By Sam Van Kopp, Alan Chvotkin, Adrian Wigston, Robert Nichols

October 25, 2021

Contract Terminations and Cost Settlements for federal contractors in Afghanistan

When the Government of the Islamic Republic of Afghanistan (GIRoA) collapsed on August 15, it left more than $3 billion in obligated but undisbursed funds that the U.S. government intended for Afghanistan’s reconstruction and security.[1]  In the intervening months, federal agencies have begun to reprogram funds and terminate contracts that are no longer feasible or necessary given the Taliban’s control of the country.  For federal contractors who struggled to evacuate their employees from the country, much less their equipment and records, settling with the government for unpaid contract costs may seem daunting.

Nichols Liu LLP provides this Note for contractors and subcontractors that have recently received, or are anticipating receiving, termination letters from the U.S. government concerning contracts performed in Afghanistan.[2]  It is evident that the pace of contract terminations is accelerating as federal agencies are beginning to prioritize this often-difficult process.  Nichols Liu has experience negotiating Termination Settlement Proposals (TSP)s with government agencies and litigating Claims for unpaid costs.  We hope that this brief overview of the TSP process will be of assistance for contractors who need assistance in drafting TSPs or claims.

I. Recovery of Costs by Termination Settlement Proposal or Claim

The FAR provides two general mechanisms for recovery after a contract termination for convenience: settlements and claims.  The decision to file a TSP or a certified claim is largely outside of the contractor’s control, since the government must first issue a Notice of Termination before the Contractor can begin to negotiate a termination settlement.[3]  If an agency is slow to terminate a contract that has become impossible to perform, a Contractor could submit a Request for Equitable Adjustment (REA) for performance costs that have accrued since the contract became impossible to perform, with the intent of later converting the REA into a claim.[4]  The benefit of drafting an REA before a claim is that the costs associated with preparing an REA are recoverable.[5]  However, because the costs of preparing a TSP are also recoverable, and because the legal and reputational costs of litigating a claim can be difficult to anticipate, it is usually advisable to work with an agency and await its termination decision before seeking to recover costs through a certified claim.

II. How to Draft a Termination Settlement Proposal as a Prime Contractor

Once an agency issues a Notice of Termination for the Convenience of the Government, a contractor may begin work on its TSP with the knowledge that reasonable costs related to preparing that settlement proposal are now recoverable.[6]  As this process begins, many contractors run into difficulties identifying and classifying costs that, while incurred in the course of contract performance, may not have been well documented or fit neatly within the FAR’s cost allowability framework.  In these circumstances, it is important to remember that the termination settlement process is designed to be a negotiation.[7]  FAR cost principles frequently conflict, and the FAR has explicitly recognized “that business judgment, as distinguished from strict accounting principles, is the heart of a settlement.”[8]  An agency’s Termination Contracting Officer (TCO) is obligated to discuss and negotiate the allowability of claimed costs, and may unilaterally dictate the quantum of the settlement “only when [a termination] cannot be settled by agreement.”[9]

As a first step, a contractor should determine how  to account for its costs in its TSP.  If the contractor has segregated and itemized costs by effort and type, as is typical for cost-reimbursement contracts, the contractor should use the “inventory” basis for recovery as that is the FAR’s preferred methodology.[10]  If the contractor did not maintain such records, as often occurs with fixed-price contracts or small contractors, then the contractor must seek approval from the TCO to use the “total cost” basis for recovery.[11]  The “total cost” basis should not be mistaken as propounding a lower standard of proof for recovery, and contractors are still obligated to “itemize all costs incurred under the contract up to the effective date of contract termination” [12] under the total cost method.  Rather, the “total cost” basis simply allows for the use of a different methodology in arriving at those costs, and that difference is critical for contractors that did not segregate their costs during performance of the contract.

After deciding on its methodology, a contractor should select the pre-formatted TSP form from FAR 49.602-1 that corresponds to its contract type and settlement methodology.  These forms are functionally invoices – they require the contractor to quantify its costs with complete accuracy, but they do not provide room for a contractor to justify the costs claimed.[13]  Unless a TCO and contractor are in complete agreement about the universe of costs the contractor intends to claim, the contractor should also submit a certified document that both recounts the facts of contract performance and establishes the contractor’s legal entitlement to the termination costs it claims.  If the contractor’s TSP is denied, its standard form and narrative will serve as a certified claim that may be appealed under the Contract Disputes Act.[14]  Further, drafting a narrative TSP will help contractors identify the full scope of costs they are legally entitled to recover before submitting a TSP.  Because TSPs must be submitted within one year from the effective date of contract termination,[15] failing to identify recoverable costs within that time period raises questions of waiver.  While it is possible to amend an incomplete TSP after submission,[16] doing so will only delay settlement.

