Tuesday, April 13, 2010

Terminations - Part II

In yesterday's post, we introduced the two ways that the Government can terminate your contract - termination for default and termination for convenience - and identified some of the costs that contractors might include in their termination settlement proposal/claim. If you missed that article, you can read it here. Today we want to go deeper into the cost allowability aspects of termination settlements. Our focus here is on Terminations for Convenience (T for C). We will not be covering Terminations for Default. The allowability of costs under T for Ds is severely limited. Hopefully, none of you will ever find yourselves facing a T for D.

The fundamental financial principle underlying a T for C is the contractors’ responsibility to mitigate costs or damages to the Government. A contractor must do everything it can to limit cost exposure to the Government. The allowability of costs under a termination for settlement is essentially the same as for pricing a contract or for seeking reimbursement of costs under a cost-type contract. However there are a few differences. These differences are identified in FAR 31.205-42. According to this cost principle, the following termination costs are allowable:

  • Common items: Items purchased for the contract that cannot be reasonably used on other work. In other words, if items purchased for the terminated contract can be used on other work, the items and associated costs should be transferred to those other jobs.
  • Costs continuing after termination: Costs that cannot be immediately discontinued upon the effective date of the termination are allowable so long as they are not attributable to the negligent or willful failure of the contractor to stop work. 
  • Initial costs: Costs spent on preparation and startup costs that haven't been fully amortized. If you factored in a learning curve into your production cost estimates but the contract is terminated before you fully realized the effects of the learning curve, you can include "loss of learning" in your settlement proposal. 
  • Loss of useful value: These costs are usually associated with special tooling and test equipment.
  •  Rental costs: Contractors must mitigate rental costs and the rental period cannot exceed the initial period of contract performance.
  •  Alterations of leased property: Cost to restore leases to original conditions, if required. Costs to prepare a leased property for use on another project/contract, are not allowable under this provision.
  • Settlement expenses: These include accounting, legal, and clerical costs for the preparation of the settlement proposal. For example, if you hire Pacific Northwest Consultants to prepare your termination settlement proposal, those costs would be allowable as a direct charge.
  • Subcontractor claims: Subcontractors must follow the same rules as the prime. Subject to this restriction, subcontractor claims are allowable.
Tomorrow we will discuss the “settlement” process.

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