Contractor Recovers Termination Costs Even Without Receiving a Notice to Proceed

In 2011, the Corps of Engineers awarded a contract to Pro-Built Construction to build a police station in Afghanistan. The Corps did not issue a notice to proceed however, and in 2012 (about seven months later), issued a TforC (Termination for Convenience) due to "negative security conditions.. Pro-Built submitted a TforC claim for about $1.1 million. In a final decision, the Contracting Officer determined that Pro-Built was entitled to a mere $49 thousand. Pro-Built appealed to the ASBCA.

While waiting for the notice to proceed, Pro-Built prepared its pre-construction submittal, a quality control plan, accident prevention plan, and security plan. It also sent staff and subcontractors to see the site, talk with the local people and talk with the village elders, and considered elements for the design including building codes and specifications.

The Corp asked DCAA (Defense Contract Audit Agency) to audit Pro-Built's $1.1 million claim. DCAA questioned the entire amount because the company incurred the costs prior to receiving a notice to proceed (FAR 31.201-2 and FAR 52.211-10). DCAA piled on more allegations; it was unreasonable for Pro-Built to have incurred any costs, other than to meet bond, insurance, or administrative requirements prior to receiving the notice to proceed, that Pro-Build did not have a formal accounting system; the Pro-Built's proposal was not an acceptable basis for settlement, and that Pro-Built had not properly calculated its G&A (General and Administrative) rate.

Ultimately the Board awarded Pro-Built $339,000 for a variety of reasons but most importantly, because they found, given the labor market and security situation in Afghanistan, it was reasonable for Pro-Built to incur standby costs prior to the notice to proceed. The Board allowed three months of stand-by costs rather than the eight months proposed by Pro-Built. The Board also noted that the Corps strung Pro-Built along with multiple correspondences stating, to the effect, that it would be issuing a notice to proceed imminently.

The entire Board decision can be read here.

Threshold for Audit of Termination Proposals Set to Substantially Increase

Well, it looks like more of DCAA's (Defense Contract Audit Agency) is going away. The FAR (Federal Acquisition Regulation) Councils are about ready to raise the audit threshold for termination settlement proposals.

Currently, the threshold sits at $100,000. If a settlement proposal exceeds that amount, the TCO (terminating contracting officer) is required by FAR 49.107 to refer the proposal to the appropriate audit agency (DCAA, in the great majority of cases) for review and recommendation (i.e. audit).

A revision in the "Final Rule Stage" will increase that $100,000 threshold to the Truth-in-Negotiation Act (TINA) threshold currently at $750,000. That would be a 750% increase in the threshold and will certainly impact (i.e. reduce) the workload at audit agencies who perform these audits.

According to the FAR Councils, the new threshold is necessary to help alleviate the backlog of contract close-outs (i.e. let DCAA focus on winnowing its backlog of incurred cost audits) and to enable contracting officers to more quickly de-obligate excess funds from terminated contracts (i.e. TCOs won't have to wait months to receive audits).

Under the new provisions, TCOs will still have the opportunity to request audits of termination settlement proposals under the new $750,000 threshold if they want to. That usually means that some level of risk has been identified in contractor proposals.

Terminations for Convenience and Bad Faith by the Government

Did you know that the Government can terminate your contract at any time for any reason? Well, so long as there is no bad faith or a clear abuse of discretion that is. Every Government contract has a termination for convenience clause. These clauses are found at FAR 52.249-1 through -10, depending upon the type of contract. Although these clauses are not mandatory flow down clauses for subcontractors, prime contractors would be taking undue risk if they don't flow them down to their subcontractors  - if the Government terminates the prime, the prime will certainly need to do the same to its subcontractors.

The Government has the right to terminate a contract at will under the termination for convenience clause and, absent bad faith or a clear abuse of discretion, the contracting officer's decision is final.

How would a contractor go about proving the contracting officer acted in bad faith? Its not easy. It is well established that Government officials are presumed to act in good faith. To prove that a Government official acted in bad faith, a contractor must show a specific intent to injure by clear and convincing evidence. That requires a showing of "well-nigh irrefragable proof of malice" or a specific intent to injure. Due to this heavy burden of proof, contractors have rarely succeeded in demonstrating the Government's bad faith.

