Danger Zone: How Cost-Plus Contracts Defrauded Top Gun Heroes
Cost plus percentage of cost contracts violate the False Claims Act.
Let’s say you need to remodel your house. You interview a few contractors, decide on a plan, and then get to the really important part: how to pay for it. There are all sorts of ways to pay your contractor. Here’s one that you would never choose: a cost plus percentage of cost contract. A cost-plus-percentage-of-cost contract is a type of contract where the contractor is paid for all the actual costs incurred during a project (such as labor, materials, and equipment) plus an additional fee that is a predetermined percentage of those costs. In that type of contract, the contractor's profit increases in direct proportion to the project's total cost.
That’s crazy! Instead of encouraging efficiency and cost-saving measures, it rewards the contractor for driving up expenses, which could lead to unnecessary upgrades, expensive materials, and extended timelines.
The Department of Defense agrees and has outlawed these types of contracts. As the Government Accountability Office noted:
“The purpose of Congress was to protect the government against the sort of exploitation so easily accomplished under cost-plus-a- percentage-of-cost contracts”
This is not a recent change. This policy has been in effect since January 1956.
The scheme
The United States Navy's mission is to protect America at sea. It doesn’t make ships, it sails them. When it needs ships, it buys them from a contractor. In this case, it bought spare parts and materials needed to repair and maintain the primary aircraft used to train naval aviators from Sikorsky Support Services Inc.
Now, Sikorsky didn’t have a cost plus percentage of cost contract (CPPC) with the Navy, that probably would have been caught during the procurement process. No, Sikorsky had a cost plus percentage of cost contract with a subcontractor, Derco Aerospace Inc., and then passed those inflated costs along to the Navy. Under that contract, SSSI agreed to purchase parts from Derco at the cost that Derco paid other suppliers for those parts, plus a fixed 32% markup. SSSI, in turn, submitted cost vouchers to the Navy for reimbursement of the amounts it paid to Derco.
Fun fact: Derco and Sikorsky are owned by the same company. The government alleged that, by failing to disclose that the costs claimed by Sikorsky were the product of an illegal CPPC subcontract between Sikorsky and Derco, Sikorsky and Derco knowingly presented false and fraudulent cost vouchers to the Navy.
The penalty
$70 million. According to the Settlement Agreement, Defendants shall pay to the United States $70,000,000 (the “Settlement Amount”), of which $36,467,990 is restitution, and interest on the Settlement Amount at a rate of 4% per annum.
The whistleblower(s)
There were two whistleblowers, or relators, here, but only one got paid. Mary Patzer and Peter Cimma both reported the fraud and filed lawsuits. But, because of the first to file rule, only Patzer’s case went forward. Patzer was originally hired by Derco as a financial analyst. By the time she filed her lawsuit in 2009, she was the point of contact for the company’s defense contract audits. As she said in a statement, “I had to stand up and do the right thing. But after I questioned the markups with the company, I was walked out.”
The whistleblower reward
For speaking up, Patzer will receive $13,976,900, or 19.9% of the United States’ recovery. Under the qui tam provision of the False Claims Act, a private party (also referred to as a whistleblower or relator) may file an action on behalf of the United States and receive a portion of the recovery, typically between 15-30%.
If you think you’ve observed fraud or misconduct, we can evaluate your options. Vivek Kothari is a former federal prosecutor who represents whistleblowers. For a free consultation, contact Vivek by email, phone, Signal, or fill out the contact form.