This guidebook was developed to provide guidance, suggestions and lessons learned on issues relating to the settlement of contracts terminated for convenience. The contents are discretionary and support DCMA policy established in the DCMAD 1 (One Book). The contents are intended only as a guide and may be supplemented locally. All DCMA personnel are encouraged to submit suggestions to the HQ performance advocate Juanita McKee for publication and sharing throughout DCMA. We hope you find this Guidebook useful.
FAR Parts 49, 12, 13 and 31 (et al) establish the regulatory requirements for termination and settlement of Government contracts. While the FAR is clear about the basic requirements, many aspects of a settlement are not clear-cut. This guide attempts to provide general guidance in addition to the FAR and offer lessons learned to assist the TCO in negotiation of a settlement.
Once a contract has been terminated for convenience, the PCO may delegate settlement costs to DCMA. Settlement can be very simple or complex. It may involve many players both within DCMA and from the buying activity. Communication amongst all players is essential for a successful settlement that ensures the contractor has been fairly compensated on a timely basis while protecting the rights and interests of the Government.
Once a contract has been terminated for convenience, timely settlement of the costs by the TCO involves the coordination and effort of a variety of functional specialists. The key players in the settlement phase may include the PCO, PM, ACO, TCO, Plant Clearance Officer (PLCO), Industrial Specialist (IS), Legal Counsel and the Defense Contract Audit Agency (DCAA) auditor.
The PCO and the PM will make the decision to terminate a contract for convenience of the Government. Once this decision has been made, the PCO will issue a written notice in accordance with FAR 49.601 to the contractor. The notice should state that the contract is being terminated for the convenience of the Government, cite the termination clause, identify the effective date of termination and extent of the termination (full or partial) and detail any special instructions. If the contract has been delegated to DCMA for administration, the PCO may delegate settlement of the termination to DCMA. The PCO must send a notice of delegation and a copy of the termination notice/modification to the CMO and any known Assignee, Guarantor, or Surety of the contractor.
The PCO should advise the ACO/TCO of any outstanding requests for equitable adjustments, any technical or delivery problems, and any Government caused delays. The PCO should also ensure that he/she and his/her representatives are available to assist the TCO in identifying, evaluating and making technical recommendations with respect to any unadjusted contract changes that may require negotiation by the TCO.
At times, DCMA may accept delegation of termination settlement responsibilities although we did not receive the initial administration delegation. This effort should be coordinated with the District and HQ performance advocates.
Upon receipt of the notice of termination/modification, the ACO must immediately forward a copy of the notice to the TCO. This can be accomplished via email, fax, or regular mail. The ACO should review the notice and prepare the contract and associated documents as necessary for shipment to the TCO. A brief summary of any issues relating to the contract or contractor's systems may accompany the contract documents to inform the TCO of important issues that may affect the settlement. Examples of issues include a disapproved property system, accounting system deficiencies and status of the contract (quantity delivered, paid to date, overruns, etc).
Upon conclusion of the settlement, the TCO will return the completed docket to the ACO to be filed with the contract. If the contract was completely terminated, the ACO, upon receipt of the docket, should take actions for closeout.
The TCO is responsible for settlement of the termination, and, if delegated by the PCO, any equitable adjustment claims in conjunction with the termination. To accomplish this, the TCO may need the services of the PLCO, IS, and DCAA auditor. Settlement responsibilities include ensuring receipt of a termination proposal, schedule of accounting information, and inventory schedule (if applicable), identification of excess funds to the PCO, and generation of a settlement that compensates the contractor for work accomplished while protecting the rights and interests of the Government. More examples and suggestions will be provided in the section titled "Submission of Settlement Proposal."
Prime Contractor Duties
Upon receipt of the notice of termination, the prime contractor should immediately stop all work and terminate all subcontracts related to the terminated portion of the prime contract. The contractor should initiate efforts to preserve property. Actions should be undertaken to solicit settlement proposals from all subcontractors. The contractor is responsible for submission of a settlement proposal and inventory schedule to the TCO. The proposal must be adequately supported.
The TCO may request a review of the contractor's settlement proposal from the IS and DCAA auditor. The IS is responsible for documenting the percent of completion. Per FAR 49.107, when requested, the DCAA auditor will perform a review of the contractor's proposed costs. This review, with any questioned costs, will be forwarded to the TCO for use in preparing a Government position prior to negotiation. The PLCO is responsible for review of the contractor's inventory schedule and directing disposition of the items listed.
Receipt of Notice of Termination
Upon receipt of the notice of termination and accompanying contract files, the TCO should perform contract receipt and review as applicable on all incoming contractual documents. This review may include review of the termination modification issued by the PCO, contract requirements such as type and kind, and MOCAS data. An abstract should be printed from MOCAS identifying the available funds, ULO and date the information was obtained. Since some payments may be in the process, the TCO may want to check with DFAS or DCAA to identify any invoices/vouchers approved but not paid.
