Cost Recovery Issues After A
Termination For Convenience
Breakout Session # C15
Leslie Anderson, Program Manager,
BAE Systems
Greg Bingham, Vice President, The Kenrich
Group
Chelsea Taylor, Manager, The Kenrich Group
July 28, 2014
4:00pm
Agenda
1.
Overview of Termination for Convenience Issues
2.
FAR 49.1 General Principles
3.
FAR 49.2 Additional Principles for Fixed-Price Contracts
4.
FAR 49.3 Additional Principles for Cost-Reimbursement Contracts
5.
FAR 31.205-42 Termination Cost Principle
6.
FAR Part 12 – Commercial Item Termination
7.
Audit Issues in Terminations for Convenience
8.
Questions & Answers
2
Termination for Convenience Overview
• Federal Acquisition Regulation (FAR) requires
that a Termination for Convenience clause be
included in most federal procurement contracts.
• This grants the Government the right to terminate
contracts, or partially terminate contracts, for
convenience.
3
Overview of Termination Process
The Process for terminating a contract for
convenience is specified in FAR Part 49.
• Contracting Officer must send a written
Termination Notice to the contractor.
• Upon receiving the Notice of Termination, the
contractor is required to stop all work
immediately under the terminated portion of the
contract, and terminate all related subcontracts.
4
Overview of Termination Process
• The contractor must deliver to the Government a
“Termination Inventory” that lists materials
produced or acquired under the contract and
Government-furnished property and account for
all inventory related to the terminated portion of
the contract.
• Contractor must dispose of all remaining
property.
• Contractor also begins the process of settling
with its subcontractors.
5
Termination Settlement
• The contractor has one year from the effective
date of the termination to submit a settlement
proposal to the Contracting Officer.
• The amount of the settlement proposal reflects
all of the costs for which the contractor believes it
is entitled to be reimbursed.
6
Details of Termination Process
FAR Part 49
• Subpart 49.1 -- General Principles
• Subpart 49.2 -- Additional Principles for Fixed-Price
Contracts Terminated for Convenience
• Subpart 49.3 -- Additional Principles for CostReimbursement Contracts Terminated for Convenience
• Subpart 49.4 -- Termination for Default
• Subpart 49.5 -- Contract Termination Clauses
• Subpart 49.6 -- Contract Termination Forms and Formats
7
General Principals
FAR 49.104
Contractor Responsibilities
• Stop Work Immediately
• Terminate All Subcontractors
• Advise TCO of Special Circumstances Precluding Work Stoppage
• Perform the Continued Portion of the Contract
• Protect and Preserve Government Property
• Notify the TCO of any Legal Proceedings
• Settle with Subcontractors/Suppliers (Subject to TCO Approval)
• Submit a Termination Settlement Proposal (TSP)
• Dispose of Termination Inventory
8
General Principals
Additional Termination Activities
•
•
•
•
•
•
•
Cost Accumulation
Budgeting/Forecasting
Inventory Identification and Classification
Data Management
Reductions in Force
Training/Reassignment
Any Other Tasks Requested by TCO
9
General Principals
FAR 49.112-1
Partial Payments
• Available after submission of Interim or Final TSP
if authorized in the contract
• Submit requests on SF 1440
• No fee on SF 1440 terminated effort, except for
undelivered acceptable finished product
• SF 1440 eligible cost recovery ranges from 90%
- 100% of costs incurred
10
Details of Termination Process
FAR Part 49
• Subpart 49.1 -- General Principles
• Subpart 49.2 -- Additional Principles for Fixed-Price
Contracts Terminated for Convenience
• Subpart 49.3 -- Additional Principles for CostReimbursement Contracts Terminated for Convenience
• Subpart 49.4 -- Termination for Default
• Subpart 49.5 -- Contract Termination Clauses
• Subpart 49.6 -- Contract Termination Forms and Formats
11
Fixed-Price Contracts
FAR Subpart 49.2
FAR
Reference
Key Points
Settlement Profit Factors
Loss Contract Recovery
Adjustment
Settlement Proposal Bases
12
49.202
49.203
49.206
The “Fair Compensation Principle”
• "A settlement should compensate the contractor fairly for the
work done and the preparations made for the terminated
portion of the contract, including a reasonable allowance for
profit. (Emphasis Added)” FAR 49.201(a)
• See also - FAR 49.206-1(c) “Settlement proposals must be in
reasonable detail supported by adequate accounting data. . . .
When actual, standard, or average costs are not reasonably
available, estimated costs may be used . . .”
