What Happens When a Contractor Files for Bankruptcy?

It doesn't happen frequently but contractor bankruptcy happens often enough to warrant a special contract clause that appears in every contract above the simplified acquisition threshold (currently set at $150 thousand). The Bankruptcy clause is found at FAR (Federal Acquisition Regulations) 52.242-13. and requires contractors entering into proceedings relating to bankruptcy, whether voluntary or involuntary, to furnish by certified mail (or electronic commerce method authorized by contract), written notification to the contracting officer responsible for administering the contract.

This notification is time sensitive. It must be furnished within five days of the initiation of the proceedings relating to bankruptcy filing. Additionally, the notification must include certain information:

1. The date on which the bankruptcy petition was filed
2. The identity of the court in which the bankruptcy petition was filed
3. A listing of Government contract numbers and contracting offices for all Government contracts against which final payment has not been made.

Once notified, the contracting officer has certain responsibilities as well. These responsibilities are delineated in FAR 42.902. When notified of bankruptcy proceedings, the contracting officer must do the following:

1. Furnish the notice of bankruptcy to legal counsel and other appropriate agency offices (e.g. contracting, financial, property) and affected buying activities
2. Determine the amount of the Government's potential claim against the contractor (in assessing this impact, identify and review any contracts that have not been closed out, including those physically completed or terminated)
3. Take actions necessary to protect the Government's financial interests and safeguard Government property, and
4. Furnish pertinent contract information to the legal counsel representing the Government.

The Government's financial exposure to bankruptcy is highly dependent upon the goods or services being purchased. A bankruptcy of a  fuel supplier for example, will not be too disruptive. The Government can go to the next supplier standing. On the other hand, purchases of systems that take months to produce and where advance payments or progress payments have been advanced represent significant financial risk to the Government.

Some of you have been subjected to the Government's financial capability review process. These reviews are simply the Government's way of mitigating the risk that contracts will be awarded to companies that are in financial distress and could end up in bankruptcy. If the Government doesn't think a prospective contractor has the necessary financial resources to complete a contract, and the prospective contractor cannot convince the Government otherwise, there will probably be no contract.

Contractors Filing Bankruptcy

It's not often that a Government contractor files for bankruptcy. It is probably a less frequent occurrence among Government contractors than in the general population. First of all, prospective Government contractors must endure pre-award surveys which include a financial responsibility determination. If a contractor cannot satisfy the Government that it has the financial resources to complete the contract (or can acquire the financial resources), it will be disqualified from the selection process. And then there is the matter of contract financing. With the ability to to earn progress payments and/or obtain monthly reimbursements of cost, contractors need only two to three months of working capital before the cash pipeline begins flowing.

Nevertheless, contractors sometimes file bankruptcy for various reasons, usually catching the Government completely unaware of their going concern issues. Included in every Government contract (that exceeds the simplified acquisition threshold) is a notification clause (see FAR 52.242-13). The clause reads:

In the event the contractor enters into proceedings relating to bankruptcy, whether voluntary or involuntary, the contractor agrees to furnish, by certified mail or electronic commerce method authorized by the contract, written notification of the bankruptcy to the contracting officer responsible for administering the contract. This notification shall be furnished within five days of the initiation of the proceedings relating to bankruptcy filing. This notification shall include the date on which the bankruptcy petition was filed, the identity of the court in which the bankruptcy petition was filed, and a listing of government contract numbers and contracting offices for all government contracts against which final payment has not been made. This obligation remains in effect until final payment under the contract.

After receipt of this letter and forwarding it to legal counsel and anyone else that might be interested, the contracting officer must do two things (see FAR 42.9).

1. Determine the amount of the Government's potential claim against the contractor.
2. Take actions necessary to protect the Government's financial interests and safeguard Government property.

This is where a bankrupt contractor can help the contracting officer and ensure that having a contract terminated doesn't exacerbate the situation. A bankrupt contractor needs to quickly and efficiently ensure contracting officers that continued performance on its contracts are not in jeopardy. This is especially true of a Chapter 13 bankruptcy proceeding. At the time of filing, cash flow is perilous and to disrupt the cash flow that comes through progress payments (fixed price contracts) and claims for reimbursement (cost-type contracts), would not serve the contractor's (or the Government's) interest.