PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
This memorandum is protected by the attorney-client privilege and the work-product doctrine. It has been prepared by counsel for Whitmore Aerospace LLC in anticipation of litigation and for the purpose of providing legal advice. It is not to be disclosed to any third party without the prior written consent of the undersigned or authorized client representatives. Any unauthorized disclosure may constitute a waiver of applicable privileges.
INTERNAL MEMORANDUM
TO: Priya Anand, Partner; Douglas Carmichael, Partner
FROM: Patrick Gallagher, Associate; Simone Laroche, Associate
DATE: June 12, 2024
RE: Analysis of Potential DCMA Contracting Officer's Final Decision ("COFD") Outcomes and Impact on Whitmore Aerospace LLC v. Hargrove-Dalton Defense Systems, Inc., No. 1:22-cv-10147-RMB (S.D.N.Y.)
CLIENT: Whitmore Aerospace LLC ("WAL" or "Whitmore")
MATTER NO.: 1019-00005
I. EXECUTIVE SUMMARY
The purpose of this memorandum is to analyze the range of potential outcomes that may result when Administrative Contracting Officer ("ACO") Lt. Col. Sandra M. Vickers issues the Contracting Officer's Final Decision ("COFD") under Prime Contract No. FA8620-19-C-0337 (the "Prime Contract") and to assess the implications of each such outcome for WAL's declaratory judgment action and for Hargrove-Dalton Defense Systems, Inc.'s ("HDDS") counterclaim seeking $14,726,583 in contractual indemnification.
As the litigation team is aware, WAL's declaratory judgment action has been stayed since March 17, 2023, pursuant to an order of the Honorable Richard M. Brannigan of the United States District Court for the Southern District of New York, pending the conclusion of the Defense Contract Management Agency ("DCMA") administrative review of the Prime Contract's cost overruns. Since the imposition of the stay, six joint status reports have been filed by the parties, the most recent of which was filed on March 11, 2024. The fourth joint status report is due on July 9, 2024. As of the third joint status report, DCMA has completed its field audit of the Prime Contract but the cost analysis remains under internal legal review at DCMA headquarters. No firm timeline for the issuance of the COFD has been communicated by DCMA, and our coordination with Ashford & Reeves LLP — WAL's government contracts regulatory counsel — confirms that the timing remains uncertain.
This memorandum models three principal COFD scenarios:
Scenario 1: The COFD confirms the full $14,726,583 allocation set forth in the Contracting Officer's Preliminary Determination ("COPD") and attributes the WP-4 cost overruns to WAL's performance deficiencies.
Scenario 2: The COFD reduces the WP-4 allocation below the COPD level or attributes the overruns partially to HDDS, the government, or other external causes.
Scenario 3: The COFD finds no disallowable costs or reverses the COPD in its entirety.
For each scenario, we assess WAL's litigation posture, the likely impact on HDDS's counterclaim, estimated exposure ranges, and recommended tactical responses. In addition, we address several cross-cutting considerations — including HDDS's administrative appeal rights under the Contract Disputes Act, insurance coverage implications, lender covenant compliance, financial statement treatment, and the expiration of the Prime Contract's base period of performance — that will affect WAL's strategic position regardless of which scenario materializes.
Key Conclusion: WAL's strongest litigation posture arises under Scenario 2 or Scenario 3, where the COFD either reduces the WP-4 allocation or finds no disallowable costs. Even under the worst-case scenario (Scenario 1 — full confirmation of the COPD), WAL retains viable defenses grounded in the causation requirement of Section 11.4(b) of the Teaming Agreement and the overbreadth of HDDS's demand, which improperly encompasses $1,909,142 in non-WP-4 overruns. The litigation team should remain in a state of readiness for prompt reactivation of the DJ action upon the issuance of the COFD, while continuing to monitor the DCMA review process and minimize costs during the dormancy period.
II. BACKGROUND
A. The Underlying Government Contract and Cost-Overrun Dispute
The dispute at issue arises out of the Advanced Tactical Airframe Program ("ATAP"), a major defense acquisition program under Prime Contract No. FA8620-19-C-0337, awarded by the United States Air Force, Air Force Life Cycle Management Center ("AFLCMC"), headquartered at Wright-Patterson Air Force Base, Ohio. The Prime Contract was awarded to Hargrove-Dalton Defense Systems, Inc. ("HDDS") as the prime contractor for the design, development, and initial production of advanced tactical airframe assemblies.
The Prime Contract is structured as a cost-plus-incentive-fee ("CPIF") contract, the principal financial parameters of which are as follows:
The base period of performance under the Prime Contract runs from September 1, 2019, through August 31, 2024 — a five-year period. The contract includes two one-year option periods, the exercise of which is at the government's discretion. It bears noting that the base period of performance is scheduled to expire on August 31, 2024, approximately two and one-half months from the date of this memorandum. The implications of this approaching expiration are addressed in Section V.E below.
WAL's involvement in the ATAP program is governed by a Teaming Agreement dated June 12, 2019 (the "Teaming Agreement"), between WAL and HDDS. Under the Teaming Agreement, WAL serves as a subcontractor and teaming partner to HDDS, responsible for the fabrication and delivery of titanium structural assemblies — specifically, the wing-box substructure, center fuselage longerons, and bulkhead fittings — collectively designated as Work Package 4 ("WP-4"). WAL's share of the contract value represents approximately 18% of the target cost, equating to approximately $74,160,000.
On August 1, 2022, ACO Lt. Col. Sandra M. Vickers issued a Contracting Officer's Preliminary Determination ("COPD") identifying $14,726,583 in total cost overruns under the Prime Contract. The COPD attributed $12,817,441 — representing 87.03% of the total overrun amount — to WP-4, and the remaining $1,909,142 (12.97%) to other work packages performed by HDDS or its other subcontractors.
The COPD identified four root causes for the WP-4 cost overruns:
1. Titanium raw-material cost escalation — approximately $4,200,000, attributed to significant increases in the market price of aerospace-grade titanium during the 2020–2022 period, which exceeded the pricing assumptions embedded in WAL's original cost estimates.