III. Cost Recovery Considerations Based on Contract Type

For contractors with indefinite delivery, indefinite quantity (“IDIQ”) contracts, cost recovery is extremely limited.  Though one might presume from the text of FAR 16.504(a)(1) that an IDIQ contractor would be entitled to the full value of the minimum order established by the contract, the Federal Circuit has established a narrower basis for recovery: the net value to the contractor of the minimum quantity order after accounting for the expenses of performance.[17]  IDIQ contractors are thus in the unusual position of having to prove “expectancy damages,” also referred to as “lost profits,” by proving the absence of costs, which is a difficult evidentiary task.[18]  The contractor’s only consolation in this context is that it is not required to prove its lost profits “with absolute exactness or mathematical precision”[19] since the Government is the party responsible for the termination, and the Courts apply “a generous standard of proof” when evaluating a contractor’s estimations.[20]

In cost-reimbursement contracting, the contractor is regularly compensated by the Government by design, so identifying recoverable costs arising from a  contract termination is generally straightforward.  Cost reimbursement contractors may continue to submit invoices for all types of costs that it has invoiced for in the past, up to six months after the date of termination.[21]  In submitting its TSP for costs not recoverable via invoicing, a cost-reimbursement contractor may include any reasonable cost that has not been previously been disallowed by the CO, or formally questioned by the Government on previous invoices.[22]  Additionally, the FAR states with specificity that cost-reimbursement contractors may not recover costs that are “clearly not allowable under the terms of the contract.”[23]  Though this last regulation seems obvious, it reflects the fact that cost-reimbursement contracts are unique; in most other forms of contracting, the contract will not discuss unallowable costs at length, since fixed price contracts do not usually include a requirement to negotiate the individual elements of costs.[24]

Finally, in fixed-price contracting, termination is a transformative process.  Suddenly,  contractors who would otherwise bear their own costs are entitled to recover “costs incurred in performance of the work terminated,”[25] a “reasonable allowance for profit on work done,”[26] the cost of materials provided to the government,[27] and the “reasonable cost of settlement.”[28] Termination effectively converts a fixed-price contract into a cost-reimbursement contract,[29] except that the scope for compensable expenses is not limited to the FAR’s classification of allowability because of the negotiated nature of the termination proceeding.[30]  The FAR recognizes that fixed-price contractors may not have itemized these expenses during contract performance, so contractors are allowed latitude in evidencing their data,[31] providing that the evidence “whether documentary, testimonial, or both” be credible.[32]  In our practice, we have found fixed-price TSPs to be the most difficult to evidence and negotiate, and thus also the form of contract most typically requiring professional assistance.

IV. Settlements for Subcontractors

Because a subcontractor is not in privity with the government, the subcontractor’s entitlement to its costs rests with the prime contractor.[33]  Fortunately, the FAR obligates prime contractors to settle with subcontractors before the primes can resolve their own TSPs with the government.[34]  Further, the FAR encourages subcontractor settlement by authorizing the prime to recover the costs of its settlements with subcontractors, providing that the settlement amount was reasonable, and the settlement negotiations occurred at arms-length.[35]

Though subcontractors must look to the terms of their subcontract for the full scope of their recovery, subcontractors are generally limited to recovering the same types of costs as the prime contractor for two reasons: the prime may only recover from the government the costs of its sub-contractor settlements that are allowable;[36] and prime contractors generally apply the same FAR provisions found in their prime contracts when flowing down provisions in subcontracts.[37]  However, there are two important exceptions to this general rule.  First, because subcontractors are recovering from the prime contractor rather than the government, the sub may recover otherwise unallowable costs – like anticipatory profits – if allowed by its subcontract; the prime contractor is merely precluded from recovering those settlement costs as part of its own TSP.[38]  Second, if the subcontractor sues or arbitrates with the prime following a failure to settle costs, the TCO may reimburse the prime for otherwise unallowable costs resulting from the litigation in certain circumstances.[39]

Finally, despite the typical absence of privity, subcontractors have three possible means of negotiating settlements directly with the government.  If the prime consents, the TCO may negotiate directly with the subcontractor to settle its claims as part of the agency’s settlement with the prime.[40]  Alternatively, if the contracting agency worked closely with the subcontractor and gave orders directly to the subcontractor in the course of contract performance, the subcontractor may assert that the contact “created a contractual relationship” independent of the formal contract, placing the sub in privity with the government.[41]  Finally, if the prime and sub cannot agree on the sub’s entitlement to costs resulting from government conduct, the sub may bring a claim directly against the government with the prime’s sponsorship.

