Michael B. Donley, Secretary of the Air Force v. Lockheed Martin Corporation

United States Court of Appeals
for the Federal Circuit
__________________________
MICHAEL B. DONLEY, SECRETARY OF THE AIR
FORCE,
Appellant,
v.
LOCKHEED MARTIN CORPORATION,
Appellee.
__________________________
2009-1261
__________________________
Appeal from the Armed Services Board of Contract
Appeals in no. 53822, Administrative Judge Robert T.
Peacock.
___________________________
Decided: June 10, 2010
___________________________
STEPHEN C. TOSINI, Trial Attorney, Commercial Liti-
gation Branch, Civil Division, United States Department
of Justice, of Washington, DC, argued for appellant. With
him on the brief were TONY WEST, Assistant Attorney
General, JEANNE E. D AVIDSON , Director, and BRYANT G.
SNEE, Deputy Director.
TERRY L. ALBERTSON , Crowell & Moring LLP, of
Washington, DC, argued for appellee.

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AIR FORCE v. LOCKHEED MARTIN 2
__________________________
Before BRYSON , CLEVENGER, and LINN , Circuit Judges.
BRYSON , Circuit Judge.
In 1991, the Air Force and Lockheed Corporation (now
Lockheed Martin Corporation) entered into a contract for
the development of the F-22 “new generation” fighter
aircraft. The F-22 contract was a cost-plus-award fee
contract with a total value of $9.55 billion. Under a cost-
plus-award fee contract, a contractor is reimbursed for its
costs and receives a profit, or fee. Northrop Grumman
Corp. v. Goldin, 136 F.3d 1479, 1481 (Fed. Cir. 1998).
Performance was scheduled to take place over an eight-to-
nine-year period. This case grows out of a “rephasing” of
the F-22 contract that was negotiated by the parties early
in the contract performance period. The dispute concerns
whether, under the applicable statutory, regulatory, and
contractual provisions, the government is entitled to
recover a portion of the negotiated price increase on the
ground that it resulted from a change in Lockheed’s
accounting practices and could not lawfully be charged
against the contract price.
I
The F-22 contract incorporated a number of provi-
sions of the Federal Acquisition Regulation (“FAR”),
including provisions of the Cost Accounting Standards
(“CAS”). Among the pertinent FAR provisions incorpo-
rated into the contract was 48 C.F.R. § 52.230-2 (“FAR
52.230-2”), which governs the manner in which a contrac-
tor may alter its accounting practices and what duties the
contractor must undertake when it makes such an ac-
counting change. That regulation was issued pursuant to
41 U.S.C. § 422(h), which requires the Cost Accounting

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AIR FORCE v. LOCKHEED MARTIN 3
Standards Board to promulgate regulations requiring
contractors to agree to a contract price adjustment “for
any increased costs . . . by reason of a change in the
contractor’s . . . cost accounting practices.” Id. §
422(h)(1)(B).
By regulation, a contractor that wishes to modify its
accounting practices must first negotiate the terms and
conditions under which the change will be made with the
appropriate Divisional Administrative Contracting Officer
(“DACO”). FAR 52.230-2(a)(4)(ii). If the accounting
change results in increased costs because expenses previ-
ously accounted as indirect are now directly charged to
the government contract, the contractor is required to
agree to a contract price adjustment and repay the gov-
ernment any increased costs caused by the accounting
change. FAR 52.230-2(a)(2), (a)(5). The regulations also
state that the amount of the price adjustment is generally
limited to the additional amount paid by the government
“in the aggregate” over “all of the contractor’s affected
CAS-covered contracts and subcontracts.” FAR 30.602-3
(1993); see 41 U.S.C. § 422(h)(3); FAR 52.230-2(a)(5).
The FAR defines the term “affected CAS-covered con-
tract,” in pertinent part, to mean a contract in which the
contractor “[u]sed one accounting practice to estimate
costs and a changed cost accounting practice to accumu-
late and report costs under the contract.” FAR 52.230-
6(a)(1) (2005); FAR 30.001 (2005). The dispute in this
case focuses on whether the F-22 contract was an “af-
fected contract” and thus whether Lockheed’s mid-1993
change in its accounting practices was subject to the
FAR’s limitations on the allowance of increased costs
resulting from that change.
A