2. Rework due to non-conforming machining tolerances — approximately $5,100,000, attributed to a pattern of out-of-tolerance conditions in WAL's precision machining of titanium structural components, necessitating rework, scrap, and remanufacturing.
3. Schedule delays causing idle-labor charges — approximately $2,300,000, attributed to delays in WAL's delivery schedule that resulted in idle labor at HDDS's final assembly facility.
4. Engineering change proposal ("ECP") implementation costs — approximately $1,200,000, attributed to the costs of implementing engineering changes directed during the course of performance.
These four categories sum to approximately $12,800,000, consistent with the $12,817,441 total attributed to WP-4 in the COPD.
Following the issuance of the COPD, HDDS filed a formal response and request for a COFD with DCMA on October 15, 2022. In that submission, HDDS disputed the allocation methodology employed in the COPD and asserted that all WP-4 overruns are solely the responsibility of WAL. Separately, on September 9, 2022 — prior to its formal submission to DCMA — HDDS issued an indemnification demand letter to WAL, seeking payment of the full $14,726,583. Notably, HDDS's demand was not limited to the WP-4 portion of the overruns but encompassed the entire COPD amount, including the $1,909,142 attributable to non-WP-4 work packages.
B. The Teaming Agreement Indemnity Provisions
The dispute between WAL and HDDS centers on the interpretation and application of the indemnification provisions contained in Article 11 of the Teaming Agreement. The relevant provisions are as follows:
Section 11.4 (Indemnification). Section 11.4 provides that the Team Member (WAL) shall indemnify and hold harmless the Team Lead (HDDS) from and against all losses, damages, liabilities, costs, and expenses (collectively, "Losses") arising out of:
(a) the Team Member's negligent acts or omissions, willful misconduct, or material breach of the Teaming Agreement; or
(b) any claim by the U.S. Government that costs incurred under the Team Member's Work Package are unallowable, unreasonable, or otherwise subject to disallowance under the Prime Contract, "to the extent such claim is caused by Team Member's acts or omissions."
The quoted causation language in subsection (b) is critical to WAL's defense. It limits WAL's indemnification obligation to government claims that are caused by WAL's own acts or omissions, as opposed to claims arising from factors outside WAL's control — such as government-directed engineering changes, market-driven raw material price fluctuations, or HDDS's own performance deficiencies.
Section 11.5 (Limitation of Liability). WAL's aggregate liability under the Teaming Agreement is capped at 120% of WAL's Work Package value. Based on WAL's $74,160,000 share of the target cost, this cap equals $88,992,000. While this cap is not at issue in the current dispute — the claimed amount of $14,726,583 is well below the cap — it sets the outer boundary of WAL's potential exposure.
Section 11.6 (Attorneys' Fees). Section 11.6 provides that the prevailing party in any dispute arising out of or relating to the Teaming Agreement shall be entitled to recover its reasonable attorneys' fees and costs from the non-prevailing party. This provision is the basis for HDDS's claim for attorneys' fees in its counterclaim, but it also provides WAL with a basis for fee recovery if WAL prevails in the DJ action.
Section 18.1 (Governing Law). The Teaming Agreement is governed by the laws of the State of New York, without regard to its conflict-of-laws principles.
C. Procedural Posture of the DJ Action
WAL commenced the declaratory judgment action on November 28, 2022, in the United States District Court for the Southern District of New York. The complaint asserts a single count under the Declaratory Judgment Act, 28 U.S.C. §§ 2201–2202, and seeks three declarations:
(1) That Section 11.4 of the Teaming Agreement does not obligate WAL to indemnify HDDS for the cost overruns identified in the COPD;
(2) That even if Section 11.4 applies, the causation requirement of subsection (b) is not satisfied because the WP-4 overruns were not caused by WAL's acts or omissions; and
(3) That HDDS's indemnification demand is overbroad because it includes $1,909,142 in non-WP-4 overruns that cannot be WAL's responsibility under any reasonable reading of the Teaming Agreement.
HDDS filed its Answer and Counterclaim on January 13, 2023. The counterclaim seeks $14,726,583 in contractual indemnification under Section 11.4 of the Teaming Agreement, together with attorneys' fees and costs under Section 11.6. HDDS's counterclaim theory is that the COPD's attribution of cost overruns to WP-4 establishes a government claim that costs under WAL's Work Package are subject to disallowance, thereby triggering WAL's indemnification obligation under Section 11.4(b).
WAL filed its Reply to Counterclaim on February 3, 2023, denying all material allegations and reasserting its three core defenses.
On March 17, 2023, Judge Brannigan granted a joint motion to stay the action, finding that the ongoing DCMA administrative review would likely "resolve or narrow the factual predicate" underlying the parties' dispute and that a stay would promote judicial economy and avoid potentially inconsistent determinations. The stay order requires the parties to file joint status reports every 120 days and directs the parties to notify the court within 14 days of the issuance of the COFD.
To date, three joint status reports have been filed:
The fourth joint status report is due July 9, 2024. Each report has consistently indicated that the DCMA review remains pending and that no COFD has been issued.
Total fees incurred by WAL in connection with this matter through approximately this period are tracking below the original engagement budget, largely due to the dormancy occasioned by the stay. As discussed further in Section VI.F below, approximately $400,000 has been incurred to date, predominantly during the pre-filing investigation, the stay motion practice, and the ongoing monitoring activities.
D. Current DCMA Administrative Review Status
As of the date of this memorandum, the status of the DCMA administrative review is as follows:
• DCMA has completed the field audit of Prime Contract FA8620-19-C-0337. The field audit was conducted at HDDS's facilities in Arlington, Virginia, and involved a review of contract cost records, subcontractor invoicing, and performance documentation.
• The cost analysis is currently under internal legal review at DCMA headquarters. This review is being conducted by DCMA's Office of General Counsel, which is assessing the legal sufficiency of the audit findings and the proposed cost-allocation methodology before the ACO issues the COFD.
• No COFD has been issued by ACO Lt. Col. Vickers.
• No firm timeline for the issuance of the COFD has been communicated by DCMA, either to HDDS (as prime contractor) or through any channel available to WAL.
