Collapse of A-12 Project Deflates Jet Contractors : Defense: Legal fights rage as vendors are trapped in a procurement twilight zone with secret inventory. The situation may dampen the industry’s willingness to take risks.

Behind a set of locked doors in Garden Grove, Swedlow Inc. is protecting one of the Navy’s most coveted secrets: a pile of scrap.

The scrap is leftover inventory from the Navy’s A-12 attack jet program, which was canceled in January and has quickly degenerated into the most convoluted weapons termination in U.S. history.

Defense Secretary Dick Cheney cut short the program after it skidded wildly out of control and was headed toward busting its development budget by several billion dollars, according to Pentagon projections.

The decision, widely praised at the time, has triggered an acrimonious legal battle between the government and the two A-12 prime contractors, McDonnell Douglas and General Dynamics.

Although the aerospace industry turned its attention last week to the monumental contract award for a new Air Force fighter, the outcome of the A-12 termination could well be as important a determinant of the industry’s future.

All the Navy has to show after giving the firms $2.9 billion are random A-12 parts scattered around the nation and several sets of engineering drawings for the aircraft, a stealthy attack jet for Navy carriers. Even though the A-12 no longer formally exists, it remains highly classified, and vendors such as Swedlow are trapped in a procurement twilight zone with secret inventory.

By all accounts, the A-12’s demise is developing into a Pentagon fiasco of epic proportions, destined to be played out in federal courts, congressional committee hearings and in the board rooms of the nation’s defense firms. Subcontractors, particularly the large number in Southern California, face millions of dollars in losses on their investments in A-12 technology.

The painful process will undoubtedly be another setback to the future of the American aerospace industry, which has had to abide by ever stiffer government controls. In the aftermath of the A-12, Congress may take an even more active role in managing the defense industry.

“The A-12 sets back the willingness of the industry to take risks and the willingness to innovate,” said Robert Paulson, director of aerospace practice at the consulting firm McKinsey & Co. “It will lead to micromanagement by the Congress and to doing business by the book. This is as big as the stakes get.”

Indeed, the Navy has assigned 30 attorneys to the case, though the service declined to comment about what they are doing. McDonnell Douglas and General Dynamics have dozens of their own attorneys strategizing how to reverse the punitive “default” terms under which the program was canceled.

Attorneys for the contractors have offered lucrative expert-witness fees to retired Navy admirals, The Times learned. One former flag officer said he was offered upward of $30,000.

“They have gone out of their way to try to tie down key witnesses early,” the former flag officer said. “There are going to be suits and countersuits between the prime contractors and the government--and between the prime contractors and their subcontractors. There are only so many expert witnesses that can be brought to bear.”

Spokesmen for both firms declined to discuss their legal efforts; other corporate officials declined to be interviewed.

McDonnell and General Dynamics are in such precarious financial condition that the Pentagon permitted the firms to defer repayment of $1.3 billion in A-12 expenses, Assistant Defense Secretary Eleanor Spector said early this month. Critics have called the deferral a bailout.

The ultimate legal issue, however, is likely to revolve around whether the Navy’s fixed-price contract for the A-12 itself was illegal, according to legal experts knowledgeable about the case. The argument: that the government knew that the prime contractors could not develop the aircraft without sustaining major losses and that federal regulations outlaw money-losing contracts.

Under fixed-price agreements, a firm must absorb all costs that exceed a contract ceiling. In its zeal to curtail cost overruns, the Pentagon seized on such contracts in the early 1980s. But the effort mortally wounded a large number of weapons programs.

Spector, the director of defense procurement, said in a speech March 20 that the policy of using fixed-price contracts to guarantee the A-12’s cost, performance and schedule “has again proven to be mistaken.” She added later that the “negative consequences of the inappropriate use of the fixed-price development contract have become so clear that the department’s senior management has said, ‘No more.’ ”

After that admission of failure, Adm. William R. Morris, assistant commander for contracts at the Navy’s air system command and a key figure in the A-12 termination, stormed out of the speech, according to observers. Morris declined to be interviewed. Spector’s admissions are likely to end as a key part of the contractor’s case, according to knowledgeable sources.

A number of industry and congressional experts predict that time is on the side of the companies. Cheney, they say, erred seriously in the hasty way he handled the termination. He also failed to ask the contractors to “show cause” and did not give them time to correct their problems.

William A. Lawrence, vice president of the Assn. of Naval Aviation and a former vice admiral, said the Navy undoubtedly shares some of the blame for the A-12’s failure, if for no other reason than because the program was flawed from the outset.

As early as 1985, top Pentagon officials, including former Navy Secretary John Lehman, were warned that the fixed-price contracts would lead to costly program failures. But Lehman, who championed the policy, pressed on, according to a series of letters obtained by The Times.

