Report finds Army broke contracting regulations in Iraq

The Army broke federal procurement rules in 2004, when two commanding generals improperly directed a contracting officer to pay millions of dollars in fees to KBR Inc., according to a report released on Monday by the Defense Department inspector general.

Under the Federal Acquisition Regulation, the Army Sustainment Command should have withheld 15 percent of its payments to KBR under a cost-reimbursement task order through the massive Logistics Civil Augmentation Program III, because terms and price had not been finalized.

But when a contracting officer tried to withhold the funds, she was overruled by Army leaders who said KBR warned the move could hurt battlefield operations.

"The decision to postpone enforcement of the clause was influenced by contractor claims that withholding of funds might adversely affect vital support services provided to the troops," the IG report said. "ASC's failure to enforce the clause from inception of the contract and develop a contingency plan for obtaining LOGCAP III services from other sources put the government at significant risk of overpayment."

In its written response, the Army disagreed with many of the report's conclusions, noting that the service had legal authority to suspend the withholding of funds and that top officials, including the assistant Army secretary, agreed with the decision.

"The review also fails to recognize that LOGCAP III is the contingency contract for use by the Army during times of crisis to ensure continuation of essential services," said Teresa Gerton, the Army's acting executive deputy to the commanding general.

KBR officials said they still are reviewing the report and aren't in a position to comment specifically.

Many of the key findings outlined in the report, which was requested by the Senate Armed Services Committee, are not new. But the report does shed light on the timeline of events leading up to the controversial payments to Houston-based KBR, the largest contractor in Iraq.

The Army Sustainment Command awarded the 10-year sole-source LOGCAP III contract in December 2001. KBR was responsible for providing support services such as fuel, food, water and shelter to troops. The firm still operates exclusively in Iraq under the LOGCAP contract, although the Army is planning to compete the work among three firms. The service already has awarded task orders under the revamped LOGCAP IV contract for Kuwait and Afghanistan.

During the initial years of the Iraq war, the Army depended almost exclusively on the former Halliburton subsidiary to take care of troops in theater. And to meet urgent operational needs the Army frequently authorized KBR to begin work before individual task orders were set in stone.

Although "undefinitized" task orders allow contractors to begin work earlier, investigators said they carry major risks to the government. To reduce those risks, the FAR mandates that no more than 85 percent of fees can be paid to a contractor on a reimbursement contract until the terms are finalized.

It was not until February 2004 -- more than three years after awarding the contract -- that the Army discovered it had failed to comply with the 15 percent rule. After some initial delays, the contracting officer moved to correct the mistake and withhold future funds.

KBR opposed the decision and lobbied the Army to reverse it, saying it would cost the company $60 million per month, the IG report said.

"The contractor warned the Army that it would pass the withholding of funds to its subcontractors, which could cause a severe disruption of vital support services provided to the troops," the report said. "Two officials, one from ASC and one from the Army Materiel Command, testified that a contractor representative had even threatened to initiate a lawsuit against them personally as well as the Army over any withholding of funds."

While officials at the Defense Contract Audit Agency and the Defense Contract Management Agency dismissed KBR's claims of financial hardship, the Army apparently took the company's threats seriously. ASC leadership began expressing concern that imposing the clause "could seriously jeopardize battlefield operations," the report said.

After postponing enforcement of the clause for several months in 2004, the Army eventually asked the director of defense procurement and acquisition policy to grant a waiver that would allow them to reimburse KBR for all allowable costs.

But the request lacked key information, such as proof that the Army had considered alternatives in obtaining the LOGCAP III services, the report said. Nonetheless the waiver was granted in February 2005.

"We are not questioning the consequences that might have occurred if the LOGCAP contractor was unable to financially support the Army," the report said. "We previously stated the Army could not risk a significant disruption of LOGCAP III support services given the critical nature of those services. However, we do question why the Army cited some of the contractor's financial hardship claims without verifying them."

The IG also found there was not enough evidence to prove that the Army reassigned Charles Smith, the former chief of the Field Support Contracting Division for the then-Army Field Support Command, because he supported the 15 percent hold.

Smith told a congressional panel in 2008 that he was verbally attacked by then-Brig. Gen. Jerome Johnson, the head of the Army Sustainment Command who later relieved Smith of his duties, at KBR's offices in June 2004. Smith said he was then told to draft a letter to KBR that would not implement the 15 percent hold.

But the IG said it appeared that the Army wanted to go in a new direction with the LOGCAP contract and that the 15 percent withholding dispute likely was not a primary factor in his reassignment.