The Wall Street Journal-20080130-Pentagon Seeks to Limit Food-Supplier Discounts- New Rules Proposed- Critics Say Deals Resemble Kickbacks

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Pentagon Seeks to Limit Food-Supplier Discounts; New Rules Proposed; Critics Say Deals Resemble Kickbacks

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The Pentagon has declared war on possible abuses in its multibillion-dollar program for feeding American military personnel around the world.

In a draft contract proposal, as well as recent letters to its primary food suppliers, the Pentagon says it intends to impose limits on their ability to collect "discounts" from suppliers that aren't shared with the government. Critics say the discounts, the subject of several articles in The Wall Street Journal last year, resemble kickbacks.

The payments, which can add up to millions of dollars, are at the center of a criminal investigation by the Justice Department into the military's main food supplier for U.S. troops in Iraq, Kuwait-based Public Warehousing Co.

The U.S. attorney in Atlanta recently issued a new round of subpoenas in that yearlong inquiry. Subpoena recipients include chicken producer Perdue Farms Inc., people familiar with the inquiry said.

Julie DeYoung, a Perdue spokeswoman, said the company is cooperating with the investigation and isn't a target of the probe.

In a recent notice published in the Federal Register, the Pentagon signaled it may seek to take billions of dollars in business away from Public Warehousing, which the Justice Department says may have improperly pocketed tens of millions of dollars in discounts and also bought millions of dollars in overpriced supplies from another Kuwaiti firm with which it has ties. Public Warehousing says it hasn't violated any Pentagon rules and has fulfilled its contracts successfully.

The military's major food contractors typically buy food from subcontractors at full price, deliver that food to American forces and bill the government. Then, they sometimes receive rebates or "discounts" from these subcontractors. The controversy is over whether these payments should be shared with the government, which is the ultimate buyer of the food.

The Pentagon's proposed new rules, described in documents reviewed by the Journal, limit so-called early payment discounts that military contractors can receive from their suppliers to just 2% of the invoice involved. The rules also require the contractor to pay the invoice within 10 days.

Currently, Public Warehousing and other military contractors are making deals with their suppliers to receive discounts of 6% or more, and lenient payment terms of up to 90 days, internal company records show.

The new rules set up a potential battle between the Pentagon and the food industry, where early payment discounts are a standard practice in supply contracts involving hospitals, schools, prisons, hotels and restaurants.

Among the companies the Pentagon has asked to change their practices is giant food distributor Sysco Corp., people familiar with the matter said last night. The request prompted Sysco's Houston headquarters to tell its operating companies not to agree to the Defense Department's proposed contract modifications until top executives can address the matter. A Sysco spokesman said the company is reviewing the issue.

In court filings, the Justice Department says the discounts may be fraudulent. But the Pentagon's effort to rewrite the rules on discounts may be a tacit admission that the practice traces at least partly to the way the existing rules are written.

The government has been quietly exploring for months whether it is being overcharged for feeding American troops abroad, especially soldiers and Marines on the ground in Iraq and Kuwait. While the logistical challenges of delivering food into a war zone halfway around the world makes it difficult to determine what a fair price might be, some within the military procurement system have asserted in recent months that some of the prices being paid are excessive.

The ramifications of the proposed rule changes go far beyond Iraq, however. If the Pentagon successfully imposes the new rules, it will affect more than $4 billion a year in government food spending around the globe.

In letters mailed in recent days to at least three of its primary food vendors, the Pentagon has asked for a voluntarily agreement to modify their contracts to rein in discounts. In addition to the 2% ceiling on discounts and the 10-day payment requirement on invoices, the letters said such payments must be consistent with commercial practice and applied across the board by a firm to government and private suppliers alike.

The practice of giving discounts for early payment is a byproduct of the economics of large-scale food distribution, which requires big outlays of cash for warehouse space and shipping that force companies to absorb substantial costs unless they are paid promptly for their products. In addition, discounts are used by food producers to compensate companies that specialize in marketing and logistics.

The proposed contract modifications also seek to eliminate other alleged abuses in the military food program, such as excessive "pass- through charges" imposed by middlemen and passed on to the government. "Excessive pass-through charges are charges resulting from or attributable to the contractor's or its subcontractor's effort when that effort did not add substantive value to the work performed under the contract," the Pentagon's letters state.

The criminal probe of Public Warehousing also is looking closely at middlemen. Perdue and two other companies received subpoenas last month seeking information on their dealings with a little-known food supplier called Texas Best, people involved in the case said. Ms. DeYoung, the Perdue spokeswoman, said the company had no direct dealings with Public Warehousing and merely supplied its products to Texas Best.

Gregory Padgham, a lawyer for Texas Best, said the company received a subpoena in January 2007 and company officials were interviewed in the case in August 2007. He declined to answer further questions. Record show Texas Best paid Public Warehousing an 8.5% discount on many of its purchases.