Contract
Termination:
It
May
Be
the
End
of
Your
Contract,
But
It’s
Not
the
End
of
the
World
Presented by:
Susan Moser, Cherry Bekaert
Mike LaCorte, Cherry Bekaert
Gunjan R. Talati, Reed Smith LLP
Joelle E.K. Laszlo, Reed Smith LLP
Overview
While the spending cuts mandated under Budget Control Act of
2011 were delayed by two months under the recently signed
American Taxpayer Relief Act of 2012, near term federal
budgetary cuts remain very likely. As a result, government
contractors should be prepared for prospects of increased
contract terminations in 2013 and beyond.
Gunjan Talati and Joelle Laszlo of Reed Smith and Susan Moser
and Mike LaCorte of Cherry Bekaert will discuss federal contract
terminations, best practices pertaining to contract terminations,
and steps contractors can take to ensure maximum cost recovery
should their contract(s) be terminated.
Program Schedule
8:00am - 8:30am
Registration & Continental Breakfast
8:30am - 10:30am
Agenda
Where Can Terminations Enter Into the
Contract Lifecycle?
What is a Notice of Termination?
What are a Terminated Contractor’s
Responsibilities?
Settlement of Subcontract Settlement
Proposals
What are the Government Parties
Responsibilities?
Settlement Proposals/Agreements Overview
Strategies for Maximizing Termination
Recovery
Speakers
Michael J. LaCorte, CPA – Manager, Cherry Bekaert LLP
Mike specializes in governmental cost accounting, business
systems, regulatory compliance, litigation support, and M&A due
diligence. He has extensive experience with the Cost Accounting
Standards and has completed multiple cost impact models relating
to several CAS standards. Mike has experience with several
governmental business systems, including accounting, estimating,
and purchasing. In addition to conducting discounted cash flow
analysis for contractors, he has also been involved in several
buy-side M&A due diligence efforts and has supported litigation efforts
for lost profits recovery and contract termination settlements.
Joelle E.K. Laszlo, JD – Attorney, Reed Smith LLP
Joelle is an associate in Reed Smith's Washington, D.C. office,
where she practices in the Global Regulatory Enforcement Group.
Joelle's practice primarily involves assisting clients with a variety
of issues related to federal and state contracts and grants,
including the interpretation and applicability of Federal Acquisition
Regulation provisions and clauses, administrative and
record-keeping requirements for contractors and grantees, and
Speakers
(Cont.)
Susan J. Moser, CPA, CITP – Partner, Cherry Bekaert LLP
Founder of the Firm’s Government Contractor Services Group and
Managing Partner of the Industries & Specialization practice,
Susan provides a unique insight into the needs and perspective of
her clients. She assists federal government agencies and
government contractor clients with a wide array of accounting and
consulting services, including strategic assessment plans,
business process reviews, cost allocation plans, regulatory
guidance, proposal pricing and cost strategies. Susan is also a
member of Cherry Bekaert’s Executive Management Team. In
addition to her tenure as the CFO of a federal contractor with
international operations, Susan has served as an auditor with a
national accounting firm, a project accounting manager for a large
real estate corporation with federal projects and a controller for
one of the Hampton Roads area’s largest government contractors.
Gunjan Talati, JD – Attorney, Reed Smith LLP
Gunjan is a senior associate in Reed Smith's Washington, D.C.
office, where he practices in the Government Contracts & Grants
Group. Gunjan's practice focuses on all aspects of government
procurement law, including small business matters, ethics and
compliance issues, and litigation, including bid protests.
Where
Can
Terminations
Enter
Into
the
Contract
Lifecycle?
The potential for terminations, both for convenience and default, arise before a contract is awarded.
The RFP usually contains the applicable clauses which will be incorporated into a contract.
The RFP terms and conditions should be thoroughly reviewed in order to fully understand what a contractor is signing up for.
Typically, clauses incorporated into the contract provide for the administration of a termination (in the event the
Government decides to terminate a contract).
The exclusion of clauses allowing for contract terminations does not preclude the Government from terminating a contract.
