This post was written by Stephanie E. Giese.

The issue of senior executive compensation limits continues to be a contentious one for the federal government and its contractors. This may explain why the limit has not been raised since 2010 from the current amount of $693,951. In fact, the Obama administration has proposed lowering senior executive compensation limits to $200,000, the level it caps salaries for its own executives. Given the administration’s focus, this is an area where we are likely to see more litigation. The Appeals of J.F. Taylor, Inc., ASBCA Nos. 56105, 56322 (January 18, 2012) (“JFT”) is an example of such litigation that was recently decided in favor of the contractor.

The JFT decision is relevant to contractors subject to Federal Acquisition Regulation (“FAR”) 31.205-6(p), the federal limitation on the allowability of compensation for senior executives. This benchmark limitation is the maximum amount a contractor may seek reimbursement for under its government contracts, but does not limit the compensation an executive may earn. Further, the limit that applies to small-to-midsize government contractors may actually be lower than the benchmark limitation. Regardless of the size of the contractor, a contractor subject to FAR 31.205-6(p) must show that the executive compensation costs it charged the government are reasonable in order for the government to reimburse those costs. To evaluate reasonableness, Defense Contract Audit Agency (“DCAA”) conducts a statistical analysis considering factors such as industry, company revenue relative to other companies in the same industry, geographic location, and the executive position being evaluated.

The JFT decision offers arguments that may allow a contractor to resolve disputes with DCAA in annual Executive Compensation Reviews (“ECRs”) and to avoid potential litigation. In its JFT decision, the Armed Services Board of Contract Appeals held that DCAA’s methodology was “fatally flawed statistically”:

(a) as a matter of basic statistical analysis,

(b) because the method market priced JFT’s executive compensation at the median without adequate consideration of the company’s superior performance,

(c) because DCAA failed to evaluate the compensation of the JFT vice presidents based on the revenues of the whole company even though each vice president had companywide responsibilities for the success of the company, and

(d) because the method used does not yield auditable and reliable results.

Thus, JFT was not required to repay the government approximately $600,000 in disallowed executive compensation costs. A contractor should consider the fatal flaws cited by the Board as potential arguments to defend its own executive compensation costs.