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AIR FORCE v. LOCKHEED MARTIN 4
In 1992, the Air Force informed Lockheed that it an-
ticipated a funding shortfall for the F-22 program. At the
same time, Lockheed told the Air Force that it expected
the costs of the F-22 project to increase. As a response to
those funding issues, the Air Force issued a Request for
Proposal (“RFP”) on November 18, 1992, to “rephase” the
F-22 contract. The RFP asked Lockheed to prepare a cost
proposal that would bring the F-22 contract within the
program’s “revised funding profile” for fiscal years 1993
through 2001. The RFP identified several technical and
schedule changes to the F-22 contract, such as deleting
two aircraft and modifying the date for several perform-
ance milestones. The RFP also required Lockheed’s
proposal to include both an estimated cost and a not-to-
exceed base price for the rephased contract.
The RFP required Lockheed to divide estimated ex-
penses into five categories, referred to as “buckets.”
Those buckets were (1) deletion of two aircraft, (2) “Re-
vised Program Baseline,” (3) “Other Cost Changes,” (4)
“Weight Reduction Requirement Challenges,” and (5)
“Program Rephase Impacts.” In the RFP, the Air Force
specifically stated that the cost estimate should include
“the proposed rephased hours with narrative substantia-
tion including a discussion comparing the proposed
changes with the current program.” In addition, the Air
Force required Lockheed to disclose a detailed breakout of
labor costs.
On December 22, 1992, the Air Force issued Contract
Modification P00059 as an “undefinitized contract action,”
which required Lockheed to rephase the F-22 contract.
The Air Force later issued additional instructions for the
rephase proposal, each time repeating the requirement for
a summary of the build-up of man hours by calendar year.

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AIR FORCE v. LOCKHEED MARTIN 5
Lockheed timely submitted its cost proposal on April 23,
1993.
Meanwhile, the Secretary of the Air Force recom-
mended that several government contractors, including
Lockheed, change their cost accounting practices to more
accurately reflect the costs incurred on each of their
contracts. As part of that effort, the Air Force initiated a
“Comprehensive Overhead Cost Analysis and Control
Review” process, which recommended specific changes to
various contractors’ accounting practices. In the course of
that review process, the government urged Lockheed to
change its accounting practices and directly charge cer-
tain personnel costs to the F-22 contract. Even though
Lockheed voiced concern about the cost impact of those
changes, it notified its DACO on June 4, 1993, that it
would comply with the Air Force recommendation and
change its accounting methods for all of its contracts.
Lockheed indicated that to make those changes it would
treat personnel costs associated with program manage-
ment, master scheduling, industrial engineering, and
engineering administration as direct costs. Lockheed
sought to amend its disclosure statement to reflect the
changed practices. In addition, it requested a waiver of
the 60-day waiting requirement, and it asked permission
to make the accounting changes effective as of June 28,
1993. The DACO waived the waiting period and permit-
ted the changes to be made effective as requested.
On June 22, 1993, Lockheed sent a “General Order of
Magnitude Cost and Rate Impact Study Reflecting Mid
Year 1993 Accounting Changes” to the DACO. That study
estimated that the accounting changes would increase the
cost of the F-22 contract by more than $10 million for the
period between mid-1993 and 1997. On July 19, 1993,
Lockheed submitted its proposed forward pricing rates to

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AIR FORCE v. LOCKHEED MARTIN 6
the DACO. Those pricing rates included both direct and
indirect labor rates estimated under Lockheed’s new
accounting practices.
Lockheed also disclosed its new accounting practices
to the Air Force’s rephase negotiating team and indicated
that it would use the new accounting practices in the
rephase negotiation process. On July 29, 1993, Lockheed
submitted an update to its rephase cost proposal. That
update incorporated Lockheed’s new accounting practices
as well as a new union agreement that reduced labor
rates. The update specifically identified, year by year, the
increased costs to the F-22 contract caused by the change
in Lockheed’s accounting practices as well as the amount
saved by the new labor agreement.
In August 1993 the DACO asked Lockheed to provide
a more detailed study analyzing the effect of its account-
ing changes as applied to all of its contracts. The DACO
initially required the study within 60 days, but later
granted a 60-day extension of the deadline. The following
month, the DACO provided “interim recommended rates”
to the Air Force negotiating team to use in negotiating the
estimated costs of the rephased F-22 contract. The DACO
based those rates on Lockheed’s then-existing accounting
practices, which included the mid-year accounting
changes.
On November 15, 1993, the Air Force and Lockheed
agreed on the total estimated cost plus award fee for the
rephased F-22 contract and executed contract Modifica-
tion No. P00098, which “definitized” contract modification
P00059. As part of that modification, the government
included a provision that reserved its right to obtain a
contract price adjustment in the event of contractor