1
Where
Can
Terminations
Enter
Into
the
Contract
Lifecycle
(Cont.)?
G.L. Christian and Associates v. US– Informally known as the Christian Doctrine
The case held that a mandatory clause will be “read in” to a government contract, even if the clause was omitted from the contract.
A 1993 ruling further clarified the impact of the Doctrine by asserting that it only applied to those contract clauses which are essential to public procurement activities.
No established rulings or promulgations under the CDA exist as of this time that apply Christian doctrine principles to subcontractors if a prime omits clauses.
Important: make sure termination clauses are flowed down to help ensure the promulgated rules under FAR Part 49 apply to your subcontractors.
What
is
a
Notice
of
Termination?
The contracting officer shall terminate contracts for convenience or default via written notice to the contractor.
The notice shall include the following information:
The contract clause authorizing the termination;
The effective date of termination;
Extent of termination;
Any special instructions; and
The steps the contractor should take to minimize the impact on personnel if it will result in a drastic reduction in the contractor’s work force.
Source: FAR Part 49.102(a)
3
What
are
a
Terminated
Contractor’s
Responsibilities?
Immediately cease performing and issuing subcontracts on the terminated portion(s) of the contract.
Terminate all subcontracts related to the terminated portion(s) of the prime contract.
Immediately alert the Contracting Officer responsible for Termination of any circumstances preventing the stoppage of work.
Continue performing on the non-terminated portion(s) of the contract.
Promptly submit sufficient requests for equitable adjustment for any continued portion(s) of the contract(s).
What
are
a
Terminated
Contractor’s
Responsibilities
(Cont.)?
Preserve property in the contractor’s possession in which the Government has or may take ownership of in the future.
Notify the Government in writing of any legal proceedings growing out of any subcontract or other commitment related to the terminated portion of the contract.
Settle outstanding liabilities and proposals arising out of termination of subcontracts.
Promptly submit a settlement proposal, supported by sufficient evidence.
Dispose of terminated inventory. Source: FAR Part 49.104
5
Settlement
of
Subcontract
Settlement
Proposals
A subcontractor has no contractual rights against the Government when a prime contract is terminated.
Subcontractors may or may not have rights against the prime contractor or lower-tier subcontractor with whom it has contracted.
Flowing down termination clauses to subcontractors helps mitigate prime contractor liability.
Upon termination of a prime contract, the prime contractor and each subcontractor are responsible for prompt settlement with their immediate subcontractors.
In unusual cases and with consent from the prime, the Government may assist in the settlement of subcontracts. Source: FAR Part 49.108-1, 49.108-7
Settlement
of
Subcontract
Settlement
Proposals
(Cont.)
The failure of a prime contractor to include an appropriate termination clause in any subcontract, or to exercise the clause rights, shall not—
Affect the Government’s right to require the termination of the subcontract; or
Increase the obligation of the Government beyond what it would have been if the subcontract had contained an appropriate clause.
The FAR does not protect the prime in the case of the omission of a termination clause flow down.
Source: FAR Part 49.108-2
7
What
are
the
Government
Parties
Responsibilities?
Direct the action required of the prime contractor.
Examine settlement proposal of the prime contractor and (if necessary) the settlement proposal(s) of subcontractor(s).
Negotiate settlement with the contractor and enter into a settlement agreement.
In the event a complete settlement cannot be agreed upon, settle to the maximum extent practicable.
What
are
the
Government
Parties
Responsibilities
(Cont.)?
To expedite settlement, the Terminating Contracting Officer (“TCO”) may request specially qualified personnel to—
Assist in dealings with the contractor;
Advise on legal and contractual matters;
Conduct accounting reviews and advise and assist on accounting matters; and
Perform the following functions regarding termination inventory: Verify its existence; Determine qualitative and quantitative allocability; Make recommendations concerning serviceability; Undertake necessary screening and
redistribution; Assist the contractor in accomplishing other disposition.
Source: FAR Part 49.105(b)
9
What
are
the
Government
Parties
Responsibilities
(Cont.)?