A party to a contract cannot use an implied duty of good faith and fair dealing to expand another party's contractual duties beyond those in the express contract or create duties inconsistent with the contract's provisions. As a result, if the government has the contractual right to terminate a contract for convenience (and it does), the Government may exercise that right without breaching the duty of good faith and fair dealing. Seems obvious, right, but contractors have tried that argument.

If a contract is terminated, contractors are entitled to costs that have not already been reimbursed, a portion of the fee that was earned, and settlement costs.

Threshold for Audit of Termination Settlement Proposals to Increase

The FAR (Federal Acquisition Regulation) Councils have proposed to increase the dollar threshold for requiring audit of termination settlement proposals from $100,000 to $750,000. The proposed new threshold will be tied to the threshold for obtaining cost or pricing data (FAR 15.403-4(a)(1), thus whenever that threshold increases (once every five years based on inflation), the audit threshold for termination settlement proposals will increase as well.

According to the FAR Councils, this increased threshold will significantly reduce the number of termination settlement proposals requiring audit, help alleviate contract close-out backlogs and enable contracting officers to more quickly de-obligate excess funds from terminated contracts. Additionally, (and unstated) it removes a significant source of audit work from DCAA (Defense Contract Audit Agency) who, in recent years, hasn't been quite as nimble as it once was in completing audits low risk/low dollar termination settlement proposals - much to the consternation of contracting officers.

The proposed revision does provide an option for referring termination settlement proposals under the $750,000 threshold to the auditor. Such referrals must indicate any specific information or data that the contracting officer considers relevant and include facts and circumstances that will assist the audit agency in performing its function. This referral is not an audit however. The audit agency merely "develops requested information and make further accounting reviews it considers appropriate". Then, the audit agency will submit written comments and recommendations (something less than a full-audit report).

The new threshold will apply to subcontractors as well as primes.

This is a proposed regulation and the comment period is open for 60 days. If anyone bothers to submit comments, they follow the familiar refrain of support from contractors and industry groups and dismay by government and watchdog groups.

Read more here.

Email Notification vs. Hard-Copy Notification

Here's something to tuck into the back of your mind should you ever find yourself in a situation where a few days one way or another matters when filing an appeal.

The Army Corps of Engineers awarded a contract to HK&S Construction to perform repairs to a jetty at Block Island, Rhode Island in September 2014. On June 5, 2015, the contracting officer terminated the contract for default. We don't know why the contract was terminated for default but ultimately it doesn't matter for purposes of this discussion. What does matter is the date that the contractor was notified of the termination for default (TforD).

As stated, the Government notified the contractor that it was terminating the contract on June 5, 2015. The notification was sent via email on the same date as an attachment. The email advised that a hardcopy of the attached letter had been mailed overnight via Federal Express. The mailed notice of termination was received by HK&S on June 8, 2015, three days after the emailed copy.

Once a contract has been terminated for default, the contractor has only 90 days to appeal the contracting officer's decision. HK&S filed its appeal with the ASBCA (Armed Services Board of Contract Appeals) on September 4, 2015 - 91 days after the email notification but only 88 days after receipt of the hard copy notice. The Government then moved to dismiss the contractor's ASBCA appeal because it was one day late. The ASBCA denied the Government's motion on the basis that the date the contractor received the hard copy notification applied for determining the 90 day period, not the date that the email copy was sent and received.

The Board ruled:

Sending multiple copies of a contracting officer's final decision without indicating which of them is intended to begin the running of the appeal period entitles the contractor to compute the date from receipt of the last copy. However, where an appellant has previously requested to receive correspondence by means of a particular medium, an earlier copy of the decision received through that medium may start the 90-day appeal clock.

Since the Government's email did not specify which of the two notifications was intended to begin the running of the appeal period. Consequently HK&S was entitled to compute the commencement of the appeal period from its receipt of the hard-copy notification.

Its probably not a good idea to wait until the last minute when filing an appeal. The contractor got lucky in this case.

Blame the Government - That'll Work, No?

Last fall, the ASBCA (Armed Services Board of Contract Appeals) issued a decision on a appeal filed by a contractor whose contract had been terminated for default. The initial solicitation required bidders to provide proof that electricians working on the construction project had a current and active U.S. State Certified Electrician License. This requirement was also listed as an evaluation factor in the selection process.

Vertex Construction and Engineering (VCE), the winning bidder, submitted a proposal listing an electrician out of New Mexico with a current license. Almost immediately, the project ran into technical problems and the Government demanded that the electrician show up at the job site. Turns out however, this guy from New Mexico had only been a journeyman electrician, not a master electrician as required. Moreover, his license had expired in 2006, seven years before VCE submitted its proposal. The Government terminated the contract for default. VCE appealed to the ASBCA.