• And - FAR 49.303-5(d) “If an overall settlement of costs is
agreed upon, agreement on each element of cost is not
necessary. . .”
13
Do the Cost Principles Apply?
• YES - Relevant clauses read that all termination
costs shall be in accordance with the applicable
Cost Principle (See FAR 31.205-42)
• NO - See the “Fair Compensation Principle” at
FAR 49.201
• YES / NO - See case law precedent
14
Settlement Profit Factors
FAR 49.202 (b)
1. Extent and difficulty of work performed as compared with
the total contract requirements
2. Engineering work, production scheduling, planning,
technical study and supervision
3. Contractor efficiency related to (i) quality, (ii) cost
reduction, (iii) resource management and (iv) inventory
disposal
4. Capital investment and risk assumed
5. Inventive and developmental contributions
15
Settlement Profit Factors
FAR 49.202 (b), (cont.)
6. Complexity of manufacturing techniques
7. Contractor’s profit rate assuming a completed
contract
8. Profit rate contemplated by the parties during
contract negotiations
9. Subcontracting environment, including effort to negotiate
settlements of terminated subcontracts
• Summary: Broad TCO discretion to determine profit
16
Equitable Adjustment After Partial
Termination
FAR 49.208
• Contractor may request an Equitable Adjustment on
continued work
• Contracting Officer has authority, unless delegated to the
TCO
• Follow Cost/Pricing Proposal Format (15.408)
• Costs included in a Request for Equitable Adjustment
shall not also be included in the termination settlement
proposal (“TSP”)
• Subcontractor shall complete TINA Certification
17
Details of Termination Process
FAR Part 49
• Subpart 49.1 -- General Principles
• Subpart 49.2 -- Additional Principles for Fixed-Price
Contracts Terminated for Convenience
• Subpart 49.3 -- Additional Principles for CostReimbursement Contracts Terminated for
Convenience
• Subpart 49.4 -- Termination for Default
• Subpart 49.5 -- Contract Termination Clauses
• Subpart 49.6 -- Contract Termination Forms and Formats
18
Additional Principles for Cost
Reimbursement Contracts
FAR Subpart 49.3
Key Points
FAR Reference
Vouching
Fee Adjustment
49.302
49.305
19
Vouching
FAR 49.302
• Continue normal cost-reimbursement billing
procedures after termination
• Voucher period ends the last day of the sixth
month following the month of termination
• Creates incentive to maximize termination effort
during voucher period
20
Fee Adjustment
FAR 49.305-1
a) Generally based on percent complete
•
Considers extent and difficulty of work performed
•
- Fee does not include subcontract effort included in
subcontractor TSPs
b) “The ratio of costs incurred to the total
estimated cost of performing the contract… is
only one factor in computing the percentage of
completion.”
• (49.115) Target Fee Applies
21
Contract Termination Forms
FAR Subpart 49.6
Cost
Type
Form
Amendment of Solicitation / Contract
Modification
Inventory Schedule B
Form No.
SF30
1428/29
Inventory Schedule E for Use With
Short Form Settlements
1434
Inventory Basis Settlement Proposal
1435
Total Cost Basis Settlement Proposal
1436
Cost Reimbursement Settlement
Proposal
1437
Short Form Settlement Proposal
1438
Schedule of Accounting Information
1439
Partial Payment Request
1440
22
Fixed Price
Short
Form
Inventory
Basis
Total Cost
Basis
General Principles
Cost Principles
• Use FAR 31.205-42 Termination Costs
- “Contract terminations 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.”
FAR 31.205-42
(a) Common Items
(e) Rental Under Unexpired Leases
(b) Continuing Costs
(f) Alterations of Leased Property
(c) Initial Costs
(g) Settlement Expenses
(d) Loss of Useful Value
(h) Subcontractor Claims
23
Common Items
FAR 31.205-42(a)
• Transfer items to other work when reasonable
• Contemporaneous purchases indicate items are
usable on other work
• Common items charged to termination should
exceed requirements on other work
24
Cost Continuing After Termination
FAR 31.205-42
• (b) Despite all reasonable efforts by the contractor, costs
which cannot be discontinued immediately after the
effective date of termination are generally allowable. . .
• Examples Include:
- Idle Facilities
- Unabsorbed or Extended Overhead
- Severance Pay
25
Cost Continuing After Termination
FAR 31.205-17
Example – Idle Facilities
(b) The costs of idle facilities are unallowable unless the
facilities—
(1) are necessary to meet fluctuations in workload; or
(2) were necessary when acquired and are now idle
because of changes in requirements, production
economies, reorganization, termination, or other causes
which could not have been reasonably foreseen. . . .
