COMMENTARY

Are you prepared for a contract cancellation?

You should be

Going back to his campaign pledges, President Trump promised to cut government waste in conjunction with cutting corporate tax rates. As part of this, the president threatened to terminate contracts with the two largest government contractors: Lockheed Martin’s F-35 and Boeing’s Air Force One programs.

A surge in contract terminations could be in the offing as federal agencies align their goals with White House intentions. With this in mind, preparing for the possibility of a contract termination is a defensive strategy that contractors should undertake now. Here are three key steps you should consider immediately:

  1. Plan ahead. Never consider your contract as “termination-proof.”
  2. Fully understand the contract termination process
  3. Learn how to calculate and submit your Request for Equitable Adjustment or settlement proposal.

The possibility of a contract termination should be incorporated into every government contractor’s business continuity plan. Implementing safeguards and procedures designed to mitigate the risk of a termination will limit the impact it has on your organization’s operations. Ask yourself, “Does my organization have procedures in place to deal with cure notices, customer complaints, and quality issues? What about monitoring subcontractors?”

If you are still reading this article, you probably are not as well prepared for a contract termination as you should be. Most contract terminations have a root cause and are not solely due to the government no longer requiring the items or services.

Here are some common contract termination causes and how to prevent them:

Failure to immediately address government concerns

Whether a complaint or “suggestion” is received verbally or in writing from the government, there should be a process in place to respond immediately. Often, we hear from clients that their program personnel were in the process of addressing a government issue (but apparently not in real-time). Now, they are dealing with a cure notice for many items to be corrected in two weeks.

Incorporate the handling and response to government communications and complaints/concerns into your program management policy and procedures. All complaints/concerns should be documented and tracked from the initial problem to the eventual solutions.

Regular communication with the government is also critical in staying ahead of potential contract issues and preventing a termination. The contractor program manager should routinely relay project status to the government in writing – even if not required under the contract terms. We recommend weekly communications but, depending on the project, monthly communications may suffice.

Failure to evaluate change orders for potential effect on cost or schedule

Sometimes, trying to fully please the client can actually lead to a termination. A contractor has only 30 days from the date of receipt of a written order to assert its right to an adjustment. Often, accepting changes without evaluating the impact on scope, cost, and/or schedule can lead to project delays and cost overruns. These may ultimately result in missed delivery/performance dates.

As a preventative measure, create a standard procedure to evaluate the impact of any change request on the scope, cost, and/or schedule of a project. Share this required procedure with the customer: “Yes, we can make changes, but we first need to evaluate the scope, cost, and schedule to identify any project impacts.”

Subcontractor performance issues

Many contractors focus on complying with the requirement to issue subcontracts and neglect their associated responsibility for managing subcontractors under FAR 42.202(e)(2), Assignment of Contract Administration. Prime contractors often assume, without oversight or verification, that their subcontractors will meet prescribed performance and deliverable requirements.

When a subcontractor fails to deliver, the prime contractor is ultimately responsible for addressing the issue, or may face termination. Therefore, you should ensure that you flow down the proper terms and conditions to your subcontractors, including the prime contract termination clauses and deliverable dates.

Another step we recommend is to create a post-award subcontract administration procedure to address the risk. Ensure that adequate and comprehensive subcontractor oversight is built in to your procurement and project management processes. Any issue that can affect contract performance/delivery must be escalated quickly for resolution.

Bidding on unprofitable work

Today, when lowest price, technically acceptable typically beats out best value (though recent legislation directs more limited use of LPTA procurements), contractors often estimate their cost to fit the price they want to bid and what they think the government is willing to pay. Instead, you should be focusing on the actual cost required to address the government’s mission-stated requirements.

Even though you may know that the “price to win” is too low to perform the work adequately, the proposal development organization might not want to deviate from that winning number.

To avoid bidding on unprofitable work, you should develop a comprehensive estimating manual and system so that your estimated costs are based on real costs/prices currently in the marketplace. As part of this, build and encourage a corporate culture that incentivizes employees for more profitable work as opposed to contract wins exclusively.

As no contract is termination proof, the key is to always be prepared and have a defense strategy in place at all times.

About the Authors

Darrell Hineman is the director of the government compliance group at the accounting, tax and advisory firm CohnReznick LLP. https://www.cohnreznick.com/industries/government-contracting

Brian Courtney is a senior manager at the accounting, tax and advisory firm CohnReznick LLP. https://www.cohnreznick.com/industries/government-contracting

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