Cross Charging/Cost Shifting

There are two basic types of defense contracts. A “fixed price” contract involves a fixed amount of compensation to produce a certain item or provide a service, regardless of cost. The most obvious benefit to this type of arrangement is that it allows the buyer to contractually set a budget. Since both parties know the allotted budget before work begins, there should be no sticker shock at the end.

By contrast, a “cost-plus” contract pays the cost to produce the item, and then an additional amount as profit. Cost-plus contracts were designed as a way to incentivize large American companies to produce wartime materials in the 1940s. A cost-plus contract is especially useful in cases where the item purchased cannot be explicitly defined or when it is impossible to calculate an estimated cost. This arrangement effectively shifts some of the risk of the contract from the contractor to the buyer. In the context of defense contracts, they are therefore highly desirable.

The combination of these contracts creates the incentive to illegally switch some costs on a fixed price contract over to the cost-plus contract. This may be desirable to a company if it goes over the allotted budget of a fixed price contract. In that case the company would tell its employees to bill work on the fixed price contract to a cost-plus project. This artificially increase the amount of money received on the cost-plus contract. This deceptive practice causes the government to pay more money to defense contractors based on fraudulent billing procedures and violates the FCA. It is also the reason why cross-charging is one of the most common types of defense procurement fraud.

A simpler version of cross-charging involves improper costs allocation. If a contractor has many commercial contracts and government contracts together, he or she might attempt to shift the costs from the commercial accounts to the government account. This kind of fraud is especially likely where a contractor incurs significant overhead costs from commercial contracts. If the contractor has a cost-plus contract with the government, he or she might attempt to defraud the government into reimbursing those costs. Cost shifting also allows a defense contractor who has an existing cost-plus government contract to submit an artificially low bid for a commercial contract, since the contractor intends to make up the difference from the government contract.

Example

Parker Hannifin Corporation, a major defense contractor, settled an FCA case for $7.8 million to resolve allegations that it had improperly charged government contracts. The company had many simultaneous contracts with the government, some being “fixed price.” Instead of allocating charges directly to the appropriate fixed price contracts, the company allocated the costs as shared costs spread around all of the company’s contracts. This fraudulent billing practice inflated the price the government paid on about 70 contracts, a total cost to the government of over $2 million.

Example

In 2003, TRW Inc. (a subsidiary of Northrop Grumman Corp.) agreed to pay $111.2 million to settle False Claims Act allegations against it. The government alleged that TRW illegally cross-charged expenses from its commercial operations onto its accounts with the U.S. government. The relator was awarded $27.2 million.