The required "Patents" clause provides as follows:46

(a) For the purpose of determining the rights of the Government and the Contractor in and to inventions, the Contractor agrees to be bound by all of the provisions of Executive Order 10096, dated 23 January 1950, and any orders, rules, regulations, or the like issued thereunder.

(b) The Contractor shall: (i) make written disclosure promptly to the Contracting Officer of all inventions of the Contractor which are conceived or first reduced to practice during the term of this contract, and sign and execute all papers necessary for conveying to the Government the rights to which the Government is entitled in accordance with the determination made under the provisions of Executive Order 10096, or (ii) certify to the Contracting Officer that, to the best of the Contractor's knowledge and belief, no inventions have been conceived or first reduced to practice during the term of this contract. 15. Patent royalties. Because of the large numbers of research, developmental and experimental contracts and projects sponsored by the Government, it has received licenses under large numbers of patents. The Government, in procuring supplies may pay, as part of the contract price, patent royalties which the contractor is remitting to the patent owner. Because this is anomalous in the case. where the Government already holds a license to the patent, all contracts in excess of $10,000* are required to contain a "Reporting of Royalties" clause which obligates the contractor to report to the agency concerned the names and addresses of licensors to whom royalty payments of more than $250 have been paid or are to be paid, an identification of the patent or patent application under which the royalty is paid, and certain other information.48 The possession of such information enables the Government to eliminate improper payments (ie., where it has a license). In addition, it enables the Government better to negotiate agreements for the voluntary reduction of excessive royalties.49

40 ASPR 9-108 (Dec 1953). Upon written request by the prospective contractor and approval by the head of the procuring activity or his authorized representative, the clause may be modified or omitted, as the case may be, where (1) the period of employment is to be not more than 90 days in any one calendar year, or (2) both the following conditions are present: (1) the period of employment called for in the contract, or in any renewal thereof, is more than 90 days but not more than one year of full-time service, and (11) the prospective contractor is bound by an obligation which existed prior to entering into the proposed contract with the Government and which was not entered into in contemplation thereof, the discharge of which would be inconsistent with the discharge of any obligation arising under Executive Order 10096. ASPR 7-503.9 (1 July 1960).

47 ASPR 9-110 (a) (April 1959). See also, ASPR 7-104 (1 July 1960) and 7-204 (1 July 1960). This clause need not be inserted in contracts for research, developmental, or experimental work which call for only the delivery of a report or reports to the Government. In contracts which call for work to be performed outside the United States, its possessions or Puerto Rico (regardless of place of delivery), the "Reporting of Royalties" clause found in ASPR 9-110(b) (Jan 1958) is required to be inserted instead of the ASPR 9-110 (a) clause.

48 The text of the clause is found in ASPR 9-110 (a) (Apr 1959). 49 ASPR 9-110, 9-111 (1 July 1960).

CHAPTER 12

GOVERNMENT ASSISTANCE AND PRIVATE ECONOMIC ORGANIZATION FOR DEFENSE

1. Introduction. The voluminous defense requirements of the United States,1 while beneficial to the economy as a whole, severely strain the capacity and ingenuity of private producers who undertake to satisfy them. The complexity of military technology and its dependence upon specialized property, know-how and continuing research and development necessarily reduce the number of producers who are able to perform. Further, the unusual business risks which inhere in the inconstancy of defense procurement make otherwise capable producers unwilling to perform Government contracts unless these risks can be reduced and a fair profit assured. This is paradoxical since an underlying procurement goal is maximum competition and a broad distribution of Government work. To the extent that private producers are unable or unwilling to perform defense contracts the benefits in price and quality which the Government obtains from maximum competition are decreased. The net effect of this may be a few contractors performing a large percentage of defense contracts with a minimum distribution of work to small business. But of equal importance, the capacity of industry to develop,

