Facility Closing/Consolidation

Facility Closing/Consolidation

Large corporations may have many different locations and often expand to new locations or close current locations. When a location is closed the question is often asked, are Facility Closing/Consolidation costs allowable, and if so, how do you recover those costs.

FAR 31 - Contract Cost Principles and Procedures

In order to determine allowability a couple of FAR 31 - Contract Cost Principles need to be reviewed. They are:

• Idle Facilities and Idle Capacity Costs - FAR 31.205-17.

This is important because if the facilities were necessary when acquired or to meet fluctuations in workload, the costs are allowable up to a reasonable period of time. For example, a facility rent expense is $5M per year and has a 5 year lease left ($25M). A reasonable business expense for the lease cancellation would be $5M. However, there are other regulations (DFAR, see below) that could affect this.

• Organization Costs - FAR 31.205-27.

This cost principle is tricky, and note that the three areas described in the regulation are resisting or planning to resist a change in interest, raising capital, or changing the corporate structure. These are all typically external restructuring activities. The cost principles are silent on internal restructuring, they therefore are not expressly unallowable.

Allowability Determination

The determination of allowability of Internal Restructuring costs rest on the broader Cost Principle concept of "Reasonableness".

(a) A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Reasonableness of specific costs must be examined with particular care in connection with firms or their separate divisions that may not be subject to effective competitive restraints. No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by the contracting officer or the contracting officer’s representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable.

(b) What is reasonable depends upon a variety of considerations and circumstances, including—

(1) Whether it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance;

(2) Generally accepted sound business practices, arm’s-length bargaining, and Federal and State laws and regulations;

(3) The contractor’s responsibilities to the Government, other customers, the owners of the business, employees, and the public at large; and

(4) Any significant deviations from the contractor’s established practices.

Other Considerations/Regulations

DFARs

Please read the related page, DFAR 231.205-70 External Restructuring Costs. This page talks about external restructuring costs and provides guidance on obtaining an advance agreement as well as for the costs to be acceptable to the USG, for every dollar spent on restructuring costs, the cost savings would need to be $2. Also, be sure to read the definitions.

DFAR 231.205-70 while only relevant to external restructuring costs some of the requirements for external and internal may be the same such as novation agreements. For internal restructuring, a simple name change may be appropriate. For more on these requirements see.

Seeking Reimbursement of Facility Closing Costs

Step 1 - Eliminating Unallowable Costs

Step 1 of seeking reimbursement of facility closing costs is to determine if there are any expressly unallowable costs and if so eliminate them.

Step 2 - Compiling a Cost Impact/Benefit Analysis

While costs may be allowable they still may not be reasonable, and that is always the challenge with plant closure costs. For instance, if it costs a company $55M to close a site, how would the government benefit from that closure, and if they benefit, how much do they benefit, $55M?

The first step in the recovery of plant re-organization/restructuring after eliminating unallowable costs is to determine how the government benefits from the closure of a facility by compiling a cost impact/benefit analysis. It is best to look at this from a before and after approach. For the before picture, you would add together the two sites total costs, and the after approach would be to combine the two site costs but eliminating cost such as electricity, utilities, facilities, and redundant functions. For instance, manpower can normally be reduced by combining sites. A company no longer has to pay for security at 2 facilities, and functions like accounting can be done by the remaining facility with little or no increase in headcount.

The analysis has to take into account current and future contracts and have a reasonable period of costs recovery. That recovery period would also need to be matched with the reimbursement period of the restructuring costs.