Managing Contract Terminations to Protect or Improve Your Profit Position A Guide to Winning Settlement Proposals. Mark J. Meagher Britton Nohe-Braun

Transcription

1 Managing Contract Terminations to Protect or Improve Your Profit Position A Guide to Winning Settlement Proposals Mark J. Meagher Britton Nohe-Braun November 14, 2017

2 Agenda Terminations overview Current terminations environment Terminations for Convenience (T4C) Terminations for Default (T4D) Limitation of Cost (LOC)/Limitation of Funds (LOF) issues Preparing the settlement proposal Recovery of costs incurred pre-termination Application of loss adjustment ratios Early obsolescence Recovery of continuing costs Idle facilities Rental/lease costs Subcontractor claims Profit/fee Settlement expenses 2

3 Current Terminations Environment Large federal deficit Risk of terminations for convenience in response to budgetary constraints Assess at-risk (non-essential) contracts Have a plan ready in event of a termination Know the essential sources for termination rules FAR , Termination costs FAR Part 49, Termination of Contracts FAR Part , Termination clauses FAR (l), (m), Termination clauses for Commercial Item contracts 3

4 Termination for Convenience Purpose: flexibility and avoidance of breach damages Unilateral government right Contractor recovery Allowable incurred costs + allowable continuing costs + fee + settlement expenses Up to contract amount No anticipatory profits Unique clause Sharp contrast with commercial contracts Allows government to cancel without fault by contractor Government termination not a breach 4

5 Limits on Right to T4C? Torncello (Ct. Cl. 1982) T4C required change in circumstances Two views of Torncello No T4C without change of circumstances T4C only improper if abuse of discretion or bad faith Krygoski Construction (Fed. Cir. 1996) T4C improper only when government had no intention of keeping its promise Bottom line: T4C will be upheld absent unusual facts showing egregious government conduct 5

6 Termination for Default Grounds for T4D: failure to Timely perform Meet specifications Make progress Contractor recovery: paid for accepted work only Common defenses Conversion to T4C Beyond control and without fault Waiver of due date/schedule CO abuse of discretion Government remedies Excess costs of reprocurement Unliquidated amounts previously paid Liquidated damages 6

7 Government Termination Methods Usually budget-driven termination will be T4C But Government has used T4D as budget tool T4D can be perceived by government as no-risk option Consequence of improper T4D is conversion to T4C Many at risk development contracts are behind schedule and not meeting specs, which could support T4D T4C methods Written notice by CO per T4C clause By operation of law Conversion of T4D Constructive T4C Cancelled contract; but treated as a T4C 7

8 Contractor s Duties Stop work Terminate subcontractors/orders Settle subcontractor claims Perform work not terminated Protect property related to contract Transfer or sell termination inventory After plant clearance, remove or store 8

9 Contractor Recovery in T4C Costs of performing up to termination Certain continuing costs necessary after termination Reasonable settlement expenses For fixed-price contracts, allowance for profit (unless loss would have resulted) For cost contracts, portion of fee 9

10 Partial T4C Termination Government can terminate all or part of contract Continued portion Possible equitable adjustment (FAR Partial termination vs. deductive change Kahaluu Constr. Co. (ASBCA 1990) : if change caused a major variation in plans, then partial T4C Lionsgate Corp. (ENGBCA 1990): minor segregable modification equals deductive change 10

11 Subcontract Issues Generally, same rules as for prime Fair and reasonable, plus good faith Properly flowed-down T4C clause? If not, breach May compromise via lump sum TCO may require approval or ratification of subcontractor settlements Include full final judgment or arbitration award, plus defense costs of prime? 11

12 Termination Settlement Proposal In writing; within one year One year deadline may be strictly enforced Swanson Group (ASBCA 2008): claim for termination costs barred because Settlement Proposal was one day late Form and certification prescribed Settlement by agreement, if possible Unilateral determination by TCO Termination settlement proposal may then be certified as a claim Appealable under Disputes clause 12

13 Basis for Settlement Fixed price contracts subject to T4C essentially converted to cost reimbursement agreement FAR Part 31 cost principles apply See FAR , Termination Costs Fairness principle supplements cost principles (FAR ) Business judgment preferred over strict accounting principles Bottom-line settlement is acceptable 13

14 Limitations on Settlement Fixed-price contracts Cannot exceed contract price (plus changes); excludes settlement expenses Cannot include anticipatory profits Cost reimbursement contracts Limitation of Costs ("LOC") clause creates ceiling But are termination costs within the LOC ceiling? Contract language controls Language in standard LOC clause ( ) suggests so Best practice: include termination costs in EAC calculation for purposes of LOC notice DOE M&O analog clause, Obligation of Funds (DEAR ) excludes T4C costs from funding estimate 14

15 Settlement Proposal Best Practices Set up job order for post-termination costs Appoint termination director Meet ASAP with TCO regarding disposition and transfer issues; ensure understanding Prepare claims or requests for equitable adjustment for pre- T4C acts 15

16 Cost Issues Pre-termination costs Contractor entitled to recover costs of performing up to termination Subject to loss adjustment REAs can be important If contractor would have incurred a loss had the contract been completed, loss ratio is applied to incurred costs Loss ratio = contract price EAC Loss adjustment = loss ratio x incurred costs Early obsolescence Loss of useful value of special tooling, special machinery and equipment purchased for the contract Allowable if not usable in other work Transfer title to government or sell 16

17 Cost Issues (cont.) Pre-contract costs Allowable if Pursuant to negotiation of contract Necessary to meet delivery schedule Strict FAR compliance not applicable in T4C context Argue the "fairness principle" Idle facilities/idle capacity Under utilization okay for idle capacity Reasonable period, ordinarily not to exceed one year Be prepared to argue no mitigation of damages is reasonably possible 17

18 Cost Issues (cont.) Rental costs Requires reasonable efforts to minimize Can exceed contract period Reasonableness; at time of lease Not limited to ownership costs Defective work Allowable if not willful misconduct/negligence 18

19 Cost Issues (cont.) Severance costs Okay if obligated to pay by company policy, law or labor agreement Causation and allocability issues Metropolitan Life Ins. Co. (ASBCA 1985) Retraining costs not allowable because benefit to company's commercial operations receiving the re-trained workers Outplacement costs? WARN Act considerations 19

20 Cost Issues (cont.) Pensions, post retirement benefits, Worker s Compensation and long-term disability Recovery under segment closure Recovery without segment closing Environmental remediation costs Unabsorbed overhead Generally not allowable; cost of continuing in business Potential for winding up costs Proof that cost caused by T4C 20

21 Cost Issues (cont.) Facilities costs Dismantle, restore and rearrange Segregate and justify costs regarding T4C vs. preparation for new work Dedicated facilities Subcontractor claims Generally allowable... In recent years DCAA has more frequently challenged cost reasonableness Ensure notice to and coordination with TCO Indirect costs allocable to subcontract settlements are allowable 21

22 Cost Issues (cont.) Settlement expenses Accounting, legal and clerical needed for: Preparation and settlement with CO/subcontractors Storage and protection of property Indirect costs related to salary and wages for costs stated above Common problem: proof and reasonable Legal costs: not after adversarial role Converting indirect costs to direct costs Example: corporate legal/personnel, factory supplies, equipment repair, quality assurance and manufacturing management Reclassification may be critical to maximize recovery Must remove from indirect pools No conflict with CAS 402 b/c not "like circumstances" 22

23 Profit/Fee Recovery Cost reimbursement Contractor entitled to percentage of fee equal to percent complete Excludes subcontractor settlements Best practice: maximize fee recovery by paying incurred subcontract costs pursuant to vouchers and minimizing subcontract costs included in subcontract settlements Fixed-price Contractor entitled to reasonable profit on work performed Excludes settlement expenses No anticipatory profit Excludes subcontractor settlements, but includes contractor efforts associated with subcontractor settlements 23

24 Best Practices Complete or partial T4C requires prompt and focused management attention Advance planning equals higher recovery Time is of the essence Develop T4C plan immediately Team approach, including legal, contracts and finance Emphasis on reasonable actions Emphasize post- T4C record keeping Include costs based on fairness Capture any pre-termination changes for development of REAs 24

25 Best Practices (cont.) Challenge loss adjustments - calculation and causation Resist excessive proof requirements (especially pre-t4c fixed-price portion) Reclassify indirect costs as direct Maximize vouchered subcontract costs; minimize subcontract settlements Request partial payment Claim certification when impasse 25

26 Presenters Mark J. Meagher Office Managing Partner Government Contracts P E mark.meagher@dentons.com Britton Nohe-Braun Managing Associate Government Contracts P E britton.nohe-braun@dentons.com 26

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