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AIR FORCE v. LOCKHEED MARTIN 7
noncompliance with the requirements of the governing
Cost Accounting Standards.
While the Air Force Procurement Contracting Officer
(“PCO”) was negotiating the contract rephase with Lock-
heed, the DACO separately addressed the cumulative
effect of the mid-1993 accounting changes on all of Lock-
heed’s contracts. Lockheed timely submitted its cost
impact study in December 1993. When submitting the
study, Lockheed explained that the F-22 contract was not
treated as an “affected contract” within the meaning of
the CAS provisions and therefore was not included in the
study.
Five years later, the Defense Contract Audit Agency
(“DCAA”) issued an audit report on Lockheed’s cost im-
pact study. In its report, the DCAA concluded that the
change in Lockheed’s accounting practices caused a
significant increase in the cost to the United States of the
F-22 contract. It further concluded that the F-22 contract
was an “affected contract” and therefore should have been
included in the cost impact study. The DCAA reached
that conclusion based on its finding that the rephasing of
the F-22 contract was merely a modification of the origi-
nal contract and not a new contract. In 2002, the new
DACO who was assigned to the F-22 contract issued a
decision that the F-22 contract should have been included
in Lockheed’s cost impact study. As a result of that
decision, the DACO asserted a government claim of
approximately $14.7 million against Lockheed. Lockheed
disputed that claim.
B
The Armed Services Board of Contract Appeals up-
held Lockheed’s challenge to the government’s claim. The

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AIR FORCE v. LOCKHEED MARTIN 8
Board cited the 2005 definition of the term “affected
contract” and concluded that the 2005 definition applied
to the 1993 rephased F-22 contract because the 2005
definition merely “makes explicit what we consider im-
plicit in the CAS provisions.”
In analyzing the negotiations associated with the re-
pricing of the rephase modification of the F-22 contract,
the Board noted that the negotiations were “unusually
comprehensive,” that the parties described the scope of
the effort as a “repricing” of the contract, and that the
scope of the rephase repricing efforts “was not coextensive
with the scope of the incremental rephase technical
changes.” In particular, the Board found that the rephase
negotiation process “comprehensively reexamined and
reevaluated all of the work items to be performed,” not
just the “‘incremental’ or discrete additive/deductive items
specifically mentioned in the RFP letter.” Based on its
findings, the Board concluded that the parties were
“attempting to accurately determine the cost of the entire
program and ‘rebaseline’ the contract to ensure compli-
ance with budgetary constraints.”
The Board then addressed the question whether “the
cost impacts of the changed practices were fully inte-
grated into the pricing structure of the entire contract as
rephased” and concluded that they were. The Board
found that “not only were the changed practices fully
disclosed, but also that the DACO incorporated their
effects in forward pricing rates provided to the Air Force
for express use in the rephase negotiations.” The Board
noted that “the parties conducted extensive cost-specific
negotiations regarding the increased number of hours,
personnel, and associated costs that would be charged
directly as a consequence of the changed practices.”
Based on its factual findings and its analysis of the nego-

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AIR FORCE v. LOCKHEED MARTIN 9
tiating history of the rephase effort, the Board concluded
that the F-22 contract was not an “affected contract”
within the meaning of the applicable regulations and thus
was not required to be included in Lockheed’s cost impact
study. The Board therefore sustained Lockheed’s appeal.
The government then took this appeal from the Board’s
decision.
II
Under the Contract Disputes Act, we uphold findings
of fact by the Board “unless the decision is fraudulent, or
arbitrary, or capricious, or so grossly erroneous as to
necessarily imply bad faith, or if such decision is not
supported by substantial evidence.” 41 U.S.C. § 609(b).
We review the Board’s legal conclusions de novo. W.
Coast Gen. Corp. v. Dalton, 39 F.3d 312, 314-15 (Fed. Cir.
1994). In so doing, however, we give “careful considera-
tion and great respect” to the Board’s legal interpreta-
tions in light of the Board’s considerable experience in the
field of government contracts, Fruin-Colnon Corp. v.
United States, 912 F.2d 1426, 1429 (Fed. Cir. 1990),
including “its experience in interpreting the Federal
Acquisition Regulations,” Titan Corp. v. West, 129 F.3d
1479, 1481 (Fed. Cir. 1997).
As an initial matter, we note that although the Board
applied the 2005 regulatory definition of “affected con-
tract” to the 1993 rephased F-22 contract, the government
did not object to the Board’s doing so and does not argue
for a different interpretation on appeal. In any event, as
the Board recognized, the principles underlying the 2005
definition, e.g., requiring the accounting change to be the
cause of the additional costs, were already implicit in the
relevant regulations at the time of the 1992-93 contract
modification. See 48 C.F.R. § 9903.306(a) (1993) (“In-

