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United States Court of Appeals for the Federal Circuit
BOEING NORTH AMERICAN, INC.,
James G. Roche, SECRETARY OF THE AIR FORCE,
Terry L. Albertson, Crowell & Moring LLP, of Washington DC, for appellant. Of counsel were Scott James Preston and Richard J. Ney, of Chadbourne & Parke, of Los Angeles, California.
Lawrence N. Minch, Attorney, Commercial Litigation Branch, Civil Division, Department of Justice, of Washington, DC, for appellee. On the brief were Stuart E. Schiffer, Acting Assistant Attorney General; David M. Cohen, Director; Deborah A. Bynum, Assistant Director; and J. Mark Powell, Attorney.
Clarence T. Kipps, Jr., Miller & Chevalier, Chartered, of Washington, DC, for amicus curiae. Of counsel was Lynda Troutman O’Sullivan.
Appealed from: Armed Services Board of Contract Appeals
United States Court of Appeals for the Federal Circuit
BOEING NORTH AMERICAN, INC.,
James G. Roche, SECRETARY OF THE AIR FORCE,
DECIDED: July 29, 2002
Before LOURIE, Circuit Judge, ARCHER, Senior Circuit Judge, and DYK, Circuit Judge.
DYK, Circuit Judge.
Acting en banc, the court today vacated the March 15, 2002, judgment in this case, and the panel’s original opinion, which is reported at 283 F.3d 1320 (Fed. Cir. 2002), was withdrawn. The en banc court reassigned the opinion to the panel for revision. The panel’s original opinion is revised as follows:
Boeing North American, Inc. (“Boeing”) appeals from the decision of the Armed Services Board of Contract Appeals (“Board”) disallowing legal costs incurred in 1989, 1990, and 1991 for defending a shareholder derivative suit. Boeing North American, Inc., ASBCA No. 49994 00-2 BCA ¶ 30,970 (June 8, 2000). Because the Board applied the wrong legal standard when disallowing the costs and failed to make an assessment of the contractor’s likelihood of prevailing in its defense of the shareholder suit, we vacate and remand for further proceedings.
In December 1996 Rockwell International Corp. (“Rockwell”) merged with a wholly-owned subsidiary of The Boeing Company and changed its name to Boeing North American, Inc. Before the merger, Rockwell was a large defense and aerospace contractor. Among the many contracts Rockwell had with the federal government was Contract No. F04704-90-C-0016 (“contract 16”), awarded by the United States Air Force to Rockwell on March 5, 1990, for inertial measurement units for use in missiles. Contract 16 included both firm fixed-price and cost-reimbursable line items, and had a total value of over $100 million.
The allowability of costs generally, and of selected costs in particular, is covered by subpart 31.2 of the Federal Acquisition Regulations (“FAR”) . Contract 16 explicitly incorporated by reference numerous FAR provisions, including FAR § 52.216-7. That provision provided, inter alia, for reimbursement of costs “determined to be allowable by the Contracting Officer in accordance with subpart 31.2 of the Federal Acquisition Regulation[s] . . . .” Rockwell sought reimbursement of its legal defense costs incurred in the defense of a shareholder derivative action and of the plaintiffs’ legal costs that Rockwell paid. The government urged that the costs were not allowable. The background of the dispute is as follows.
In June 1989 four Rockwell shareholders filed a shareholder derivative complaint in Los Angeles County Superior Court. Citron v. Beall, No. C728809 (Cal. Super. Ct., filed June 26, 1989) (“Citron”). The suit was brought against fourteen directors of the corporation (some of whom were also officers) and 200 unidentified “John Does” who were “officers, directors and other members of management and employees, who were involved in the wrongdoing complained of.” The gravamen of the complaint was that the “defendants knowingly, recklessly, or culpably breached their fiduciary duties to the [c]orporation by . . . failing to establish internal controls sufficient to insure that the [c]orporation’s business was carried on in a lawful manner . . . .” On this appeal, the parties agree that the five instances of underlying misconduct alleged in the Citron suit were as follows.
