TITLE:  Alleged violations of the Antideficiency Act in the Air Force's procurement of advanced cruise missiles., File:	B-255831, Date:	July 7, 1995
BNUMBER:  B-255831
DATE:  July 7, 1995
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Alleged violations of the Antideficiency Act in the Air Force's procurement
of advanced cruise missiles., File: B-255831, Date: July 7, 1995

Subject: Alleged violations of the Antideficiency Act in the Air Force's
procurement of advanced cruise missiles.

File: B-255831

Date: July 7, 1995

B-255831

July 7, 1995

Derek J. Vander Schaaf
Deputy Inspector General
Department of Defense

Dear Mr. Vander Schaaf:

You asked for our views on three questions concerning the Air Force's
procurement of advanced cruise missiles (ACM) for fiscal year (FY) 1987 and
1988. The questions involve alleged violations of the Antideficiency Act
pertaining to the FY 87 procurement. The Act, codified in part at 31 U.S.C.
sect. 1341, prohibits federal employees from incurring obligations in excess of
available funds. Attempting to avoid a violation of the Antideficiency Act,
in April 1992 the Air Force terminated its contract for ACMs because
projected cost overruns would have exceeded available funds. In this
respect, we reported in 1994 [1] that the ACM program had to be restructured
dramatically in 1992 in key part because of the lack of funds to cover FY 87
and 88 cost overruns.

You question whether three separate aspects of the Air Force actions
violated the Antideficiency Act. The first is the failure to commit funds to
cover the ceiling price of the contract and the resulting projection of
unfunded cost overruns. Second, you ask whether the Air Force violated the
Act when it allowed contract performance to continue unabated until all
available funds were exhausted. Third, you assert that costs actually
incurred by the contractor prior to termination exceed available funds in
the account, thus causing a deficiency.

We do not believe that the Act was violated. While it is clear the Air Force
could have done substantially more to manage the contract effectively, a
projection of overruns does not in itself constitute an Antideficiency Act
violation. Further, we see no violation in allowing contract performance to
continue, as opposed to terminating the contract based on the projection
overruns. Moreover, the Air Force's termination strategy avoided costs that,
had the transaction been structured differently, may have caused a
deficiency.

Our finding that the Air Force did not violate the Antideficiency Act should
not be taken as an endorsement of its actions with regard to the FY 87 ACM
procurement. In view of the difficult technical and cost problems that
delayed contract definitization for a year and a half, the Air Force should
have anticipated that cost overruns likely would take the contract to
ceiling price. Yet, at the time of definitization, the Air Force did not act
to commit sufficient funds in the appropriation account to complete the
contract. Even after definitization, as the likelihood of overruns
approached reality, the Air Force took no steps to manage the contract
(e.g., cutting back the number of missiles), or the account (e.g., reducing
other demands on the account), to cover the ceiling. Other than requesting
additional funds from the Congress, this left the Air Force with only one
practical option as costs continued to increase while the account was being
exhausted: termination of the contract.

BACKGROUND

Contract Award and Performance History

In March 1986, the Air Force awarded an undefinitized contract to General
Dynamics Corporation, Convair Division (GD/C), to begin production of
advanced cruise missiles for FY 87 (referred to as "Lot III"). [2] It was
not until September 12, 1989, that the Air Force definitized this
fixed-price-incentive (FPI) contract (No. F33657-88-C-0103). [3] At
definitization the firm target price under the Lot III contract was $537.2
million and the ceiling price was $613.1 million for 150 missiles. The
contract contained an option for an additional 100 missiles for FY 88 ("Lot
IV') at a target price of $231.7 million and a ceiling price of $261.9
million. The contractor was to be liable for 30 percent of any overrun of
the target cost, in the form of reduced profit; the ceiling price
established the government's maximum liability. The Air Force exercised the
Lot IV option on January 30, 1990.

Both before and after Lot III definitization, the serious design and
production problems persisted on GD/C's'1985 and 1986 ACM contracts (Lots I
and II). In November 1989, 2 months after definitization of Lot III, these
continuing problems culminated in the Air Force ordering GD/C to halt
deliveries of all missiles on all production lots until the technical
difficulties were resolved. [4] In November 1990, GD/C formally alerted the
Air Force to the probability that the difficulties would cause the Lot III
contract to exceed the target cost by $40.9 million. The contractor sought
to correct the problems and eventually did so. Meanwhile, the Air Force was
trying to verify the exact amount the contract costs would increase. The Air
Force's final cost estimate was completed in October 1991, 11 months after
the contractor's formal notice of increasing costs. By that time, however,
the projected overrun for the contract had increased to approximately $100
million.