26
Cost Continuing After Termination
FAR 31.205-6(g)
Example – Severance Pay
(2) Severance pay is allowable only to the extent that, in
each case, it is required by:
(i) Law;
(ii) Employer-Employee agreement;
(iii) Established policy that constitutes, in effect, an
implied agreement on the contractor’s part; or
(iv) Circumstances of the particular employment. . .
27
Cost Continuing After Termination
Reduction in Force (RIF) Issues
• Separate policies for divisions/locations
• Differing benefits for each employee category
• Calculation of required reductions (all related to
the termination?)
• Bumping (termination of personnel not assigned
to the terminated contract)
28
Cost Continuing After Termination
Reduction in Force (RIF) Issues (cont.)
• Relevant Costs
•
•
•
•
Severance payments
Job search costs
Outplacement services
COBRA benefits (subject to HIPAA restrictions)
• Key Issues: comply with policies and document
steps taken
29
Termination Costs
FAR 31.205-42(c)
Initial Costs – Starting Load & Preparatory Costs
(c) Initial Costs. Initial costs, including starting load and
preparatory costs, are allowable as follows:
(1) Starting load costs not fully absorbed because of
termination are nonrecurring labor, material, and
related overhead costs incurred in the early part of
production . . .
(2) Preparatory costs incurred in preparing to perform
the terminated contract include such costs as those
incurred for initial plant rearrangement and
alterations, management and personnel
organization, and production planning. . .
30
Termination Costs
FAR 31.205-42(d)
Loss of Useful Value
(d) Loss of useful value of special tooling, and special
machinery and equipment is generally allowable,
provided –
(1) the special tooling, or special machinery and
equipment is not reasonably capable of use in other
work of the contractor;
(2) the Government’s interest is protected by transfer
of title.
31
Termination Costs
FAR 31.205-42(e)
Rental Under Unexpired Leases
(e) Rental costs under unexpired leases, less the residual
value of such leases, are generally allowable when
shown to have been reasonably necessary for the
performance of the terminated contract, if—
(1) the amount of rental claimed does not exceed the
reasonable use value of the property . . .; and
(2) the contractor makes all reasonable efforts to
terminate, assign, settle, or otherwise reduce the
cost of such lease.
32
Termination Costs
FAR 31.205-42(f)
Alteration of Leased Property
(f) The cost of alterations and reasonable
restorations required by the lease may be
allowed when the alterations were necessary
for performing the contract.
33
Termination Costs
FAR 31.205-42(g)
Settlement Expenses
(1) Settlement expenses, including the following, are generally
allowable:
(i) Accounting, legal, clerical, and similar costs reasonably
necessary for(a) The preparation and presentation . . . of settlement claim
to the Contracting Officer; and
(b) The termination and settlement of subcontracts.
(ii) Reasonable costs for the storage, transportation, protection, and
disposition of property acquired or produced for the contract.
(iii) Indirect costs related to salary and wages incurred as settlement
expenses in (i) and (ii); . . .
(2) If settlement expenses are significant, a cost account or work order
shall be established to separately identify and accumulate them.
34
Termination Costs
FAR 31.205-42(h)
Settlement with Subcontractors
• Limited to settlements allocable to the termination
(31.201-4)
• Appropriate Indirect Costs (31.203)

Proportionate to benefits received

Not claimed elsewhere
• Contractor does not earn profit on subcontract effort
included in the termination settlement proposal
35
Termination Costs
“Reaccounting”: A General Explanation
• The issue generally is the reclassifying of
indirect costs to direct and the inclusion of
them in a settlement proposal.
• The premature end of a contract can throw
askew The Contractor’s original business
plans for cost absorption. This may
necessitate a new approach to recovery of
costs.
36
Commercial Item Termination
FAR 12.403(a)
• General
– “…the requirements of Part 49 do not apply
when terminating contracts for commercial
items”
37
Commercial Item Termination
FAR 12.403(c)
• Termination For Cause
– (a) Notify Contracting Officer as soon as
possible of any excusable delay
– (b) Government remedies
– (c) Written notice of termination from
Contracting Officer
38
Commercial Item Termination
FAR 12.403(d)
Termination for the Government’s Convenience
• “… the contractor shall be paid -– (i)(A) The percentage of the
contract price reflecting the
percentage of the work
performed prior to the notice of
the termination for fixed-price or
fixed price with economic price
adjustments, or
– (B) An amount for direct labor
hours (as defined in the
Schedule of the contract)
determined by multiplying the
number of direct labor hours
expended before the effective
date of termination by the hourly
rate(s) in the Schedule; and
39
– (ii) Any charges the contractor
can demonstrate directly
resulted from the termination.
