Direct Result of Disaster – Reasonable Costs

Appeal Brief Appeal Letter Appeal Analysis

Appeal Brief

Disaster	1603
Applicant	Archdiocese of New Orleans
Appeal Type	Second
PA ID#	000-UV6IX-00
PW ID#	PW 11695
Date Signed	2020-09-23T16:00:00

Summary Paragraph

In 2005, Hurricane Katrina damaged St. Martin’s Manor, an assisted living facility (Facility) owned by the Archdiocese of New Orleans (Applicant).  FEMA prepared Project Worksheet (PW) 11695 to replace the Facility.  The Applicant opted to repair the damage and FEMA capped the project at the replacement or the repair cost, whichever is lower.  The Applicant properly procured a contractor and entered in an adjustable fixed-price contract.  Per 44 C.F.R. § 13.36(i)(2) (2004), the Applicant’s contract included a termination for convenience clause that, if exercised, required the Applicant to pay reasonable overhead and profits to the contractor on the value of the contract’s uncompleted work.  When the contract was running over time, the Applicant terminated the contract for convenience.  The contractor made demands, including its overhead costs, and the Applicant entered into a settlement with the contractor and recorded $918,894.00 as overhead costs.  FEMA determined that the costs were not incurred as a result of the disaster, nor associated with eligible work, and were instead the result of the Applicant’s decision to terminate for convenience.  The Applicant appealed, claiming, among other things, that FEMA incorrectly determined the costs were not directly related to the disaster damages because the costs were incurred pursuant to the terms of a contract for eligible work; failed to acknowledge the work contracted for was eligible; was aware of the issues with the contractor and did not tell the Applicant that costs to terminate for convenience were ineligible; and, did not take into account the costs were reasonable and the least cost alternative.  The Region VI Regional Administrator found that the claimed costs are not directly tied to the performance of eligible work required as a direct result of the disaster and denied the appeal.  On second appeal, the Applicant maintains its previous claims and states that FEMA failed to acknowledge that the contract was for eligible work to repair damage directly caused by Hurricane Katrina and the cost associated with that work was reasonable, therefore eligible.  

Authorities and Second Appeals

• Stafford Act § 406
• 44 C.F.R. §§ 206.223(a); 13.22(a)(1); 13.36(i)(2)
• PA Guide (1999), at 23, 33-34.
• OMB Circular A-122

Headnotes

• Pursuant to 44 C.F.R. § 206.223(a), an eligible item of work must be required as a direct result of the disaster.
• FEMA reimburses costs that can be directly tied to the performance of eligible work. 
  • The Applicant’s costs of contractor overheads costs were incurred as a result of the Applicant deciding to exercise a Federally mandated procurement clause within an industry standard American Institute of Architects’ (AIA) contract for eligible work. 
  • The Applicant’s costs of overhead costs are allowable costs under 44 C.F.R. § 13.22.

Conclusion

The Applicant’s work is required as a result of the disaster and therefore eligible.  The Applicant’s costs of contractor overheads costs are allowable costs under 44 C.F.R. § 13.22 and incurred as a result of the Applicant prudently deciding to exercise a federally mandated procurement clause within an industry standard American Institute of Architects contract for eligible work. 

Appeal Letter

Appeal Analysis

Background

In August 2005, Hurricane Katrina damaged St. Martin’s Manor (Facility), an assisted living facility owned by the Archdiocese of New Orleans (Applicant).  FEMA prepared Project Worksheet (PW) 11695 to document $21,146,839.00 in building replacement costs and $3,045,972.00 in demolition costs.  Although FEMA determined the Facility eligible for replacement funding, the Applicant opted to instead repair it due to the historic nature of the structure.  Therefore, FEMA obligated the project at $21,723,987.00[1] for the estimated capped replacement expenses, or the amount of the final actual repair costs, whichever was lower. 

The Applicant executed a contract with TKTMJ, Inc. (TKTMJ) to perform the repair work.  Its American Institute of Architects (AIA) contract included an industry-standard General Conditions “termination for convenience” clause that allowed the Applicant to terminate the contract at its convenience and without cause, but required the Applicant pay for “[w]ork executed, and costs incurred by reason of such termination, along with reasonable overhead and profit on the [w]ork not executed.”[2] 

The Applicant indicates TKTMJ began its repair work on March 16, 2012.  On May 22, 2013, the Applicant issued Construction Change Directive (CCD) #1, which included a $4,056,783.00 not-to-exceed addition to the contract value and instructed TKTMJ “to provide back-up documentation supporting the costs associated with this work.”  On June 25, 2013, after TKTMJ failed to comply with the CCD, the Applicant executed the termination for convenience clause. The Applicant calculated that TKTMJ was behind schedule, with only 37 percent of the work complete at 40 days behind the original completion date.