1 Spending for national security is between $40 and $45 billion a year, or approximately 10% of the gross national product. The largest part of the $25 billion spent by the Department of Defense in fiscal year 1959 was used for research and development and the production of complex military weapons and equipment which had no commercial counterpart. DEPARTMENT OF DEFENSE, PROCUREMENT PRESENTATION TO THE PROCUREMENT SUBCOMMITTEE OF THE COMMITTEE ON ARMED SERVICES, UNITED STATES SENATE 1-2 (1960). See also, Weidenbaum, The Timing of the Economic Impact of Government Spending, 12 NAT'L TAX J. 79 (1959); Novick & Springer, Economics of Defense Procurement and Small Business, 24 LAW & CONTEMP. PROB. 118 (1959).

See e.g., Armed Services Procurement Act, 10 U.S.C. Sec. 2305 (1958) (formal advertising requirement); Small Business Act, 72 Stat. 384 (1958), 15 U.S.C. Sec. 631(a) (1958): "The essence of the American economic system of private enterprise is free competition. . . . The preservation and expansion of such competition is basic not only to the economic well-being but to the security of this Nation...."

The general trend toward business concentration is clearly reflected in defense procurement. In fiscal year 1959, 73.8% of the total dollar volume of defense prime contracts over $10,000 was shared by 100 contractors and 21% of the total dollar volume was awarded to but 4 contractors. See Wall Street Journal, January 14, 1960, p. 15, col. 6. This situation has been severely criticized. See Hamilton, The Politics of Industry 21-22 (1957):

The military has exhibited a preference to deal with the few rather than the many; it has shown reluctance to break down a large order which can be filled only by a giant concern into a series of smaller orders which will invite independents to bid. Thus the military, with an eye solely to defense, gives impact to the trend toward concentration.

...

See also, Rosebluth, The Trend in Concentration and its Implications for Small Business, 24 Law & Contemp. Prob. 192 (1959).

manufacture and deliver superior weapons in the event of world war III may be jeopardized. A basic purpose of Government assistance, therefore, is to facilitate defense production by increasing the number of prime contractors and subcontractors who are willing and able to satisfy the Government's needs. The nature and effectiveness of this assistance is the subject of this article.

I. Type of Contract: Profit and Risk

2. Fixed-price contracts. Standardized or well defined products with predictable costs are procured by the Government through formal advertising. Competition among qualified bidders insures realistic pricing and the nature of the item purchased minimizes business risks. Since no special incentives are needed to attract bidders, the Government is more concerned with whether the successful contractor receives an excessive profit than with whether the profit margin is fair. In much defense procurement, however, changing requirements mitigate against standardization and cost certainty. The Government is actually buying services and techniques rather than well defined products. These needs both limit the pool of available contractors and increase the business risks of those to whom contracts are awarded. Consequently, the Government must maintain the attractiveness of defense procurement by insuring a fair profit to contractors. This can be accomplished by minimizing or eliminating certain business risks through the use of a proper type of contract' or appropriate contract clauses.

A few illustrations are appropriate. If a negotiated fixed-price contract is used where production costs are uncertain, price flexibility is maintained by price redetermination provisions. By this tech

The difficulties encountered in mobilizing for World War II are discussed in Smith, U.S. Army In World War II; The Army And Economic Mobilization (Office of the Chief of Military History, Department of the Army, 1959).

In the interest of lower prices, the Government will absorb certain risks in the performance of advertised fixed-price contracts. See ASPR 8-707 (c) (Sep 1958) (contractor excused from excess costs of repurchase if default due to causes beyond control and without fault or negligence); ASPR 3-403.2 (price escalation protects against labor or market instability). The values of widespread competition and equal treatment to all bidders are thought to justify formal advertising despite administrative complexity and expense. See Department of Defense, Procurement Presentation, op. cit. supra note

1, at 18. Unless otherwise indicated, all ASPR dates are 1 July 1960.

