Legal Insights: Coping with Government Budget Cuts
Fall 2011

Reductions in procurement budgets are coming and contractors must be prepared to cope with these cuts. The Department of Defense will be particularly affected. DOD has reduced its requested base budget for fiscal year 2012 by $13 billion. DOD has also announced a spending reduction for future years providing for a savings of $178 billion in FY 2012 to FY 2016. The Budget Control Act of 2011 may require further cuts to procurement spending. Among other things, the Act caps discretionary spending each year for the next decade. If the spending caps are exceeded, the Act imposes an across-the-board cut (a sequester) on discretionary spending (with a permissible exemption for military pay) to eliminate the excess spending. Since DOD consumes the largest share of the government’s discretionary budget, it will absorb the greatest impact of a sequester.

Companies performing contracts for the federal government, and especially defense contractors, need to be prepared for reductions in contract spending. As to existing contracts, government actions resulting from budget cuts may include changing, restructuring, or abandoning programs and contracts. Contractors should anticipate efforts on the part of the government to conserve funds through -

  • Partial or total terminations; 
  • De-scoping of quantities or required capabilities; 
  • Contract stretch-outs; 
  • Breaks in production; and/or 
  • Non-payment or payment delays.

Such actions are likely to be implemented through contract provisions concerning contract funding, contract payments, government delay of work, government orders to stop work, contract changes, and termination.

This two-part article addresses the government’s rights and obligations under those contract provisions that may be used to implement budget cuts, and contractor rights, and obligations in responding to government action under these contract provisions. Part one of the article discusses action by the government pursuant to provisions concerning contract funding, contract payments, and government delay of work. The second part appearing in the next issue of the PACA Pulse, addresses governmental action under contract provisions concerning government orders to stop work, contract changes, and termination.

Contract Funding Provisions

The Anti-Deficiency Act provides that a government officer or employee may not spend money or commit the government to an obligation exceeding the amount available in the appropriation or fund for that expenditure or obligation. It further provides that such an officer or employee may not involve the government in a contract or obligation for the payment of money before a corresponding appropriation is in place unless otherwise authorized by law. To comply with the Anti-Deficiency Act, before executing any contract the contracting officer must obtain written assurance from a responsible fiscal authority that adequate funds are available or expressly condition the contract upon availability of funds.

FAR 52.232-18 sets forth the Availability of Funds clause. In contracts into which this clause is inserted, it provides that funds are not presently available for the contract and that the government’s obligation under the contract is contingent upon the availability of funds. No legal liability on the part of the government for any payment may arise until funds are available to the contracting officer and the contractor receives notice of such availability. This notice to the contractor is to be confirmed in writing by the contracting officer.

FAR 52.232-20 contains the Limitation of Cost clause for insertion in fully funded cost-reimbursement contracts. Pursuant to this clause, the parties agree that performance of the contract, exclusive of fee, will not cost the government more than the estimated cost specified in the contract schedule. The contractor is to notify the contracting officer in writing whenever it has reason to believe that (i) the costs the contractor expects to incur in the next 60 days when added to all previous costs, will exceed 75 percent of estimated cost, or (ii) total costs, exclusive of fee, will be greater or substantially less than previously estimated.

The Limitation of Cost clause goes on to recite that as part of the notification, the contractor is to provide the contracting officer with a revised estimate of the total cost of performance. Yet, the government is not obligated to reimburse the contractor for costs incurred in excess of the estimated cost. On the other hand, the contractor is not obligated to continue performance until the contracting officer both notifies the contractor in writing that the estimated cost has been increased and provides a revised estimated total cost of performance.

FAR 52.232-22 sets forth the Limitation of Funds clause for insertion in incrementally funded cost-reimbursement contracts. This clause is substantially similar to the Limitation of Cost clause, except that it is concerned with the amount of funds allotted to the contract rather than the estimated cost of the contract.