The contractor may demonstrate
such charges using its standard
record keeping system and is
not required to comply with the
cost accounting standards or the
contract cost principles in Part
31. The Government does not
have any right to audit the
contractor’s records solely
because of the termination for
convenience.”
Audit Issues Encountered After A
Termination
1.
Limitation of Funds vs. Termination Responsibilities – which
contract clause rules?
2.
Funding for lower-tier suppliers and subcontractors
3.
Unsettled contract changes with Lower-Tier or Upper-Tier
Contractors (e.g., undefinitized changes, Requests For Equitable
Adjustments)
4.
Scope of Ongoing Work (e.g., charge numbers, scope definition,
continuing to voucher past the six month period)
5.
Form of Termination Settlement proposal on fixed-price contracts
(i.e., SF 1435 Inventory Basis vs. SF 1436 Total Cost Basis)
40
Audit Issues Continued
6. Recovery of the cost of layoffs and severance (e.g., demonstrating
that the termination caused the severance, how much of the
severance cost should the terminated contract bear)
7. Cash Flow Issues (e.g., vouchering for six months, SF 1440
Application for Partial Payment, Recovery Of Settlement Expenses,
and Settlements with Subcontractors)
8. Inventory (e.g., Ongoing Protection, Physical Count, Spoilage,
Inventory Schedules Within 120 Days)
9. Auditing of subcontractors who are also competitors (e.g., obtaining
Cost or Pricing Data, DCAA Audits, Third Party Audits)
41
Audit Issues Continued
10. Fee on Cost-Plus Contracts and FAR 49.305
•
Fixed fee and measurement of completion percentage
•
Award fee and the application of award fee plans which do not
anticipate termination
11. Profit on fixed-price contracts and the nine factors at FAR 49.202
12. Loss on fixed-price contracts and the loss ratio provisions of FAR
49.203
13. Termination Forms (e.g., SF1439 Schedule of Accounting
Information)
42
Audit Issues Continued
14. Dealing with DCAA Audit Reports
•
Extensive qualifications or limitations
•
“We do not consider… to be acceptable as the basis for the
settlement of a fair and reasonable amount.”
•
Extensive delay in conducting audit
15. Fraud Referrals and other allegations
16. Records Retention
17. Reliance on copies
43
Audit Issues Continued
18. Interpretation of FAR 31.201-2(d)
19. Questioning completion of work
20. DCAA’s audit standards compared to “preponderance of the
evidence”
21. Settlement Negotiation Memorandum and FAR 49.110 and FAR
15.406-3
22. Settling prior to the finalization of indirect rates
23. Settlement contingent on subcontractor settlements or other issues
44
Audit Issues Continued
• Interpretation of FAR 31.201-2(d)
– A contractor is responsible for accounting for costs
appropriately and for maintaining records, including
supporting documentation, adequate to demonstrate
that costs claimed have been incurred, are allocable to
the contract, and comply with applicable cost
principles in this subpart and agency supplements.
The Contracting officer may disallow all or part of a
claimed cost that is inadequately supported
45
Audit Issues Continued
• Reliance on copies
– “[The Contractor] did not maintain original source documentation
for all transaction selected for testing… [S]upport provided
included documentation received by [the Contractor] in an
electronic formation (invoices received via email). … [W]e are
unable to evaluate [the Contractor’s] process for maintaining the
integrity of documents received electronically. Accordingly, we
were unable to determine whether reliance could be placed on
the copies provided and relied on during our audit.”
– Example DCAA Audit Report
46
Greg Bingham
Greg Bingham is a Vice President with The Kenrich Group, LLC. He has over 25
years of experience in the fields of business and litigation consulting including
investigation of allegations of fraud or overbilling.
