REQUESTS FOR EQUITABLE
ADJUSTMENTS – ARE YOU A
WINNER OR A SINNER?
How to be a winner in the REA process.
National Contract
Management Association
(NCMA) Contract
Management Magazine
Featured Article,
May 2010
In contract negotiations, it is a sin to leave money on the table. It is also a sin to leave money
on the table during contract performance, which many contractors do without even realizing it.
Through various clauses, the government establishes its right to make changes in the contract
statement of work or period of performance. In exchange for this right, the contractor receives
compensating rights to equitable adjustments in contract price and/or schedule. The contractor
exercises this right through the preparation and submission of a “request for equitable
adjustment” (REA).
The Federal Acquisition Regulation (FAR) does not define “equitable adjustments.” However,
case law establishes that it consists of adjustments to the contract schedule and/or price of
a contract generally including profit. The cost adjustment is based on the impact or harm to a
contractor represented by the difference between the reasonable cost of contract performance
without the change or changes and the reasonable actual cost of performance resulting from
the change or changes. The equitable adjustment is not the difference between the negotiated
cost of contract performance and the actual cost of contract performance. It is the difference
between the planned cost of contract performance and the actual cost of performance.
Contractors sometimes need to be creative when preparing an REA. Formal contract cost
accounting rules do not always apply.
Recognizing REA situations is the responsibility of all contractor personnel. Everyone involved
in contract performance needs to be able to recognize deviations from the contractual statement
of work, terms of the contract, and the period of contract performance. Only by knowing what
is required by the contract can REA situations be identified, therefore communication, training,
and awareness are critical.
Advantages of the REA Process
Utilizing the REA process can provide several significant advantages to the contractor, including
the following benefits.
Improvement of Profit - The biggest advantage to utilizing the REA is receiving what
is rightfully yours. We all want to be responsive suppliers, but we must be compensated
for changes in the contract that increase cost or change the period of performance.
Contractors are not obligated to absorb these costs in their profits.
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Increase in Competitiveness - Utilizing the REA can be a subtle way to increase your
competitiveness. Pricing only what the proposal specifications request and not including
those items not requested may mean the difference between winning and not winning
the award. Let the changes process, on a noncompetitive basis, correct for request for
proposal deficiencies.
Avoid the Perception of Program Mismanagement - Utilizing the REA can help avoid the
perception of mismanagement when delays and overrun situations occur. Documented
and negotiated changes in the contract price and/or schedule place the responsibilities for
cost overruns and untimely performance on the buyer, not the contractor.
REA Requirements
REA situations apply to all contract types— firm-fixed-price, cost reimbursement, time and
materials, labor hour, and even General Services Administration multiple-award contracts.
Any performance situation where requirements are not considered in the negotiation process
and determination of the price could create the need for an REA.
To receive an equitable adjustment, a contractor must be able to establish the following:
+ The need for an adjustment (HARM),
+ The connection of these circumstances to the contract (ENTITLEMENT), and
+ The reasonableness of the amount of adjustment requested (QUANTUM).
Preparing Equitable Adjustments Claim Assessment Checklist
This checklist is to be used as a guide to the assessment of a contractor’s entitlement to
an equitable adjustment. It does not purport to be all-inclusive, but is merely illustrative of
those change situations impacting contract performance.
YES
NO
Does the contract contain any of the FAR clauses that provide for an
equitable adjustment?
1.
Did the government fail to issue a formal or express change order under
the FAR Changes Clause?
2.
Is the government demanding an unreasonable interpretation of the
contract requirements?
3.
4.
Are the contract specifications ambiguous?
5.
Has the government included conflicting clauses in the contract?
Has the government awarded a contract type that is inappropriate for
the procurement (e.g., fixed-price development)?
6.
7.
Has the government increased the scope of the tasks under the contract?
8.
Has the government revised the tasks to be performed under the contract?
Is the government’s interpretation of contract requirements more costly
than that of the contractor?
9.
Is the government imposing a higher standard of performance than is
required by the express requirements of the contract?
10.
Has the government rejected work that actually meets the requirements
of the contract?
11.
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Preparing Equitable Adjustments Claim Assessment Checklist continued
YES
NO
Has the government imposed inspection procedures that are in excess of
those deemed reasonable?