The TCO should hold a conference with the contractor to develop a program for effecting the settlement. Topics that should be discussed at the conference and documented include—
General principles relating to the settlement of any settlement proposal, including obligations of the contractor under the termination clause of the contract;
Extent of the termination, point at which work is stopped, and status of any plans, drawings, and information that would have been delivered had the contract been completed;
Status of any continuing work;
Obligation of the contractor to terminate subcontracts and general principles to be followed in settling subcontractor settlement proposals;
What
are
the
Government
Parties
Responsibilities
(Cont.)?
Names of subcontractors involved and the dates termination notices were issued to them;
Contractor personnel handling review and settlement of
subcontractor settlement proposals and the methods being used;
Arrangements for transfer of title and delivery to the Government of any material required by the Government;
General principles and procedures to be followed in the protection, preservation, and disposition of the contractor’s and subcontractors’ termination inventories, including the preparation of termination inventory schedules;
Contractor accounting practices and preparation of SF 1439;
Form in which to submit settlement proposals; Source: FAR Part 49.105(c)
11
What
are
the
Government
Parties
Responsibilities
(Cont.)?
Any requirement for interim financing in the nature of partial payments;
Tentative time schedule for negotiation of the settlement, including submission by the contractor and subcontractors of settlement proposals, termination inventory schedules, and accounting information schedules
Actions taken by the contractor to minimize impact upon employees affected adversely by the termination; and,
Obligation of the contractor to furnish accurate, complete, and current cost or pricing data, and to certify to that effect in accordance with 15.403-4(a)(1), when required.
What
are
the
Government
Parties
Responsibilities
(Cont.)?
When the TCO and CO are in different activities, the TCO will furnish periodic status reports on termination actions to the CO upon request. The contracting office shall specify the information required.
Source: FAR Part 49.105-1
The TCO shall estimate the funds required to settle the termination, and within 30 days after the receipt of the
termination notice, recommend the release of excess funds to the CO. The deobligation of excess funds should be
accomplished in a timely manner by the CO, or the TCO. The TCO shall not recommend the release of amounts under $1,000, unless requested by the CO.
Source: FAR Part 49.105-2
13
What
are
the
Government
Parties
Responsibilities
(Cont.)?
The TCO shall maintain continuous surveillance of required funds to permit timely release of any additional excess funds. If previous releases of excess funds result in a shortage of the amount required for settlement, the TCO shall promptly inform the CO, who shall reinstate the funds within 30 days.
Source: FAR Part 49.105-2
The TCO responsible for negotiating the final settlement shall establish a separate case file for each termination.
Source: FAR Part 49.105-3
In the case of terminated construction contracts, the contracting officer shall direct action to ensure the cleanup of the site, protection of serviceable materials, removal of hazards, and other action necessary to leave a safe and healthful site.
Settlement
Proposals/Agreements
Overview
When a termination settlement has been negotiated and all required reviews have been obtained, the contractor and the TCO shall execute a settlement agreement. The settlement shall cover:
Any setoffs that the Government has against the contractor that may be applied against the terminated contract; and
All settlement proposals of subcontractors, except proposals that are specifically excepted from the agreement and reserved for separate settlement.
Source: FAR Part 49.109-1
15
Settlement
Proposals/Agreements
Overview
(Cont.)
Submit A Timely Proposal
A prime contractor in a Government contract must submit its “final” termination settlement proposal to the Government within one year of the effective date of the termination.
The settlement proposal must cover all cost elements including settlements with subcontractors and profit. Source: FAR Part 49.206-1
Settlement
Proposals/Agreements
Overview
(Cont.)
Traditional Government Contracts—Cost-Based Formula
The Government uses a “fair compensation” principle, which generally provides for:
allowable costs incurred in the performance of the work,
reasonable profit for work performed,
reasonable settlement expenses, and
certain continuing (post-termination) costs. Source: FAR Part 49.201(a)
17
Settlement
Proposals/Agreements
Overview
(Cont.)