Professional Experience
• Masters of Business
Administration
University of Texas at
Austin
Mr. Bingham has assisted clients on Government Contract matters including: 1)
• Bachelor of Science in
Electrical Engineering
regulatory consulting on allowable costs issues arising from the Cost Principles found
University of Kentucky
at Part 31 of the Federal Acquisition Regulation (“FAR”) as well as allocation of cost
issues associated with the Cost Accounting Standards (“CAS”), 2) consulting on
• Contact Information:
matters involving allegations of defective pricing, false claims, mischarges and other
1919 M Street, NW
improper billings to the Government, 3) the Earned Value Management Systems
Suite 620
Washington, DC 20036
requirements of Department of Defense regulation 5000.2-R (April 5, 2002), 4)
Tel: (202) 420-7680
financial statement and special purpose auditing, 5) management consulting and 6)
Fax: (202) 429-5673
Foreign Military Sales issues and foreign sales issues. This experience has provided
gbingham@kenrichgroup.com
him with substantial knowledge of the program management, financial and accounting
records and systems maintained by companies who sell to the Federal Government.
Greg’s work has included the quantification of cost impacts and negotiation with
Government auditors and oversight personnel. Greg has planned and performed
reviews of various defense contractors’ systems including material management,
accounting, inventory and internal policies and procedures along with the evaluation of
operating inefficiencies and internal control deficiencies.
47
Selected Termination Experience












Future Combat System Termination. Various roles.
Army Armed Reconnaissance Helicopter (ARH)-70A Termination
USPS Convenience Termination and Dispute with Subcontractor
Convenience Termination of Crusader Artillery Program. Oversaw evaluation
and settlement with approximately 50 subcontractors
A-12 Termination. Primary Focus was More Than Three Hundred
Subcontractors and Suppliers
Convenience Termination of Power Plant Construction Project
Compaq v Hardware Technologies – Dispute Over Convenience Termination
of IDIQ Contract
Earth Tech v IT Corporation – Dispute Over Costs in Convenience Termination
of IDIQ Contract
InTown – Termination for Default Overturned and Convenience Termination
Settlement. Provided Testimony at Mediation Which Proved Successful
Obayashi – Super Collider Convenience Termination
Raytheon v Datatape – Termination of Subcontractor for Default. Default
Converted to Convenience. Evaluated Termination for Convenience Claims
Raytheon – Default Termination and Claims
48
Chelsea Taylor
Chelsea Taylor is a Manager with The Kenrich Group, LLC. She is a Certified Fraud
Examiner with extensive experience in government contracts, construction, utilities,
and other commercial industries. The support she provides to clients has included
• Bachelor of Science in
compliance review, damages analysis, and litigation support..
Commerce, with
Professional Experience
Chelsea has worked on multiple government contract matters helping government
contractors with: (1) consulting on compliance with FAR Part 31 Cost Principles for
Government audits and disputes between contractors and the Government; (2) the
preparation, review, and negotiation of termination settlement proposals (TSPs), (3) the
preparation and review of Incurred Cost Submissions; (4) preparation, review, and
analysis of Requests for Equitable Adjustment (“REAs”) and claims; (5) damages
analysis resulting from defective pricing, false claims, Truth in Negotiations Act (TINA)
claims, Contract Disputes Act (CDA) claims, and (6) analyzing cost realism in bid
protests, among other matters.
Chelsea’s experience in terminations has included auditing TSPs in accordance with FAR
Part 49 and CAM Chapter 12, as well as other termination-related regulations. Chelsea
has also assisted clients in negotiations with the client’s prime contractor, the
Government’s Termination Contracting Officer, and negotiating termination settlements
with hundreds of lower-tier subcontractors with TSPs ranging from the hundreds of
dollars to the hundreds of millions of dollars. Chelsea has worked with numerous foreign
suppliers in Canada, Belgium, Turkey, the United Arab Emirates, and the United
Kingdom, among others.
49
Concentrations in Finance
and International Business
University of Virginia
• Contact Information:
1919 M Street, NW
Suite 620
Washington, DC 20036
Tel: (202) 420-7680
Fax: (202) 429-5673
ctaylor@kenrichgroup.com
Citations and Documents
1.
Slides Relating to Termination for Convenience Issues
2.
FAR 49.1 General Principles
3.
FAR 49.2 Additional Principles for Fixed-Price Contracts
4.
FAR 49.3 Additional Principles for Cost-Reimbursement Contracts
5.
FAR 31.205-42 Termination Cost Principle
6.
FAR 52.249-6 Termination Cost Reimbursement
7.
Selected Termination Forms
8.
DCAA Contract Audit Manual Chapter 12 -- Auditing Contract Termination,
Delay/Disruption, and Other Price Adjustment Proposals or Claims (excerpt
relating to terminations)
9.
Administering Subcontracts After A Termination For Convenience, by
Patricia Meagher and Greg Bingham, Briefing Papers, March 2004,
Thomson West Publishers
50