The underlying dispute stemmed from a cost-reimbursement contract between KBR and the DOD, under which KBR was required to provide dining services for up to 50,000 troops in support of military operations in Iraq. As the military action escalated, however, the dining service requirements quickly and dramatically expanded to supporting 200,000 soldiers at 56 sites throughout Iraq.

After a “disastrous” attempt to self-perform certain portions of the expanded contract, KBR engaged a subcontractor, Tamimi Global Company, (“Tamimi”) to provide dining services at one of the Army camps and sought payment for those subcontractor services. The Defense Contract Audit Agency (“DCAA”) subsequently audited KBR and determined that KBR incurred $41 million in unreasonable subcontractor costs between July and December 2004. Acting on DCAA’s audit report, the contracting officer then withheld $41 million from payment to KBR. KBR filed a claim against the agency, which the Government denied, and then filed its claim appeal with the COFC. The COFC denied KBR‘s claim, adopting DCAA’s position that the costs were unreasonable because KBR did not engage in effective bargaining with Tamimi. The Court noted that although KBR‘s failed attempt at self-performance undermined its negotiating position, that complication did not mitigate KBR‘s failure or inability to negotiate better service rates with Tamimi.

Before the Federal Circuit, KBR argued that DCAA, the contracting agency, and the COFC impermissibly second-guessed KBR‘s business judgment in a wartime environment, contending that contractor’s cost of performance should be presumed reasonable unless the result of “gross misconduct,” “arbitrary action,” or “a clear abuse of discretion.” In substance, KBR advocated for application of the “business judgment rule” (a fundamental corporate law doctrine) to cost reasonableness determinations. The Federal Circuit rejected KBR‘s position, noting that earlier precedent deferring to contractor cost judgments does not outweigh the regulatory flexibility embodied in the cost principles contained in Federal Acquisition Regulation Part 31.

Now that the Supreme Court has denied certiorari and the Federal Circuit’s decision is final, contractors, subcontractors, accountants, auditors, and counsel must adapt to the newly recognized regulatory discretion held by all agency contracting personnel who are called upon to make cost reasonableness determinations. A few important aspects of theKBR decision may prove helpful to that adaptation process:

Documentation. Well-documented subcontractor price negotiations and flowdown provisions. KBR‘s exposure resulted from subcontract terms negotiated in and around the exigencies of a war zone at a time when performance was urgently needed. These unique circumstances left KBR without a comparable private marketplace benchmark for establishing cost reasonableness. KBR was forced to rely solely on its record of subcontract negotiations and the subcontract itself to establish reasonableness. Taking KBR‘s lessons learned to heart, cost-reimbursement contractors that are considering subcontracting should (i) look early (even at the time of proposal preparation) for a commercial market benchmark against which to make outsourcing price comparisons, and where no such counterpart exists, (ii) develop and pursue a robust plan for conducting and documenting subcontract negotiations, to include specially tailored clauses that enable the contractor to claw back costs paid and subsequently disallowed by the agency.

Burden of Proof. KBR I preserves the fundamental tenet that the burden to prove cost reasonableness always falls on the contractor. To meet that burden, contractors performing on large complex cost reimbursement contracts should expect and prepare for cost controversies and claims with the Government by meticulously documenting costs in order to justify their claim.

No Business Judgment Rule. The KBR I court took a dim view of KBR‘s argument that the costs were not unreasonable and were not the result of gross negligence. 

Second-Guessing — the New Standard. Cost-reimbursement contracts are now even more susceptible to agency second-guessing. Contractors should consider stepping up their administrative efforts to justify and document costs to mitigate the risk of material second-guessing during audit and closeout actions.

Those failures are now massive, undeniable and unfolding: Atrocities in Syria (including the death of more than 10,000 children); an endless Syrian civil war in which the threat of the Islamic State gathered strength; the victory of the Islamic State against a hollowed-out Iraqi military; the massacre of religious minorities; the establishment of a terrorist safe haven the size of New England, controlled by well-armed, expansionist, messianic militants; the attraction of more than 10,000 global jihadists to the conflict, including thousands with Western passports; and now the forced return of U.S. attention to the region under dramatically less-favorable circumstances.

This is what the complete collapse of a foreign policy doctrine looks like. In the absence of stabilizing U.S. leadership, the Middle East has become a regional Sunni-Shiite proxy war in which the most radical and ruthless thrive.

The Obama administration seems gobsmacked by the speed and extent of this unraveling. The possible collapse of Kurdistan (one of our most reliable friends in the region) was something that even the worst-case American analyses during the grimmest days of the Iraq War did not contemplate. This is what shocked the administration into (limited) action and accelerated the rethinking of U.S. policy.

The options are few. The administration could seek the eventual destruction of the Islamic State safe haven. This would involve encouraging a political accommodation to increase the legitimacy of Iraq’s central government; stabilizing the defense of Irbil and Baghdad with immediate military aid (which the administration has tentatively begun); targeting the extremists on both sides of the (nonexistent) Iraq/Syria border; attempting to peel off support among Sunni tribes sickened by the Islamic State’s brutality; and dramatically strengthening the Iraqi government and the Kurds so they can regain the offensive over time. Thousands of U.S. troops would be necessary to advise Iraqi units, collect intelligence, conduct airstrikes and carry out special operations raids. This approach would require presidential leadership to mobilize American national will for a difficult fight against a determined enemy.

An alternative option might be the long-term containment of the Islamic State threat. This would also involve stabilizing the military situation in Iraq’s north and south but leaving Islamic State militants in control of large sections of Syria and Iraq — trying to degrade their ability to strike globally and making clear that attacks on Western targets would bring massive retribution. This assumes a level of rationality (Western, secular rationality) on the part of Islamic State leaders that can only be called laughable. It is also the strategy most likely — after, say, a large-scale attack traced to the Islamic State on a U.S. city — to result in U.S. divisions back in Mosul.

Or the Obama administration could continue to make a series of tactical adjustments to avoid further disaster while avoiding setting out any definition of victory, which might become a standard against which it is judged. This might (with luck) run out the second-term clock; it would also leave a toxic mess for the next president.

Clearly, the Obama administration is undergoing an internal struggle to define its ultimate policy goal. Joint Chiefs Chairman Gen. Martin Dempsey talks of a strategy to “initially contain, eventually disrupt and finally defeat [the Islamic State] over time.” Meanwhile, unnamed White House officials consistently downplay the ambition of U.S. goals in Iraq. And the president himself is a model of ambiguity, leaving the world to wonder if any of his various lines have a hint of red.

Is it even possible for Obama to make the psychological adjustment from “the ender of wars” to “the sworn enemy of the Islamic State”? His record offers no reason for encouragement. But on this unlikely transformation now depends the future of the Middle East and the security of the United States.

By Michael Gerson of The Washington Post