FAR Part 12 Commercial Item Contracts—Modified Price-Based Formula
A contractor’s recovery for the termination for convenience of a FAR Part 12 contract for commercial items is composed of two elements:
the percentage of the contract price reflecting the percentage of the work performed prior to the notice of the termination, and
any charges the contractor can demonstrate resulted directly from the termination.
Strategies
for
Maximizing
Termination
Recovery
Determine whether a cancellation is a breach of contract.
If there is a breach of contract, contractors are not bound by the FAR cost principles pertaining to terminations or the requirements of FAR Part 49, and could therefore increase recovery.
Difficult to prove breach of contract because of wide latitude afforded to the Government.
19
Strategies
for
Maximizing
Termination
Recovery
(Cont.)
Fair Compensation
Fair compensation dictates that if the disallowance of a cost would not be fair, the cost should be claimed within the termination proposal.
Should be sought regardless of treatment mandated by the cost principles.
Detailed explanations of costs sought for recovery under the fair compensation standard increase the likelihood of recovery.
Strategies
for
Maximizing
Termination
Recovery
(Cont.)
Direct and Indirect Cost Charging
Terminations tend to lend themselves to situations where costs which are traditionally indirect in nature are treated like direct costs.
Example: HR personnel who work to reassign displaced workers under the terminated contract.
Direct cost assignment to cost objectives is preferable to indirect allocation and may increase recovery.
Cost accounting records must be adjusted to accurately reflect any reclassifications of direct and indirect costs.
21
Strategies
for
Maximizing
Termination
Recovery
(Cont.)
Frontload Profit
Profit can be viewed as earned unevenly through the contract.
For example, contracts which require significant efforts in the beginning of the contract.
DFARS provides weighted guidelines (DFARS 215.4).
The weighted guidelines considers cost efficiency, performance risk, contract type risk, and other factors.
Strategies
for
Maximizing
Termination
Recovery
(Cont.)
Requests for Equitable Adjustment (“REA”)
Effective for partially terminated fixed price work.
If there is an increased cost in performing non-terminated work, and REA is appropriate for non-terminated work. Effective Record Keeping
Record all costs associated with the termination in a separate accounting system project.
Maintain adequate records on profitability projections to help thwart potential loss adjustments.
23
Termination
for
Default
Agenda
Termination for Default (“T4D”) and Its Basis in the Federal Acquisition Regulation
Common T4D Triggers
Common Excuses for Failure to Perform
Procedural Aspects of a T4D
Remedies the Government May Pursue
Challenging a T4D
Contractor Remedies After a Successful T4D Challenge
T4D
and
the
FAR
A termination for default is one of the most severe sanctions the government can impose
Serious impact on contractor’s current and future work
Impact on the government, too
Enabled by standard contract clauses, which vary by contract type
25
T4D
and
the
FAR,
continued
FAR clauses:
FAR 52.212-4(m)
• Applies to contracts for commercial items
FAR 52.249-8
• Applies to fixed-price supply and service contracts
FAR 52.249-10
Common
T4D
Triggers
Failure to deliver or perform
Failure to deliver on date specified
• T4D may be made immediately, no notice required • Applies even if contract calls for incremental delivery • Possible excuse is government “waived” delivery date
Failure to comply with technical specifications
• Government is entitled to demand strict compliance – even minor deviations may be cause for T4D
• Refusal to correct flaws in performance also grounds
27
Common
T4D Triggers
(Cont.)
Failure to make adequate progress in performance
In commercial item contracts: “[failure to] provide . . ., upon request, . . . adequate assurances of performance”
In supply and service contracts: “failure to make progress so as to endanger contract performance”
In construction contracts: “[failure to] prosecute the work . . . with the diligence that will ensure its completion within the time specified”
Common
T4D Triggers
(Cont.)
