You have to have some method. Why should it not be this same yardstick that you apply to the man who has a definite contract? Captain STRAUSS. The terms of a cost-plus-fixed-fee contract include the terms of settlement in the body of the contract. The CHAIRMAN. All of them do? Captain STRAUSs. That is my understanding. I have not examined all of them, naturally. I make that statement with some reservation. The CHAIRMAN. Are those terms more equitable to the contractor than these terms? Captain STRAUSS. They are not comparable because of the complete difference in the contract. The contractor in a cost-plus-fixed-fee con tract takes no risk whatever. The CHAIRMAN. He takes his time. Captain STRAUSS. But no financial risk. Admiral ROBINSON. But here is the trouble, Mr. Chairman. He is perfectly correct so far as a shipbuilder is concerned, but the shipbuilder has made contracts on a fixed price all over the United States. The CHAIRMAN. That is right. Admiral ROBINSON. Those contracts are going to have to be settled, and while it may be that the Government will want to have the fixedfee shipbuilders settle those contracts and then reimburse the shipbuilders for the amounts of the settlements, we may very well have to do the same thing there with those subcontractors that we do elsewhere. The CHAIRMAN. But, you see, his contract on his fixed fee is for delivering an article. If he has not delivered the article he cannot get the fee. Admiral ROBINSON. He will have to get partial payment. Let us take the General Electric Co., which is manufacturing turbines for the Orange Shipbuilding Co. If those turbines are twothirds built when the contract is canceled———— The CHAIRMAN. He will get two-thirds of his fee. Admiral ROBINSON. But I say there has to be a provision for doing that, and if we are going to make company-wide settlements, we certainly have to be able to settle those at the same time we do other obligations. The CHAIRMAN. I think so myself. I think something ought to provide for dealing with all phases of the contract. This would apply to a contract that has been awarded by competitive bidding? Lieutenant CALHOUN. Yes. The CHAIRMAN. This would apply to a contract where you bought an article at a fixed price; and that is all, under the language of the bill, that it applies to. Admiral ROBINSON. I think that is correct, and I think we ought to include some of these other things in there, because if we do not, it is going to be difficult to carry out the intent the people have in negotiating. Captain STRAUSS. I would like to ask the lawyers to speak to that point. Lieutenant SWIDLER. In the first place, a contract is defined in the bill to include cost-plus-fixed-fee contracts, so that all the provisions giving flexibility in making advance payments and settlement, and so forth, cover that type of contract. It is only in setting up the stand ards for settlement that there is a restriction to fixed-price supply contracts. In other words, this question arises only in section 6 of the bill. I have thought, and most of the others with whom I have discussed it have thought, that because the cost-plus contract usually contains special provisions and sets out the basis for termination settlements right in the body, because in effect the contractor is merely an agent of the United States and makes all of his commitments on behalf of the United States so that the Government is obligated to settle with his subcontractors for him, that because of those differences it would be safer to restrict this section to fixed-price supply contracts. But it is by no means an open-and-shut proposition, and if Admiral Robinson feels differently, there would be no objection to making the change. The CHAIRMAN. Your point is well taken, because the Government is paying all the costs on a fixed-fee contract. It pays everything and it is audited by the Navy, and the manufacturer is practically acting as an agent for the Government and merely getting a fee, a commission, for doing that work. So you have nothing involved in it except the fee which the man is earning for acting as agent for the Govern ment. Lieutenant SwIDLER. Expenditures must be approved in advance under these contracts. The CHAIRMAN. Therefore, of course, if he has a fee to do certain. things and he does 85 percent of them, he will not get a 100-percent payment. He would get only the proportionate fee which he has actually earned, and all of the cost of material, the labor, and the plant facilities and all are already being paid for by the Government. Admiral ROBINSON. There is no trouble, Mr. Chairman, with the fixed-fee contractor. That is easy. That is taken care of in the contract. But it is his subcontractors. The CHAIRMAN. But the Government pays the subcontractors. Let us take this case: The Government has a contract, we will say, with the American Aluminum Co., and they are going to make aluminum sheets, and