FAR 32.704 requires that upon learning that the contractor is approaching the estimated cost of the contract or the limit of the funds allotted under either the Limitation of Cost or Limitation of Funds clauses respectively, the contracting officer must notify the contractor in writing that -

  • The estimated cost has been increased or additional funds have been allotted; 
  • The contract is not to be further funded and the contractor should submit a proposal for an adjustment of fee; 
  • The contract is to be terminated; or 
  • The government is considering whether to increase the estimated cost or allot additional funds, the contractor is entitled to stop work when the cost or funding limit is reached and any work beyond the limit will be at the contractor’s risk.

Government personnel encouraging a contractor to continue work in the absence of funds will be in violation of the Anti-Deficiency Act and may be subject to civil or
criminal penalties. Moreover, the government can waive the protections of the Limitation of Cost or Limitation of Funds clauses if it induces the contractor to incur costs in the reasonable belief that it will be reimbursed for them.

Contract Payment Provisions

Upon the submission of proper invoices or vouchers, the government is obligated to pay a contractor the price stipulated in the contract less any deductions provided for in the contract. The Prompt Payment Act provides that if the government does not pay the contractor for each complete delivered item of property or service by the required payment date, it shall pay an interest penalty to the contractor on the amount due. If the contract does not specify a due date for making an invoice payment, the due date is generally the later of the 30th day after either the billing office receives a proper invoice or government acceptance of the supplies or services.

If the government is required to pay an interest penalty, it shall do so automatically without a request from a contractor should the following three conditions be met: The government has received a proper invoice; there is no disagreement over quantity, quality, or the contractor’s compliance with any contract requirement; and payment of the final invoice is not subject to further contract settlement actions.

If the government fails to pay interest when it is required to do so, it will be required to pay another penalty in addition to the interest penalty. The contractor must make demand upon the government for payment of this additional penalty within 40 days after the invoice is paid.

FAR 32.503-6 contains the Progress Payment clause. This permits the government to reduce or suspend progress payments where -

  • The contractor is not in compliance with the contract; 
  • The contractor’s financial condition is deemed unsatisfactory; 
  • The contractor is holding excessive inventory; 
  • The contractor is delinquent in paying its subcontractors or vendors;
  • The fair value of undelivered work is less than the amount of progress payments made; or 
  • The sum of total costs plus estimated costs to complete performance is likely to exceed the contract price.

Government Delay of Work Provisions

FAR 52.242-17 sets forth the Government Delay of Work clause. Under this provision, if performance of contract work is delayed or interrupted by an act of the contracting officer that is not expressly or impliedly authorized by the contract or by a failure of the contracting officer to act when required, an adjustment shall be made. A delay under this clause does not involve an actual order by the contracting officer. Such an adjustment (excluding profit) shall consist of any increase in the cost of performance caused by the delay or interruption, and the contract shall be modified in writing accordingly. Adjustment is also to be made in the delivery or performance dates and any other term or condition affected by the delay or interruption.

A contractor may not make a claim for an adjustment under the Government Delay of Work clause for any costs incurred more than 20 days before the contractor notifies the contracting officer in writing of the act or failure to act. The contractor must assert the claim in writing as soon as practicable after termination of the delay or interruption.

The government is permitted to suspend work under the Suspension of Work clause contained in FAR 52.242-14. This clause allows the contracting officer to order the contractor in writing to suspend, delay, or interrupt contract work for a period of time that the contracting officer considers appropriate for the convenience of the government. If, however, performance of contract work is suspended, delayed, or interrupted for an unreasonable period by an act of the contracting officer or failure to act, an adjustment shall be made.

Similar to the Government Delay of Work clause, this adjustment (excluding profit) shall consist of any increase in the cost of performance caused by the unreasonable suspension, delay, or interruption and the contract shall be modified in writing accordingly. A claim by the contractor for an adjustment under the Suspension of Work clause shall not be allowed for any costs incurred more than 20 days before the contractor notifies the contracting officer in writing of the act or failure to act (but this requirement shall not apply to a claim resulting from a suspension order). The contractor must assert the claim in writing as soon as practicable after termination of the suspension, delay, or interruption.

See the next issue of the PACA Pulse for part two of this article.

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