Federal Contracts: Termination for Convenience
By Peter F. Mueller, Ernst & Young
The Unique Rights of the Federal Government to Terminate Contracts for Convenience
Preparing for a Potential Termination for Convenience
Assembling the Right Team
Governing Regulations and Unique Accounting Considerations
With the continuing fiscal debate in Washington, politicians face increasing pressures to reign in Federal spending. Recently, the Office of Management and Budget reported on several programs facing budgetary cuts and are likely targets for contract terminations. Other federal agencies with large procurement budgets, including the Department of Defense, Department of Energy, and Health and Human Services, may also see programs ended through Congressional action. While many contractors undoubtedly are anticipating cuts or cancellations of particular contracts, they may be ill prepared for the challenge of financial recovery under the “termination for convenience” clause.
The Termination for Convenience contract clauses provides government contracting officers with the right to unilaterally terminate contracts when it is in the government’s best interest. Federal procurement agencies in the United States initially began using the concept of a T for C during the Civil War as a means for the government to terminate contracts for wartime supplies at the point they were no longer needed. The 1964 edition of the Federal Procurement Regulations gave agencies the option to use T for C clauses and a revision in June 1967 made the use of the clauses mandatory with limited exception. The clauses are incorporated in the Code of Federal Regulations (CFR) Title 48, Federal Acquisition Regulations (FAR), which provide for the federal procurement regulations issued pursuant to the Office of Federal Procurement Policy Act of 1974.
Subcontractors are Not Immune
The Termination for Convenience clauses are mandatory flow-down clauses to subcontracts at all tiers below the prime contract. Thus, termination of prime contract begins a daisy chain of cascading termination actions down through the supplier ranks.
Even experienced defense contractors often have little knowledge of termination for convenience claims because, historically, such terminations have been rare. Without a solid understanding of the types of expenses that may be recoverable and accounting practices that may be employed, a defense contractor risks losing:
Compounding the unique challenges inherent in managing a termination for convenience are the human capital realities. While efficiently and effectively completing the termination for convenience is a measure impacting the contractors past performance history and reputation with procurement agencies, the majority of contractors typically lack employees with significant or even any hands-on experience in managing the myriad of complexities inherent in the termination of a significant program.
Additionally, contractors struggle to retain key management talent with the program thru completion of the termination, a process that can extend over a multi-year period. A contractor and its management talent often favor new programs and opportunities over the essential, but less glamorous completion on a contract termination.
While at first blush it might seem that accounting is at the heart of a contract termination, a multitude of skill sets is required to effectively carry out the requirements imposed by the termination for convenience contract clause. To effectively discharge the responsibilities obligated by the termination for convenience contract clause, a contractor must assemble a termination team with:
Typically, contractors faced with a major contract termination augment their teams with legal and accounting subject matter experts, a direct settlement cost to the termination.
Although a contractor may be able to exert little influence over the termination of a program, a contractor can and should take steps to minimize the adverse impact to its organization, preserve and protect its rights to equitable compensation, and demonstrate its ability to protect the interests of the government. A termination settlement should compensate the contractor fairly for the work done and the preparations made for the terminated portions of the contract, including a reasonable allowance for profit for work performed prior to the termination. There are a number of steps a contractor should be prepared to execute if it has reason to be concerned about a potential T for C. These include being prepared to:
FAR Part 49 provides guidance to the government contracting officers and to the contractors on terminations. Additionally, the cost principle set forth at FAR 31.205-42 prescribes regulations for the some of the unique costs and circumstances that may arise in a T for C that can give rise to recoverable costs, if properly documented and supported, such as:
These costs are illustrative and not intended to be a full listing of the costs recoverable under a termination.
Management of the termination settlement process can prove complex, particularly in instances where the contractor is terminated for a portion of the work under contract while continuing work under other aspects of the contract. On virtually all large complex terminations for convenience, contractors engage professionals experienced in terminations to work their way through the unique regulations and the multitude of issues and steps involved in a termination, in order to preserve and protect the contractor’s rights to equitable recovery of costs, compliance with regulations, allowing company resources to focus on ongoing and future business opportunities. The costs of professional assistance in preparing and presenting a termination settlement proposal to the government is considered to be an allowable direct cost of the termination and is not expected to be accounted for as an indirect cost to be allocated to other work.
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Published July 29, 2009 (Updated August 6, 2012)
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