Circuit seemed “skeptical a reimbursed cost could be properly included in the overhead pool,” but declined to reach the issue, remanding to the Board to address and resolve it in the first instance.

Potential Impact on Existing and Future Advance Agreements

The Pratt & Whitney decision certainly emphasizes compliance with the FAR requirements for advance agreements. Parties to any such agreement in the future will need to consider the bounds of this holding and how best to meet those requirements where applicable, including the two specifically cited against Pratt — that the agreement be incorporated into applicable current and future contracts and contain a statement of its duration. As to the parties to an existing advance agreement, it remains to be seen whether this decision will disrupt the status quo and potentially upend the certainty upon which both the government and contractor have come to rely.

It bears noting that FAR 31.109(a) specifically recognizes that the reasonableness, allocability, and allowability of certain costs “may be difficult to determine” and therefore instructs that “contracting officers and contractors should seek advance agreement on the treatment of special or unusual costs.” Advance agreements no doubt afford contractors and the government an opportunity for alignment and predictability regarding that accounting treatment moving forward. As the government revisits the FAR as part of its comprehensive overhaul, it may consider injecting a common-sense approach to achieving this purpose.³

© Arnold & Porter Kaye Scholer LLP 2025 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.