Opinion ID: 397836
Heading Depth: 1
Heading Rank: 2

Heading: proper scope of the access clause

Text: 48 The second question of statutory interpretation raised by this dispute, and the one on which Merck prevailed below, is the scope of the access-to-records clause when that clause is properly invoked. The trial court held that the Comptroller General had a right of access to data on Merck's 49 manufacturing costs (including raw and packaging materials, labor and fringe benefits, quality control and supervision), manufacturing overhead (including plant administration, production planning, warehousing, utilities and security), royalty expenses, and delivery costs .... 50 Judgment and Order of January 24, 1979, J.A. 518. The court limited the government's access, however, by ordering 51 that defendant Comptroller General shall not demand access to books, documents, papers, or records with respect to research and development, marketing and promotion, distribution, and administration (except to the extent such data may be included in the cost items listed above) .... 52 Id. For the reasons stated in Part I supra, and in recognition of the special economic structure of the pharmaceutical industry, I think we have an obligation to review this holding and to reverse it. 53 The trial court's ruling on this point can be said to differentiate between Merck's direct costs and indirect costs. The trial court granted access to data on direct costs, such as manufacturing and labor expenses, but denied access to data on indirect costs such as research, development, promotion, and distribution. 24 Initially, this holding appears entirely reasonable; it is an attempt, in the government's words, to split the baby. Government Brief at 10, 28. On closer analysis, however, it seems inescapable that this holding fails to give adequate consideration to the congressional purpose in enacting the access-to-records clause. If the access legislation was in fact meant to equalize the relationship between the government and private contractors, see Part I supra, then the trial court's narrow reading of the clause in this case utterly fails to advance that purpose because of the special characteristics of the pharmaceutical industry. 54 The Comptroller General asserts that the direct costs of manufacture in the pharmaceutical industry, such as labor and raw materials, may constitute an extraordinarily small part of the product price-less than nine percent. Government Brief at 25; see Eli Lilly & Co. v. Staats, 574 F.2d at 913-14. The remainder of drug revenues may go to indirect costs, such as research, development, promotion, and distribution, as well as taxes and profits. In short, the indirect costs of the pharmaceutical industry may be ten times the size of its direct costs, 25 and denial of the government's access to the preponderance of this cost data effectively defeats the purpose of the access provision. Improvement of procurement techniques is impossible if the government cannot get a fair idea of the industry with which it negotiates. 55 Merck argues that giving the United States access to data on its indirect costs would constitute a failure to apply the directly pertinent limitation in the access clause. It argues, in effect, that although direct costs might be directly pertinent, indirect costs cannot be directly pertinent by definition. The similarity of these phrases, though seductive, cannot substitute for analysis. The lower court's decision approving this distinction 26 was erroneous on two main grounds. 56 First, the narrow reading of the clause defies reason. The four contracts involved here between Merck and the United States concerned the supply of pharmaceutical products for a total price of more than $2,800,000. J.A. 34-37. If Merck's direct costs are only nine percent of this figure, and if Congress' grant of access is limited to direct costs, the lower court's decision precludes governmental access to cost data behind the remaining charges of $2,548,000. The implications of such a limited interpretation of the access clause become even more significant when one considers the extent of the federal government's contractual business with drug companies. Federal expenditures for pharmaceuticals exceed one billion dollars annually. J.A. 366. The narrow reading of the district court, if generally followed, would preclude government access to data concerning the underlying costs of more than $900,000,000 in pharmaceutical purchases annually. It should be obvious that Merck's indirect costs are directly pertinent to procurement transactions concerning these government contracts, for otherwise the legislative purpose of reducing waste in government procurement would be undermined severely. 57 Fortunately for the public fisc, the district court's reasoning has been followed by only one circuit. Staats v. Bristol Laboratories, 620 F.2d 17 (2d Cir. 1980). The Seventh Circuit, on the other hand, has consistently held that such costs as research and development have a logical, causal and consequential relationship to a portion of the price of the products purchased by the Government. Eli Lilly & Co. v. Staats, 574 F.2d at 914. 58 Although it might be possible to argue in other industries that costs such as research and development have such a small impact that they are not directly pertinent to the contract and its price, research and other costs not immediately attributable to one product form such a large portion of the costs of a pharmaceutical product that their import to such a contract seems inescapable. 59 Id. at 913-14. The same conclusion was reached in SmithKline Corp. v. Staats, 483 F.Supp. at 722 (E.D.Pa.1980), and arguably by the Ninth Circuit in Hewlett-Packard Co. v. United States, 385 F.2d at 1016 (9th Cir. 1967). 27 60 The lower court's decision is erroneous for a second reason. Its ruling should have been restricted to an analysis of the congressional purpose in enacting the access legislation, but embarked instead on a misguided attempt to find a realistic interpretation of the intent of the parties.... J.A. at 512. This emphasis on the parties' intent misapprehends the applicable law, for although the access clause was included in Merck's contracts, it was required in those contracts by statute. When a clause is included by reason of congressional command, rather than as the result of contractual negotiations, the proper focus of inquiry is the intent of Congress. 28 Merck did business with the government voluntarily, and thereby accepted the access clause as a precondition to doing business with the government. 