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AIR FORCE v. LOCKHEED MARTIN 10
creased costs shall be deemed to have resulted whenever
the cost paid by the Government results from a change in
a contractor’s cost accounting practices . . . and such cost
is higher than it would have been had the practices not
been changed.”).
Under the principles incorporated in the 2005 regula-
tion, a contract is “affected” and requires a price adjust-
ment when the contractor “used one accounting practice
to estimate costs and a changed cost accounting practice
to accumulate and report costs under the contract.” FAR
52.230-6(a)(1); FAR 30.001. We agree with the Board that
a contract is not “affected” when each contract cost is
estimated and reported using the same accounting meth-
ods, even if some costs are estimated and reported using
one practice and other costs are estimated and reported
using a different practice.
A
The government takes the position that the F-22 con-
tract was “affected” by Lockheed’s accounting changes
because the November 1993 estimated cost agreement
covered only a portion of the contract and did not reprice,
for example, costs incurred prior to the contract modifica-
tion. According to the government, because the 1992-93
repricing of the F-22 contract did not constitute an en-
tirely new contract that replaced the original contract, but
was only a modification of an existing contract, the F-22
contract is an “affected contract,” and the government is
entitled to recover the increased costs resulting from the
change in Lockheed’s accounting practices.
The critical inquiry under the FAR provision that de-
fines an “affected contract” is not whether there is an
entirely new contract; it is whether costs were estimated

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AIR FORCE v. LOCKHEED MARTIN 11
under one accounting practice but reported under an-
other. The Board answered that factual question in the
negative. The Board first identified the “essential ques-
tions” to be whether the negotiating parties “knowingly
repriced the contract using the changed practices rather
than the practices used in pricing the original contract
and whether the scope of that repricing effort was suffi-
ciently comprehensive to justify a conclusion that the
impact of the changed practices [was] fully incorporated
in the contract price as rephased.” It then determined
that the additional accounting costs were “fully integrated
and factored into the price of the entire contract as re-
phased,” so that all expenses reported under the new
accounting practices were also estimated under those
practices.
In particular, the Board found that the “scope of the
rephase repricing effort was not coextensive with the
scope of the incremental rephase technical changes,” and
that the parties were “attempting to accurately determine
the cost of the entire program” in light of the new budget-
ary constraints. The Board also observed that Lockheed
“identified and justified” the increased costs, that the Air
Force “understood and verified” those costs, and that from
“late July through the completion of negotiations in
October 1993, [Lockheed] and the Air Force negotiation
team thoroughly discussed and negotiated the estimated
impacts of the [accounting changes].” Those findings are
supported by substantial evidence. The record shows that
(1) Lockheed disclosed, in specific detail, the cost of the
accounting changes to the Air Force during negotiations;
(2) the DACO used Lockheed’s new accounting practices
to calculate forward pricing rates, which were used to
negotiate the rephase cost estimate; and (3) a representa-
tive of the Air Force negotiating team acknowledged that
“it was our intent to incorporate the impact of the ac-

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AIR FORCE v. LOCKHEED MARTIN 12
counting changes, as they impacted the F-22, in our
negotiations, and we believe we did so.” The government
attempts to dismiss that statement on the ground that it
was made several years after the negotiations ended. The
statement, however, was made in a memorandum repre-
senting the views of the Air Force negotiating team, and
the government has not suggested any reason to believe
that the Air Force representative was not being candid
and accurate in his characterization of the pertinent
events. With respect to that and other similar evidence,
the government concedes that “there may be some evi-
dence indicating that Lockheed’s mid-year accounting
changes were ‘integrated and factored’ into the rephrased
F-22 contract price,” but it regards that evidence as
immaterial absent the formation of an entirely new
contract.
The government contends that a contract must be an
“affected contract” if the accounting changes were inte-
grated into the contract price and the final estimated
costs were not reduced to compensate for those additional
expenses. However, the Board did not determine that
additional accounting costs were tacked on to the contract
estimate; it found that the parties created a wholly new
cost estimate incorporating all of the additional expenses.
Because those costs were consistently estimated and
accrued, the Board concluded that the F-22 contract was
not an “affected contract.” Based on the Board’s detailed
findings and analysis of the rephase negotiations and the
rules applicable to changes in accounting practices, we
uphold the Board’s conclusion that the statutory and
regulatory provisions governing “affected contracts” were
inapplicable to the rephased F-22 contract.