•The termination date of the Renegotiation Act, 65 Stat. 7 (1951), as amended, 70 Stat. 786 (1956), 50 U.S.C. App. Sec. 1211–1233 (1958), has been extended to 30 June 1962. P.L. 86–89, 50 U.S.C.A. App. Sec. 1212 (c) (1) (Supp., 1959).

"Type of contract in this context refers to the method by which the contractor is compensated rather than the contract form or end purpose. The head of a procurement agency may award any type of negotiated contract "that he considers will promote the best interests of the United States." 10 U.S.C. Sec. 2306(a) (1958). While the Government's interest is protected by flexible and realistic pricing, the contractor also benefits when the type of contract used reduces pricing risks which affect profit. Cf. Cohen, Law And The Social Order 110-111 (1935) (primary purpose of contracts and contract law is to distribute risks in complicated transactions).

ASPR 3-403.3; ASPR 7-109 (July 1960). Where a new product is required and production costs are uncertain, the parties will negotiate an initial fixed price based upon estimates of cost. This will be subject to redetermination at a future date in light of actual production costs.

nique, the contractor's profit margin is protected from a cost overrun. If the contractor is required to develop a new product, a termination for default in the event that a definite delivery date is not met is unrealistic. Accordingly, the contractor may be awarded a special incentive contract which rewards success by higher profits but does not unduly penalize failure 10 or may be required to use "best efforts" rather than deliver within a specified time." Finally, the Government will, in certain cases, indemnify contractors against extra-hazardous risks.12 Thus, flexible pricing, realistic standards of work and indemnification, particularly in negotiated fixed-price contracts, protect the contractor's profit margin and reduce the chance of sustaining a loss.

3. Cost-type contracts. The cost-plus-fixed-fee type contract, which is common in research and development, provides maximum insulation against business risks.13 Consequently, profit has been arbitrarily limited to fixed percentages of estimated costs at the time of contracting. It has been suggested that higher fees would at

14

For an illustration of the problems which might arise when research and development work is done under a fixed-price contract requiring delivery of an acceptable product within a specified period of time, see Aerosonic Instrument Corp., ASBCA No. 4129, 12 March 1959, DA Pam 715-50-2, p. 213, par. 2. See also, 87 Comp. Gen. 239 (1957). If a termination for default is proper, the contractor receives neither profit nor costs for unfinished work and may be liable for the excess costs of a repurchase.

10 The Government awards both performance and cost type incentive contracts. In the former, the contractor earns more profit if standards of performance exceed minimum contract requirements, ASPR 3-406, and in the latter a higher profit is paid if production costs are kept below estimates, ASPR 3-403.3 (111) (b). In both instances, a failure to meet desired cost or performance standards results only in a profit reduction. See Department of Defense, Procurement Presentation, op. cit. supra note 1, at 26 (discussion of special performance incentive).

11 ASPR 7-402.2 (a) (Feb 1959); ASPR 7-402.4 (Feb 1959).

13 The Government will indemnify contractors with the Atomic Energy Commission, 71 Stat. 576 (1957), as amended, 72 Stat. 525,837 (1958), 42 U.S.C. Sec. 2210 (1958), and research and development contractors with military departments (with secretarial approval), 10 U.S.C. Sec. 2354 (1958), from damage to others arising out of unusually hazardous activities. In both cases, commercial insurance must not be available. See Lyons, Government Indemnification Against Unusually Hazardous Risks for Military Research and Development Contractors, 17 Fed. B.J. 314 (1957). In cost type contracts, the Government agrees to indemnify the contractor for liability to third persons from extraordinary claims not insured. See ASPR 7-203.22 (c) (Jan 1960). The Army position is that this potential liability does not violate the anti-deficiency act. JAGT 1957/7982, 25 October 1957, DA Pam 715-50-2, p. 16, par. 11.