The Government moved for summary judgment on the grounds of fraud asserting that VCE's misrepresentation rendered the contract void "ab inito" (from the beginning). VCE appealed the termination. VCE argued that it did not knowingly misrepresent the electrician and that it did not have access to US licensing facilities. But here's the interesting argument. VCE's primary defense is that the Government had an obligation to verify the certificate and had it done so, appellant's misrepresentation would have been discovered, and the Government could have disqualified VCE from the bidding process.

The ASBCA didn't buy that argument. It stated in its decision that the argument that bids can present misinformation, and the burden is on the Government to ferret it out, is not persuasive. The requirement for the Government to verify the certificate submitted by VCE was for the  benefit of the Government, not for VCE. The law is clear that when contractors try to shift responsibility for their deficiencies not discovered when the Government has conducted a pre-award survey, a contractor's obligation to verify information submitted in its bid remains. It is the contractor's responsibility, not the Government's, to determine its own capability to perform a contract and, thus, even if a Government pre-award survey is conducted negligently, that circumstance can be of no consequence or benefit to the contractor.

In this case, VCE presented no evidence contradicting the Government's facts, only unsupported arguments as to why its misrepresentations should be excused. In addition to blaming the Government for not discovering VCE's fraud by verifying the master electrician's certification, VCE tried to justify its failures by pointing to is small size, its status as a local company, and its lack of computer capability. However, even if those assertions were relevant, VCE provided no evidence upon which such statements were based.

You can read the entire ASBCA case here.

Terminations for Convenience - Settlement Expenses

The Government can terminate a contract at any time. Government contracts contain one of the several "termination" clauses depending upon type of contract. For example fixed price contracts (non-commercial) include FAR 52.249-2, Termination for Convenience of the Government. Contractors have very little recourse when the Government terminates their contract other than ensuring that whatever was spent prior to the termination, is somehow reimbursed. We don't know of any cases where a contractor successfully lobbied a Government agency to withdraw their termination notice.

Once the termination notice is delivered, the contractor is obligated to cease work. Those costs become part of a contractor's settlement proposal. There's a second category of costs - cost continuing after termination. These are costs that can't be avoided such as a cancellation fee on an unexpired lease. Contractors have an affirmative duty to minimize or mitigate these costs. A third category of costs related to terminations are "settlement expenses".

The FAR coverage of settlement expenses is found in FAR 31.205-42(g). That section reads as follows:

1. Settlement expense, including the following, are generally allowable:
    (i) Accounting, legal, clerical, and similar costs reasonably necessary for
        (A) The preparation and presentation, including supporting data, of settlement claims to the contracting officer
        (B) The termination and settlement of subcontracts.
    (ii) Reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract
    (iii) Indirect costs related to salary and wages incurred as settlement expenses , normally limited to payroll taxes, fringe benefits, occupancy costs and immediate supervision costs.

So, settlement expenses are somewhat unique in that contractors are allowed to pull out costs that are normally indirect in nature, and charge them direct to settlement expenses. Contractors however must ensure that these costs are also removed from the indirect expense pool(s) from whence they came.

Also, the labor portion of settlement costs must be burdened with applicable fringe costs. For contractors with fringe rates and perhaps an occupancy pool, this is an easy task. For other contractors, a special analysis is required to calculate and claim applicable fringes.

Many contractors underestimate settlement expenses. At the time of negotiations, there is usually a portion of settlement expenses that are still estimates and these will require a thoughtful projection of how much time it will take to reach a settlement. Other contractors fail to include all settlement costs to which they are entitled. Some forget to add fringe. Some forget to post hours.

One last thing about settlement expenses. These costs are fully reimbursable as direct costs and do not need to be charged to an indirect expense pool and allocated to all the work of the contractor. For this reason, many contractors engage professional help (such as firms like ours) to assist in preparing settlement proposals.

Contract Terminations - Part II

Yesterday we discussed some of the reasons why the Government might want to terminate a contract. Sometimes the termination is for the convenience of the Government and sometimes because the contractor failed to meet expectations. These are usually referred to as T4C (termination for convenience) and T4D (termination for default).

