Performance Based Payments - Cautions Before Using

This week we've been discussing the new DoD rule regarding performance-based payments (PBPs). We want to wrap up this series with a few miscellaneous comments and observations.

1. PBPs are limited to the lesser of values assigned to PBP events or total costs incurred to date (not to exceed 90 percent of the contract price). That means that PBPs can never include profit. Profit comes when contractors deliver the product.

2. Some contractors will not benefit from PBPs and should continue to use traditional progress payment forms of financing. Contractor efficiency will not be rewarded. Coming in under budget still nets a contractor only its incurred costs. Contractors that understate the value of an event, i.e. they overrun the cost associated with that event, are limited to reimbursement equal to the value of that event. Those contractors cannot recoup their actual costs.

3. The effort involved in establishing and agreeing to PBPs will be significant. The steps include:

• Identifying the PBP events
• Establishing completion criteria for each PBP event
• Obtain and evaluate the contractor's expenditure profile
• Establish PBP event values

4. From the PBP users guide, the Government's intention is to avoid any PBP scenario that would become equivalent to advance payments:

It is important to remember that the fundamental purpose of all contract financing is to assist the contractor in the paying the cost it incurs in the performance of the contract and, per FAR 32.1004(b)(2)(i), to do so “only to the extent actually needed for prompt and efficient performance.” Clearly the contractor can never have a “need” for more than its actual cost incurred at any point in time.

FAR 32.1004(b)(3)(ii) states that the contracting officer must ensure that PBPs “are not expected to result in an unreasonably low or negative level of contractor investment in the contract.” FAR does not define “unreasonably low” level of contractor investment, but it is clear that PBPs are not intended to result in the Government funding all contract costs as they are incurred throughout the contract. The prohibition against “negative level” of contractor investment means that PBPs must not be structured in such a way as to become equivalent to advance payments.

5. Contractors contemplating PBPs should be very careful to weight the potential advantages of higher levels of funding (100 percent vs 80 percent for progress payments) with the cost of foregoing some of their negotiated profit. The higher funding level is only a potential benefit and depends upon the accuracy of subjective elements. The lesser profit amount is certain.

6. Contractors contemplating PBPs should download and study the DoD User's Guide.

7. Contractors contemplating PBPs should not expect to encounter reduced Government oversight as compared to the use of progress payments. The adequacy of the accounting system is paramount under both types of financing arrangements. Under progress payments however, contractors have the added obligation to accurately estimate cost to complete.