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 - 8:30am
Registration & Continental Breakfast
8:30am - 10:30am
Presentation
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 LLP
Mike 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 buyside 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 LLP
Joelle 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 recordkeeping requirements for contractors and grantees, and
procurement and funding processes and procedures.
Speakers (Cont.)
Susan J. Moser, CPA, CITP – Partner, Cherry Bekaert LLP
Founder 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 LLP
Gunjan 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.
1
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.
2
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:
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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)
3
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
6
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
7
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.
Source: FAR Part 49.105(a)
8
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)
9
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)
10
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;
Source: FAR Part 49.105(c)
11
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.
Source: FAR Part 49.105(c)
12
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.
Source: FAR Part 49.105-2
13
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.
Source: FAR Part 49.105-4
14
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.
Source: FAR Part 49.109-1
15
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.
Source: FAR Part 49.206-1
16
Settlement Proposals/Agreements Overview (Cont.)
Traditional Government Contracts—Cost-Based Formula
 The Government uses a “fair compensation” principle, which
generally provides for:
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allowable costs incurred in the performance of the work,
reasonable profit for work performed,
reasonable settlement expenses, and
certain continuing (post-termination) costs.
Source: FAR Part 49.201(a)
17
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)
18
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.
19
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.
20
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.
23
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
24
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
25
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
27
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
28
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
29
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
30
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
31
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 control
AND
– 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
32
Common Excuses for Failure to Perform (Cont.)
 “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
33
Common Excuses for Failure to Perform (Cont.)
 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
34
Common Excuses for Failure to Perform (Cont.)
 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
35
Common Excuses for Failure to Perform (Cont.)
 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
36
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
37
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
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]
38
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
39
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
•
•
•
•
40
Cost to government to remove defective items
Recovery of interest
Administrative costs of reprocurement
Necessary costs unique to a particular procurement
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
41
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
42
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
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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
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44
Pretrial orders and conferences
Discovery
Motions practice
Trial
Post-trial briefing
Contractor Remedies After a Successful T4D Challenge
 T4D converted into a termination for convenience
 Potential recovery of
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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
45
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!
46
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
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Questions?
Susan J. Moser, CPA, CITP
Partner
E
D
P
smoser@cbh.com
703.584.0224
703.506.4440
1934 Old Gallows Road
Suite 400
Tysons Corner, VA 22182
cbh.com
Mike LaCorte, CPA, CVA
Consulting Manager
E
D
P
48
mlacorte@cbh.com
703.584.0265
703.506.4440
1934 Old Gallows Road
Suite 400
Tysons Corner, VA 22182
cbh.com
Questions?
Gunjan R. Talati
Attorney
gtalati@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
Joelle E.K. Laszlo
Attorney
jlaszlo@reedsmith.com
1301 K Street, N.W.
Suite 1100 – East Tower
Washington, DC 20005
T: +1 202 414 9212
F: +1 202 414 9299
reedsmith.com
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