The TCO will establish a new termination docket into the Termination Automated Management System (TAMS) within three days of receipt of the termination notice. As events occur, the TCO will update TAMS accordingly.
Post Termination Conference
FAR 49.105(c) directs the TCO to conduct a post termination conference. This conference is an excellent opportunity to remind the contractor of the requirements of FAR and timeframes for submission of information. Topics that should be discussed should include:
obligation of the contractor to settle subcontracts
names/phone numbers of contracting personnel handling the settlement
discussion of the roles and responsibilities of the players
diversion or retention of property
preparation of inventory schedules
contractor accounting practices
basis for settlement and required forms
accounting review of settlement proposal
interim financing (partial payment requests)
tentative time schedule to settle claim
contractor action to minimize impact on employees
contractor obligation to furnish pricing data
It is advisable to follow-up this meeting with a letter to the contractor, again restating the required timeframes for submission of the inventory schedule and the 365-day time limit for submittal of the settlement proposal. The contractor should be reminded of the TCO's authority to issue a unilateral settlement modification in the event that the contractor fails to submit a timely proposal. The contractor should be advised that a unilateral determination issued by the TCO as a consequence of the contractor's failure to submit a timely proposal may not be appealed.
The TCO should obtain an initial estimate of funds and advise the PCO within 30 days of assignment.
Submission of Settlement Proposals
The contractor should promptly submit to the TCO a settlement proposal for the amount claimed because of the termination. This proposal must be submitted within one year from the effective date of termination unless extended by the TCO. Termination charges under a single prime contractor may be consolidated and included in a single settlement proposal.
Fixed Price Contracts
According to the FAR, a settlement should compensate the contractor fairly for the work done and the preparations made for the terminated contract, including a reasonable allowance for profit. Fair compensation is a matter of judgment and cannot be measured exactly. In a given case, various methods may be equally appropriate for arriving at fair compensation and therefore the use of business judgment is at the heart of a settlement.
Per FAR 49.206-2, the contractor's settlement proposal must be on an inventory or total cost basis. The inventory basis is preferred by FAR. The total cost basis must be approved in advance by the TCO. FAR 49.602-1(d) says the contractor shall use a short form if the proposal is less than $10,000.00 while FAR 49.206-1(d) says the contractor may use this form. Therefore, use of this form should be included as a topic of discussion at the Post Termination Conference.
Cost Reimbursement Contracts
The contractor's settlement proposal should include all unvouchered costs and any proposed fee. The proposal should not include costs that have been disallowed by the Contracting Officer or formally questioned by the Government and not yet decided as to allowability.
The termination clauses included in a commercial contract differ from those found in FAR Part 49 which does not apply when terminating contracts for commercial items awarded under FAR Part 12. Instead, FAR 12.403 provides guidance for settlement of a terminated commercial contract. Probably most important to remember in a termination for convenience of commercial items is that the contractor is paid for the percentage of the contract price reflecting the percentage of work performed prior to the termination plus any directly related termination costs. Listed below are the most significant aspects of a commercial termination:
There is no visibility of mitigated costs
The contractor is not required to comply with the cost accounting standards or contract cost principles
The Government does not have any right to audit the Contractor's records solely as a result of the termination
There is no time limit for submitting a proposal
The final settlement is not restricted to the contract value
There is no allowance for partial payments prior to final settlement
There is no certification required on the proposal
There is no allowance for equitable adjustments to the continuing portion of the contract in the event of a partial termination.
There is no proposed modification format such as found for Fixed-Price Contract - Complete Termination (FAR49.603-1) and Fixed-Price Contracts (FAR 49.603-2) although one is included in TAMS 4.0
There is no plant clearance activity required
The Administrative Agreements Officer (AAO) and Administrative Grants Officer (AGO) are responsible for settlement of Other Transactions and Grants terminated for the convenience of the Government. It is important to remember that these OTs and Grants do not incorporate the provisions/clauses of the FAR and DFARS. Any settlements must be in accordance with the terms and conditions of the OT agreement/grant and sound business judgment.
There are far too many cost elements involved in a termination to discuss them here but the following areas attempt to address some of the more common questions regarding cost elements.
Bid and Proposal (B&P) Costs
The ASBCA has repeatedly denied reimbursement of B&P costs. Under the standard termination for convenience clause “Bidding costs were not reimbursed by the government as part of a convenience termination settlement because costs incurred pursuant to competitive bidding are pre-contract costs of doing business and belong in overhead or general and administrative pools. No contractor has a reasonable expectation that bidding costs, when incurred, will be directly reimbursed by the government because no contractor has a reasonable expectation of award when it puts together its bid.”