12.
13.
Has the government greatly increased the amount of documentation required?
Has the government introduced the use of an entirely different inspection
system than planned, which has increased the cost of contract performance?
14.
15.
Are the government inspectors following inconsistent inspection procedures?
Has the government performed its inspections at a later time than required
by the contract, increasing contractor costs?
16.
Has the government provided approvals or disapprovals of plans, drawings,
reports, etc. outside of the time limits included in the contract?
17.
Do the specifications of the contract make it impractical or impossible for the
contractor to perform?
18.
19.
Are the contract specifications unachievable due to some technical error?
Do the contract specifications exceed what any contractor could possibly
achieve given the technology available?
20.
21.
Is the cost of achieving contract requirements prohibitive or wasteful?
Has the government failed to disclose superior knowledge vital to the
successful performance of the contract?
22.
Was the undisclosed information known to the contracting agency or a
meaningfully connected agency?
23.
24.
Was the contractor unaware that the undisclosed information was available?
Did the government cause the contractor actual harm (e.g., increased cost
of performance) by not disclosing the information?
25.
Did the government in any way require or imply that the contractor should
accelerate contract performance?
26.
Did the government refuse to adjust schedule or completion dates even
though the contractor experienced excusable delay?
27.
Did the contractor, at the insistence of the contracting officer, attempt to
accelerate contract performance and incur additional costs?
28.
Did the government fail to provide government-furnished property or
information in accordance with the contract requirements?
29.
Was the government-furnished property or information provided unsuitable
for its intended use?
30.
Did the government fail to cooperate, through an action or inaction, during
contract performance?
31.
Did the government exercise a contract option after the option’s indicated
expiration date?
32.
Did the government fail to satisfy all of its requirements as defined in the
“requirements” contract?
33.
“YES” answers to the above questions indicate the potential existence of an equitable adjustment
situation. Each “YES” answer should be researched and, if appropriate, a claim for equitable adjustment
should be prepared and submitted to the government.
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Contract Change
REAs are based on contract changes. There are two types of changes: 1) express or formal
changes and 2) constructive changes. Express or formal changes are directed by the contracting
officer, priced and scheduled (preferably before performance) through negotiation, and the
contractor must perform as asked if the effort is within the scope of the contract. On the other
hand, constructive changes are not contractually recognized by the contracting officer at the
time of the change, and the notification of their existence is left to the contractor. They are usually
priced after the fact, which means that the government needs to be convinced of the need to
increase the contract value, revise the schedule, and provide more funding.
Again, it is important to remember that the value of the REA is calculated based on the difference
between the reasonable costs of performing the contract without the change, which may be
more or less than the amount originally proposed, and the reasonable cost of performing the
contract with the change.
Common causes of constructive changes include, to name a few:
+ Differing interpretations of contract requirements,
+ Acts of over-inspection,
+ Defective specifications,
+ Failure of the government to disclose superior knowledge,
+ Acceleration of contract performance,
+ Failure to cooperate on the part of the government,
+ Untimely notice to proceed, and
+ Differing site conditions.
Costs of Contract Delays
Contract changes more often than not lead to delays, and delays cost money. There are excusable
delays that arise from causes beyond the control and without the fault or neglect of the contractor
that allow for an extension or adjustment to the period of performance, but no recovery of any
costs resulting from the delay. Such delays include:
+ Labor strikes,
+ Subcontractor or supplier delays,
+ Unforeseeable unavailability of materials,
+ Abnormal weather conditions,
+ Floods,
+ Fires,
+ Epidemics,
+ Pandemics,
+ Embargos,
+ Acts of God, and
+ Financial difficulties caused by the government
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Additionally, there are compensable delays caused by the government that allow for both
recovery of the costs associated with the delay and/or adjustment to the period of performance.
Compensable delays include, but are not limited to:
+ Not issuing the “Notice to Proceed” within a reasonable time,
+ Not making the work site available or not allowing access to the work site,
+ Government interference in the contractor’s planned performance,
+ Failure of the government to cooperate,
+ Government delay in providing funding,
+ Unreasonable delays,
+ Inspection delays, and
+ Unreasonable delays in gaining government approval.
