There's a contract clause included in all firm-fixed price research and development contracts that allows the Government to reject non-conforming work and make an equitable price reduction if its not fixed. FAR 52.246-7, Inspection of Research and Development - Fixed Price requires, among other things, that contractors implement and maintain an inspection system acceptable to the Government and maintain complete records of such inspections and make those records available to the Government during contract performance and for as long afterwards as the contract requires. This clause also give the Government the right to perform its own inspections.
But here's the hammer. After delivery, the Government either accepts or rejects the work. The Government has the right to reject nonconforming work. If the Contractor fails or is unable to correct or to replace nonconforming work within the delivery schedule, the Contracting Officer may accept the work and make an equitable price reduction. Failure to agree on a price reduction shall be a dispute. So, the Government withholds payment and its up to the contractor to appeal that decision if it wants additional contract funds.
How does this work in practice? A recent ASBCA (Armed Services Board of Contract Appeals) case involving a fixed-price research and development contract, illustrates how the Government applied this clause to withhold funds from a contractor.
NASA awarded a SBIR (Small Business Innovation Research) contract to Energia for photo-chemical remediation of sites contaminated with hazardous solvents at the Kennedy Space Center. The contract was for a fixed price of $597,960. The research contract was not fully completed and the Government withheld about $160,000 from the contract price based on the aforementioned contract clause. Energia appealed back in 2016 but lost the appeal on entitlement grounds. The ASBCA (Armed Services Board of Contract Appeals) remanded the case back to the parties for quantum (i.e. figuring out what the withhold should be).
The parties couldn't reach agreement. Energia wanted it all. The Board found that Energia had no basis for its claim for the full amount and found credible, NASA's calculations of the equitable price reduction. Ultimately, the Board ruled that the Government was entitled to an equitable price reduction of $160,000 which exceeded the amount previously withheld by NASA. The Board found that Energia was not entitled to payment of any additional contract amounts.