Coordination with Ashford & Reeves LLP — specifically Harold Reeves, partner, and Natalie Cheng, counsel — continues pursuant to the coordination protocol established on January 5, 2023. Under that protocol, Ashford & Reeves monitors DCMA developments through their government-contracts regulatory practice and provides periodic updates to this litigation team. The most recent update from Ashford & Reeves, received on June 3, 2024, confirmed that no material developments had occurred and that the DCMA legal review remains in progress.
III. ANALYTICAL FRAMEWORK
Before turning to the scenario analysis, it is useful to set forth the analytical framework governing the relationship between the COFD and the DJ action.
The COFD as the Government's Definitive Administrative Determination. The COFD will constitute the government's definitive administrative determination on the cost overruns under the Prime Contract and their allocation among work packages. Under FAR 33.211 and the Contract Disputes Act ("CDA"), 41 U.S.C. §§ 7101–7109, a COFD is the formal mechanism by which a contracting officer renders a final decision on a claim or dispute arising under or relating to a government contract. The COFD supersedes any prior preliminary determinations, including the COPD issued on August 1, 2022, and establishes the government's official position on the matters addressed therein.
Administrative Appeal Rights Under the CDA. Upon issuance of the COFD, HDDS — as the prime contractor and the entity in privity with the government — will have the right to appeal an adverse determination. Under the CDA, HDDS may appeal to the Armed Services Board of Contract Appeals ("ASBCA") within 90 days of receipt of the COFD, or, alternatively, may bring a direct action in the United States Court of Federal Claims within 12 months. WAL, as a subcontractor without privity of contract with the government, does not have independent standing to appeal the COFD. This asymmetry has significant strategic implications, as discussed further in Section V.A below.
The COFD's Evidentiary Weight in the DJ Action. The COFD's findings will not be binding on the United States District Court for the Southern District of New York in the DJ action. The DJ action concerns the interpretation and application of a private Teaming Agreement under New York law — a matter entirely within the jurisdiction of the federal district court. The COFD is an administrative determination by a government contracting officer concerning the cost-accounting treatment of expenditures under a CPIF contract, governed by the Federal Acquisition Regulation and applicable cost-accounting standards.
Notwithstanding this distinction, the COFD will be highly probative on the factual predicate underlying the parties' dispute. Specifically, the COFD is expected to address three factual questions that are directly relevant to the DJ action:
(a) Whether costs are disallowed. The COFD will determine whether the identified cost overruns constitute unallowable, unreasonable, or otherwise disallowable costs under the CPIF contract. This determination is directly relevant to whether the trigger condition of Section 11.4(b) of the Teaming Agreement is satisfied — i.e., whether there exists a "claim by the U.S. Government that costs incurred under Team Member's Work Package are unallowable, unreasonable, or otherwise subject to disallowance."
(b) The amount attributed to WP-4. The COFD will establish the government's official allocation of cost overruns among work packages, including the amount attributable to WP-4. This allocation is relevant to the quantum of any indemnification obligation and to WAL's overbreadth defense.
(c) The root causes. The COFD is expected to include findings regarding the causes of the cost overruns, which are directly relevant to WAL's causation defense under Section 11.4(b).
WAL's Three Core Defenses. Throughout this analysis, we evaluate each scenario against WAL's three core defenses, which have remained consistent since the filing of the DJ action:
1. Causation. Section 11.4(b) requires that the government's claim of cost disallowance be "caused by Team Member's acts or omissions." WAL's position is that significant components of the WP-4 overruns — including titanium raw-material cost escalation, idle-labor charges resulting from HDDS-caused delays, and ECP implementation costs directed by HDDS or the Air Force — were not caused by WAL's acts or omissions. Under New York law, the causation requirement in an indemnification provision is interpreted according to its plain meaning, and the indemnitee bears the burden of establishing that the claimed losses fall within the scope of the indemnity. See Hooper Assocs., Ltd. v. AGS Computers, Inc., 74 N.Y.2d 487, 491 (1989) (indemnification agreements are "strictly construed to avoid reading into [them] a duty to indemnify that the parties did not intend to include").
2. Overbreadth. HDDS's indemnification demand encompasses the full $14,726,583 identified in the COPD, including $1,909,142 in overruns attributable to non-WP-4 work packages. Section 11.4(b) limits WAL's indemnification obligation to costs incurred "under the Team Member's Work Package." WAL's position is that HDDS cannot recover indemnification for overruns arising outside WP-4 under any reasonable interpretation of the Teaming Agreement.
3. Ripeness/Triggering. WAL has maintained an alternative argument that a COPD — as a preliminary, non-final administrative determination — does not constitute a "claim" of cost disallowance within the meaning of Section 11.4(b). The issuance of the COFD may moot this argument, depending on the nature and finality of the COFD's determinations.
With this framework in mind, we turn to the three principal COFD scenarios.
IV. SCENARIO ANALYSIS
A. Scenario 1: COFD Confirms Full $14,726,583 Allocation and Attributes WP-4 Overruns to WAL's Performance
1. Description of Scenario. Under this scenario, ACO Lt. Col. Vickers issues a COFD that confirms the COPD's findings in their entirety. Specifically, the COFD would find that:
• Total cost overruns under the Prime Contract amount to $14,726,583;
• Of that total, $12,817,441 (87.03%) is attributable to WP-4, and $1,909,142 (12.97%) is attributable to other work packages;
• The WP-4 overruns constitute unallowable or unreasonable costs that are subject to disallowance under the CPIF contract structure; and
• The WP-4 overruns were caused by WAL's performance deficiencies — specifically, inadequate quality control on machining tolerances (driving rework costs of approximately $5.1 million), failure to mitigate titanium raw-material cost escalation (approximately $4.2 million), and WAL-caused schedule delays resulting in idle-labor charges at HDDS's final assembly facility (approximately $2.3 million). The COFD narrative under this scenario would also address ECP implementation costs (approximately $1.2 million), attributing them to WAL's performance rather than to government or HDDS direction.
This scenario represents the DCMA legal review's endorsement of the ACO's original analysis without material modification. While not inevitable, this outcome is plausible given that the COPD was based on a detailed field audit and that DCMA headquarters legal review often results in modest refinements rather than wholesale reversals.
