Cost Sharing Insights – section 2371 | Other Transactions

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     One of the areas of confusion and misunderstanding concerning Other Transactions (OTs) that has greatly limited use of section 2371 OTs is “cost sharing” a term not used in the OT statutes. Always remember the first principle of interpreting the OT statutes: “OTs are FAR out.” Do not attempt to apply Federal Acquisition Regulation concepts and rules to OT cost sharing, a better term is probably joint funding. There are two different joint funding regimes. One applies to science and technology OTs (10 U.S.C. 2371) and the other applies to prototype OTs (10 U.S.C. 2371b, the former section 845). Section 2371 is discussed here.

    The operative statutory language for 2371 is “to the extent that the Secretary determines practicable, the funds provided by the Government under…a transaction authorized by subsection (a) do not exceed the total amount provided by other parties…” First thing to note is that the determination that must be made is a determination that it is practicable for funding by the Government to be limited to no more than funding by other parties. This is not an absolute tilt in favor of cost sharing but requires a determination that joint funding makes sense and will not preclude or harm project execution. Additionally “practicable” in 10 USC 2371 (e) (1) (B) is to be distinguished from “maximum extent practicable” in (e) (1) (A). Clearly “practicable” applicable to joint funding is a lesser standard than “maximum extent practicable.” It is a common sense determination. Projects that are truly dual-use with financially sound performers will typically meet the practicability standard. Projects with strong military potential but limited commercial potential will not. For example, DOD’s 2017 Guide for OT Prototype Projects states that cost sharing is not appropriate for defense unique items (C2.16). Projects with venture capital supported firms or other organizations with limited financial backing are also not good candidates for joint funding.

    Questions flow from other words of the statute. For example, “other parties” do not have to be parties engaged in project performance. Third parties can finance projects. What does “total amount” mean? Again – “OTs are FAR out.” Obviously if the joint funding is going to performers other than a party to the agreement, i.e., subcontractors, then cash payments of the government and non-government parties are matched on an agreed ratio. However, often the non-government party to the agreement will be both joint funder and performer. One methodology would estimate the government’s outlay to the performer if the entire project was funded by the government. That would be performer’s fully burdened cost including things such as normal profit and overhead based on the performer’s established method of accounting for costs. Half, or other agreed ratio, of that amount would be non-government party’s share meeting the statutory standard. This is not to rule out other methodologies but to emphasize that traditional government (FAR) approaches to cost sharing are not what 2371 (e) (1) (B) contemplates. Moreover, the fact that performer actually directs all assets to project performance and does not sequester any of its own or government funds as profit, the preferred practice, does not undercut the validity of this methodology. Remember (e)(1)(B) requires an affirmative determination that joint funding is practicable rather than a finding that it is not practicable.

    But just what is “practicable”? The enactment of science and technology (S&T) “other transaction” authority contemplated a scenario in which elements of the Department of Defense would fully understand the power of the commercial market place and a dual-use approach to technology development would become DOD’s default position for S&T. This informs practicability to a great extent. But…is not the whole answer.

    A little history: the very first DOD OT was a DARPA agreement with Gazelle Microcircuits concerning gallium arsenide communication devices. The agreement was not jointly funded but provided a fixed amount to continue on-going work. Gazelle was a firm entirely supported by venture capital (VC) investment and had no source of revenue from sales of product or otherwise. VC investment had reduced the risk involved in the technology development but scale up funding was needed to speed product to market and address DOD-specific needs. Cost sharing was not deemed practicable in these circumstances. As the first OT agreement the Gazelle transaction was reviewed by Congress in a hearing by the Senate Armed Services Committee. Deputy Secretary of Defense Donald Atwood stated unequivocally that DOD approved and supported the Gazelle agreement. The project resulted in radiation hardened, high performance communication devices going into a number of operational DOD systems.

    The very first section 2371 OT agreement did not incorporate any cost sharing. Relevant questions include: (1) is there strong commercial potential or is the military market the primary beneficiary, (2) is the performer technically capable but not financially positioned to enter into 50/50 or other joint funding, (3) has previous non-government investment provided DOD an opportunity to accelerate and guide the technology to its advantage. In short, if the project is important to DOD (if not, why is DOD involved?) then does joint funding help or hinder executing the project. Most dual-use projects with strong potential market acceptance in both the military and commercial world will benefit from joint funding (resource stacking) and absent circumstances like the Gazelle agreement (VC funded, no revenue stream from product) joint funding will be practicable. In cases of a technically strong but financially weak performer or where there is little or no potential commercial pay-off requiring a financial contribution from the performer is not practicable. Summary – if joint funding helps the project, it is practicable; if it impedes the success of the project, it is not practicable.

    The principles discussed apply to multi-party or consortia arrangements as well as individual projects. For consortia aimed at defense unique or defense dominant technologies joint funding by non-government parties should be deemed not practicable or reduced below 50/50. The determination should be made at the level of parties in privity of contract, that is, between government and consortium and not necessarily for each individual sub-contracted project if the consortium is organized so that some or all performance is sub-contracted.

    DOD regulations on this subject are of limited help. They apply only to a fraction of 2371 projects. Regulatory guidance is as much confusing as elucidating. Fortunately it does not apply to most OTs, only those used for assistance with certain IP provisions (specifically only “TIAs”, DODGARS Part 37). A future discussion will highlight joint funding in the context of prototype projects (section 2371b) and discuss the cost principle at FAR 31.205-18 (e).    

Written by Richard L. Dunn

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