Contract Financing - Performance-Based Payments - Generally

Performance-based payments (PBPs) for non-cost-reimbursable contracts are the Government's preferred financing method when the contracting officer finds them practical and the contractor agrees to their use (see FAR 32.1001(a)). The 2017 NDAA, as we discussed yesterday, removes the qualification "when the contracting officer finds them practical and the contractor agrees to their use" making PBPs the unquestionable preferred financing method. There's a lot to like with PBPs in lieu of Progress Payments based on costs. With PBPs, once contractors achieve a predetermined milestone, it gets paid. Progress payments on the other hand require considerable administrative effort including cost roll-ups, liquidation rates, subcontractor billings, loss ratio calculations and more.

Performance-based payments or PBPs can be based on

• performance measured by objective, quantifiable methods
• accomplishment of defined events, or
• other quantifiable measures of results.

The procedure for establishing PBPs is a two-part process. First, the Government and contractor must establish the performance bases (events or criteria) and second, the parties must assign payment amounts to each base. Almost any rational basis for associating payments to bases can be used. Examples include:

• engineering estimates of stages of completion, 
• engineering estimates of hours or other measures of effort to be expended in the performance of the event or achievement of a performance criterion, and 
• the estimated projected cost of performance of particular events 

Typically, the contractor proposes the PBP events and amounts but the contracting officer will review them to ensure that they result in equitable financing arrangements. The risk to the Government is paying too much up front where the amount of the financing is not commensurate with the milestone. Certainly the Government would not want to be in a position where it has paid half the cost of the contract at, say, ten percent completion.

The Government has developed a user's guide to facilitate the establishment of performance-based events. Although written for contracting officers, the guide can be very useful to contractors as well - especially establishing proposed performance-based events and assigning payment amounts to (or valuing) those events. That Guide can be downloaded here.