Federal contractors who participate, or have subcontractors who participate, in the Paycheck Protection Program must critically consider what the funds mean to them. While the program poses challenges for commercial entities as well, federal contractors must contend with different and additional complexities, specifically in determining what PPP funds mean to their existing and future contracts. The dominant question most contractors are asking themselves is, “Do I owe the U.S. government a credit if the loan is forgiven?”
Qualification: It is important to acknowledge up front that a loan must actually be forgiven for a credit to be applicable to a contract. The earliest a contractor can expect a loan to be forgiven appears to be July. We expect the U.S. government to provide further information prior to a contractor administering a credit. With that in mind, this overview is preparatory in nature. Further information leading up to an actual forgiveness event will dictate final interpretation and administration of applicable credits, to the extent they apply.
Current guidance
While facts and interpretations are evolving in real time, one thing is clear: According to the Office of Management and Budget’s guidance published April 17, 2020 (and updated April 24), the U.S. government believes it is entitled to a credit to the extent you participate in contracts subject to Federal Acquisition Regulation part 31. See Q&A from that guidance below:
“Q23: Please confirm that neither the FAR Credits provision, FAR 31.201-5, the credit provision in the Allowable Cost and Payment Clause, FAR 52.216- 7(h)(2), nor any other FAR or DFARS provision imposes an obligation on a contractor to credit any amount of a Payroll Protection Program (PPP) loan that is forgiven to any flexibly priced government contract or subcontract. We consider a contractor that has received a PPP loan will use the loan proceeds as it would any other funds in its corporate treasury to pay costs of doing business.
A23: We disagree, any PPP loan that has been forgiven necessarily can be treated as though it belongs to the company to use as it pleases. FAR 31.201-1, Composition of Total Cost, states that total cost is the sum of the direct and indirect costs allocable to the contract less any allocable credits. Accordingly, to the extent that PPP credits are allocable to costs allowed under a contract, the Government should receive a credit or a reduction in billing for any PPP loans or loan payments that are forgiven. Furthermore, any reimbursements, tax credits, etc. from whatever source that contractors receive for any COVID-19 Paid Leave costs should be treated in a similar manner and disclosed to the government.”
While there may be alternative industry interpretations, we cannot ignore the federal government’s position. This current position seems fairly clear that credits will apply to contracts where FAR 31 applies. That could occur in two types of contracts: those in which certification of cost and pricing is required, and flexibly-priced contracts.
The question then becomes how to administer a credit for these contracts. Let’s address each type of contract separately.
1. Contracts in which certification of cost and pricing is required
The Q&A did not separately address contract types. The question specifically asked about flexibly-priced contracts. However, the FAR 31.201-5 Credits cost principle also applies to contracts where certified cost or pricing is required, which includes fixed-price contracts. Accordingly, there should be consideration for credits in open negotiations or pricing actions subject to FAR Part 15 certified cost or pricing data that requires the disclosure of all facts that may reasonably be expected to significantly affect price negotiations. So it is our recommendation for contractors to disclose to their U.S. government customers during price negotiations that PPP funds have been received, as this is factual information. There are judgmental factors involved as to whether the loan will be forgiven, but the acceptance of PPP funds, at minimum, should be disclosed in order to satisfy required disclosure of “any facts that, as of the date of price agreement, or if applicable, an earlier date agreed upon between the parties that is as close as practicable to the date of agreement on price, prudent buyers and sellers would reasonably expect to affect price negotiations significantly. (FAR 2, definition of cost or pricing data).” FAR Part 15 should be adequate to protect the government’s price point with regards to PPP funds, as long as it is disclosed for negotiation during the time in which it has occurred.
If its loan is forgiven, a contractor should evaluate the effect on pricing actions for this year. That could include a change to labor rates, forward pricing rates, or simply, disclosure to the government. These decisions should be made with the objective of disclosure, at minimum, further guided by materiality and equitability to your unique contract mix.