Contract Funding

The Air Force definitized the Lot III contract just 2-1/2 weeks before the
FY 87 Missile Procurement, Air Force account ("account 3020")" was to
expire, and obligated the account only for the target price. Air Force
officials did not commit additional funds in the account to cover
predictable cost overruns. As a result, when the cost overruns were later
projected, the account balance was not sufficient to cover them.

An Air Force audit completed in September 1994 indicates that in order to
cover the overruns Air Force officials had intended to seek access to the
merged surplus account. [5] The merged surplus account housed large
unobligated balances without fiscal year identity that could be used for
upward adjustment of obligations from expired fiscal years. However, those
balances were canceled by statute in 1990. [6] Because FY 87 and 88 funds
were nearly exhausted and the merged surplus account was no longer available
when the cost overruns were firmly estimated in the fall of 1991, the Air
Force needed to find another source of funds, take some action to limit
costs charged by the contractor, or request a deficiency appropriation.

The Air Force pursued only the first of those options, as Air Force
officials began discussions with the Assistant Secretary of the Air Force
(Financial Management and Comptroller) about funds to cover the projected
overrun. In October 1991, these discussions culminated in requests for
expired year funds. The amounts requested were $71.5 million from FY 87 and
$27.1 million from FY 88. These requests were denied because such large
amounts were not available.

Next, the Air Force asked to use FY 92 ACM funds to finish the Lot III and
IV contract. The request relied on the theory that the new legislation
allowed the use of current year funds to carry out contract changes within
the original scope of work. The Assistant Secretary at first agreed with
that position. [7] Ultimately, the Department of Defense (DOD) Comptroller
denied the request to use 1992 funds to complete the contract. [8] When the
use of current year funds finally was ruled out, the Air Force decided to
terminate the contract for Lot III to prevent an Antideficiency Act
violation. On April 6, 1992, the Air Force terminated the Lot III contract
with GD/C for the convenience of the government. Days later, the Air Force
also terminated 24 missiles from Lot IV. Only 54 of the 250 missiles in Lots
III and IV had been delivered as of the date of termination.

Immediately prior to termination, obligations on the contract had reached
$565 million ($28 million over target, and $48 million below ceiling). On
March 31, 1992, the FY 87 unobligated balance in account 3020 was $25.188
million. The balance increased slightly as of the end of April 1992.
According to the Air Force's calculations, termination prevented
contractor-incurred costs from surpassing available budget authority. For
that reason, Air Force officials believe their action avoided an
Antideficiency Act violation.

Subsequent Procurement

Actions on Lots III and IV occurred against a backdrop of other changes to
the ACM program. In January 1992, citing changing defense needs in the
post-Cold War era, the President announced a major cutback in total ACM
procurement. The President determined that only 640 missiles were needed,
instead of the previously planned 1,000. On February 27, 1992, the Air Force
program manager issued a stop work order for activities related to the FY 92
procurement of 120 ACMs. [9] The stop work order directed GD/C immediately
to suspend advance buy and long lead activities then underway for FY 92 and
later years. The ACM program was later reduced still further to 520
missiles. [10]

Two months later, the 1987-88 contract was terminated for lack of funds. The
day after terminating the Lot III contract, the Air Force used 1992 funds to
enter into a new sole-source contract with GD/C for 120 missiles at a firm,
fixed price. This contract used 96 partially completed missiles from the
terminated contract, and 24 that were about to be terminated from the Lot IV
contract, as government-furnished equipment. These 120 missiles filled out
the final missile complement of 520.