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AIR FORCE v. LOCKHEED MARTIN 13
B
As an element of its challenge to the Board’s decision,
the government disputes the Board’s finding that the Air
Force validly agreed to the additional accounting costs.
The government points to the clause in the rephased
contract stating that “[a]ward of this contract does not
constitute a determination [that Lockheed’s practices are
CAS compliant],” and reserving the government’s right to
an adjustment if Lockheed’s practices are ultimately
determined to be non-compliant. That clause, however,
does not create a right to an adjustment or demonstrate a
disagreement over contract costs. It merely indicates that
the Air Force was not waiving whatever adjustment
rights it may have had. Because the rephased F-22
contract was not an “affected contract,” the government
did not have any adjustment rights to retain.
Moreover, the government’s contention that Lockheed
“did not disclose its intent to remove the F-22 contract
from the universe of CAS-affected contracts” and “failed
to fully disclose the effect of its increased cost to the
Government” is totally without merit. The Board found,
with considerable evidentiary support, that Lockheed
made the cost effects of its accounting changes clear to the
Air Force negotiators and that they understood the effects
of those changes.
C
The government argues that the Board erred because
the relevant regulations require contractors to resolve
increased accounting costs through a contract price ad-
justment, not through a contract modification, and that
only the DACO can perform that adjustment. As the
Board noted and the government does not contest, how-

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AIR FORCE v. LOCKHEED MARTIN 14
ever, the PCO has authority to negotiate contract modifi-
cations. Because the PCO properly exercised the author-
ity to negotiate and integrate the additional accounting
costs into the modified contract, no adjustment was
required under the relevant regulations, and the DACO’s
authority to perform that adjustment was not necessary.
The government also contends that the Board misin-
terpreted the DACO’s actions with respect to the F-22
contract. In particular, the government asserts that the
Board erroneously concluded that the DACO waived the
right to an adjustment for three reasons: (1) because the
DACO provided interim rates that reflected Lockheed’s
changed accounting practices; (2) because the DACO
waived the 60-day notice period before Lockheed could
implement its new accounting practices; and (3) because
the DACO extended Lockheed’s deadline for filing its
detailed cost impact proposal. We disagree with the
government’s interpretation of the Board’s decision. The
Board did not hold that the DACO waived the govern-
ment’s right to an adjustment; rather, it held that the F-
22 contract was not an “affected contract.” The Board
properly relied on the DACO’s actions because they
enabled Lockheed and the PCO to accurately incorporate
the additional accounting costs into the rephase cost
estimate.
The government argues that the DACO’s use of in-
terim forward pricing rates did not alter the status of the
F-22 contract as an “affected contract” or prevent the
DACO from later readjusting for cost increases, especially
when the DACO did not have the detailed cost impact
proposal. It is true that a DACO must provide accurate
forward pricing rates for contracting officers, see FAR
15.407-3, and that the DACO has the authority to require
an adjustment for any costs reported under a later ac-

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AIR FORCE v. LOCKHEED MARTIN 15
counting practice but estimated under a former account-
ing practice, see FAR 52.230-2(a)(2). In this case, how-
ever, the Board determined that Lockheed and the Air
Force used the forward pricing rates to negotiate and
integrate all of the additional costs into the rephased
contract cost estimate, and it is that action that precludes
the government’s right to an adjustment.
Finally, the government asserts that the Board per-
mitted Lockheed’s accounting changes to be applied
retroactively to the F-22 contract, in violation of FAR
52.230-2(a)(2). Specifically, the government argues that
the new accounting practices could not legitimately be
incorporated into the rephased contract because the
government issued P00059 before Lockheed implemented
its new accounting practices. However, P00059 was not a
final agreement on estimated costs; it was an “undefini-
tized” contract modification that required the parties to
submit and negotiate a new cost estimate. For that
reason, the fact that P00059 issued before Lockheed
changed its accounting practices does not undermine the
Board’s decision.
AFFIRMED

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