The Government will usually go out of its way to avoid T4Ds. When contract problems arise, T4D is a last resort, primarily because it significantly extends the completion date of whatever project or service is needed. Even if there is a performance bond involved, delays occur. Therefore, the Government will usually explore alternatives to termination. For example, the Government might (i) revise a delivery schedule, (ii) allow the contractor to subcontract some effort or enter into other third party arrangements, or (iii) change contract requirements to permit continued performance (usually with some kind of consideration on the contractor's part).

Termination is not an all or nothing event. The Government can also "partially" terminate a contract. You see this when production is curtailed because of funding constraints or when there is a troop draw down in a particular area and less "support" is required. A partial termination can also be used in a T4D situation.

Cost recovery depends on the type of terminations. The regulations are much more generous under a T4C than under T4D situation. Under a T4C, contractors can be compensated for actual performance to date, profit on work performed, left over inventory, subcontractor settlement costs, and settlement proposal preparation costs. Under a T4D situation, the contractor is entitled to almost nothing.

Contract Termionations - Part I

Under all Government contracts, the Government reserves the right to terminate the contract. Every contract contains one or more of the clauses at FAR 52.249-1 through 10 (or FAR 212-4 for commercial items). By far, most of the contracts that are ultimately terminated are done so for the convenience of the Government. A few are terminated for default or for cause.

There are any number of factors, circumstances, or conditions that make terminations necessary. Sometimes the Government runs out of money for a particular project or the requirement is no longer needed. Sometimes quantities of requirements need to be reduced (draw down of troops in Iraq). These are all situations where the Government terminates contracts for its convenience (T4C). Other T4C situations include a change in requirement beyond the contractor's capability or expertise, a significant increase in the scope of a requirement, or the impossibility of contract performance (such as sometimes occurs in Research and Development programs).

While the prospect of having a contract terminated for convenience might hurt financially, it doesn't carry any negative connotations for a contractor. At its root, it is simply the Government's decision to spend its money elsewhere. Not so when it come to "terminations for default" (or "terminations for cause" in the case of commercial items). Terminations for default (T4D) occurs because there has been, in the Government's estimation, a material breach of the contract. Examples of material breaches include:

• Refusal to perform
• Prohibited activity
• Poor performance (product or service does not meet specification)
• Failure to comply with material contract terms and conditions
• Abandonment of work

T4Ds can jeopardize a contractor's chances of winning future contracts. All such actions are recorded in the Government's FAPIIS (Federal Awardee Performance and Integrity Information System) which contracting officers consult prior to awarding any contract. If a contractor appears in that database, a contracting officer must prepare additional documentation and rationale, and solicit higher-up approval before awarding a contract. Unless that contractor is a sole source for a particular item, a contracting officer will not be able to justify award to a contractor with such a black mark.

New Regulation Proposed for Payments under Commercial Time-and-Material Contracts

Back in 2006, FAR was revised to expressly authorize the use of time-and-materials (T&M) and labor-hour contracts for commercial services under specified conditions as well as policies regarding payments under those contracts. The proposed change affects payments under T&M contracts that are terminated for cause.

Commercial T&M contracts include a termination for cause clause (FAR 42.212-4) that gives the Government the right to terminate commercial contracts. If the Government terminates the contract for the Government's convenience, the Government pays the contractor for work performed prior to the termination, plus reasonable charges resulting from the termination. If the Government terminates the contract for cause, the Government only pays for supplies and services ``accepted by the Government.''

The proposed change will, for contracts terminated for cause, allow the contractor to be paid for work performed prior to the termination for cause, including work not delivered or accepted by the Government, less applicable profit. 

When supplies or services do not conform to contract requirements, the Government generally rejects the supplies or services. The Government ordinarily provides contractors an opportunity to correct or replace nonconforming supplies or services when correction or replacement can be accomplished within the required delivery schedule. Correction or replacement is generally made without additional cost to the Government. However, certain contract types, including T&M contracts, generally require the Government to pay additional costs for replacement or correction, but no additional fee is paid. Payment for replacement or re-performance is consistent with the ``best efforts'' nature of T&M contracts. The Government generally pays for replacement and re-performance on both commercial and noncommercial T&M contracts.

  

Terminations - Part IV

Today we are concluding, for now, our discussion on Terminations. We invite you to view our Termination FAQ that was edited by Terry Nuzzo. This FAQ has been available on our website (http://www.pacificnwc.com/) for a number of years or can be accessed and downloaded directly by clicking here.