they are paid a fee to do so. The Government buys everything that goes into that plant and the Government furnishes it all. The Government pays for it all, so it does not make a particle of difference whether the Aluminum Co. has subcontractors to furnish that material to the Aluminum Co., because they are going to be paid, not by the Aluminum Co. when the material comes in, but by the Government, because the Government is having the Aluminum Co. manufacture the article for it, and for their management services the Government gives the Aluminum Co. a fee. Admiral ROBINSON. But the contracts are actually made, Mr. Chairman, by the company. The subcontract is between the General Electric Co. and the Consolidated Steel Co. The CHAIRMAN. Who sees that they are paid now? Suppose that the company went into bankruptcy. Then the Government would pay those subcontractors for furnishing that material to whom? To the Government, through the Aluminum Co. Admiral ROBINSON. The question of what would be done in case of bankruptcy is arguable, but of course there is no question of bankruptcy involved here. The CHAIRMAN. There is no doubt that every subcontractor on a fixed-fee contract looks ultimately to the Government, if it becomes necessary, to get his money. Admiral ROBINSON. But somebody has to negotiate the settlement of that contract. The CHAIRMAN. The Bureau of Supplies and Accounts in the Navy Department looks to that. Mr. COLE. Who is going to settle the account of the prime contractor with his subcontractors for damages incurred by a subcontractor by reason of the sudden termination of the contract? Admiral ROBINSON. That is the point, exactly. Captain STRAUSS. I think that what might be done is to insert language which would include within the purview of this act subcontractors with fixed-price subcontracts under prime contractors who have cost-plus-fixed-fee contracts with the Government. Lieutenant SWIDLER. I did not get Admiral Robinson's suggestion at first, that he was concerned with the fixed-price subcontractor under cost-plus prime contracts. The point can be taken care of by striking the words "under such contracts" in line 5 on page 7. "Such contracts" now might be taken to refer only to fixed-price supply contracts. If you struck these words you would leave no doubt that fixed-price subcontracts under any type of contract were covered. The CHAIRMAN (reading): (b) In establishing, pursuant to subsection (a), the standards, methods, and bases for negotiating with respect to and for settling claims of prime contractors under fixed-price supply contracts, other than contracts under which the purchaser is not obligated to accept articles or services except as he may need or desire, and in establishing standards, methods, and bases for approving, ratifying, authorizing, or settling claims of subcontractors under Lieutenant SWIDLER. That is the place. Leave out the "under such contracts." The only thing that that does not take care of, it does not now exclude the case of the open-end contract, but that can be taken care of very simply. Mr. COLE. I am afraid it might be argued that that second clause, relating solely to subcontractors, might throw it back into the type of prime contractor set forth in the first clause. Lieutenant CALHOUN. It would clarify it if you would say, "whether under cost-plus contracts or fixed-fee." Lieutenant SWIDLER. It is a simple change. The CHAIRMAN. All right; page 7, line 12. [Reading:] (1) Full payment at the contract price shall be allowed for all completed items accepted by the Navy Department. For everything that is finished you give him 100 percent, which includes profit and everything. You pay him for what he has done. Captain STRAUSS. That is right. The CHAIRMAN (reading): (2) Cost of all work done and all materials acquired for the performance of the contract shall be allowed, less approprite adjustments for materials retained by the contractor. Then all the work that he has done and all the materials he acquired for the performance of the contract shall be allowed? Captain STRAUSS. We may make some deduction by selling him some of the material. The CHAIRMAN. That is right, exactly. [Reading:] (3) Salaries shall be allowed on a basis consistent with the policies of the Bureau of Internal Revenue for income-tax purposes. Then, against the cost of the article, he is permitted to charge the same salary fixed by the Internal Revenue Act, which I think under Treasury decision is now fixed at $25,000. Captain STRAUSS. That is my understanding. The CHAIRMAN (reading): (4) The cost of settling and paying claims of subcontractors shall be allowed. If he has paid any subcontractor he has subrogated to himself the claim of the subcontractor and he is reimbursed. Captain STRAUSS. That refers, as I understand it, to costs incurred by the prime contractor in connection with the settling and paying the claims of subcontractors, rather