2. Independent Research & Development Costs: A Review of Recent Case Law & Regulatory Changes 1 Breakout Session # E05 Mark J. Nackman & Gary J. Campbell Tuesday, July 31, 2012 2:30 - 3:45 PM

3. Overview 2 IR&D Cost Principle “required in the performance of a contract” Data Rights Basics Private Funds FY 2012 NDAA § 815 Segregation Data Proprietary Data Restrictions Commercial Items Rule Reporting Requirements

4. IR&D Cost Principle 3 FAR 31.205-18(a)(2) “Independent research and development (IR&D)”: Costs that consists of projects falling within the four following areas: (1) basic research, (2) applied research, (3) development, and (4) systems and other concept formulation studies. Does not include the costs of effort sponsored by a grant or required in the performance of a contract. Shall not include technical effort expended in developing and preparing technical data specifically to support submitting a bid or proposal.

5. “required in the performance of…” 4 United States v. Newport News Shipbuilding, Inc. (E.D. Va. 2003) = Implicit requirement. ATK Thiokol, Inc. v. United States (Fed. Cl. 2005) = Case-by-case basis / parties’ intent. ATK Thiokol, Inc. v. United States (Fed. Cir. 2010) = Specifically required by the contract. New Rule: Specifically Required.

6. DoD Data Rights Basics 5 Tech Data & Software developed with 100% USG Funds = Unlimited Rights for the USG. Tech Data & Software developed with any combination of USG and Private Funds = Government Purpose Rights for the USG. Tech Data & Software developed exclusively with Private Funds = Limited Rights in Tech Data & Restricted Rights in Software for the USG.

7. Private Funds 6 Congress passed § 824 of the Ike Skelton National Defense Authorization Act of 2011 Would have made “exclusively with” IR&D count as USG Funds for purposes of IR&D (although there was a loophole). However § 815(a)(1)(c) of the NDAA for FY2012 retroactively reversed. But the FY 2012 NDAA added new means for DoD to get tech data. New Rule: Same as The Old Rule – IR&D costs are Private Funds

8. FY 2012 NDAA § 815 7 Addresses tech data, not computer software (regulations will probably include computer software anyway). Extends statute of limitations on data rights challenges from 3 to 6 years. USG can disclose data developed at private expense if “necessary for the segregation of an item or process from, or the reintegration of that item or process (or a physically or functionally equivalent item or process) with, other items or processes….”

9. Segregation Data 8 New Rule: USG can disclose data developed at private expense if “necessary for the segregation of an item or process from, or the reintegration of that item or process (or a physically or functionally equivalent item or process) with, other items or processes….” Must disclose release to contractor who supplied the data. Data cannot be released beyond to additional third parties, etc.

10. Proprietary Data Restrictions 9 New Rule: USG now has 6 years (vice 3) to challenge the restriction on use or release of proprietary data asserted by the contractor. Clock still starts running on the later of the date of final payment or when the tech data is delivered.

11. Proprietary Data Restrictions Cont. 10 Old Rule: 3-year statute of limitations did not apply if USG believed the contractor’s assertion was erroneous. New Rule: FY12 NDAA eliminated this exception to the new 6-year statute of limitations. Exception now only if the tech data is “the subject of a fraudulently asserted use or release restriction.”

12. Commercial Items Rule 11 Old rule: Commercial items presumed developed at private expense & delivered under standard commercial terms (not FAR/DFARS clauses) Contractor was not required to justify assertion Burden was on CO to overcome presumption John Warner NDAA for Fiscal Year 2007 § 802(b) - Reversed presumption of development at private expense for commercial items under contracts or subcontracts for major systems (or subsystems or components thereof) NDAA of 2008 limited reach of NDAA of 2007 § 815(a)(2) – Exempted commercial off-the-shelf (COTS) items from the requirements established under § 802(b) of 2007 NDAA

13. Commercial Items Rule Cont. 12 Implementing regulations: 252.227 ‐ 7013 (Technical Data – Noncommercial Items) 252.227 ‐ 7015 (Technical Data – Commercial Items) 252.227-7019 (Validation of asserted restrictions—Computer software) New Rule: Commercial Items – If developed partially at Government expense, both DFARS 252.227-7013 & 7015 apply. 7015 applies to the portions developed exclusively at private expense and 7013 applies to the portions developed at Government expense. Commercially available off-the- shelf (COTS) items exempt from these requirements and retain presumption of development exclusively at private expense.

14. Commercial Items Rule Cont. 13 New Rule: Major Systems (or a subsystem or component of a major system) – No presumption (unless it is a COTS item). DoD extended this rule to noncommercial computer software for major systems (technically without the statutory basis to do so), by amending DFARS 252.227-7019. The preamble states the “major systems rule” is only for noncommercial computer software and the validation procedures are not applicable to assertions based on mixed funds and do not restrict the contractor’s ability to segregate mixed-funding software development into privately-funded and Government-funded portions.

15. Commercial Items Rule Cont. 14 New Rule: Subcontractors – Subcontracts for commercial items are now subject to validation (DFARS 252.227-7037). DFARS 252.227-7015 is now a mandatory flow-down where commercial item tech data developed at least partially at private expense will be delivered to the USG. If subcontractor’s commercial item was developed at Government expense, DFARS 252.227-7013 applies to the tech data (commercial items rule). Now more than ever, sources of funding must be scrutinized, before developing or modifying items – including commercial items. Appropriate markings discipline is critical as well.

16. Reporting Requirements 15 77 Fed. Reg. 4632 (Jan. 30, 2012) (to be codified at 48 C.F.R. pt. 231) New Rule: DoD requires quarterly on-line reporting of IR&D projects by major defense contractors. If unreported, all IR&D is disallowed. Intended to give DoD greater insight into IR&D activities to make sure they “meet DoD needs and promote technical prowess of our industry.” Likely to eventually result in more disallowance of costs.

17. Reporting Requirements Cont. 16 “Major contractors” are those with $11 million or more of IR&D and B&P “to covered contracts during the preceding year.” Contractors that do not meet the threshold as a major contractor are encouraged to also report so as to provide visibility into their IR&D projects. Final rule raised proposed threshold from $50,000 due to concerns of impact on small businesses.

18. Reporting Requirements Cont. 17 Reports will be made online to the Defense Technical Information Center (DTIC). Basic information required (title, anticipated expenditures, readiness level, etc.). Only a “concise one-and-a-half to two-page overview. Does not force contractors to file patent applications early to avoid the public disclosure bar to patentability. Classified projects are not to be reported (on-line DTIC system is UNCLASSIFIED only).

19. Reporting Requirements Cont. 18 Reports will be available to contracting personnel to determine any potential government interest and rendering the IR&D costs allowable. The information submitted will be within the scope of Freedom of Information Act (FOIA) exemption (b)(4), and thus exempt from disclosure under FOIA.