On July 29, 2013, TKTMJ submitted an early payment request for $3.6 million which the Applicant disputed.  TKTMJ’s request included overhead for the remaining contract value including $735,071.00 on the base contract, and $378,210.00 on CCD #1 (representing 10 percent on the remaining balances).  After two years of liens, discussions, and litigation[3], the Applicant and TKTMJ settled the dispute.  The Applicant agreed to pay TKTMJ $1.6 million for a complete release of its claims.  The settlement documents were silent on the make-up of the payment, but the Applicant’s Change Order #7 represents the settlement as including, among other costs, at Item No. 6 “remaining contractors overhead-base contract” at $622,456.00, and at Item No. 7 “contractor overhead on CCD #1” at $296,438.00.  The Applicant requested FEMA approve a PW version that addressed Change Order #7.

On January 21, 2014, the Applicant contracted with Construction Masters, Inc. to complete the repair work.  On November 21, 2017, FEMA generated PW 11695, Version 9, which included FEMA’s determination regarding TKTMJ’s overhead costs.  FEMA determined that $918,894.00 (including base contract overhead costs of $622,456.00 and CCD No.1 overhead costs of $296,438.00) was ineligible for Public Assistance (PA) funding because the costs were not incurred as a result of the disaster and not associated with eligible work.  Rather, the claimed costs were a direct result of the Applicant’s decision to terminate the contract for convenience.  The Grantee notified the Applicant of the “zero-obligated” adjustment for Version 9 through a February 22, 2018 letter.[4]

 

First Appeal

The Applicant first appealed FEMA’s denial of $918,894.00 on April 23, 2018.  The Applicant believed that the costs were incurred pursuant to the terms of the contract; the contracted work was eligible and directly required as a result of Hurricane Katrina, and therefore the associated costs were eligible; FEMA did not advise the Applicant that costs to terminate for convenience would be ineligible; and, exercising the termination for convenience clause was reasonable and the least cost alternative option.

In a June 19, 2018 letter and analysis, the Grantee supported the Applicant’s appeal.  The Grantee first noted that the termination for convenience clause is required under Title 44 Code of Federal Regulations (44 C.F.R.) § 13.36 and that requiring a provision to be included in a contract and then penalizing the contracting party for enforcing it is counterintuitive.  The Grantee also pointed out that the settlement costs did not modify the scope of work and were directly tied to the performance of eligible work.  The Grantee stated the costs were reasonable and necessary.  The Grantee also explained that exercising the clause was the least-cost option, and the final cost of the project came in well under FEMA’s cap.

FEMA issued a Final Request for Information (RFI) on December 26, 2018.  The RFI notified the Applicant that it had not sufficiently documented that costs associated with Change Order #7, specifically items No. 6 and 7, were associated with work required as a direct result of the disaster.  The RFI requested contract documentation, including change orders, construction change directives, the termination letter, and proof of payment.  On January 25, 2019, the Applicant responded and provided all the information requested, including proof of payments, disputed change orders, and a copy of the termination letter dated June 26, 2013.

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The FEMA Region VI Regional Administrator (RA) denied the appeal on April 10, 2019.  The RA found that the claimed costs were not required as a direct result of the disaster and were not directly tied to the performance of eligible work.  Instead, they were the direct result of the Applicant’s decision to terminate the contract.

 

Second Appeal

In its second appeal dated June 13, 2019, the Applicant seeks $918,894.00 in funding incorporating and reiterating its arguments raised on first appeal.  In addition, it puts forth the following assertions:

• FEMA representatives repetitively acknowledged that continuance of the contract would substantially increase the cost of repairs and may jeopardize FEMA funding for the entire project.  Therefore, termination was the least cost alternative.  It would have been negligent of the Applicant not to terminate the contract.
• The costs are ordinary and necessary for the subject facility and type of work. 
• The administration of properly procured contracts is an Applicant’s responsibility, and FEMA should not substitute its own judgment for the Applicant’s.

In its August 5, 2019 letter and analysis, the Grantee supports the Applicant’s second appeal by reiterating its previously-raised arguments.