V. Types of Costs Recoverable Under a Termination for the Government’s Convenience

The most important thing to remember when deciding what costs to claim as part of a TSP is that the FAR’s cost principles do not strictly apply to contract termination settlements.[42]  Under FAR 49.113, the FAR’s considerations of allowability are only “a guide for the negotiation of settlements.”  The ultimate determination of what costs are compensable falls to the TCO’s business judgement as to the reasonableness of the cost at issue.[43] There are, however, some basic rules that contractors should follow when deciding which costs to include in its proposal.

First, check the cost at issue against FAR 31.205-42 to determine if it is explicitly authorized or excluded.   FAR 31.205-42 categorizes contract termination costs by (a) type, e.g.  common items, rental expenses, alterations of property, or settlement expenses, and (b) timing, e.g. costs continuing after contract termination; or initial or preparatory costs for contract performance.  Categorization of such costs are not intuitive and may have decisive consequences for recovery.  For example, the cost of equipment that may be used on work outside the terminated contract is not recoverable,[44] while the cost of specialized equipment acquired for the purpose of completing the terminated contract is recoverable in whole or in part depending on how much value the equipment lost in the course of contract performance.[45]

Second, if the cost is critical and its allowability uncertain, have legal counsel verify recovery in precedent.  To remain with our specialized equipment example, a manufacturer of laser printers was able to recover the entire cost of die that it had procured for a Department of the Treasury printing contract despite the arguable applicability of the die to other print jobs generally and to Treasury contracts specifically.[46]  From a simple reading of FAR 31.205-42, such costs would seem unrecoverable, and a contractor who sought to pursue its TSP without knowledgeable counsel might have excluded similar costs in its TSP form and narrative.

As discussed above, the narrative brief that should accompany your Standard Form TSP provides an opportunity to advocate for the recoverability of your cost.  Since recovery is ultimately a question of TCO judgement rather than legal entitlement, it’s critical to have the TCO’s first impression of your proposal be one of strong substantiation.  Should a contractor misstate the basis for its recovery in the beginning, correcting a TCO’s impression of the appropriateness or necessity of that cost may be difficult, and recovery depends on that TCO’s judgement.

VI. When Settlement Fails: Pursuing Termination Costs through a Certified Claim

Fortunately, the Courts treat certified TSPs as containing all the elements of a certified Claim, so that when negotiations over settlement reach an impasse, the TSP ripens into a claim.[47]  It is not necessary for the parties to disagree on all elements of a TSP in order to pursue an appeal; the TCO and contractor may reach agreement on some contract termination costs and litigate others so long as the agency formally denies the disputed costs. Further, if the appeal is brought before the Civilian or Armed Services Board of Contract Appeals, settlement authority remains with the Contracting Officer and not the Agency’s counsel,[48] so that the parties can continue to negotiate during the course of litigation.

Litigating a certified claim is an involved process that often lasts for more than a year.  Contractors who have received a determination from a TCO denying settlement costs should retain counsel before deciding whether their claim is worth the expense of litigation.  Because an appeal must be brought within 90 days of the TCO’s final decision if litigation is pursued before the Civilian or Armed Services Board of Contract Appeals,[49] or within a year if pursued before the Court of Federal Claims,[50] contractors should be careful not to allow their rights to expire while considering their options.

VII. Conclusion

The unique circumstances of America’s departure from Afghanistan will raise novel questions of assumption of risk, impossibility, and mitigation for those seeking to recover contract termination costs.  Nichols Liu attorneys have experience in negotiating settlements and litigating claims in challenging circumstances, particularly for clients contracting with the Department of Defense and Department of State for work performed outside the United States. If you have any questions or need any additional information, please do not hesitate to contact:

Sam Van Kopp
[email protected]
(202) 846-9834

Alan Chvotkin
[email protected]
(202) 255-3786

Adrian Wigston
[email protected]
(509) 548-2195

Robert Nichols
[email protected]
(202) 846-9801

References

[1] Special Inspector General for Afghanistan Reconstruction, Quarterly Report for the United States Congress, July 30, 2021, at 29.

[2] Government-directed Stop Work Orders have also been issued. Although there are different rules for them, many of the actions in this Note will be applicable to them as well.