2. Impact on WAL's DJ Action. This is the worst-case scenario for WAL from an evidentiary standpoint. A COFD confirming the COPD's findings in full would provide HDDS with a powerful piece of evidence — the government's formal administrative determination that costs under WAL's Work Package are disallowable and that WAL's performance was the cause.
HDDS's anticipated arguments. In the DJ action, HDDS would be expected to argue that the COFD satisfies both the trigger condition and the causation requirement of Section 11.4(b). Specifically, HDDS would contend that: (i) the COFD constitutes a "claim by the U.S. Government that costs incurred under Team Member's Work Package are unallowable, unreasonable, or otherwise subject to disallowance," thereby triggering WAL's indemnification obligation; and (ii) the COFD's narrative finding that WAL's performance deficiencies caused the WP-4 overruns satisfies the "caused by Team Member's acts or omissions" requirement. HDDS would also likely argue that the COFD should be given significant, if not preclusive, weight by the court.
WAL's overbreadth defense. Even under this worst-case scenario, WAL's overbreadth defense remains strong with respect to the $1,909,142 in non-WP-4 overruns. The Teaming Agreement unambiguously limits WAL's indemnification obligation to costs incurred "under the Team Member's Work Package." WP-4 is defined with specificity in the Teaming Agreement and encompasses only the titanium structural assemblies (wing-box substructure, center fuselage longerons, and bulkhead fittings) that WAL was responsible for fabricating and delivering. Overruns attributable to other work packages — regardless of their cause — fall outside the scope of WAL's indemnity. HDDS's attempt to recover the full $14,726,583 is therefore overbroad by at least $1,909,142, and this argument is effectively independent of the COFD's findings regarding WP-4. Under New York law, an indemnitee may not recover amounts outside the scope of the indemnity clause, regardless of the factual findings underlying the claim. See generally Great N. Ins. Co. v. Interior Constr. Corp., 7 N.Y.3d 412, 417–18 (2006).
WAL's causation defense. WAL's causation defense becomes more challenging under this scenario but is by no means eliminated. The COFD's findings regarding causation, while probative, are not binding on the district court. The court will independently evaluate the causation evidence under the standard applicable to the interpretation of the Teaming Agreement under New York law. WAL would need to develop the following factual record through discovery and expert testimony:
(a) Titanium raw-material cost escalation (~$4.2 million). WAL would argue that the dramatic increase in the market price of aerospace-grade titanium during the 2020–2022 period was a force-majeure event — driven by global supply-chain disruptions, pandemic-related production constraints, and geopolitical factors affecting titanium supply from key source nations — that was entirely outside WAL's control. WAL would seek to establish that its original cost estimates were reasonable at the time of contract formation and that no commercially reasonable mitigation strategy was available to offset the full magnitude of the price escalation. If WAL can establish that the titanium cost increases were not "caused by" WAL's acts or omissions, this approximately $4.2 million component should fall outside the scope of the indemnity even if the COFD characterizes these costs as disallowable.
(b) Non-conforming machining tolerances (~$5.1 million in rework costs). This is the most significant and most contested component. WAL's position is that a substantial portion of the non-conformance events resulted from deficiencies in the engineering specifications furnished by HDDS to WAL, rather than from errors in WAL's fabrication processes. Specifically, WAL has identified instances in which HDDS's geometric dimensioning and tolerancing ("GD&T") callouts on the wing-box substructure drawings were internally inconsistent or specified tolerances that were not achievable using the manufacturing processes contemplated in the Teaming Agreement's Statement of Work. To prevail on this argument, WAL will need to obtain HDDS's internal engineering records, correspondence with the Air Force regarding specification changes, and testimony from HDDS's design engineers. A manufacturing or engineering expert would also be required.
(c) Idle-labor charges (~$2.3 million). WAL would argue that the schedule delays giving rise to idle-labor charges at HDDS's final assembly facility were not attributable to WAL but rather stemmed from HDDS's late delivery of government-furnished equipment ("GFE") that was a prerequisite to WAL's performance. If WAL can establish that the delays were caused by HDDS's failure to timely deliver GFE — or by the government's failure to provide GFE to HDDS on schedule — the resulting idle-labor charges would not have been "caused by" WAL's acts or omissions.
(d) ECP implementation costs (~$1.2 million). WAL would argue that the engineering changes at issue were directed by HDDS and/or the Air Force and that the costs of implementing those changes should be borne by the party that directed them, not by WAL. If the ECPs were government-directed changes within the meaning of FAR 52.243-2 (Changes — Cost-Reimbursement), the resulting costs may be allowable under the Prime Contract in any event, and the indemnity provision would not be triggered.
Estimated WAL exposure. Under this scenario, WAL's maximum exposure is up to $12,817,441 (the WP-4 portion of the overruns), plus HDDS's attorneys' fees under Section 11.6 if HDDS prevails on its counterclaim. The aggregate cap of $88,992,000 under Section 11.5 is not implicated, as the claimed amount is well below that threshold. However, if WAL is able to establish its causation defenses on one or more of the four cost components identified above, the actual liability could be significantly lower. As a rough order of magnitude, if WAL prevails on the titanium escalation and ECP components, the remaining disputed amount would be in the range of $5.1 million to $7.4 million.
3. Recommended Litigation Posture. Under Scenario 1, WAL should adopt the following litigation posture:
First, aggressively pursue discovery on causation. The causation defense is WAL's strongest line of attack in this scenario, and its success depends on a robust factual record. Priority discovery targets include: (i) HDDS's internal engineering records, specifications, and GD&T drawings for the WP-4 components; (ii) government-furnished equipment delivery logs and correspondence; (iii) the ECP directive chain, including correspondence between HDDS, the Air Force Contracting Officer, and WAL regarding each engineering change; (iv) HDDS's internal schedule analyses and delay attribution reports; and (v) any correspondence between HDDS and the ACO regarding the COPD and the cost-allocation methodology.
Second, retain a government-contracts accounting expert to challenge the COFD's cost-allocation methodology. Even under a full-confirmation scenario, the methodology by which the ACO allocated costs to WP-4 is subject to scrutiny. An expert in government-contracts cost accounting — particularly one with experience in CPIF contract structures and FAR Part 31 cost-allowability principles — could identify flaws in the allocation methodology or demonstrate that certain costs classified as "disallowable" are in fact allowable under the applicable cost-accounting standards.