2. Flexibly-priced contracts
For flexibly-priced contracts where the federal government (or your prime contractor) requires settlement to actual costs, the credits cost principle is more complicated. The primary contracts affected will be cost-reimbursement contracts, given the labor portion of time and materials (T&M) contracts would be fixed at the point of contract award. The materials portion, to the extent it participates in indirect cost absorption, is the portion of T&M contracts that may require adjustment.
The complexity is in determining what portion of credit the government is due. Clearly, it is not due the entire portion of the forgiven loan. But what portion is it due? There are a variety of variables, including:
- Employees who earn more than $100K in annual salary (the PPP compensation cap)
- $10 million PPP loan threshold
- Labor performed related to unallowable activities in accordance with FAR Part 31
- Traceability of expended funds to specific personnel
- Contract mix
- Labor distribution
Upfront, we must consider whether to apply the credits to direct costs or to indirect cost pools, or perhaps both. The credits cost principle, of course, did not contemplate the concept of PPP loan forgiveness. That provides opportunity for varied interpretation and application.
Applying loan forgiveness credits to direct costs may be too complex, as it would require contractors to trace and monitor PPP loan funds to specific final cost objectives and direct cost elements. While there is a nexus to allowable cost (as required by the credits cost principle definition), it is likely not specific enough to tie how loan costs were used to a final cost objective (e.g., as there would be if a net 30 discount was taken for a direct cost in a simple example). So unless your contracting portfolio is simple enough to accommodate this practice (e.g., a single cost-reimbursement contract makes up your entire business), it is going to be difficult to refund PPP loan forgiveness via direct cost credits—at least in their entirety.
A more practical, but potentially inequitable, approach would be via a credit to the indirect cost pool. This may be practical for some contractors depending on how equitable the results are to their contract mix. The other alternative may be a hybrid approach executed through the annual indirect cost rate proposal. At the point of preparing the indirect cost rate proposal, a contractor will have had the benefit of knowing the true effects to its contract mix and should have sufficient information to come up with an equitable, auditable approach. Addressing complex cost accounting matters from a retroactive perspective has recent precedent with the so-called “blended rate” approach many contractors used to resolve the variety of statutory and agency compensation caps. Please note with that approach, it was required that contractors receive an advance agreement with their contracting officer, so that may be coming here, too.
The effects and solutions may not be one-size-fits-all. As with all things in cost-type contracts, we expect “equitable” to be the prevailing word when settling how the government participates in the potential loan forgiveness credit.
Consideration of competing COVID-19 relief efforts
Contractors must also consider whether they are participating in other COVID-19 relief efforts pursuant to the CARES Act, such as negotiated equitable adjustments for personnel pursuant to section 3610. Contractors must be sure to avoid any perception of double-dipping in these programs. It is anticipated that oversight committees will be strict about reviewing these programs. Documentation on how a contractor has participated in each and every program will be critical to ensuring adequate and compliant support for downstream oversight interests.
Conclusion
While we wait for and expect more information on the government’s position on the matter, we recommend:
- Disclosing to the government and/or prime that you received PPP funds as part of cost or pricing packages for which you will be required to certify cost or pricing
- Engaging your subcontractors to understand their participation in PPP and its potential effects on your contracts
- Setting expectations in your organization for having to credit some portion of a forgiven PPP loan back to the government in proportional share to your cost-type work
- Maintaining documentation at the lowest-level of detail practical for how and where PPP funds were used
It would be a welcome surprise for the government to change its position on having to treat PPP loan forgiveness dollars as credits. There is a position emerging among some contractors that treating the loan as a credit is inconsistent relative to the commercial world. Forgiven loan dollars provided to commercial entities will simply show up as “other income” and go right to their bottom-line. Why should cost type contractors (which include research and development contractors fighting for a cure for COVID-19) be treated differently? It’s a fair point, but one we would not expect to prevail; or if it does, not before court hearings years down the road.
