Pentagon Had a Bailout Plan for McDonnell

In what amounted to a plan to bail out the nation’s largest defense contractor, the Pentagon had a secret program to “fix” McDonnell Douglas Corp.’s severe financial problems late in 1990, according to a confidential audit by the Defense Department’s inspector general.

Auditors found that the plan--which would have been undertaken with public funding but without any public debate--included six options, many of which were “pursued in some form” to increase the amount of Pentagon cash paid to the St. Louis-based aerospace firm at a time when its business was in crisis.

McDonnell received two questionable payments in late 1990--one for $148 million and another for $72 million, according to the audit. But the report does not give a full accounting of what other actions may have benefited the company.

The payments and the overall plan “involved significant noncompliance with requirements” of federal defense procurement law, according to the audit. The report was issued last month, but findings about the bailout were deleted. The Times obtained the confidential sections about the bailout.

Although McDonnell recovered from its immediate cash problems by mid-1991, a government debate is continuing about the firm’s financial condition and its need for a $2-billion foreign investment into its commercial aircraft business.

A company spokesman declined to comment Sunday. Senior defense officials have stated in congressional hearings that there was no bailout of the firm. Other defense officials who asked not be quoted by name also denied in interviews that a bailout was intended. Clearly, not all of the Pentagon’s actions have benefited McDonnell.

The findings of the audit raise important public policy questions about how the Defense Department will deal with troubled contractors as the industry shrinks in the aftermath of the Cold War.

The audit does not address whether the secret fix-it plan was legal. Past government bailouts of major corporations--including those of Lockheed Corp. in 1971 and Chrysler Corp. in 1979--were debated and approved by Congress.

Rep. John Conyers Jr. (D-Mich.) asked the Pentagon’s inspector general in a recent letter to investigate the alleged bailout plan, including a complete accounting of how much was funneled to McDonnell and who authorized the plan. Those questions were not addressed in the recent audit, which focuses mainly on the two payments and refers to the bailout plan in a few passages.

The House Government Operations Committee, which Conyers chairs, is conducting an investigation of all of McDonnell’s programs to determine if the military services have provided other types of relief to the company since 1990. A hearing is scheduled for next month.

The Pentagon’s alleged actions in 1990 to help McDonnell came against a backdrop in which the government was virtually backed into a corner by the contractor’s problems. The company was suffering from huge cost overruns on many of its major military programs and losing money on its commercial aircraft business.

During an extraordinary teleconference involving the Pentagon’s highest civilian and military procurement officials in October, 1990, McDonnell Douglas Chairman John McDonnell threatened to stop the C-17 cargo jet program if he were not provided with about $500 million in special payments, according to a participant in the teleconference and congressional investigators probing the plan.

The teleconference involved John Betti, then the Pentagon’s undersecretary for acquisition; John Welch, assistant Air Force secretary; then-Brig. Gen. Michael Butchko, at the time the Air Force’s program manager for the C-17, and John McDonnell, among others. At one point, the Navy’s representative walked out of the meeting because he wanted no part in the plan, according to two sources knowledgeable about the meeting.

At least one of the senior officials at the teleconference told McDonnell that the best he could do in terms of providing financial assistance was $250 million to $300 million by speeding up contract payments on the C-17, according to key sources.

The audit does not directly cite that meeting, but it does refer to a “Finance Condition Review Team” that included representatives from all of the military services, the Defense Department and McDonnell--many of the same players involved in the teleconference.

According to the audit, the bailout plan was “documented” in a briefing provided to the review team in September and October of 1990. It encompassed three options that would not require approval outside the Defense Department and three options that would require outside government approval.

The internal options were to allow some shifting of costs in the firm’s contracts, to make unusual contract payments and to direct advances on contracts. The external options included transferring funds to increase the size of McDonnell’s contracts and “extraordinary financial relief” under public law.

The audit found that McDonnell received a $148-million payment on the C-17 cargo jet program in 1990 because the Air Force allowed the firm to shift development costs to its aircraft production contract, which had the effect of accelerating payments to the firm. That assertion about the C-17, which McDonnell builds in Long Beach, was previously made by Pentagon auditors in congressional hearings last year.

In addition, the public portions of the audit released last month found that in October of 1990, another payment to McDonnell was made that appeared improper because the firm’s progress on the C-17 was not adequate to justify the money.

But a memorandum by a Defense Department contracting officer stressed the importance of approving the payment based on an “urgent and pressing financial need of McDonnell Douglas and potential adverse impact to the C-17 program,” the audit said. That $81-million payment was $72 million more than the firm deserved, the public report states.

Other Pentagon actions involving McDonnell are coming under scrutiny.

Congressional sources said they were examining the Navy’s termination of the A-12 Stealth attack jet program in early 1991, to determine whether that was part of the bailout plan. The Pentagon deferred its demand for a repayment of $1.35 billion by McDonnell and its partner, General Dynamics.