Third, consider whether to move for partial summary judgment on the $1,909,142 non-WP-4 component. As discussed above, WAL's overbreadth defense on this component is strong regardless of the COFD's findings regarding WP-4. An early partial summary judgment motion could narrow the scope of the dispute and demonstrate the weakness of HDDS's overreaching indemnity demand.
Fourth, assess whether to seek continuation of the stay if HDDS appeals the COFD to the ASBCA or the Court of Federal Claims. As discussed further in Section V.A below, an HDDS appeal could delay the resolution of the administrative process and may or may not justify a further extension of the stay in the DJ action.
B. Scenario 2: COFD Reduces WP-4 Allocation or Attributes Overruns Partially to HDDS/Other Causes
1. Description of Scenario. Under this scenario, ACO Lt. Col. Vickers issues a COFD that finds total cost overruns at or near the $14,726,583 level identified in the COPD but modifies the allocation among work packages and/or the attribution of root causes. Specifically, the COFD under this scenario would reduce the allocation to WP-4 below the 87.03% level set forth in the COPD, or would find that certain WP-4 overrun components were caused by factors outside WAL's control.
Several sub-scenarios are plausible:
(a) Reduced WP-4 allocation. The COFD might reduce the share of total overruns attributable to WP-4 from 87.03% to a lower figure — for example, 50–60%, corresponding to approximately $7,400,000 to $8,800,000. This could result from a reassessment of the indirect cost allocation methodology, a reattribution of shared overhead costs, or a determination that certain costs previously attributed to WP-4 are more properly allocated to other work packages.
(b) Allowable cost determination. The COFD might find that certain cost categories — particularly the titanium raw-material cost escalation (approximately $4.2 million) — are allowable costs under the CPIF contract structure. Under a CPIF contract, cost overruns within the ceiling price are shared between the government and the contractor per the share ratio (here, 70/30). If the COFD concludes that the titanium cost increases represent allowable cost growth that is properly addressed through the CPIF cost-sharing mechanism rather than through cost disallowance, those costs would not trigger Section 11.4(b) of the Teaming Agreement.
(c) HDDS-attributable causes. The COFD might attribute a portion of the rework costs (approximately $5.1 million) to HDDS specification errors rather than WAL fabrication deficiencies. If the ACO's review of the technical data reveals that HDDS's engineering drawings contained errors or ambiguities that contributed to out-of-tolerance conditions, the COFD could allocate a share of the rework costs to HDDS.
This scenario is, in our assessment, the most likely outcome. DCMA headquarters legal reviews frequently result in modifications to preliminary determinations, and the extended duration of the current review suggests that the legal team may be grappling with questions about the proper allocation methodology or the allowability of certain cost categories.
2. Impact on WAL's DJ Action. A COFD that reduces the WP-4 allocation or reattributes certain overrun causes substantially strengthens WAL's litigation position on both the causation and quantum dimensions of the dispute.
Causation. A reduced WP-4 allocation directly narrows the scope of HDDS's indemnity claim under Section 11.4(b). To the extent the COFD finds that certain WP-4 overruns were caused by factors other than WAL's acts or omissions — e.g., HDDS specification errors, government-directed ECPs, or market-driven raw-material cost increases — those findings would constitute powerful evidence in support of WAL's causation defense. While the COFD's causation findings are not binding on the district court, they represent the considered judgment of the government's administrative contracting officer after a comprehensive field audit and legal review. The court is likely to give such findings significant weight, particularly where they are adverse to the government's own interests.
Triggering/Allowability. If the COFD determines that certain cost categories are allowable under the CPIF contract — i.e., that they do not constitute "unallowable, unreasonable, or otherwise [disallowable]" costs — those categories would fall outside the trigger of Section 11.4(b) entirely. The indemnity provision is not a general cost-overrun guarantee; it is triggered only by government claims that costs are subject to disallowance. Costs that the government has affirmatively determined to be allowable cannot, by definition, give rise to a "claim . . . that costs . . . are unallowable, unreasonable, or otherwise subject to disallowance."
Overbreadth. WAL's overbreadth defense on the $1,909,142 non-WP-4 component is further bolstered if the COFD itself reduces the WP-4 share. A government determination that a material portion of the overruns is not attributable to WP-4 underscores the impropriety of HDDS's demand for indemnification of the full $14,726,583 and demonstrates that HDDS's counterclaim is, at minimum, substantially inflated.
Estimated WAL exposure. Under this scenario, WAL's potential exposure is reduced proportionally. Depending on the specific findings of the COFD, the disputed amount could fall in the range of approximately $5,000,000 to $8,000,000, and WAL's viable causation defenses would further reduce the likely actual liability below that range.
3. Recommended Litigation Posture. Under Scenario 2, WAL should adopt an assertive litigation posture designed to capitalize on the COFD's favorable findings:
First, move promptly to lift the stay. The COFD's issuance satisfies the condition that prompted Judge Brannigan to impose the stay — i.e., the conclusion of the DCMA administrative review. WAL should file a motion to lift the stay within 14 days of COFD issuance, accompanied by a brief explaining how the COFD has narrowed the factual predicate and demonstrating that the DJ action is now ripe for adjudication.
Second, seek summary judgment on the components that the COFD has excluded from WP-4 or found to be allowable costs. If the COFD reduces the WP-4 allocation or determines that specific cost categories are allowable, WAL should move for partial summary judgment on those components, arguing that the COFD findings eliminate any factual basis for HDDS's indemnity claim with respect to those costs.
Third, use the COFD findings as evidence in support of WAL's causation defense. To the extent the COFD attributes WP-4 overruns to causes other than WAL's acts or omissions, WAL should present those findings prominently in its summary judgment briefing and at trial.
Fourth, explore settlement discussions from a position of significantly greater leverage. Under this scenario, WAL's settlement posture is substantially improved. A potential settlement range of $2,000,000 to $5,000,000 — reflecting WAL's reduced exposure and the significant litigation risk facing HDDS — should be explored. Settlement discussions should also emphasize to HDDS the risk that the court may award WAL attorneys' fees under Section 11.6 as the prevailing party if the DJ action succeeds on WAL's core defenses.