than to the costs of the sub contractors. The CHAIRMAN. What do you classify as the costs of settling? Captain STRAUSS. He may have to have accountants; he may have to have lawyers, in that connection. The CHAIRMAN. Oh, yes; that is just to get up the facts. Captain STRAUSS. He may have litigation with the subcontractor. Mr. GRANT. Will you go back to the prime contractor and look into the reasonableness of the terms of the subcontracts? Captain STRAUSS. We expect to look into the settlements with subcontractors, because in the case of many prime contractors that will be the bulk of their claim. If we settled them without looking at the subcontractor's claim at all, we would be settling with our eyes shut. Mr. GRANT. Where are you going to draw the line in that long chain of sub-sub-sub-subcontracts? Captain STRAUSS. We will have to draw a line in practice three or four tiers down unless it so happens that the very largest one of the claims is at the bottom, or close to the bottom. In other words, good business judgment will be exercised. If it finally splits down into little five- and ten-thousand-dollar items, we will not follow those down. The CHAIRMAN (reading): (5) Advertising expense shall be allowed to the extent consistent with the pre-war program of the contractor, but not in excess of such an amount as may be reasonable under the circumstances. Mr. COLE. Consistent with what pre-war program? Lieutenant CALHOUN. Yes; add the word "advertising." Captain STRAUSS. That should be implicit, but I think it would be well to spell it out. The CHAIRMAN (reading): (6) Depreciation, amortization, and obsolescence shall be allowed on bases consistent with those allowed by the Bureau of Internal Revenue for incometax purposes. That is all right. [Continues reading:] (7) General experimental and research expense shall be allowed to the extent consistent with the established pre-war program of the contractor, or to the extent related to war purposes. Now, when you say that latter there, "to the extent related to war purposes," you got into a field there that is very broad. Captain STRAUSS. In some cases we have encouraged contractors to engage in fields of research and experiment totally foreign to their business and to their pre-war business. The CHAIRMAN. But does it have any relation to the war effort? Captain STRAUSS. It has a relation to a product which they are now manufacturing for the war, but unfortunately I cannot go into particulars without going into classified examples. The CHAIRMAN. We can all visualize a great many of these companies. Right in that connection you are going to find this. You are going to find that the research is going to be very high on a great many things, and there has always been some limitation put by somebody on the amount of research that can be charged against the cost of an article. Captain STRAUSS. All of this is limited, in that it is only to the extent properly allocable to the contract. That is to say, if we had a contract with a man for guns, and he carried on research into radar, that would not be allocable. The CHAIRMAN. I understand that, but at the same time he could have such a high staff of research engineers that it would make your price 'way out of line as to what should be the true cost of it. Sometimes some of these directors and presidents might be research men themselves. That opens up the broadest latitude, to use a somewhat ugly expression, for somewhat padding claims. Captain STRAUSS. But you have as your insurance against that, Mr. Chairman, the contracting officer, who is familiar with that item and the research that should be compatible with its development, and a review board in the bureau which is familiar with it. The CHAIRMAN. Yes; I know; but you are fixing the cost of the article. These are the things that can be fixed into the cost of the article, you say, all those factors? Captain STRAUSS. Yes. The CHAIRMAN. Is there not some rule-I know this question has been up quite frequently-in the Internal Revenue Bureau about how much is allowed on the cost of an article for experimental research work? Admiral ROBINSON. You are thinking of TD-5000 now. There is some mention of it in there, Mr. Chairman, but I do not recall now. It is not a limitation in dollars; it is covered in general terms, but I do not recall them. Unfortunately it has been 4 or 5 years since I have seen it. (A discussion was had off the record.) Captain STRAUSS. The limiting words are "to the extent consistent with," and any development research expense that was inconsistent with the product would not be included. Mr. COLE. If we are going to follow the same pattern set in the other one with regard to advertising, in line 6, at the beginning of the line, we should insert "experimental and research." Lieutenant CALHOUN. Yes, sir. Mr. COLE. Are we adopting amendments as we go along? Mr. COLE. Then go gack to page 7, line 10. |