[3] See 48 CFR 49.104(h)(requiring notice of termination for submission of TSP).

[4] See, e.g., Pyrotechnic Specialties, Inc., ASBCA Nos. 53469, 53493, 02-1 BCA ¶ 31,668 (finding recovery via REA independent of termination settlement where cost derived from impossibility of performance).

[5] FAR 31.205-42

[6] See FAR 49.104(h).

[7] 48 C.F.R. 49.103 (“[w]hen possible, the TCO should negotiate a fair and prompt settlement with the contractor.”)

[8] FAR 49.201.

[9] FAR 49.103.

[10] FAR 49.206-2(a).  As the name suggests, the ‘inventory method’ provides for a detailed accounting for 17 different categories of costs, plus other unspecified cost categories identified by the contractor.

[11] See FAR 49.206-2(b)

[12] FAR 49.206-2(b)(2).

[13] See, e.g., SF 1435, 1436.

[14] See James M. Ellett Const. Co. v. United States, 93 F.3d 1537, 1542 (Fed. Cir. 1996)

[15] FAR 52.249-2(c)

[16] See Consolidated Def. Corp., ASBCA 52315, 01-2 BCA ¶ 31,484.

[17] White v. Delta Const. Int’l, Inc., 285 F.3d 1040 (Fed. Cir. 2002).  The difference in standard arises from the obligation of a breaching party not to be placed in a better – or worse – position that it would have been without the breach.

[18] Glendale Federal Bank, FSB v. United States, 239 F.3d 1374 (Fed.Cir.2001)

[19] San Carlos Irr. & Drainage Dist. v. United States, 111 F.3d 1557, 1563 (Fed. Cir. 1997).

[20] Glendale Fed. Bank, FSB v. United States, supra at 1380.

[21] FAR 49.302(a).

[22] FAR 49.303-1.

[23] FAR 49.303-5.

[24]  FAR 48.31.102.

[25] FAR 52.249–2(g)(2)(i).

[26] FAR 52.249–2(f).

[27] FAR 52.249-2(g)(1).

[28] FAR 52.249-2(g)(3).

[29] See, e.g., Raytheon Co., ASBCA No. 51652, 03-2 BCA ¶ 32337.

[30] See FAR 49.206-2(b).

[31] FAR 49.201(c)(“ The amount of recordkeeping, reporting, and accounting related to the settlement of terminated contracts should be kept to a minimum compatible with the reasonable protection of the public interest”).

[32] Indus. Refrigeration Serv. Corp., VABCA No. 2532, 91-3 BCA ¶ 24093 (outlining what the Courts have come to term the “fairness concept” in evidencing fixed price TSPs).

[33] See FAR 49.108-1.

[34] FAR 49.104(g).

[35] FAR 49.108(c); see also  Gen. Dynamics Land Sys., Inc., ASBCA No. 52283, 02-1 BCA ¶ 31,659 (ruling for appellant where prime “reached a prudent, arms-length business settlement” with sub).

[36] See FAR 49.108–3; FAR 49.108-5.

[37] As recommended in FAR 49.108-2.

[38] Note that the FAR expressly prohibits reimbursement for either consequential damages or anticipatory profits. See 49.108-3

[39] See FAR 49.108-5 (setting five pre-conditions for recovery dependent on the prime “reasonable efforts” to settle without paying unallowable costs).

[40] FAR 49.108-7.

[41] See, e.g., Key Federal Finance v. General Services Administration, CBCA 411, et al., 07-1 BCA ¶ 33,555, at 166,184.

[42] FAR 49.113.

[43] For Cost-Reimbursement contracts, see FAR 52.249-1(h)(3); for fixed-price contracts, see FAR 49.201(a).

[44] Referred to as “common items.”  See FAR 31.205-42(a).

[45] Referred to as “loss of useful value.”  See 31.205-42(C).

[46]  Hospital Healthcare Systems, Inc. v. Department of the Treasury, GSBCA 14442-TD, 98-2 BCA ¶ 29,986.

[47] James M. Ellett Const. Co. v. United States, 93 F.3d 1537, 1544 (Fed. Cir. 1996) (establishing “[t]hat the termination settlement proposal would ripen into a claim requiring the contracting officer to issue a unilateral settlement determination was contemplated by the contract and the FAR.”).

[48] J.H. Strain & Sons, Inc., ASBCA No. 34432, 88-3 BCA ¶ 20,909.

[49] 41 U.S.C. § 7104(a).

[50] 41 U.S.C.A. § 7104(b).