Fifth, emphasize the Section 11.6 fee-shifting risk to HDDS. Under Section 11.6, the "prevailing party" in any dispute arising out of the Teaming Agreement is entitled to recover reasonable attorneys' fees. If the COFD substantially undermines HDDS's counterclaim, HDDS faces the risk of not only losing on the merits but also being required to pay WAL's attorneys' fees. This risk should be communicated clearly to opposing counsel as part of any settlement discussion.
C. Scenario 3: COFD Finds No Disallowable Costs or Reverses the COPD
1. Description of Scenario. Under this scenario, ACO Lt. Col. Vickers issues a COFD concluding that the cost overruns identified in the COPD do not constitute unallowable or unreasonable costs under the Prime Contract. Specifically, the COFD might determine that:
• The identified overruns fall within the normal CPIF cost-sharing framework, with the government bearing 70% of overruns per the 70/30 share ratio and the contractor bearing 30%, and that no separate disallowance action is warranted;
• The cost categories identified in the COPD — including titanium raw-material cost escalation, rework costs, idle-labor charges, and ECP implementation costs — are allowable costs under FAR Part 31 and applicable cost-accounting standards; or
• The COPD methodology was flawed and the costs as properly analyzed do not meet the threshold for disallowance.
This outcome, while the least likely of the three scenarios given the generally adverse tone of the COPD, is not implausible. The extended duration of the DCMA headquarters legal review may indicate that the legal team has identified substantive issues with the COPD's methodology or conclusions. It is also possible that the legal review has revealed that the CPIF cost-sharing mechanism — under which the government bears 70% of cost overruns within the ceiling price — adequately addresses the identified overruns and that a separate disallowance determination is neither necessary nor appropriate.
2. Impact on WAL's DJ Action. A COFD finding no disallowable costs is the best-case scenario for WAL and would be potentially dispositive of the DJ action.
Trigger condition not satisfied. If the COFD finds no disallowable costs, the trigger condition of Section 11.4(b) is not satisfied. Section 11.4(b) requires a "claim by the U.S. Government that costs incurred under Team Member's Work Package are unallowable, unreasonable, or otherwise subject to disallowance." A COFD affirmatively finding that the costs at issue are allowable and not subject to disallowance negates the existence of any such government claim. HDDS cannot manufacture an indemnification trigger where the government itself has concluded that no disallowance is warranted.
HDDS's counterclaim fails. HDDS's counterclaim is premised entirely on the existence of a government claim of cost disallowance that triggers Section 11.4(b). If the COFD eliminates the factual predicate for that claim, the counterclaim fails as a matter of law. There is no independent basis in the Teaming Agreement for HDDS to recover indemnification for cost overruns that the government has determined to be allowable.
WAL as prevailing party. Under this scenario, WAL would be the prevailing party in the DJ action, entitling WAL to seek recovery of its reasonable attorneys' fees and costs under Section 11.6 of the Teaming Agreement.
Ripeness defense vindicated. This scenario would also vindicate WAL's ripeness/triggering defense — that the COPD, as a non-final preliminary determination, was insufficient to trigger the indemnity. The COFD's reversal of the COPD would demonstrate that preliminary administrative determinations are unreliable predictors of final outcomes and that HDDS's premature indemnity demand was unwarranted.
3. Recommended Litigation Posture. Under Scenario 3, WAL should move aggressively and decisively to terminate the litigation:
First, file a motion to lift the stay within 14 days of COFD issuance. The motion should be accompanied by a copy of the COFD and a brief explaining that the administrative review has concluded with findings that are favorable to WAL and dispositive of the DJ action.
Second, file a motion for summary judgment on all three declarations sought in the DJ complaint and on HDDS's counterclaim. The motion should argue that the COFD eliminates the factual predicate for HDDS's indemnification claim, that the trigger condition of Section 11.4(b) is not satisfied, and that HDDS's counterclaim fails as a matter of law.
Third, demand dismissal of HDDS's counterclaim with prejudice. If summary judgment is granted, WAL should insist on dismissal with prejudice to preclude any future attempt by HDDS to relitigate the indemnification claim.
Fourth, seek attorneys' fees and costs under Section 11.6. As the prevailing party, WAL would be entitled to recover its reasonable attorneys' fees and costs incurred in defending against HDDS's baseless indemnification demand and prosecuting the DJ action.
V. CROSS-CUTTING CONSIDERATIONS
Regardless of which scenario materializes, several considerations will affect WAL's strategic position and require ongoing attention.
A. HDDS Administrative Appeal Rights
Under the Contract Disputes Act, HDDS — as the prime contractor in privity with the government — has the right to appeal an unfavorable COFD to the Armed Services Board of Contract Appeals ("ASBCA") within 90 days of receipt of the COFD, or to bring a direct action in the United States Court of Federal Claims ("COFC") within 12 months. WAL, as a subcontractor, has no independent standing to appeal the COFD.
If HDDS elects to appeal the COFD, several implications follow for the DJ action:
Potential extension of the stay. HDDS may argue that an administrative appeal further delays the finalization of the government's position on cost allocation and that the stay should be extended pending the appeal's resolution. This argument has some logical force — if the ASBCA or COFC reverses or modifies the COFD, the factual predicate for the DJ action could change again. However, WAL should be prepared to resist an indefinite extension of the stay. The court's original stay rationale was that the DCMA review would "resolve or narrow the factual predicate." The COFD's issuance fulfills that purpose. An ASBCA appeal could take 18 months to three years, and a COFC action could take even longer. At some point, the DJ action must proceed on its own merits under New York contract law, and the court should not allow HDDS to use sequential administrative proceedings to indefinitely delay resolution of WAL's contractual rights.
Scenario-dependent considerations. Under Scenario 1, if the COFD confirms the full allocation, HDDS would have no incentive to appeal and would instead seek to reactivate the DJ action. Under Scenario 2, HDDS might appeal the reduction in WP-4 allocation in an effort to obtain a more favorable administrative determination before returning to the DJ action. Under Scenario 3, HDDS would almost certainly appeal the COFD's finding of no disallowable costs, as that finding would be fatal to its counterclaim.