First, the government brought a civil suit under the False Claims Act, 31 U.S.C. § 3730, alleging that Rockwell fraudulently mischarged the government for work performed on a Space Shuttle contract in 1975-77. In 1982, Rockwell entered a consent decree to settle the suit, under which it agreed to pay a $500,000 fine and to take corrective action to ensure that Rockwell would not make false claims or conspire to defraud the government in the future. Second, the government brought criminal charges against Rockwell for making false statements under 18 U.S.C. § 1001 in connection with work performed under a government contract in 1982. Rockwell pled guilty to this charge and was fined $1 million. Third, the government alleged that Rockwell had engaged in defective pricing related to a 1982-83 Global Positioning System subcontract. A grand jury indicted Rockwell and two Rockwell employees, charging them with fraud, mail fraud, and willfully making false statements. Rockwell pled guilty to two counts of the indictment under a plea agreement and was fined $5.5 million. Fourth, a civil qui tam lawsuit was filed against Rockwell on behalf of the government under the False Claims Act, charging the company with permitting employees to use government assets for personal gain in 1984. In addition to the qui tam suit, the government convened a grand jury but decided not to prosecute Rockwell. The civil suit apparently was also dismissed. Fifth, Rockwell was the subject of a Department of Justice investigation of alleged illegal hazardous waste dumping and other environmental law violations between 1975 and 1989. In March 1992, after settlement of the Citron lawsuit, Rockwell pled guilty to four felony violations of the Resource Conservation and Recovery Act, one felony and five misdemeanor violations of the Clean Water Act, and agreed to pay a criminal fine of $18.5 million.
Rockwell responded to the Citron complaint by retaining counsel to represent the corporation in the suit and by hiring separate counsel to represent the director defendants named in the complaint, as required by Rockwell’s by-laws. Rockwell also formed a special litigation committee (“SLC”) (composed of three members of Rockwell’s Board of Directors who were not named as defendants in the complaint) to investigate and report on the Citron allegations. The SLC also hired separate legal counsel to assist in the investigation and provide independent legal advice. In July 1990 the SLC prepared a report summarizing its conclusion that the Citron lawsuit was not reasonably likely to succeed and would be disruptive to Rockwell’s ongoing businesses and that prosecution of the suit was not in the best interest of Rockwell or its shareholders. The SLC report recommended that Rockwell’s counsel take steps to obtain a dismissal in favor of all defendants.
Defendants moved for summary judgment and submitted the SLC report in support of their motion. The court denied the summary judgment motion on July 16, 1991, because it was “not satisfied that there is ‘no triable issue as to any material fact,’ as to the good faith, the independence and the quality and character of the investigation of the Special Litigation Committee . . . .” Order at 1. In denying defendant’s motion, the court stated “it would appear that, were this a trial, defendants would prevail on the present state of the record (though plaintiffs’ counsel will quickly note that the proceeding[s] so far have hamstrung their discovery efforts).” Id. at 2.
Subsequently, on October 28, 1991, Rockwell and the Citron plaintiffs entered into a settlement agreement. In that agreement, the Rockwell defendants “vigorously den[ied] all liability with respect to any and all of the purported facts or claims alleged in the Complaint . . . .” Settlement Agreement at 4. Pursuant to the agreement, Rockwell agreed to maintain an Audit Committee that would, for at least three years, “meet at least annually with [Rockwell’s] Vice President [of] Contracts, Pricing & Subcontracts to review policies and procedures and training programs designed to effect compliance with the laws and regulations applicable to federal government contracts.” Id. at 7. Also pursuant to the agreement, Rockwell agreed to pay plaintiffs’ attorneys’ fees of up to $1.5 million. On October 29, 1991, the court dismissed the Citron action with prejudice based on the settlement between the parties. The dismissal order, drafted by the parties and approved by the court, dismissed the complaint on the merits, released the defendants from liability for all claims that were, or might have been, asserted in the lawsuit, and awarded plaintiffs $1.4 million in legal fees and costs. The dismissal order additionally required Rockwell to indemnify the defendant directors against any expenses and legal fees incurred in connection with the lawsuit to the “fullest extent permitted” by the applicable Delaware law. Under Delaware law, a corporation has the power to indemnify a director-defendant if the director “acted in good faith and in a manner the [director] reasonably believed to be in or not opposed to the best interests of the corporation.” 8 Del. C. § 145(a) & (b) (2000).
In total, between 1989 and 1991, Rockwell incurred approximately $4,576,000 of legal fees and costs associated with the Citron action, including costs incurred for representing Rockwell, for representing the director defendants, for legal counsel to the SLC, and for reimbursement of the plaintiffs’ legal fees and costs. Rockwell included these costs as general and administrative (“G&A”) costs in its home office overhead for fiscal years 1989, 1990, and 1991, and it claimed reimbursement for a portion of the costs under its various contracts with the government. Rockwell allocated 33.2% of these costs to its cost-type and flexibly-priced government work and 66.8% of the costs to its commercial and firm-fixed-price work. Rockwell subsequently submitted a certified claim for $161.91 to the contracting officer based upon the share of the Citron costs included in the G&A expenses allocated to contract 16. The parties agreed to treat this as a test case and stipulated that the Board’s decision regarding the allowability of these costs to contract 16 would govern the allowability for all relevant contracts.