Reclassification of Costs
Under the cost principles (FAR 31.202(a) and CAS 402), "No final cost objective must have allocated to it as a direct cost any cost, if other costs incurred for the same purpose in like circumstances have been included in any indirect cost pool to be allocated to that or any other cost objective." For example, small tools cannot normally be recorded to the indirect expense pools and then charged directly to the Government upon receipt of a Government contract. This would have the effect of charging the Government for all of the small tools needed for its contract and then assessing them with a proportionate share of small tools used on the commercial contracts through the allocation of the indirect expense pools. The inequity of such an arrangement is patently evident.
The exception to this consistency rule is found in ASBCA rulings associated with terminations for convenience. Where the allocation base is insufficient to allow recovery of a cost, the cost may be allocated directly to the terminated contract. Where pre-termination costs have been reclassified to allow for recovery because the allocation base is inadequate as a result of the termination, the costs are of the same nature and were incurred in like circumstances as those costs remaining in the indirect expense pools. Thus, for computing indirect expense rates on the termination proposal, all similar costs should be removed. Where a cost is reclassified, all similar costs must be removed in the computation of the indirect expense rates for the termination settlement proposal. Further, reclassified direct charges should be removed from the indirect expense pools and charged directly to the contract in the accounting records (FAR 31.205-42(c)(3)). However, the rules for post-termination costs are not the same as those for pre-termination costs. The Cost Accounting Standards Board in Working Group (WG) paper 77-15 issued 29 March 1977 has stated that termination settlement costs are incurred in different circumstances than contract costs. Only the costs being claimed need to be removed from the indirect expense pools.
Another consideration is whether overhead and G&A should be applied to these reclassified costs in the termination proposal. Boards and courts usually do not allow contractors to recover indirect costs on costs that would be classified as indirect but for the termination. Where such reclassified costs have been included in the base for calculation of the rates, an argument could be made for the application of indirect expense rates. However, where the rates do not reflect these reclassifications, the Board has in the past viewed these as not being direct charges, but rather indirect costs allocated directly to the terminated contract. The tribunals reason that one cannot charge overhead on overhead. The Board held that the contractor can not recover additional G&A allowance on costs of a general and administrative nature for which it was reimbursed directly.
First Article Costs
The standard First Article clauses (FAR 52.209-3 and FAR 52.209-4) provide that the acquisition of materials for or the commencement of production of the contract quantity over and above the First Article quantity (i.e. the production units) is at the sole risk of the contractor. Before First Article approval, such costs are not allocable to termination settlements. The exceptions are (1) prior approval by the Contracting Officer, and (2) minimum buy requirements. The First Article clause limits the contractor to its incurred costs for the First Article, NOT the contract price for the First Article.
The measure of recovery for the exclusive remedy afforded by the termination for convenience clause is costs incurred plus reasonable termination settlement expenses and profit on work performed. Post-termination overhead costs are neither incurred as a result of the work performed on the contract nor generated directly by the termination action. The termination action merely reduces the base against which overhead can be applied. Just as anticipatory profits are not allowable, so a loss of business, whether in the guise of post-termination G&A or otherwise, is not recoverable in a termination claim. The courts and boards have long and consistently held that general indirect costs which continue after termination are not allocable to the terminated contract but are simply ongoing business costs unrelated to the terminated work, i.e., unabsorbed overhead costs, which the contractor incurs at its own risk. The continuing costs to which FAR 31.205-42 refers clearly are only those costs directly related to the terminated contract, which cannot reasonably be shut off immediately upon termination. Moreover, the continuation of overhead after a termination is a common occurrence and if the drafters of the regulation had intended to allow such costs, they could have done so simply and clearly as they did for rental cost. In practical effect, the Government would be guaranteeing the contractor’s overhead costs, without receiving any benefit, as a “penalty” for exercising its contractual rights.
Reclassification of costs should not be considered on cost-type contracts. The concept of “fair compensation” as contained in FAR 49.201 allows for the reclassification of costs. However, for cost-type contracts, FAR Part 31 and the contract terms govern the Termination Contracting Officer’s (TCO’s) actions. The basic termination clause for cost-reimbursement contracts provides: “the cost principles and procedures in Part 31 of the Federal Acquisition Regulation, in effect on the date of this contract, must govern all costs claimed, agreed to, or determined under this clause” (FAR 52.249-6(i)). This language is the same as that found in the fixed-price contract clause (FAR 52.249-2(i)). However the fixed-price contracts also reference FAR 49.201(a) which states, “Fair compensation is a matter of judgment and cannot be measured exactly. In a given case, various methods may be equally appropriate for arriving at fair compensation. The use of business judgment, as distinguished from strict accounting principles, is the heart of a settlement.” While this clause gives TCOs the authority to waive the cost principles, it is not applicable to cost-type contracts. There is therefore no contractual or regulatory basis on which to deviate from the terms and cost principles contained in the contract and FAR Part 31.