Failure to perform “any of the other provisions of the contract”
Applies to fixed-price supply and service contracts
Provision(s) at issue must constitute significant contract requirement
Cure notice required
Failure to comply with a FAR clause regulating contractor business or labor practices
Examples include Davis-Bacon Act, Gratuities Clause
29
One
Not
‐
So
‐
Common
T4D
Trigger
Contractor’s anticipatory breach
Available under common law (not a FAR creation)
Contractor’s repudiation may be express or implied
Arises when there is a “positive, definite, unconditional, and unequivocal manifestation of intent . . . on the part of a contractor . . . not to render the promised performance when the time fixed by the contract shall arrive”
Common
Excuses
for
Failure
to
Perform
Excusable delay
Examples in commercial item FAR clause:
• Acts of God or the public enemy, acts of government, natural disasters and unusually severe weather, common carrier delays
• Contractor must provide written notice “as soon as it is reasonably possible”
Examples in supply and service and construction contract FAR clause:
• Nearly identical to those in commercial item clause
• Written notice required in construction context but not in supply and service context
31
Common
Excuses
for
Failure
to
Perform (Cont.)
Additional excusable delay example in supply and service and construction contract FAR clause:
• Default of a subcontractor at any tier, provided
– Cause of default is beyond contractor’s and subcontractor’s control
AND
– Default is not the result of contractor or subcontractor fault or negligence
Additional excusable delay example only in construction contract FAR clause:
Common
Excuses
for
Failure
to
Perform (Cont.)
“Other” delays
Constructive change in scope or nature of performance due to government’s action or inaction
Award delay that hinders start of performance
Payment delays
Unreasonable delays in providing necessary approvals
Provision of late or defective specifications
Failure to disclose vital information
Failure to cooperate
33
Common
Excuses
for
Failure
to
Perform (Cont.)
Contractor‘s substantial performance
“Substantial compliance” in supply contracts
• Requires: (1) timely tender of goods reasonably believed to conform; and (2) defects in delivered goods are minor and correctable in a reasonable time
“Substantial performance” in service contracts
• Highly case-specific
“Substantial completion” in construction contracts
• One test requires that incomplete items: (1) do not affect the overall functionality of the project; (2) constitute no more than a minor inconvenience; and (3) do not substantially defeat the object of the parties’ bargain
Common
Excuses
for
Failure
to
Perform (Cont.)
Government’s waiver of right to terminate
Contractor must show
• Government failed to terminate within a reasonable time after the default
AND
• Contractor continued to perform in reliance on government’s failure to terminate
More significant (and potentially successful) defense in supply contract scenarios than construction contract ones
35
Common
Excuses
for
Failure
to
Perform (Cont.)
Waiver versus forbearance
Government is entitled to “reasonable period” of time to decide what to do when a contractor defaults
• “Reasonable” is highly case-specific
Contractor must continue performance
At end of forbearance period government may
• Unilaterally set new delivery schedule or • Agree with contractor on new delivery schedule
Procedural
Aspects
of
a
T4D
Cure notice
Written notice from contracting officer (“CO”) seeking correction of failure to make progress or perform
Contractor generally gets ten days to cure defects
Cure notice not required if:
• Delivery or performance schedule has expired • Contractor has repudiated performance
• Fewer than ten days remain before performance is due
37
Procedural
Aspects
of
a
T4D (Cont.)
Show cause notice
Written notice issued by CO when there is insufficient time (e.g., fewer than ten days) to cure performance failures
Contractor’s opportunity to demonstrate why the contract should not be terminated
May be used by CO to decide whether to issue T4D
SHOW CAUSE NOTICE
[Dear Contractor:]
Since you have failed to . . .. . . [insert “perform Contract No. . . .. . . within the time required by its terms,” or
“cure the conditions endangering performance under Contract No. . . .. . . as described to you in the
Government's letter of . . .. . . (date)”], the Government is considering terminating the contract under the
provisions for default of this contract. Pending a final decision in this matter, it will be necessary to determine
whether your failure to perform arose from causes beyond your control and without fault or negligence on your
part. Accordingly, you are given the opportunity to present, in writing, any facts bearing on the question to . . .. .
. [insert the name and complete address of the contracting officer], within 10 days after receipt of this notice.
Your failure to present any excuses within this time may be considered as an admission that none exist.
… [Sincerely,] [Contracting Officer]
Procedural
Aspects
of
a
T4D (Cont.)