If the delay is the fault of the government, the contractor can recover all costs associated with
the entire delay or the unreasonable portion of the delay. No recovery of costs is possible if the
contractor has caused the delay or there is a concurrent delay on the part of the contractor and
the government. The contractor is also entitled to the recovery of delay costs from the time that
the contractor could have reasonably expected to complete contract performance, even if that
date is earlier than that stated in the contract.
Unabsorbed or Misallocated Indirect Expenses
A claim for the recovery of unabsorbed or misallocated indirect expenses arises whenever a
contract has been suspended, delayed, or otherwise disrupted, reducing or eliminating the
stream of direct cost upon which indirect costs are allocated. The Defense Contract Audit
Agency’s “Audit Guidance for Delay and Disruption Claims” states: “A claim for unabsorbed
overhead is really a request to recoup overhead costs allocated to other work because of the
work stoppage which occurred on the delayed contract.”
The “Eichleay formula”¹ is used to estimate the amount of indirect expense actually incurred
that would have been allocated to the contract had the delay not occurred. The formula is the
only accepted method of calculating the impact of delay and disruption on the absorption of
overhead expenses once contract performance has begun. It is designed to approximate a daily
amount of overhead applicable to the contract that has been delayed. The daily amount of
overhead is then multiplied by the number of days of delay in order to determine the amount
of unabsorbed or misallocated overhead to be recovered. Originally calculated to determine
the amount of fixed and semi-variable home office or general and administrative-type expenses
not absorbed, the Eichleay formula now applies to the value of any indirect expense whose
absorption is impacted by a delay in contract performance.
The Court of Appeals for the Federal Circuit confirmed that the recovery of unabsorbed overhead
is valid, and established a three-part test for determining when such recovery is allowed². First,
a valid unabsorbed overhead claim requires proof of a “compensable” delay or disruption in
contract performance for which the government bears responsibility. Second, the contractor
must prove that it was “on standby” during the delay or disruption. Third, the contactor must
show that it was “unable to take on additional work during the delay.”
1. Eichleay Corp., ASCA No. 5183,
60-2 BCA 2688.
2. Wickham Contracting Co., Inc. v.
Fischer, 12 F.3d 1574 (Fed. Cir. 1994).
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An example of the Eichleay method of unabsorbed expense determination is shown in Figure 1.
FIGURE 1.
Unabsorbed Indirect Expense Calculation—Eichleay Method
Revenue Per Financial Statements (2/93–6/96)
Projected Revenue (7/96–11/96)
$42,470,636
$5,468,164
Total Revenue for Actual Contract Performance Period
$48,208,800
Delayed Contract Revenue
$11,207,021
Percent of Delayed Contract Revenue to the Total Revenue
Total Actual Indirect Expenses
(2/93–6/96)
23.24%
$5,881,137
Projected Indirect Expenses
(7/96–11/96)
$672,701
Total Indirect Expenses for the Actual Contract Performance Period
Percent of Delayed Contract Revenue to the Total Revenue
$6,553,838
23.24%
Indirect Expenses Allocable to the Delayed Contract
$1,523,112
Number of Actual Days of Delayed Contract Performance
(46 Months x 30 Days Per Month)
1,380 Days
Indirect Expenses Allocable to the Delayed Contract Per Day
$1,104 Per Day
Number of Actual Days of Delayed Contract Delay
(22 Months x 30 Days Per Month)
660 Days
Unabsorbed Indirect Expenses—Eichleay Method:
($1,104 Per Day x 660 Days)
$728,640
The Eichleay formula assumes a total work stoppage and no other recovery of the indirect costs.
If the delay is only a partial delay, then the number of days of delay needs to be adjusted to
compensate for the total versus partial days differential. If the contractor receives recovery of
the indirect expenses included in the Eichleay calculation, then the amount calculated needs
to be adjusted to remove that additional recovery.
Costs of Contract Acceleration
In some cases, contractors are requested to accelerate the performance of the contract. When
this occurs, the contractor can recover all of the additional costs incurred in addition to the
planned cost of contract performance in accelerating performance. These costs are recoverable
as part of an REA even if the contractor is not able to accelerate contract completion.