29 The access clause is of standardized, nationwide application; there was no discussion or negotiation as to inclusion of the provision or its terms. Merck acknowledges: 61 Indeed the standard-form clauses were among the various provisions that were simply incorporated by reference and not even made a physical part of the contracts. J.A. 74, 84-5. Not surprisingly, there was never any actual discussion or negotiation about the access clauses or their scope. See J.A. 88-9. 62 Merck Reply Brief at 2. Attempts to analyze the intent of the parties to such contracts must be considered dubious. Obligatory Congressional enactments are held to govern federal contracts because there is a need to guard the dominant legislative policy against ad hoc encroachment or dispensation by the executive .... G.L. Christian & Associates v. United States, 320 F.2d 345 (Ct.Cl.), cert. denied, 375 U.S. 954, 84 S.Ct. 444, 11 L.Ed.2d 314 (1963). This rule of deference to congressional intent is especially important in this case, in which the legislative history demonstrates the expectation of Congress that GAO access to cost data would equalize the relationship between government and contractor. 30 63 Ultimately, Merck's position on this issue can be reduced to two rather plaintive arguments. First, Congress must have meant something when it added the word directly in front of the phrase pertinent books, documents, papers, and records. This observation, while doubtless sensible, does not help Merck's case. The amendment to the access legislation was made on the House floor by Representative Hoffman, a critic of the measure, who explained that its purpose was to limit the 'snooping' that may be carried on under this bill which we do not have the votes to defeat. 97 Cong.Rec. 13377 (emphasis added). But this word of limitation must be read in the context of the congressional debates and Representative Hoffman's understanding of the bill before his amendment was added. To Representative Hoffman, the access legislation would let the GAO go into everybody's business and look it over if they just wanted to take a look at it.... 97 Cong.Rec. 13373. For example: 64 If someone out in the country makes a contract for, as he said, an item which may be 10 percent of the total production, that under this bill, if it goes through, the GAO can send someone out there and go through the books, not only with reference to that one item of 10 percent which went into production for the Government, but into all of his other business where that same item was used. 65 97 Cong.Rec. 13377 (emphasis added). In other words, Representative Hoffman feared not that the GAO would inspect the indirect costs behind production for the government, but that GAO would inspect the direct costs of production of all items that were ever used by the government, even when the production was not relevant to government procurement at all. Representative Hoffman's opinion of what was proper governmental access under the clause merely restated Representative Hardy's position, and thus the sponsor of the legislation said he had no objection to the proposed amendment offered by one of the bill's critics. 97 Cong.Rec. 13377. The demand by the Comptroller General here for access to indirect cost data is thus entirely consistent with Representative Hoffman's amendment. The Comptroller General does not exceed the scope of the access clause envisioned by Congress, for he seeks only the data relevant to procurement by the government-but all of that data rather than a mere portion of it. 66 Merck's final argument is that it is unfair to let the definition of directly pertinent costs depend on the structure of different industries. Merck Reply Brief at 42-43. I believe Congress concluded exactly the opposite, and expected such open-ended phrases as directly pertinent to be applied in light of the particular facts and conditions of each government contract. Merck suggests that such flexibility would lead to an absurd result in the instant case, for GAO would be entitled to examine a massively greater number of documents because fewer are evidently pertinent. Merck Brief at 72. But this result is not absurd at all. The test of directly pertinent is not the number of documents an industry must furnish, or the relative burden of doing so, but whether those documents will assist the government to determine whether its negotiating practices sufficiently protect it from wasteful, fraudulent, or inefficient procurement practices. Merck notes that there simply are no generally accepted accounting principles permitting allocation of these indirect costs in an accurate and meaningful manner to particular products or contracts, including those at issue in this case. Id. at 71. But this is exactly why Congress gave the Comptroller General a broad grant of authority. As the Ninth Circuit noted in Eli Lilly & Co. v. Staats : 67 The mere fact that, as plaintiff asserts, it does not or even could not allocate costs such as research and development to an individual contract does not undercut the proposition that those costs are directly pertinent to an individual contract but merely indicates that they are directly pertinent to more than one individual contract. 68 574 F.2d at 914. 31 It will not do to let the difficulty of the task before GAO stand in the way of the congressional mandate that it be attempted. 69 Obviously, the government has no right to examine costs recovered exclusively from non-governmental contracts. 32 Moreover, governmental access should also be denied where Merck can show, through generally accepted accounting principles, that even its unallocated costs are minimally relevant to government contracts. But the burden of showing that such costs are irrelevant must fall on Merck because only Merck has all the data necessary to make such a showing. Indeed, Merck acknowledges that it has already undertaken a number of cost studies of these unallocated costs, an undertaking that seems somewhat surprising if these studies are as inaccurate and meaningless as Merck claims. 33 Unless the burden of showing that unallocated costs are not relevant to government contracts is imposed on the party that has the data, companies might avoid compliance under the access clause simply by refusing to allocate any of their costs to any of their products. Such a result would abort the purpose of the access-to-records legislation as adopted by Congress. The district court's order limiting the government's access to Merck's books and records should therefore be reversed.