WAL should develop contingent briefing in advance for the possibility that HDDS seeks to extend the stay based on an administrative appeal. The briefing should emphasize that: (i) the COFD satisfies the purpose of the stay; (ii) the parties' private contractual dispute under New York law is independent of the government's administrative proceedings; and (iii) further delay prejudices WAL by prolonging the cloud of contingent liability over its financial statements and business operations.
B. Insurance Coverage Implications
WAL tendered HDDS's indemnity demand to Meridian Surety & Insurance Group ("Meridian") on September 22, 2022, under two policies:
• Directors and Officers Liability Policy: Policy No. MSI-DO-2022-07814, with a $10,000,000 aggregate limit of liability and a $250,000 retention.
• Commercial General Liability Policy: Policy No. MSI-CGL-2021-33291, with a $25,000,000 aggregate limit of liability and a $500,000 self-insured retention ("SIR").
Meridian issued a reservation-of-rights letter dated November 1, 2022, in which it acknowledged receipt of the tender and agreed to monitor the matter but reserved its rights on two principal grounds: (i) the contractual-liability exclusion (Exclusion (b)) in the CGL policy, which excludes coverage for liability assumed under a contract or agreement; and (ii) the government-contract exclusion (Endorsement GC-04), which excludes coverage for claims arising out of the performance of government contracts. No definitive coverage determination has been issued by Meridian to date.
The insurance coverage question intersects with the COFD scenarios as follows:
Scenario 1 (worst case). Under the worst-case scenario, WAL's potential exposure of up to $12,817,441 (plus attorneys' fees) increases the urgency of pressing Meridian for a definitive coverage determination. Even if coverage is ultimately denied, a timely denial allows WAL to evaluate its options, including a potential bad-faith or breach-of-contract action against Meridian. The contractual-liability exclusion remains the primary coverage hurdle — if the court determines that WAL's liability arises solely from the Teaming Agreement's indemnification provisions (as opposed to an independent tort or statutory duty), the exclusion may apply. However, WAL may argue that the exclusion does not apply because WAL's liability is not a liability "assumed under a contract" in the traditional sense but rather a liability arising from the government's administrative cost-disallowance determination.
Scenarios 2 and 3. Under these more favorable scenarios, the insurance question becomes less critical from an economic standpoint, as WAL's potential exposure is reduced or eliminated. Nevertheless, the coverage question should continue to be pursued for completeness and to preserve WAL's rights under the policies.
We recommend that the litigation team coordinate with the insurance coverage group at Calderwood & Harkness (or, if the client prefers, with outside insurance coverage counsel) to renew the request to Meridian for a definitive coverage determination. The contact at Meridian is Rachel Underwood, Senior Claims Examiner.
C. Lender Covenant Compliance
WAL maintains a $75,000,000 senior secured revolving credit facility with Ridgeline National Bank, N.A. ("Ridgeline"), dated March 15, 2021 (the "Credit Agreement"). Section 6.07(b) of the Credit Agreement requires WAL to provide prompt written notice to Ridgeline of any claim, litigation, or proceeding involving an amount in controversy in excess of $5,000,000.
WAL delivered an initial litigation notice to Ridgeline (attention: David Kreutz, Senior Vice President) on September 28, 2022, promptly following HDDS's indemnity demand, and a supplemental notice on December 5, 2022, following the filing of the DJ action and HDDS's counterclaim. As of the date of this memorandum, $31,200,000 is drawn on the facility, and no event of default exists.
Under Scenario 1, WAL should consider whether a further supplemental notice is advisable upon issuance of the COFD. A COFD confirming or increasing the claimed liability could be viewed as a material development that warrants disclosure under Section 6.07(b), even though the underlying claim amount has not changed. An abundance of caution suggests providing a supplemental notice to Ridgeline describing the COFD and its implications.
Under all scenarios, WAL should ensure continued compliance with the Credit Agreement's disclosure covenants, including any quarterly reporting requirements that may encompass updates on material litigation. We recommend that the litigation team coordinate with Gregory Poole (General Counsel) and Elaine Whitmore (CFO) to ensure that all required notices and disclosures are timely provided.
D. Financial Statement Treatment
WAL's independent auditors, Pinnacle Advisory Partners LLC ("Pinnacle"), addressed the indemnity contingency in connection with the FY 2022 audit (completed April 14, 2023). Pinnacle concluded, in consultation with WAL management and outside counsel, that the indemnity contingency is "reasonably possible" but not "probable" within the meaning of ASC 450 (formerly FAS 5), Contingencies. Accordingly, the contingency was disclosed in the footnotes to WAL's FY 2022 audited financial statements as a contingent liability of up to $14,700,000, but no accrual was recorded. The FY 2023 audit maintained the same treatment.
The COFD's issuance may require Pinnacle to reassess this classification:
Scenario 1. A COFD confirming the full allocation and attributing the overruns to WAL's performance could push the assessment from "reasonably possible" toward "probable," potentially requiring WAL to record an accrual for some or all of the estimated liability. However, even under Scenario 1, WAL's viable causation defenses may support a continued "reasonably possible" classification if there is a reasonable basis to believe that WAL will ultimately prevail on those defenses. This assessment will require close coordination among Pinnacle, WAL management, and outside counsel.
Scenario 2. A COFD reducing the WP-4 allocation or reattributing certain causes would likely support a continued "reasonably possible" classification but with a reduced range of estimated loss. The footnote disclosure should be updated to reflect the COFD's specific findings.
Scenario 3. A COFD finding no disallowable costs could eliminate the contingency disclosure entirely, or at minimum reduce it to a remote classification that does not require footnote disclosure.
We recommend alerting Gregory Poole and Elaine Whitmore to the need to coordinate promptly with Pinnacle (Thomas Brennan, CPA, engagement partner) upon issuance of the COFD. The timing of the COFD relative to WAL's fiscal year-end will determine whether the reassessment affects the FY 2024 financial statements or a subsequent period.
E. Expiration of Base Period of Performance
The Prime Contract's base period of performance expires on August 31, 2024 — approximately two and one-half months from the date of this memorandum. Two one-year option periods remain unexercised.