Congressional Ratification

On April 28, 1992, the Air Force notified the Senate Appropriations
Committee of the termination of the FY 87 and FY 88 ACM production lots and
the subsequent procurement of 120 missiles with FY 92 funds. Congressional
response to that notification came on May 20, 1992, in the conference report
on the 1993 rescission legislation. In that legislation, Congress rescinded
$344 million of the $433.1 million originally appropriated for ACM
procurement in FY 1992. Some of the $89.1 million that was not rescinded had
already been expended on the suspended 1992 long lead effort. As to the
remainder, the conferees "specifically directed" the Air Force to use
"remaining fiscal year 1992 funding . . . to complete the procurement of the
fiscal year 1987 and 1988 missiles. . . ." [11]

ANALYSIS

Antideficiency Act

An agency that obligates or expends funds in excess of the amount available
in the appropriation account violates the Antideficiency Act. 31 U.S.C. sect.
1341. Inspector General Report No. 93-053, dated February 12, 1993, alleged
three violations of the Antideficiency Act arising from the Lot III
contract. First, the report asserted that because the government had a
contract requiring it to pay the cost overruns, the prediction of unfunded
overruns was a violation of the Antideficiency Act. Second, the report
stated that the Air Force violated the Act when it failed to make immediate
adjustments in funding sources, obligation levels, or contract requirements
as soon as the escalating costs became apparent. Finally, the report
suggested that the contract did in fact incur costs in excess of available
funds, thereby causing a deficiency.

The report's conclusion seems to proceed from the assumption that exposing
the government to a situation in which liability for costs on a valid
contract has the potential to exceed available appropriations violates the
Antideficiency Act. We disagree. In this case, the Air Force initially
obligated an amount equal to the target price of the contract, which is the
accepted practice. [12] In terms of appropriation accounting, the difference
between the target and ceiling prices is a contingent liability that may or
may not require future obligations. An officer of the government violates
the Act only by incurring or authorizing an obligation or making an
expenditure that puts the appropriation account in a deficiency status. That
did not happen here. Because the Air Force terminated the contract, no
obligation was ever incurred or authorized for the unfunded portion of the
projected overrun.

An agency faced with a possible violation of the Antideficiency Act has a
duty to act to prevent the violation or at least to mitigate its
consequences. One example of government action that would reduce the
contingent liability would be the modification of the contract to include
design or quantity changes that would allow the contract to be completed
within available funds. In fact, your criticism of Air Force officials for
not taking such steps implicitly recognizes that such actions would avoid an
Antideficiency Act violation. [13]

Another option to avoid a possible Antideficiency Act violation is
termination of the contract for the convenience of the government.
Termination is the ultimate tool at the government's disposal to prevent a
contractor from incurring costs beyond the account 's limit. Convenience
termination of a contract to prevent an Antideficiency Act violation is a
drastic measure with serious consequences. Termination costs can be
substantial. Moreover, the government loses the value of its original
bargain with the contractor.

Despite its negative aspects, however, termination for the convenience of
the government is an effective means of avoiding an Antideficiency Act
violation. As we said in 55 Comp. Gen. 768, 773 (1975), termination "will
fix the Government's final obligation . . . at the amount payable pursuant
to the Termination for Convenience clause." If that amount is less than what
would otherwise be due under the contract, termination is "the most that can
be done" to prevent a violation. In that case, the violation was so large
that contract termination was sufficient only to reduce it. In the current
circumstances, the Air Force, in terminating the contract for convenience,
minimized the attendant costs so as to successfully avert a violation.

In this respect, it has been suggested that the Lot III termination costs
exceeded the amount remaining in the 3020 account. If that were true, the
need to pay termination cost with FY 87 funds might have caused an
Antideficiency Act violation. The Air Force has reported, however, that
sufficient funds were available at all times to cover all contract and
termination costs. The way the transaction was structured, that appears to
be an accurate statement.

The use of the 1992 letter contract allowed GD/C and the Air Force to avoid
the expenses normally associated with terminating a contract for the
convenience of the government. [14] Because its work was not interrupted,
GD/C sustained minimal termination related costs. In fact, GD/C was willing
and agreed to perform on the letter contract for approximately the same
total amount as would have been paid under the Lot III contract, including
the 30/70 cost sharing ratio.

