Contract Termination - Reed Smith · 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,

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 - 8:30amRegistration & Continental Breakfast

8:30am - 10:30amPresentation

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

Termination for Default

Speakers

Michael J. LaCorte, CPA – Manager, Cherry Bekaert LLPMike 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 LLPJoelle 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 procurement and funding processes and procedures.

Speakers (Cont.)

Susan J. Moser, CPA, CITP – Partner, Cherry Bekaert LLPFounder 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 LLPGunjan 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.

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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.

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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)

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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).

Source: FAR Part 49.104

4

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

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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

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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.


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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)

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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;

Source: FAR Part 49.105(c)

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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;


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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.


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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.


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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.


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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.


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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.


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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.


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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.

Source: FAR Part 12.403(d)

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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.

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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.

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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.

22

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.

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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

Final Thoughts and Guidance

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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

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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• Applies to fixed-price construction contracts

26

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

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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”

Cure notice required except in construction context

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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

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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”

No cure notice required

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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

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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 controlAND

– Default is not the result of contractor or subcontractor fault or negligence

Additional excusable delay example only in construction contract FAR clause:

• Act of another contractor in performance of a government contract

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“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

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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

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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

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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

Contractor may face T4D if it fails to meet new schedule

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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

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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

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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

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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

• Necessary costs unique to a particular procurement

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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

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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

Choice of venue is binding, unless venue lacks jurisdiction

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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

Post-trial briefing

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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

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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!

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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?

48

Susan J. Moser, CPA, CITPPartner

E [email protected]

D 703.584.0224

P 703.506.4440

1934 Old Gallows Road

Suite 400

Tysons Corner, VA 22182

cbh.com

Mike LaCorte, CPA, CVAConsulting Manager

E [email protected]

D 703.584.0265

P 703.506.4440

1934 Old Gallows Road

Suite 400

Tysons Corner, VA 22182

cbh.com

Questions?

49

Gunjan R. [email protected]

Joelle E.K. [email protected]

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

reedsmith.com

Documents

Contract Termination - Reed Smith · 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,