 

Discussion

 

Direct Result of Disaster

Section 406 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act (Stafford Act), authorizes FEMA to make contributions to a local government to restore eligible facilities on the basis of the design of such facilities as they existed immediately prior to the disaster.  Pursuant to 44 C.F.R. § 206.223(a), which implements that provision, an eligible item of work must be, among other things, required as the result of the disaster event.  FEMA policy provides that work must be required as a direct result of the declared disaster.[5]

In August 2005, Hurricane Katrina damaged the Applicant’s eligible facility.  Version 2 of PW 11695 developed cost estimates for the repair and replacement of the Applicant’s facility.  The replacement cost was determined to be $24,192,811.00 and a repair vs. replacement analysis was done.  A Cost Estimate Format (CEF) estimate was completed and provided the basis of the repair costs calculated at 61% of the building replacement costs.  The Applicant opted to repair the facility and a scope of work was developed.[6]  The Applicant solicited bids based on the scope of work and properly procured TKTMJ to perform the work.[7]  Therefore, the Applicant’s work is a direct result of the disaster and is eligible work. 

Allowable Costs

FEMA reimburses costs that can be directly tied to the performance of eligible work.[8]  Section 13.22(a)(1) of Title 44 of the Code of Federal Regulations provides that allowable costs include payments to fixed-price contractors in accordance with applicable federal cost principles.  Allowable direct costs include those that can be identified specifically with a particular project.[9]  Allocable indirect costs are also allowable.[10]  Federal cost principles detail the factors in determining allowable direct and indirect costs which include, among other things, that the costs be reasonable and allocable to the performance of the award and adequately documented.[11]  FEMA policy further provides the costs be necessary to accomplish the work and compliant with Federal, State, and local requirements for procurement.[12]  FEMA determines reasonableness of costs.[13]  In determining reasonableness of a given cost, FEMA considers various factors including whether the cost is of a type generally recognized as ordinary and necessary for the performance of the award; the restraints or requirements imposed by such factors as generally accepted sound business practices, arms-length bargaining, Federal and State laws and regulations, and terms and conditions of the award; and whether the individuals concerned acted with prudence in the circumstances.[14]  FEMA policy clarifies that a cost is reasonable, if in its nature and amount, it does not exceed that which would be incurred by a prudent person under the circumstances prevailing at the time the decision was made to incur the cost.[15] 

In the Applicant’s situation, it executed an AIA contract with TKTMJ to perform the repair work for disaster damages to the Applicant’s facility.  Its AIA contract included an industry-standard General Conditions “termination for convenience” clause that allowed the Applicant to terminate the contract at its convenience and without cause with details on the way it was to be effected.  The clause complies with 44 C.F.R. § 13.36(i) which mandates that contracts must contain a provision of termination for convenience by an applicant and must include the manner by which it will be effected and the basis of settlement.  The AIA contract provides that if TKTMJ is terminated for convenience, the Applicant pays for “[w]ork executed, and costs incurred by reason of such termination, along with reasonable overhead and profit on the [w]ork not executed.”[16]  The Applicant terminated TKTMJ and TKTMJ demanded costs of work executed and overhead costs.  The parties subsequently entered into a settlement agreement and the Applicant recorded a portion of the settlement as base overhead of $622,456.00 and the CCD # 1 overhead of $296,438.00.  The Grantee and Applicant submit the settlement was cost effective and resulted in the mitigation and minimizing of costs associated with the project.  Additionally, they submit it was a prudent course of action by the Applicant to terminate the contract for convenience and rebid as the TKTMJ was only 37 percent complete and overdue on the project timeline with costs increasing.  They further submit that the end result of the Applicant’s actions and management of the project resulted in the Applicant’s work for PW 11695 coming in approximately $3 million below the FEMA capped project amount. 

Overhead costs are the “soft” costs incurred by being in business that may or may not be associated with a specific job – for example, rent, heat, light, power, insurance, depreciation, taxes, maintenance, labor, and supervision [trucks, tools, and equipment; office expenses, bookkeeping and accounting; advertising, training, legal, property taxes, depreciation, repair and other costs of being in business].[17]  Upon termination of a contract, it is possible a contractor can continue to incur overhead costs related to idle facilities and idle capacity, loss of useful value of tools, machinery and equipment, insurance costs, and rental costs of unexpired leases, and subcontractors claims costs.[18]  In the Applicant’s matter, TKTMJ’s overhead costs were incorporated in and allocated to the fixed-price AIA contract[19] and were not line items.  The costs became due and owing as a result of exercising a clause within the AIA contract.[20] 

