Fairchild Industries v. United States: funded research turns on who bears the risk

Fairchild Industries, Inc. v. United States, 71 F.3d 868 (Fed. Cir. 1995), rev'g 30 Fed. Cl. 839 (1994), is the fountainhead of funded-research doctrine. The Federal Circuit held that research a defense contractor performed under a fixed-price incentive contract with the Air Force was not "funded" within the meaning of Section 41(d)(4)(H), because Fairchild was entitled to payment only for work that met contract specifications — meaning Fairchild, not the government, bore the financial risk that the research would fail. Every funded-research dispute since has been litigated inside the framework this case built.

The dispute

Fairchild contracted with the Air Force to design and develop the T-46A trainer aircraft under a fixed-price incentive arrangement. The contract entitled Fairchild to progress payments as costs were incurred, but the government could accept or reject deliverables against detailed specifications, and Fairchild was obliged to correct failures at its own expense; final entitlement depended on delivering conforming work. Fairchild claimed research credits for its development costs. The government argued the research was funded — the Air Force was paying for it, in installments, under a development contract — and the Court of Federal Claims agreed, emphasizing the progress payments. Fairchild appealed.

The holding

The Federal Circuit reversed. Under Treas. Reg. §1.41-4A(d) (then §1.41-5(d)), amounts payable under an agreement that are contingent on the success of the research are not treated as funding; they are consideration for the product of the research rather than for the research itself. Because Fairchild was entitled to keep payments only for work meeting specifications, and had to remedy defects at its own cost, payment was contingent on success. Fairchild bore the risk of failure, so the research was not funded and the credit was available.

The reasoning that matters

Three moves define the opinion. First, the court located the inquiry in risk allocation: the regulation's contingency language asks who bears the cost if the research fails. Progress payments and interim financing do not shift that risk if the government can ultimately demand conforming work or its money back. Second, the analysis is ex ante — performed on the contract's terms at signing. That Fairchild was eventually paid does not mean the payment was ever unconditional. Third, the court read the contract as a whole: inspection rights, acceptance criteria, and the obligation to correct nonconforming work at the contractor's expense together demonstrated that the government was buying a successful trainer aircraft, not underwriting an research effort win or lose.

What it means for claims today

Fairchild is why every funded-research review starts with the contract file, not the invoice history. Fixed-price and fixed-fee arrangements generally leave risk with the researcher and support the credit; cost-reimbursement arrangements that pay regardless of outcome generally do not — the split Geosyntec later formalized. On exam, IRS teams request the actual agreements and read acceptance, warranty, and rework clauses through the Fairchild lens; a contractor whose payment terms are genuinely contingent has a strong position, while one paid time-and-materials for effort alone typically does not. The doctrine also has a mirror image: the party that does fund the research and holds substantial rights may be the one entitled to claim it, which is why prime-subcontractor pairs should confirm the credit is not claimed on both sides of the same dollar. Note that Fairchild addresses only one prong; the taxpayer must separately retain substantial rights in the research results, the issue that dominates Populous and Dynetics.

Related cases on the site

The full doctrine, including the rights prong, is covered in the funded research exclusion. Geosyntec applies Fairchild's risk test to fixed-price versus capped cost-plus contracts; Populous Holdings and Dynetics extend the analysis to professional services and clause-level review. All four are mapped in the research credit case law map, and contract-based exam challenges are covered in research credit audit defense.