At the time of termination, the prime contractor had outstanding
subcontracts worth $7.6 million. The subcontracts were orders for materials,
parts, and supplies GD/C placed with subcontractors before the Air Force
terminated the contract. Upon termination, the unliquidated payments due
subcontractors became potential termination expenses of Lot III. Under the
termination clause in the contract, the contracting officer may approve, as
part of the termination agreement, the prime contractor's proposed
termination settlement with its subcontractors. See 48 C.F.R. sect. 52.249-2.
Here, because its performance on the letter contract would have required it
to obtain the same items previously subcontracted, GD/C apparently elected
to continue rather than terminate the subcontracts. The result was that
costs that might have been associated with terminating the subcontracts were
avoided. [15]

Another element of cost avoidance was the letter contract's direction that
partially assembled missiles from Lot III and other related inventory in the
contractor's possession be used in its performance. The Federal Acquisition
Regulation confers broad discretion on a contracting officer to make
termination arrangements that are fair and reasonable. 48 C.F.R. sect.sect. 49.103
and 49.105(c). The Lot III termination achieved that objective.

Funding and Contract Management

As stated at the outset of this letter, the Air Force's successful avoidance
of an Antideficiency Act violation does not mean that its actions in this
situation should be condoned. It was the Air Force's own failure to deal
with serious funding issues effectively and timely that placed it in a
position where it needed to take drastic contract action to avoid violating
the law.

In our view, the Air Force should have known well before contract
definitization that it would not be able to pay for the number of missiles
required in the letter contract with the funds it would have available. GD/C
had experienced numerous problems, and cost overruns, on the Lots I and II
contracts for ACMs. Moreover, work on the Lot III contract was well under
way by the time of definitization in September 1989. The negotiations
leading up to definitization were unusually lengthy and had to alert the
parties to technical problems substantial enough that their resolution would
materially affect the contract costs. Accordingly, we think that Air Force
officials either knew or should have known there was a significant risk that
the Lot III contract as structured would reach its ceiling price.

The Air Force, pursuant to its own regulations and DOD accounting
procedures, should have taken actions to commit funds in the appropriation
account to cover foreseeable cost overruns up to the ceiling price. The Air
Force and DOD accounting manuals have procedures for recording obligations
in connection with incentive contracts. [16] Although the manuals state that
the minimum obligation to be recorded at contract award is the target or
base price (which is what the Air Force did), [17] the same manuals provide
guidance on how to plan for overruns to the ceiling price. The manuals
direct the contracting agency to estimate the amount by which a FPI contract
is anticipated to exceed its target. The agency then is to "commit," or
reserve, the estimated amount, so that funds will be assured to cover
foreseeable cost overruns. [18] An agency that fails, as the Air Force did,
to commit funds in the account to cover cost increases to the ceiling price
runs the risk of facing unfunded contract liabilities and Antideficiency Act
problems. Had the Air Force followed established procedures for committing
funds, the account might have been able to support the contract, [19] and
there would have been no need to terminate the contract or look to the
merged surplus account for funds.

Further, to the extent the Air Force may not have been fully aware on or
before definitization exactly how bad the Lot III situation would be, it
certainly knew the target price would be breached well before the actual
termination decision. GD/C advised the Air Force almost 1-1/2 years before
termination that it would exceed the target cost by more than $40 million.
We recognize that the precise quantum of the problem may not have been know
until later, but its significance certainly was.

In its report on ACM Contracting and Financial Activities, [20] the Air
Force Audit Agency found that the Air Force did not use available tools and
processes for identifying and quantifying the contract's over-target
condition. The report specifically criticized managers' neglect of accurate
accountability over changes in the contract values, and senior managers'
failure to take timely action in response to early indications of target
overruns. [21] The audit agency further concluded that the Air Force's
failure to explore was to cure the funding situation essentially was caused
by program officials' anticipation that the merged surplus account would be
available, as it historically had been, to fund the Air Force's share of
over-target costs. As stated above, however, the Congress canceled those
unobligated balances in 1990. That legislation was based in large part on
the Congress's general concern that controls over the use of appropriations
were not effective, but also on its finding that DOD in particular was
spending merged account funds without sufficient assurance that there was
authority for the expenditures or in ways that the Congress did not intend.
[22]

CONCLUSION

While there is no Antideficiency Act violation in the current facts, the Air
Force failed to commit funds for reasonably predictable cost overruns. We
pointed out as long ago as 1955 that when an obligation is recorded at the
target price, failure to reserve to reserve funds up to the ceiling price
exposes the contracting agency to the risk of an Antideficiency Act
violation. 34 Comp. Gen. 418 (1955). Moreover, the Air Force did not make
use of other opportunities to avoid termination of the Lot III contract by
taking effective, affirmative measures to manage costs or reduce quantities.

