With constant budget pressures, federal procurement contracts are always at risk of a termination for convenience. If a termination for the government’s convenience is forecasted by the federal government, there are steps that a contractor can take before and after the termination to attempt to maximize its recovery.
When there are rumors that a termination is imminent, prior to termination the contractor should engage in a dialogue with the Contracting Officer to resolve any open contract issues such as pending requests for equitable adjustment and undefinitized contract changes. Contractors should also determine the status of contract funding (because termination recovery usually is limited to the amount of available funding on the contract), and the status of invoicing and payment to assess the cash position of the contractor. All appropriate invoices should be timely submitted, and payment deadlines monitored. Where the contract is fixed-price, the contractor should start an analysis of its profit/loss position. If it appears that the contractor is in a loss position (and termination recovery may be reduced by application of a loss adjustment, depending on the wording of the termination for convenience provisions), then the contractor should begin assessing the reason for the loss position and explore possible government causes that can be asserted as a request for equitable adjustment to increase the contract price and thereby avoid imposition of a loss adjustment. And contractors should review their contracts for any provisions that become operative in a termination for convenience, such as a special termination costs provision (used in some DoD contracts) that places limitations on recovery of certain costs (like severance) in a termination.
In assessing its cash position, the contractor must consider the “pipeline.” Usually the contractor is obligated to subcontractors and vendors for some 60 or more days of costs not yet billed. It has its own overhead and self-performance costs that have also not been billed. Moreover, the termination will lead to yet more costs. All of these considerations impact the assessment of the contractor’s exit strategy and pricing under the termination for convenience clause.
Contractors should also review subcontracts for the applicable clauses. We believe promptly informing the subcontractors and vendors of the possible termination for convenience is usually advisable. The contractor must evaluate any and all open issues, including pending REAs, notices of possible change orders, and unresolved subcontractor performance issues.
After a termination for convenience, the contractor should establish a continuing dialogue with the contracting officer (CO) and the termination contracting officer (TCO), if one is appointed to administer the termination. Having the TCO review and approve procedures for the winding down of the contract can prevent later disputes regarding the reasonableness of the contractor’s actions (and amount of termination costs incurred). One particular area for coordination is the settlement of subcontracts, because it is critical for the contractor to have a clear understanding of the scope of the audit/accounting review of subcontractor settlement proposals that the TCO (or CO) expects the contractor to perform.
Contract terminations also generally give rise to the incurrence of costs or the need for special treatment of costs that would not have arisen had the contract not been terminated. These costs include items such as loss of useful value, rental under expired leases, and severance pay. In order to ensure maximum recovery, a contractor should identify unusual expenses that will continue to accrue after termination and make an assessment of allowability in consultation with legal and accounting experts. Notably, in a termination for convenience, legal, accounting and similar costs necessary for the preparation and presentation of the termination settlement proposal and the termination and settlement of subcontracts are generally allowable costs. Legal counsel should be consulted as early as possible in the termination process to guide the termination effort and to position the contractor for the largest possible dollar recovery.
This summary focuses on the federal termination for convenience provisions. Similar considerations arise in state and local public contracts as well as private contracts where a termination for convenience is anticipated.
If you are in the Orlando area, I will present a more detailed analysis of these considerations on July 28 from 11:15 am to 12:30 pm (EDT) at the NCMA World Congress.