Responding to show cause or cure notice
Be timely (and include a statement that demonstrates you are), or promptly request more time
Present applicable defenses
Provide assurances of performance
Avoid giving impression of anticipatory repudiation
Consider providing visual aids or other support
Consider negotiating a settlement
Explain why T4D is not in government’s interest
39
Remedies
the
Government
May
Pursue
Excess costs of reprocurement
Standard measure is difference between price of terminated contract and price government must pay for completion of work under terminated contract
May also include
• Cost to government to remove defective items • Recovery of interest
• Administrative costs of reprocurement
Remedies
the
Government
May
Pursue (Cont.)
Liquidated damages
Clause typically found in construction contracts
Damages in addition to excess costs of reprocurement
Requires contractor payment of a certain amount for each calendar day of delay in completion of work
Other remedies
Recovery of unliquidated progress payments
Transfer of title to completed contract items or supplies
41
Challenging
a
T4D
Choosing a venue: agency Board of Contract Appeals (“Board”) or Court of Federal Claims (“COFC”)
Board can be more desirable if you seek:
• Accelerated or expedited resolution • Predictable decision making
COFC can be more desirable if you seek:
• Longer time to prepare case • More “novel” decision making
Challenging
a
T4D (Cont.)
Appealing before a Board
Notice of Appeal due within 90 days of receipt of T4D notice
• Short statement of intent to appeal a specific decision Complaint due within 30 days of receipt of docketing notice
• Government’s appeal file also due within 30 days of docketing notice
Government’s Answer due within 30 days of Complaint filing
Discovery
Motions practice
Hearing…or not
43
Challenging
a
T4D (Cont.)
Appealing before the COFC
Complaint due within one year of receipt of T4D notice
• Must contain: (a) clear and concise statement of claim; (b) basis of COFC’s jurisdiction; (c) specific demand for relief
Government’s Answer due within 60 days of receipt of Complaint
• Answer may contain counterclaim Reply due within 20 days of receipt
Pretrial orders and conferences
Discovery
Motions practice
Trial
Contractor
Remedies
After
a
Successful
T4D
Challenge
T4D converted into a termination for convenience
Potential recovery of
Costs of performance
“Continuing” costs
Settlement expenses
Reasonable profit on completed work
Even if contractor cannot get T4D overturned, a challenge may result in reduction of excess costs owed to government
45
A
Note
on
Alternatives
to
Litigation
Negotiated resolution
Avoids expenses of litigation
May get T4D converted into termination for convenience
Alternative dispute resolution
Federal agencies required by Executive Order to consider
Will not toll Board or COFC appeal deadlines file appeal notice first!
Final
Thoughts
and
Guidance
Understand contract performance requirements and deadlines
Monitor and document performance progress
Monitor, document, and communicate with your CO about performance obstacles
Identify and address delays as quickly as possible
Don’t panic upon receipt of a show cause or cure notice
Don’t stop work upon receipt of a show cause or cure notice
Show that you are willing and able to do whatever it takes to get a delayed contract back on track
Make it easy for the government to choose not to terminate
47
Questions?
Susan J. Moser, CPA, CITP
Partner
Esmoser@cbh.com
D 703.584.0224
P703.506.4440
1934 Old Gallows Road
Suite 400
Tysons Corner, VA 22182
cbh.com
Mike LaCorte, CPA, CVA
Consulting Manager
Emlacorte@cbh.com
D 703.584.0265
P703.506.4440
1934 Old Gallows Road
Suite 400
Tysons Corner, VA 22182
Questions?
49
Gunjan R. Talati
Attorney gtalati@reedsmith.com
Joelle E.K. Laszlo
Attorney jlaszlo@reedsmith.com
1301 K Street, N.W.
Suite 1100 – East Tower
Washington, DC 20005
T: +1 202 414 9212
F: +1 202 414 9299
reedsmith.com
1301 K Street, N.W.
Suite 1100 – East Tower
Washington, DC 20005
T: +1 202 414 9210
F: +1 202 414 9299