The Navy selected McDonnell and General Dynamics to develop the A-12 under a cost ceiling of $4.78 billion, despite widespread sentiment that it could never be built for that price.

Northrop and Grumman, which competed for the award, submitted a bid $1 billion higher. And when the program finally got into trouble, the problems were kept from senior Pentagon officials, resulting in an embarrassment to Cheney last year when the bombshell finally went off.

If history is any guide, the A-12 dispute is likely to be resolved long after Cheney and the current Navy leadership leave office.

The massive shipbuilding claims from the 1970s, which resulted from the same type of fixed-price contracts as used on the A-12, were resolved during the 1980s for between 25 cents and 40 cents on the dollar, according to Stuart Platt, a retired rear admiral and the former chairman of the Navy Claims Board.

“In a case this large, it is hard to assume that either side is 100% pure,” Platt said. “There will be fault on both sides.”

Platt added: “In a battle between Goliaths, the people in the stands get hurt. This time, the people who are getting hurt worst are the subcontractors, employees, towns and parties that are not even connected to the contract.”

General Dynamics and McDonnell Douglas have laid off 9,000 workers in Missouri, Texas and Oklahoma, exacerbating an already difficult downturn in the defense business. (General Dynamics will be helped, however, by the fact that it was on the winning team in last week’s advanced tactical fighter contract award; McDonnell was allied with the losers.)

California suffered disproportionately because as many as a third of the major A-12 subcontractors were located here, according to a confidential list of subcontractors obtained by The Times.

The subcontractors are attempting to cope with multimillion-dollar losses on their prior investments in the program. A few firms have been forced out of business by the A-12 mess, including Solidex Technologies of San Dimas.

Solidex Technologies, a minority-owned business, decided to close shop after the A-12 termination, according to former employees. The firm had moved to larger facilities in San Dimas a year ago, partly to prepare for a big expansion after it was awarded an A-12 subcontract.

Solidex had anticipated 50% growth and hoped to exceed $1 million in sales this year. It sent employees to a special training course in soldering at the China Lake Naval Weapons Center in the Mojave Desert and successfully passed a Navy review for quality.

Now, the firm has suspended operations, leaving creditors wondering what will happen next.

“I have talked to several companies like Solidex who have been badly hurt,” one defense industry expert said. “McDonnell Douglas and General Dynamics say they have started to pay off people, but I don’t believe it.”

Both prime contractors declined to comment.

In other cases, critics charge, small firms aren’t sure what to do with their leftover inventory because the Navy and the prime contractors have mismanaged the administratively complex termination process.

One defense industry official--unsure what to do with his A-12 inventory--was driving around Los Angeles earlier this month, the trunk of his Volvo loaded with electronic components and wire harnesses.

“Here, would you like some of these?” he offered. “This is all unclassified.”

Swedlow, which produced the A-12’s canopy (the glass bubble that encloses the cockpit), is continuing to store its A-12 inventory at the highest levels of classification--”top secret compartmentalized,” according to defense industry sources. The inventory must be kept in a locked work area and only workers with specific clearance can see it.

Swedlow officials said they could not comment or even acknowledge the existence of the program, though it has not existed formally since Cheney canceled it.

Among small firms such as Swedlow, there is a deep concern that the A-12 termination could drive a wedge into important relationships within the industry. Although the prime contractors have canceled subcontractors under favorable terms, known as “convenience,” there remains a question of whether they are likely to honor all the subcontractors’ claims.

Most subcontractors bore expenses far in excess of their contracts. McDonnell and General Dynamics, several contractors say, pressured them to accept money-losing development contracts on the implicit promise that they could recover the costs later during full-scale production of the planes.

For example, H. R. Textron, a Valencia-based producer of hydraulic equipment, designed and developed hardware for the A-12 under a “zero-dollar contract”--in other words, without receiving any payment from the prime contractors. The firm ultimately sank between $15 million and $20 million of its own funds into the development effort, according to company President Richard Millman.

The A-12 cancellation forced the layoff of 40 workers and “substantially hurt our operation,” Millman said. “We are going to try to seek recovery for as much of this investment as possible.”

Millman argues that prime contractors have subjected their suppliers to the very contract terms that the primes themselves consider unfair when they are imposed by the government.

But Millman cautiously added, “We have excellent relations with our primes. The industry will not function without good relationships.”

Even when small firms have fared well, the paperwork burden of handling the termination claims has left executives astounded.

Dick Pierson, sales manager at Electro Film Manufacturing in Valencia, which made cockpit heaters for the A-12, said he spent entire evenings and weekends at home for several weeks to complete his firm’s claim.

“It was very tedious, but you can’t afford to make mistakes,” Pierson said.

By the time he was through, he had a stack of documents eight inches tall--all to seek recovery for the firm of roughly $70,000.