In a January 4, 2017 Memorandum, the Under Secretary of Defense for Acquisition, Technology and Logistics (“Under Secretary”), discussed implementation of a problematic DFARS rule issued on November 4, 2016, requiring “major contractors” to engage in a “technical interchange” with a DoD employee before IR&D costs are generated as a prerequisite for the allowability of such costs (“IR&D Rule”). The Memorandum effectively recognizes that issues with the IR&D Rule are more significant than DoD previously acknowledged. However, although the Memorandum addresses certain issues arising out of the IR&D Rule, it remains to be seen whether contractors will encounter different types of problems as the Rule is implemented.

The IR&D Rule requires major contractors, for IR&D projects initiated in the contractor’s fiscal year 2017 and later, to engage in a “technical interchange with a technical or operational DoD Government employee before IR&D costs are generated so that contractor plans and goals for IR&D projects benefit from the awareness of and feedback by a DoD Government employee who is informed of ongoing and future potential interest opportunities,” as a prerequisite for the subsequent determination of allowability. “Major contractors” are those whose covered segments allocated a total of more than $11,000,000 in IR&D and B&P costs to covered contracts during the preceding fiscal year.

DoD issued an earlier version of the IR&D Rule on February 16, 2016, as a proposed rule. The proposed rule generated several issues, such as the fact that DoD did not define the term “feedback,” which raised the question of whether DoD approval of proposed IR&D costs was required. Also, there was no requirement for DoD to provide “feedback” within a certain time period, thus raising the possibility that DoD could materially delay a contractor’s pursuit of IR&D projects. As another example, IR&D costs are supposed to be “independent” – 10 U.S.C. § 2372(f) states that regulations governing DoD’s payment of IR&D and B&P costs “may not include provisions that would infringe on the independence of a contractor to choose which technologies to pursue in its independent research and development program.” Understandably, DoD received several comments on the proposed rule, including comments from the ABA’s Public Contract Law Section.

Notwithstanding the material issues raised by the proposed rule, DoD made only two changes when it issued the final IR&D Rule: DoD (1) eliminated a requirement to include a “summary of results” in reporting IR&D projects, and (2) identified the Office of the Assistant Secretary of Defense for Research and Engineering as a resource for contractors who do not have a point of contact for the technical interchange. The substance of the technical interchange requirement remained the same. In issuing the final IR&D Rule, DoD attempted to downplay the impact of the Rule, stating, for example, that the rule “merely requires reporting of the name of the technical or operational DoD Government employee and the date of the technical interchange,” and also stating that “the impact of this rule on the contractor’s reporting burden is negligible.” The ABA’s Public Contract Law Section noted that the proposed rule “appears to be inconsistent with the longstanding policy that the Government should not direct contractor IR&D projects, which is embodied in 10 U.S.C. § 2372(f).” DoD indicated that a number of respondents stated that the rule is “in violation of existing statute.” Yet, in response, DoD avoided the critical provision at 10 U.S.C. § 2372(f), and instead claimed that the Rule is “consistent with 10 U.S.C. 2372 subsection (a), Regulations, which states that the Secretary of Defense shall prescribe regulations governing the payment, by [DoD], of” IR&D and B&P costs.

Despite issuing the final IR&D Rule with commentary that attempts to downplay the impact of the Rule, DoD now appears to recognize that the issues with the Rule are more significant than it previously acknowledged. Last week, the Under Secretary issued the January 4, 2017 Memorandum concerning “[i]mplementation” of the IR&D Rule. The first paragraph states that on December 1, 2016 – after issuance of the final IR&D Rule – DoD issued a “Class Deviation to address industry concerns that the required technical exchanges occur before costs are generated for IR&D projects.” The Class Deviation, which is Enclosure 1 to the Under Secretary’s Memorandum, “alleviates the requirement that the technical interchanges occur before costs are generated for IR&D projects initiated in a contractor’s Fiscal Year 2017 so as to afford contractor’s a phase-in period to develop processes and procedures.”

The Memorandum also addresses certain logistical issues, stating that while face-to-face discussions are the preferred approach for the technical interchange, the interchange may be accomplished by alternate means. In addition, the Memorandum states that for companies that may not have access to an informed DoD official “with which to discuss their project, we are developing an additional approach using the existing IR&D database hosted in the Defense Innovation Marketplace,” and that by January 31, 2017, DoD will implement an electronic process to facilitate this approach.

The Under Secretary is aware of the issue of contractor independence. He states that the DoD employee “may provide feedback on relevance to DoD missions, but in no case has the authority to stop the project. The DoD Government employee will not issue any official declaration stating whether any project should or should not be pursued and/or whether project costs are reimbursable or that they should be declined.” This raises the question of whether the DoD employee will issue an “unofficial declaration stating whether any project should or should not be pursued and/or whether project costs are reimbursable or that they should be declined,” and whether the DoD employee will use any means to influence a contractor’s decisions concerning what IR&D projects to pursue. The Under Secretary also states: “I want to emphasize that this is a requirement on industry to communicate its IR&D plans to some relevant Government individual and record that this has been done. There is no Government approval required or expected.” This is a welcome clarification of the term “feedback.”

However, it remains to be seen whether other aspects of the Rule will pose problems for contractors. For example, while the Rule includes a website for contractors that do not have a point of contact for the technical interchange, access to the website does not guarantee that DoD will always engage in the technical interchange in a timely fashion. This raises the possibility that contractors could experience material delays in pursuing IR&D projects, which in turn could influence business decisions about such projects. Also, the Rule states that the technical interchange will be with a DoD employee “who is informed of related ongoing and future potential opportunities.” This suggests the possibility that the DoD employee will discuss ongoing or future efforts of other contractors; even if the other contractors are not specifically named, this possibility raises concerns about disclosing proprietary efforts of competitors. In addition, the Rule does not explain how contractors will receive “feedback” in a fair or equitable manner – for example, DoD may provide an inordinate amount of information to one contractor that provides a competitive advantage. Finally, while the Under Secretary’s Memorandum recognizes the issue of contractor independence, and provides some language attempting to address that issue, there can be no question that DoD seeks to influence contractor IR&D efforts through technical interchanges. The Under Secretary indicates that the intent of the Rule includes providing “industry with some feedback on the relevance of proposed IR&D work,” a point that is made repeatedly in the commentary accompanying the final Rule.