Afterthoughts: Contract Implications of Sequestration

Following each Nash & Schooner Hot Topics Webinar event, we interview Professor Ralph Nash to get his thoughts on the topic following the panel discussion.  On October 25th, Professors Ralph Nash and Steven Schooner discussed the contract implications of potential sequestration.

Contract Implications of Sequestration: Do you think sequestration will happen?

I don’t think anybody knows whether it will happen or, if does happen, how long it will last.  My belief is whether it happens or not there are going to be significant cuts in procurement spending.  So people ought to be planning for sequestration without regard to whether it does or does not occur.

If you were a contractor looking at your company’s portfolio of government contracts, would there be particular contracts that you would be concerned about?

It’s hard to predict.  The one problem we’re seeing is that there is an expectation that this is not going to happen so people are not really addressing the problem.  In a rational environment agencies would be exploring the situation right now but that seems not to be happening.

The webinar focused on what people might do with existing contracts, issued based on existing funding which is now going to be cut by 10%.  So in the webinar we went through the most rational way to get to a 10% reduction.  The fundamental lesson is that Bilateral is better than Unilateral.  When the Government and contractors are faced with the situation of needing to reduce existing contracts by 10%, working out the problem together is a better way to deal with it than the Government taking unilateral action.  But the bilateral action takes time which is why I think that these discussions should be happening now.

My guess is that the greatest impact is going to be on supply contracts, and the reason for that is because it’s going to be hard to get the same amount of supplies for a 10% reduction of the cost.  Also supply contracts are mostly fixed price contracts.  The Government could choose to eliminate one large supply contract worth 10% of the budget.   But then there will be termination for convenience closeout costs, which is going to cut into being able to actually achieve the 10% reduction.  The more logical approach would be to buy a few less of a lot of things.  The problem is that when you purchase less, the prices for the individual remaining items tend to go up.  So, again, you will not realize the full reduction.

In service contracts, you are buying people by and large.  My speculation is that in many government service contracts you can do the work with 10% fewer people.  If the parties sit down and negotiate hard they can work out ways to do the work, either by changing aspects of the work statement or simply reducing the number of people performing the work.  There is a greater chance of the Government being able to still get what it needs and get the 10% reduction, but this will all need to be worked out on a contract by contract basis.

In construction contracts – it’s pretty hard to cut out 10% of a building that is currently under construction.  The most likely solution to the 10% cut problem is to just slow the project down and push out the expenditure of money into future years.  However, this would tend to create delay and disruption costs, and you might not realize the full 10% savings.  This, particularly, is an area for bilateral reductions to occur.

Is there a short answer for when a deductive change or equitable adjustment should be made versus a partial termination for convenience, in the sequestration context?

Steve Schooner and I pretty much agree that terminations for convenience are probably the more appropriate way to go.  If you are cutting out a small piece of work, the agency could perceive a deductive change is a more expeditious way to do it.  But for larger reductions I would think that partial terminations would be appropriate.  This choice raises issues because the pricing of the two is significantly different.  Steve pointed out on the webinar that in the termination for convenience scenario the contractor would be able to recover close out costs. But besides this it can have significant cost implications depending on the profit loss of the contract.

Do you see any default termination implications during this period?

The specter is the A-12 contract because that is the situation where the Government chose to cancel an entire project.  (One of the options, should sequestration occur, would be to just cut programs.)  In the A-12 contract they decided to cancel the project, and, at the time, it was way behind schedule and way over budget.  So the CO decided to terminate for default.  The A-12 contract was a fixed price contract so this decision had significant implications, and they are still litigating over the default determination.

That is the worst scenario that a contractor could face.  Contractors holding those kinds of contracts (behind schedule and over cost), particularly if there is a questions as to whether what they are developing is really needed by the agency, have cause to be concerned.

Contract Implications of Sequestration: What is the one piece of advice you would like to government officials and contractors during this period of possible sequestration and actual sequestration should it occur?

Start working together to figure out what the best course of action is.  But now, right now.

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