On May 15, 1996, the contracting officer issued a final decision disallowing the costs Rockwell claimed. (“Final Decision”). The contracting officer concluded that the costs were unreasonable under FAR § 31.201-3, and therefore unallowable, because “Rockwell violated its ‘responsibilities to the Government . . . and the public at large.’” Final Decision at 1 (quoting FAR § 31.201-3(b)(3)). The contracting officer additionally disallowed the costs, pursuant to FAR § 31.204(c), which provides that allowability of costs not specifically addressed by the FAR is to be based on the principles of the FAR and the “treatment of similar or related . . . items [that are specifically addressed under the FAR].” The contracting officer found Rockwell’s legal costs to be “similar or related” to the costs incurred in connection with or related to mischarging of costs on government contracts, which are expressly unallowable under FAR § 31.205-15, and “similar or related” to costs for the unsuccessful defense of fraud charges, which are expressly unallowable under FAR § 31.205-47. Final Decision at 3.
Rockwell appealed the contracting officer’s final decision to the Armed Services Board of Contract Appeals. The parties elected to submit the appeal on the record without a hearing. In its appeal to the Board, Boeing, as Rockwell’s successor-in-interest, argued that Rockwell’s costs were allowable because (i) the costs were ordinary, necessary, and allowable “professional services” costs under FAR § 31.205-33(b); (ii) the costs were reasonable in relation to the services rendered, pursuant to FAR §§ 31.201-3 and 31.205-33(b); (iii) the costs were allocable to the contract because they conferred benefit to the contract, in accordance with FAR § 31.201-4; and (iv) the costs were not limited or disallowed by any FAR cost principles. Boeing North American, Inc., slip op. at 10.
While the appeal was pending, this court decided Caldera v. Northrop Worldwide Aircraft Services, Inc., 192 F.3d 962 (Fed. Cir. 1999), and the Board required supplemental briefing concerning the impact of that case. In Northrop, we addressed the question whether certain legal costs were “allowable costs,” 192 F.3d at 972, when the costs related to the defense of an action charging that the contractor wrongfully terminated several employees because the employees refused to participate in fraud against the United States. In that action, a state court found that the employees had been wrongfully terminated because they refused to commit fraud against the government. Id. at 965. The majority of our opinion was directed to the question whether the state court had determined that Northrop committed fraud and, if so, whether that determination should be given collateral estoppel effect in Northrop’s suit to recover its legal defense costs. In a brief portion of our opinion, we concluded that recovery of the contractor’s legal costs was not allowable because those costs were not allocable. Id. at 972. They were not allocable under FAR § 31.201-4 “because the government did not benefit from [the contractor’s] defense of the [state court] lawsuit . . . .” Id. at 972-73.
The Board denied Boeing’s appeal in this case based on Northrop because there could be “no benefit to the Government in a contractor’s defense of a third party lawsuit in which the contractor’s prior violations of federal laws and regulations were an integral element of the third party[’s] allegations.” Boeing North American, slip op. at 13. The Board reasoned that “but for” Rockwell’s wrongdoing the Citron suit would not have been brought, and the costs would not have been incurred.
This timely appeal followed. We have jurisdiction over this appeal pursuant to 28 U.S.C. § 1295(a)(10).
 Federal Acquisition Regulations are codified in Title 48 of the Code of Federal Regulations. Because Boeing contests the allowability of costs incurred in 1989, 1990, and 1991, the FAR provisions in effect during those years are relevant. Unless otherwise indicated, the relevant FAR provisions in effect as of October 1, 1989, did not change in 1990 or 1991. Also, unless otherwise indicated, all references to the FAR refer to the FAR in effect on that October 1, 1989, date.
 Compl. ¶ 14. The complaint alleged that the named defendants were “controlling persons of Rockwell and had the power and influence, and exercised the same, to cause Rockwell to engage in the illegal practices complained of” and that the unidentified defendants aided, abetted, and participated in the wrongful acts and conduct. Id. ¶¶ 16-17. However, in their joint statement of facts here, the parties stipulated that the Citron “[c]omplaint did not directly allege that the director-defendants participated in, or had prior knowledge of, any of the . . . instances of wrongdoing” described in the complaint. Jt. Statement of Facts ¶ 14.
 The Dismissal Order provided in pertinent part that “Rockwell shall indemnify the Director-Defendants against expenses (including attorneys’ fees) actually and reasonably incurred in connection with the Action to the fullest extent permitted by the laws of the State of Delaware.” Dismissal Order ¶ 8.
 FAR § 31.201-3 provides standards under which the reasonableness of a cost is determined. Reasonableness is one factor in determining the allowability of a cost under FAR § 31.201-2.