Court Applies Strict Construction of Tecom Disallowing Government Contractor Litigation Costs

Last week, the Court of Federal Claims rendered the first decision on the allowability of third-party litigation expense under government contracts since the Court of Appeals for the Federal Circuit’s 2009 decision in Geren v. Tecom, Inc.¹ Bechtel National, Inc. v. United States, No. 17–657C (Fed. Cl. Apr. 3, 2018). The Court applied Tecom strictly and disallowed the costs of two discrimination cases that the parties settled. The Court did not allow for an exception to Tecom, nor did it provide any insight to the amorphous "very little likelihood of success on the merits" standard that now applies to determine the allowability of third-party litigation settlements. Unless appealed and the Federal Circuit decides to revisit its Tecom decision, the latest case confirms contractors’ fears about the allowability of settled litigation.

For decades, the case law held that the costs of third party litigation, including cases of alleged employment discrimination, were allowable as ordinary costs of doing business.² Such costs were allowable regardless of whether the contractor litigated or settled the case. The tide began to turn with the Federal Circuit’s decision in Boeing, in which it determined that the costs of settling a shareholder derivative suit brought alleging that corporate directors "knowingly, recklessly, or culpably breached their fiduciary duties to the [c]orporation by . . . failing to establish internal controls sufficient to insure [sic] that the corporation's business was carried out in a lawful manner[,]"³ were only allowable if the contracting officer determined that there was "very little likelihood of success the merits"⁴ under Federal Acquisition Regulation (FAR) 31.205-47(c) generally applicable to fraud proceedings. The Federal Circuit reasoned that the derivative shareholder suit was "like" a fraud suit that FAR 31.205-47(b) and (c) govern. The Federal Circuit, however, did not offer a definition, or even guidance, to interpret what constitutes "very little likelihood of success on the merits."

In Tecom, the Federal Circuit relied on Boeing and determined that the costs of defending and settling a lawsuit where the plaintiff alleged discrimination in violation of Title VII of the Civil Rights Act of 1964 were unallowable under the contract, which incorporated the clause at FAR 52.222-26, "Equal Opportunity." The Court took Boeing a step further and reasoned that an adverse judgment that a contractor had violated Title VII would breach FAR 52.222-26,⁵ resulting in a breach of contract, and rendering the contractor's defense costs unallowable.⁶ Therefore, the costs of defending and settling a Title VII action were determined unallowable, unless the contracting officer decided that the Title VII plaintiff had "very little likelihood of success" on the merits; the Federal Circuit found the cost unallowable in Tecom, but with no clear standard on determining very little likelihood of success on the merits.⁷

The Court took the same approach in Bechtel. Bechtel performed a contract with the Department of Energy (DoE) that included FAR 52.222-26, "Equal Opportunity."⁸ Bechtel settled two discrimination cases brought by former employees on the contract, and sought reimbursement for the cost of defending and settling the litigation.⁹ The Contracting Officer reviewed the cases and "determined" that the contractor's costs incurred "in defending these matters [were] unallowable under the standards set forth in Tecom," because plaintiffs' claims had "more than very little likelihood of success on the merits."¹⁰ Bechtel argued that a special DOE contract clause, requiring written approval from the contracting officer to proceed with third-party litigation (which it received) and dictating government reimbursement distinguished its case from Tecom. Nevertheless, the Court determined that the contractor was not entitled to recover the costs of settlement, because the DOE clause excepted reimbursement when the cost is "otherwise unallowable by law or the provision of the contract," the contractor would not be entitled to recover the costs of an adverse judgment, and the contractor did not sufficiently challenge the Contracting Officer's determination on the "very little likelihood of success on the merits" standard.¹¹ The Court, however, provided no insight to that standard.

With this decision, Bechtel affirms the concerns that rippled through the government contracting community after Tecom. First, even as FAR 31.205-47 implicitly recognizes that employment lawsuits are part of contractors' cost of doing business, a position that the dissent in Tecom advocated, the decisions in Tecom, and now Bechtel hold otherwise. These decisions force contractors to weigh the cost and risk of third-party litigation against the likelihood of bearing the full cost of settlement. The only way to recover the cost would be to litigate and win—which, ironically, would increase the costs for recovery from the government. 

Second, even though the Court was presented with a chance to clarify the "very little likelihood of success on the merits" standard, the Court chose not to do so in Bechtel. As it stands, contracting officers, most of whom are not lawyers, let alone judges, have little expertise or incentive but to determine that there is more than "very little likelihood of success on the merits" for any settled case a contractor presents. Once a contracting officer determines that there is more than a "very little likelihood of success" in a case against a government contractor, that contractor must then challenge both the contracting officer's determination of the merits of the lawsuit that the contractor settled, and the disallowance of the settlement costs. Contractors may not be willing to take on those risks.

The Court of Federal Claims' decision may not be the end of this issue. Appeal to the Federal Circuit remains a possibility. Either an appeal, or another case with this fact pattern, will hopefully test the boundaries of the "breach of contract" element of Tecom or finally clarify the amorphous "very little likelihood of success on the merits" standard.