Inadequate System? How Much will the Government Withhold?

We've been discussing the proposed DFARS regulation that will allow the Government to withhold funds if contractors are found to have inadequate business systems. This proposal affects most kinds of contracts; cost-reimbursement, incentive type, time-and-materials, labor hour, fixed price with progress payments based on costs, percentage, or stage of completion, and some construction contracts.

This regulation, if enacted, will dramatically alter the trajectory of cooperation between the Government and its contractors. Some commentators are already warning that the relationship between the Pentagon and its contractors are moving in the wrong direction. This new regulation could exacerbate the situation. There are already dire warnings that small companies will be put out of business and others will choose to exit the Government contracting scene.

The withholding process begins when the auditor issues a report with an identified deficiency. The report is sent to the ACO. If the ACO agrees with the audit finding, he/she issues an initial determination of deficiency. The contractor has only 30 days to respond to the initial notice of deficiency. The ACO will evaluate the contractor's response and notify the contractor (in writing) of the final decision. If the ACO determines that the system contains deficiencies, he/she will also include a notice of a decision to withhold payments. Upon issuance of that notice, the ACO will immediately begin withholding 10 percent of each payment.

After the final determination is issued, the contractor will have 45 days to either correct the deficiency or submit an acceptable corrective action plan. If the corrective action plan is acceptable, the ACO will reduce the withhold percentage to 5 percent until all corrections are completed. If the contractor fails to follow through on the corrective action plan, the withhold percentage returns to 10 percent.

If the ACO is withholding payments for deficiencies in more than one business system, the cumulative percentage of payments withheld cannot exceed 50 percent ... maybe. It could go as high as 100 percent if the ACO declares an emergency. In DFARS 252.242-7XXX(d)(4) we find:

Notwithstanding ...if the ACO determines that there are one or more system deficiencies that are highly likely to lead to improper contract payments being made, or represent an unacceptable risk of loss to the Government, the the ACO will withhold up to 100 percent of payments until the ACO determines that the contractor has corrected the deficiencies.

Things could get interesting.