In summary, the Government's primary objective for contract terminations is to compensate contractors fairly and negotiate a settlement by agreement. However, a contract termination for convenience is no simple matter and contractors should expect to expend considerable effort and cost in settling their terminated contract. Understanding the FAR cost principles, settlement proposal preparation process and the consequences of a contract termination can have a significant impact on maximizing the cost recovery. Fortunately, contractors’ costs incurred to settle a terminated contract are recoverable.

Terminations - Part III

Today we continue our discussion on contract terminations by taking a look at the settlement process. If you missed Parts I and II in this series, you can read them here and here.

Once the Government issues its termination notice, contractors typically have a year to submit their settlement proposals to the Government. Now before you think that one year is plenty of time, consider that your proposal must also include settlements of all of your subcontracts as well. Many subcontract settlements take an extraordinary amount of time to settle and one year passess very quickly. Requests for extensions of the time to submit are typically granted. However, consider that additional time affects your cash flow. You won't get paid for all your costs until negotiations are complete.

The Government will assign a Termination Contracting Officer (TCO) to your case. Once the TCO receives your proposal, he/she will need to develop a negotiation objective. Almost always, he will request an audit of the proposal to assist in preparing that negotiating objective. The audit will focus on certain risk areas inherent to termination proposals. These include:

• Ensuring that the contract uses the correct form and methodology (inventory basis vs. total cost basis)
• Assessing contractor efforts to mitigate costs
• Evaluating costs continuing after the date of termination
• Reviewing settlement expenses for compliance with FAR 31.205-42 (and other cost principles)
• Evaluating the potential that the contract was in a loss position at the time of termination.

The process is lengthy and your chances of "fast tracking" the settlement process is slim. It is important therefore to get your proposal right the first time so that it is not sent back for rework. It is also important to ensure that you claim all the costs to which you're entitled. Sometimes, professional help in preparing settlement proposals can be beneficial.

 

 

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.

Contract Terminations

The Government has the right to terminate a contract. It can terminate the contract for its own convenience or it can terminate the contract because the contractor defaulted on the contract. Termination for Default (T for D) is a somewhat infrequent event. Termination for Convenience (T for C) on the other hand is not that uncommon. We will focus here on "T for Cs". 
The Government's right to terminate a contract is provided for in a standard contract clause that allows it to terminate work in whole or in part. When a contract is terminated for convenience, a contractor is entitled to the following:

• Reasonable costs for the terminated work
• Termination costs
• Settlement expenses
• Reasonable profit

Under fixed price contracts, the total amount of the termination settlement, exclusive of settlement expenses, cannot exceed the total contract price. If the contract was in a "loss" position, the projected loss will be reflected in the final settlement.

Cost type contracts, on the other hand, are not subject to settlement limits or loss ratios. However the potential recovery under cost type contracts is constrained by the limitation of funds clause that exists in all cost-type contracts.

In future posts, we will discuss specific allowablility criters for termination costs, steps that a contractor must immediately take upon receipt of a termination notice, and some advice on how to "settle".

Terminations for Convenience

Every Government contract includes a clause that gives the Government the absolute right to terminate the contract for convenience (T4C). There are no limitations on the circumstances under which the Government can exercise its rights. A T4C does not mean that the contractor has failed to perform under the contract. In most T4C cases, the Government decided that it doesn't need or can no longer fund a project, system, or service.

When a contractor receives a notice of termination, it must comply with the notice. Generally, the notice will require the contractor to stop work immediately, terminate all subcontracts, immediately advise the terminating contracting officer (TCO) of any special circumstances precluding the stoppage of work, perform any continued protion of the contract, protect and preserve government property in the contractor's possession, settle outstanding liabilities, submit a settlement proposal, and dispose of termination inventory.

Timing is critical. When the Government directs contractors to stop work immediately, it really means immediately. Settlement proposals greater than $100 thousand will be audited. One of the first audit steps an auditor will undertake is to check for costs (including labor costs) incurred after the date of termination. Such costs will be challenged and unless the TCO has approved specific costs incurred after termination, will be disallowed.

Settlement expenses are a special category of costs under termination settlement proposals and are generally allowable. Settlement expenses include accounting, legal, clerical, and similar costs reasonably necessary for the preparation and presentation, including supporting data, of settlement claims to the TCO, reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract, and indirect costs related to salary and wages incurred as settlement expenses.