Adjustments to Direct Labor and Direct Material
Delays affect direct costs in many ways, including the following:
+ Labor and material escalation as a result of delayed performance or procurement,
+ Utilization of different classifications of labor due to the lack of personnel availability at
the time of delayed contract performance,
+ Loss of labor efficiency due to the utilization of inexperienced personnel other than
those originally planned of the lack of consistent performance, and
+ Loss of vendors due to the delay in procurement or performance.
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Reclassification of Indirect Costs
Most government contracting cost accounting rules do not apply when preparing an REA.
Costs normally considered indirect that are incurred due entirely to the change in contract
performance can be charged directly to the contract. To avoid “double counting,” care must
be taken to eliminate these costs from the applicable indirect cost pools.
Recognizing REA
situations is the
responsibility of
ALL contractor
personnel.
Extended Program or Contract Support Costs
Program management, quality control, production management, project management, etc. are
normally costed as direct labor. These are time-oriented “core” support functions that need to
be retained during periods of contract delay. They should be included in the adjustment of the
contract price through the REA.
Personnel Costs
Delays in contract performance can create unplanned personnel costs. If the delay requires that
employees be “let go,” any severance costs incurred that are required by law, employee-employer
agreement, or under an established policy or implied agreement should be included in the
calculation of the REA.
Once the delay is lifted, the contractor has the cost of rehiring and training employees. This
applies to both released and reassigned employees. These costs should be included in the
determination of the REA recovery.
Settlement Expenses
Costs related to the preparation, submission, and negotiation of the REA are recoverable as a
cost of the REA. These costs can be incurred internally or externally by using outside resources
such as accountants, lawyers, consultants, and clerical support. If incurred using internal personnel,
care must be taken to remove them from any indirect overhead pool to avoid “double counting.”
If the contractor is not successful in obtaining recovery through the REA process and it becomes
necessary to file a claim under the “Disputes” clause, the costs of preparing and pursuing the
claim are generally not recoverable— therefore, it is important to do the job right the first time.
Profit Considerations
Changes in contract performance can impact a contractor’s ability to recover sufficient profit
relative to the work performed and the risk assumed. FAR clauses 52.245-15 (“Stop Work
Order”), 52.243-1 (“Changes—Fixed Price”), 52.243-2 (“Changes—Cost Reimbursement”), and
52.243-3 (“Changes—T&M or Labor Hour”) allow for adjustments to price or fee. It is important
that as a part of the REA and any request for additional profit, the contractor provides appropriate
support for the amount of profit or fee claimed.
REA Certification Requirement
Submitting an REA for evaluation and acceptance by the government requires that the contractor
certify that the request is made in good faith and all supporting data is accurate and complete
to the best of the contractor’s knowledge and belief ³. This certification is different from the
3. The requirement for certification of
REAs applies only to Department
of Defense contracts. See Defense
FAR Supplement 252.243-7002,
“Certification of Request for
Equitable Adjustment.”
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certification needed to file a claim exceeding $100,000 and the certificate of current cost or
pricing data when such data is required. The REA will not be audited by DCAA until it is
certified. Since the REA is not in dispute at the time of certification, the cover letter should
indicate that it is not in dispute and is submitted for contracting officer evaluation and subsequent
acceptance or negotiation.
Submission of a noncompetitive REA in excess of $650,000 in aggregate 4 requires compliance
with the Truth in Negotiation Act. Failure to disclose accurate, complete, and current cost or
pricing data will result in defective pricing.
Conclusion
Contractors should take the initiative and prepare REAs on contracts that have been changed
during performance. The cost—internal and external—of preparing, submitting, and negotiating
the recovery of costs under an REA are recoverable as a part of the REA settlement (i.e., read
free). Do a good job and you will become a winner.
This article was featured in the National Contract Management Association magazine, Contract
Management, in May 2010.
Contact Us
For additional information about RyanSharkey’s Government Contracting services, articles or seminars,
please contact Sam Davidson, Director, at sdavidson@ryansharkey.com or (571) 299-2796.
12700 Sunrise Valley Drive
Suite 450
Reston , Virginia 20191
T 703.652.1124
F 703.652.1125
www.ryansharkey.com
4. A proposed rule amending the FAR
(FAR Case 2008-024) was released
February 4, 2010, increasing the cost
and pricing threshold from $650,000
to $700,000.
Sam Davidson
Director
571.299.2796
sdavidson@ryansharkey.com
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