Performance Based Payments - The Government will Extract Consideration from Contractors

The idea behind performance-based payments is to improve a contractor's cash flow - to provide contractors a mechanism to obtain more "interim" financing than that afforded by the traditional progress payment rules. In exchange for this "improved cash flow" however, the Government expects some consideration from the contractor. Usually this consideration means a reduction in the negotiated profit percentage. Whether that makes sense from a contractor's perspective will depend upon many factors including how badly the company needs cash. The Government thinks this can be a win-win situation - the Government gets a lower price and the contractor has to borrow less for its working capital needs. For contractors that have no debt, the attractiveness of performance-based payments loses some of its allure.

Historically, one of the attractive features of performance-based payments is that payments are not based on incurred cost but on established milestones. This created the ridiculous situation where contractors established milestones that did not reasonably correspond to the spend rate and some contractors were receiving most of the contract price well before anything was ready for delivery. That is changing. There is a requirement in the new regulations that prevent performance-based payments from exceeding incurred costs (that is why an adequate accounting system is necessary). In fact, with each performance-based payment request, the contractor must provide the following information.

• Negotiated value of all previously completed performance-based payment events
• Negotiated value of the current performance-based payment event
• Cumulative negotiated value of performance-based payment event completed to date
• Total costs incurred to date
• Cumulative amount of payments previously requested
• Payment amount requested for the current performance-based payment event (not to exceed total costs incurred to date).

Prior to using performance-based payments, the contracting officer must agree with the offeror on price using customary progress payments before negotiation begins on the use of performance-based payments. Then, the contracting officer must analyze the performance-based payment (PBP) schedule using the PBP analysis tool on DoD's website. We'll be saying more about this analysis tool later in this series but you can read about it and download it at this link.

To use the PBP analaysis tool, the contracting officer needs information from the contractor. The contracting officer will request the contractor to prepare a proposed PBP schedule that includes all performance-based payments events, completion criteria and event values along with the projected expenditure profile in order to negotiate the value of the performance events.

Then, the contracting officer must negotiate the consideration to be received by the Government if the performance-based payments payment schedule will be more favorable to the contractor than customary progress payments. The contracting officer is required to document in the contract file that the performance-based payment schedule provides a mutually beneficial settlement position that reflects adequate consideration to the Government for the improved contractor cash flow.