13 The contractor is insulated in at least two ways. First, a cost reimbursable research and development contract will not be defaulted for failure to deliver an acceptable product on time. See supra, note 11. But see ASPR 8-710 (Sep 1958) (default clause for fixed-price research and development). Second, if a cost overrun occurs, the contractor may stop work until the Government either terminates the contract for convenience, ASPR 8-701 (Sep 1958) (contractor entitled to costs plus profit on work done), or provides additional funds. If the work stoppage is caused by the overrun, the contractor cannot be required to continue work or be terminated for default until additional funds are provided. See Sterling Precision Corporation, ASBCA No. 4646, 12 October 1959, DA Pam 715-50-58, par. 7.

14 By statute, the fee is limited to 15% for experimental, research and development work and 10% for any other work (with exceptions), 10 U.S.C. Sec. 2306(d) (1958). The limitations have been reduced to 10 and 7 percent respectively by regulations, ASPR 3-404.3 (c), but the Secretary of the Department concerned may, in appropriate cases, raise fees to the statutory maximum. Profit or fee in negotiated contracts is determined in dollar amounts based upon evaluation of specified pricing factors. See ASPR 3-808.

tract better research and development and encourage more small business participation.15 Further, since the fee is based upon estimated costs at the time of contracting and does not accelerate in the event of an overrun, it may be unrealistic. Yet in evaluating the adequacy of the cost-plus-fixed-fee profit allowance, it is important to recognize that profit incentive in research and development varies with the type of project and the contractor involved. Non-profit institutions, for example, receive no fee. On the other hand, profit making firms may not demand a large fee if the project involves basic research which must be done to maintain business standing or will afford valuable experience in future Government supply contracts.16 Finally, the Secretary of Defense has power to approve fixed fees up to 15% of estimated costs.17 This provides flexibility where extra incentive is required in particular cases.

The risk of doing business with the Government cannot be completely eliminated by the type of contract or contract clause used.18 Yet a steady flow of qualified producers can be maintained by a choice of contract which minimizes risks and insures a fair profit. While this is a form of assistance to the contractor, it also contributes to realistic pricing and is in the Government's best interest.

II. Organizing a Production Base

4. General. A contractor must possess specialized and expensive capital equipment and maintain a continuous program of expansion and replacement to perform defense contracts. This section will examine the methods whereby the Government assists business in attaining the necessary capacity for defense production; tax assistance, small business loans and investment, loans under the Defense Production Act of 1950 and Government furnished property.

5. Assistance under the tax laws: rapid amortization. Under section 167 of the Internal Revenue Code of 1954, any business may deduct from gross income a reasonable allowance for the exhaustion, wear and tear and obsolesence of property used in a trade or business or held for the production of income.19 These yearly depreciation

18 See Livingston, Decision Making in Weapons Development, 36 Harv. Bus. Rev. 127 (1958); Cordiner, Introduction, 17 Fed. B.J. 186, 187 (1957). In the first 11 months of 1958, small business received only 3.2% of the total value of all military research and development prime contracts awarded. See Eighth Annual Report Of The Activities Of The Joint Committee On Defense Production, 86th Cong., 1st Sess. 457 (1959).

16 It has been asserted that the primary Inducement for firms to undertake research and development work is the increased ability to obtain more profitable production contracts growing out of the research. Memo for the Assistant Secretary of Defense (Supply and Logistics), AFMPP-PR (30 Jun 1958). This increased ability constitutes adequate consideration to support a Government contract, Pennsylvania Exchange Bank v. United States, 170 F. Supp. 629 (Ct. Cl. 1959), but is inadequate to make the contractor subject to state possessory interest taxes. United States v. Livingston, 179 F. Supp. 9 (E.D.S.C. 1959), aff'd, 364 U.S. 281 (1960).

17 See supra, note 14.

18 See Novick & Springer, Economics of Defense Procurement and Small Business, 24 Law & Contemp. Prob. 118 (1959).

19 Int. Rev. Code of 1954, Sec. 167 (a).