We trust the foregoing is helpful to you.

Sincerely yours,

Robert P. Murphy
General Counsel

B-255831 July 7, 1995

Digest

  1. The Air Force did not violate the Antideficiency Act when it terminated
     a fixed-price-incentive contract for lack of funds. Termination of a
     contract prior to incurring obligations in excess of funds available in
     the appropriation account prevents an Antideficiency Act violation.
  2. Projected cost overruns between the target and ceiling prices of a
     fixed-price-incentive contract are not de facto obligations. Until the
     contractor has a legal right to be paid for costs incurred, potential
     cost overruns are contingent liabilities.
  3. Air Force regulations permit a procuring entity to limit the initial
     obligation on a fixed-price-incentive contract to the target price.
     Regulations also require the procuring entity to commit funds to cover
     the expected cost of contract. Failure to follow those regulations on
     the advanced cruise missile contract for fiscal year 1987, where
     overruns were foreseeable, resulted in insufficient funds being
     available when needed to complete the contract at the ceiling price.

Notes

1. STRATEGIC MISSILES: Issues Regarding Advance Cruise Missile Program
Restructuring, GAO/NSIAD-94-145 (May 1994).

2. In August 1992, General Dynamics Convair Division was acquired by Hughes
Corporation. This opinion will refer to the contractor throughout as GD/C.

3. The definitized contract took effect on September 22, 1989, after
approval by the Assistant Secretary.

4. Deliveries did not resume until June 1990. This did not resolve all the
problems, however. The Air Force again found it necessary to suspend
deliveries, from April to October 1991. See STRATEGIC MISSILES: ACM Program,
Opportunity for Additional Savings, GAO/NSIAD-92-154 (Nov. 1992).

5. Report of Audit, Projects 94063015, Sept. 9, 1994.

6. Pub. L. No. 101-510, sect. 1405, 104 Stat. 1485, 1675, (1990).

7. See GAO/NSIAD-92-154, supra.

8. Memorandum from Sean O'Keefe to Assistant Secretary of the Air Force
(Financial Management and Comptroller), Mar. 31 1992,

9. A second stop work order was sent to McDonnell Douglas Corporation, which
had a contract as the second supplier of ACMs in FY 92.

10. Additional program restructuring reduced the number of missiles the Air
Force eventually acquired to 461. GAO/NSIAD-92-154, supra.

11. H.R. Rep. No. 530, 102d Cong., 2d Sess. 28.

12. See, e.g., Federal Acquisition Regulation, 48 C.F.R. sect. 32.703-1.

13. To the extent that deobligation of other funds in the account was
possible, that would also have prevented an Antideficiency Act violation in
the circumstances described. Deobligation, however, could have a negative
programmatic impact on the "donor" program or programs.

14. The Air Force was able to make use of the letter contract because, as
discussed earlier, it needed 120 missiles to reach the full missile
complement of 520, and had an FY 92 authorization and appropriation to buy
them.

15. In any event, the 3020 account balance of $25 million at the time of
termination would have been sufficient to cover the $7.6 million in
subcontract costs, had that become necessary.

16. Air Force Regulations 170-8, Accounting for Obligations, and 170-13,
Accounting for Commitments; DOD Instruction 7220.9-M, Standards for
Recording Commitments and Obligations.

17. This practice is also approved in the Federal Acquisition Regulation at
48 C.F.R. Part 32.703-1, and in the GAO Fiscal Policy and Procedures Manual
for the Guidance of Federal Agencies, title 7, sect. 3.4.C.

18. The directives and the manuals do not require an agency to commit the
full ceiling price in each instance. Instead, they require the officials to
use their best judgment of the amount of funds that will be needed, and they
encourage realistic estimates. An agency also has the option of obligating
the additional funds instead of committing them.

19. The contract was definitzed on September 12, 1989. At the end of the
prior month, there was enough money in account 3020 to cover the ceiling. By
the end of September, however, the unobligated account balance was only
$48.6 million, whereas the target/ceiling difference was $76 million, as we
reported in May 1994. The account balance on September 12 is not available.

20. Report of Audit, Project 94063015, Sept. 9, 1994.

21. For example, the Air Force did not convene a senior review team to
address contract and funding problems.

22. See 72 Comp. Gen. 343, 345 (1993).