The documentation supports the Applicant’s assertion it complied with federal procurement rules in incorporating a termination for convenience clause including the way it would be effectuated, and that the Applicant acted with prudence in terminating the contract with TKTMJ for convenience.  Also, the Applicant is performing under the provisions of its AIA contract with TKTMJ, and specifically under a provision of the contract that is federally mandated and with terms usual to construction industry as per the AIA standard general contract conditions.[21]  The AIA contract is for the performance of eligible work relating to the disaster damages.  In the circumstances, the overhead costs incurred by the Applicant as part of a settlement relating to terminating a contract for convenience are allowable costs.  Therefore, TKTMJ’s overhead costs incurred by the Applicant are eligible costs tied directly to the performance of eligible work. 

Conclusion

The Applicant’s work is required as a result of the disaster and therefore eligible.  The Applicant’s costs of contractor overhead costs are allowable costs under 44 C.F.R. § 13.22 and incurred as a result of the Applicant prudently deciding to exercise a federally mandated procurement clause within an industry standard AIA contract for eligible work.  Accordingly, the second appeal is granted.

 

[1] Inclusive of $502,216.00 for selective demolition, and $74,935.00 for asbestos abatement.

[2] American Institute of Architects (AIA) Document A201, General Conditions of the Contract for Construction, § 14.4.3 (2007).

[3] Applicant’s RFI Response, Exhibit 6, TKTMJ vs. St. Martin’s Manor, Inc. and The Roman Catholic Church of the Diocese of New Orleans, para. 30, (Civ. Dist. Ct. Parish of Orleans No. 2614 -11273 [Date not readable]).

[4] Grantee’s Letter to Applicant (February 22, 2018) [notice of determination].

[5] Public Assistance Guide, FEMA 322, at 23 (Oct. 1999) [hereinafter PA Guide].

[6] PW 12748 V3 and V4.

[7] Exhibit 1b, Applicant’s response to FEMA’s RFI (Jan. 25, 2019).

[8] PA Guide, at 33.

[9] Office of Mgmt. & Budget, Exec. Office of the President (OMB) Circular A-122(B)(1) (May 10, 2004).

[10] Id. at A.1.

[11] OMB Circular A-122, Cost Principles for Non-Profit Organizations, at (A)(2)(a) and (g).

[12] PA Guide, at 33.

[13] FEMA Second Appeal Analysis, City of Coral Springs, FEMA-1609-DR-FL at 3 (May 19, 2017).

[14] OMB Circular A-122(A)(3).

[15] PA Guide, at 34.

[16] American Institute of Architects (AIA) Document A201, General Conditions of the Contract for Construction, § 14.4.3 (2007).

[17] Internal Revenue Service (IRS) Publication 334 Tax Guide for Small Business, at line 39 (2018).

[18] 48 C.F.R. § 31.205-42; In Nicon v. United States, 331 F.3d 878, (Fed. Cir. 2003), when discussing unabsorbed overhead costs of a home office, the court stated that the purpose of a termination for convenience settlement is to fairly compensate the contractor and to make the contractor whole for the costs incurred in connection with the terminated work, and fairness in the settlement is a matter of judgment and cannot be measured exactly.[18]  Nicon also cites to Spectrum Corp. V. General Services Administration, 95-1 B.C.A. (CCH) ¶27,317, at 136, 185-86 (G.S.G.C.A. Nov. 8, 1994), regarding a FAR contract, stating that in construing regulatory guidelines, it is “axiomatic that one must strike a balance between the need for technical compliance with regulatory requirements and the need for basic fairness.”

[19] TKTMJ Inc Contract at Exhibit 1b, Applicant’s response to FEMA’s RFI (Jan. 25, 2019).

[20] AIA Document A201, General Conditions of the Contract for Construction, § 14.4.3.

[21] Analogous to the Applicant’s situation, FEMA Second Appeal Analysis, Miss. Dep’t of Wildlife, Fisheries, and Parks, FEMA-1604-DR-MS, at 5 (Jan 3, 2014), has previously decided that 44 C.F.R. § 13.22 and the standard AIA general conditions of the contract entitled a contractor to overhead in instances where a contractor saved money by deleting an item that would have been used for eligible work; FEMA Second Appeal Analysis, City of Pass Christian, FEMA-1604-DR-MS, at 2 (June 26, 2015) stated “[w]hen determining allowable costs, FEMA must follow the terms of the contract.”