If the government exercises one or both option periods, the Prime Contract continues, and additional cost overruns could theoretically arise during the option periods. The COFD currently under preparation should address only costs incurred through the period under audit. However, if the contract continues and additional overruns materialize, they could generate additional disputes between HDDS and WAL — potentially including additional indemnity demands and, depending on the resolution of the current dispute, additional litigation.
If the government does not exercise the option, the Prime Contract winds down following the base period of performance. Contract closeout procedures would then commence, which could simplify the overall cost-overrun picture by fixing the total costs incurred and eliminating the possibility of future overruns. This could also expedite the COFD process, as DCMA would be working with a complete cost record rather than a contract in active performance.
We recommend monitoring the government's exercise decision on the option periods as a factor in the overall strategic analysis. The exercise deadline and notification requirements are governed by the FAR and the specific terms of the Prime Contract; Ashford & Reeves LLP should be consulted on the applicable timelines.
VI. CONTINGENT LITIGATION REACTIVATION STRATEGY
Given the uncertainty surrounding the timing and content of the COFD, the litigation team should maintain a state of preparedness for prompt reactivation of the DJ action. This section sets forth the contingent reactivation strategy.
A. Triggering Events for Reactivation
The primary triggering event for reactivation is the issuance of the COFD by ACO Lt. Col. Vickers. Under the stay order, the parties are required to notify the court within 14 days of the COFD's issuance. The filing of that notice will initiate the process of lifting the stay and resuming active litigation.
Alternatively, if the DCMA review remains unresolved for an unreasonable period, WAL may consider moving to lift the stay on the grounds that the administrative delay no longer justifies suspension of the DJ action. As a benchmark, we recommend evaluating whether to file such a motion if the COFD has not been issued by the time of the next two reporting cycles — i.e., through the fifth joint status report, due approximately November 2024, and the sixth, due approximately March 2025. If the DCMA review has been pending for more than two years without a COFD (the COPD was issued August 1, 2022), WAL would have a strong argument that the stay has outlived its purpose and that further delay prejudices WAL's ability to obtain a timely judicial resolution of its contractual rights.
B. Immediate Post-COFD Steps (Within 30 Days of Issuance)
Upon the issuance of the COFD, the litigation team should execute the following steps within 30 days:
1. Obtain and analyze the COFD. The full text of the COFD should be obtained promptly — either through HDDS's counsel (who will receive it directly as prime contractor) or through Ashford & Reeves LLP's government-contracts channels. The litigation team and Ashford & Reeves (Harold Reeves and Natalie Cheng) should jointly analyze the COFD's findings, including the total overrun amount, the allocation among work packages, the identification of disallowable versus allowable costs, and the causation narrative.
2. Confer with opposing counsel. The litigation team should confer with HDDS's counsel — Leonard Trager and Megan Forsythe of Voss, Trager & Kendall LLP — regarding HDDS's position on the COFD, HDDS's intentions with respect to an administrative appeal, and the parties' respective positions on lifting the stay.
3. File a joint status report or motion to lift the stay. Depending on the COFD's content and the parties' positions, the appropriate filing will be either a joint status report advising the court of the COFD's issuance and the parties' proposed next steps, or a contested motion by WAL to lift the stay.
4. Update WAL's board and leadership team. The COFD outcome and its litigation implications should be communicated promptly to WAL's leadership, including:
• Marcus J. Whitmore, Chief Executive Officer
• Elaine Whitmore, Chief Financial Officer
• Gregory Poole, General Counsel
• Catherine Soo-Hyun Park, Vice President, Government Contracts & Compliance
The communication should include a concise summary of the COFD's findings, an assessment of which scenario has materialized, the recommended litigation strategy, and any immediate action items for WAL management (including insurance, lender, and financial-statement considerations).
C. Discovery Plan (Post-Reactivation)
Upon reactivation of the DJ action, the following discovery is anticipated:
HDDS discovery (from WAL to HDDS):
1. Internal HDDS documents regarding WP-4 engineering specifications, including all versions of engineering drawings, GD&T callouts, and specification change notices for the wing-box substructure, center fuselage longerons, and bulkhead fittings.
2. Government-furnished equipment delivery logs, schedules, and correspondence regarding the timing and completeness of GFE deliveries to WAL.
3. ECP directives, including all correspondence between HDDS, the Air Force Contracting Officer, and WAL regarding the initiation, scope, and cost of each engineering change implemented under WP-4.
4. HDDS's internal schedule analyses, delay attribution reports, and correspondence regarding schedule performance on the ATAP program.
5. HDDS's internal cost-accounting records and analysis supporting its allocation of overruns to WP-4.
Government discovery:
1. DCMA audit work papers and supporting cost analysis used in the preparation of the COPD and COFD. The availability of these documents may be subject to government privilege assertions, which will need to be addressed through appropriate procedures.
2. Correspondence between DCMA, the Air Force Contracting Officer, and HDDS regarding the cost-overrun review.
Depositions:
1. William Fong, SVP Contracts & Procurement, HDDS — as the HDDS executive most knowledgeable about the indemnity demand and the cost-allocation methodology.
2. Relevant HDDS program managers responsible for the ATAP program and WP-4 oversight.
3. ACO Lt. Col. Sandra M. Vickers — to the extent permitted by government privilege considerations and applicable rules regarding the deposition of government officials. The availability of this deposition will depend on whether the government asserts privilege or objects on the grounds of the Morgan doctrine (prohibiting inquiry into the mental processes of administrative decision-makers). See United States v. Morgan, 313 U.S. 409 (1941).
WAL document production:
WAL should be prepared to produce its own WP-4 manufacturing records, quality control logs and non-conformance reports, titanium procurement records (including raw-material pricing data and any hedging or mitigation efforts), and schedule correspondence with HDDS regarding deliveries and delays.
E-discovery considerations:
A litigation hold has been in place since November 2, 2022, covering all custodians and data sources relevant to the ATAP program and the WP-4 cost-overrun dispute. ESI has been preserved in accordance with the hold. Upon reactivation, the ESI should be promptly collected, processed, and reviewed for production. Given the dormancy period, it will be important to confirm that all custodians have maintained compliance with the litigation hold and that no relevant data has been lost or deleted.
D. Expert Witness Requirements
WAL's case will require expert support in three principal areas: