Preparing for Sequestration-Driven Contract Terminations and Restructures
With the looming threat of sequestration, there is significant uncertainty regarding the budgetary resources that will be available for the reminder of the fiscal year. Unless Congress acts to prevent sequestration, beginning March 1, 2013, approximately $85 billion in budgetary resources across the Federal Government will be cancelled. On January 10, DoD issued initial planning guidance on sequestration. See “The Department of Defense Issues Initial Planning Guidance on Sequestration”. This week, on January 14, 2013, OMB issued a Memorandum for the Heads of Executive Departments and Agencies providing guidance on planning for the impact of a sequestration order. While the OMB guidance is fairly limited, OMB has tasked agencies with indentifying means to reduce civilian workforce costs and has urged agencies to review grants and contracts to determine where cost savings may be achieved, being cognizant of the requirements of the Worker Adjustment and Retraining Notification (WARN) Act.1
As agencies grapple with the prospect of sequestration and plan for cost-cutting, so must contractors be cognizant of the impact sequestration will have on existing contracts. With sequestration-mandated cuts in funding levels available for procurement, government agencies will be forced to change, restructure, or abandon programs and contracts. Contractors can expect partial or total terminations, de-scoping of quantities and capabilities, contract stretch-outs, breaks in production, and other efforts by the government to alter contracts and programs to align government spending with available funds. Contractors should prepare for the inevitable.
First, contractors should assess programmatic vulnerabilities caused by: changes in threats, roles, and missions; changes in technology; changes in priorities; and cost and schedule growth. Contractors should understand the government’s most current assessment of a program’s technology, design and production maturity and other programmatic issues.
Second, contractors should re-examine their portfolios, and determine what products make long-term strategic sense to continue and to expend resources to pursue in the future. Based upon these assessments, contractors should develop a strategy for procurement advocacy.
Third, contractors must also understand the contractual limits of the government’s authority to make unilateral budget-driven changes to contracts, and the risks created by these alterations to the contractual effort.
Fourth, contractors should take steps to protect against a possible termination for default. While budget-driven terminations are usually accomplished by terminations for convenience, terminations for default have been used as a budget saving strategy. To protect against the possibility that a future termination could be for default, contractors should regularly assess their contractual vulnerabilities, including performance status. Milestone and technical reviews should be documented, and all specification changes should be formalized to minimize disputes regarding progress or performance.
Fifth, contractors should prepare for a possible termination by resolving subcontractor claims, and identifying important technology developments to be preserved or continued.
Sixth, and most importantly, contractors should regularly track contract funding status, and identify potential limitation of costs/funds issues, since contractors which incur costs in excess of funding are at risk that those costs will never be reimbursed by the government in the event of a termination.
These are just a few of the measures that contractors can be taking now to prepare for the adverse impact of sequestration, and an era of declining procurement budgets.
McKenna attorneys will continue to monitor guidance from OMB, DoD and other agencies on preparing for budget sequestration.