GovCon On Demand:

Sequestration – What to Expect and How

to Prepare

Mark D. Colley & Caitlin K. Cloonan

Government Contracts Practice Group

July 2012

Agenda

• Sequestration – Background

• Sequestration’s Impact on Federal Contracts

• What Can Contractors Do Now to Protect

Themselves?

2

Background – How Did We Get Here?

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• Sequestration was not intended as the final budget solution…it

was intended to ―drive‖ an outcome

− Budget Control Act of 2011--raised the federal debt ceiling

and included measures intended to reduce deficits by roughly

$2 trillion through FY2012-FY2021 spending reductions

− Congressional ―Super Committee‖ was charged with

recommending $1.5 trillion in additional cuts, but its failure

triggered $1.2 trillion in automatic spending reductions over

nine years

− Absent further Congressional action, the first automatic cuts

for FY 2013 will begin January 2013:

• $54.7 billion in Department of Defense programs

• $54.7 billion in non-defense programs

− Many exemptions, including most large mandatory programs

Sequestration – New Fiscal Realities

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• Sequestration in January 2013 would force dramatic action by

agencies and contractors.

• Federal agencies may be compelled to reprioritize, down-size

projects, de-scope work and even terminate programs.

• Contractors may be required to do (even) more with (even) less,

and should act proactively to protect themselves.

Sequestration Planning

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• Government representatives have indicated that agencies are not

yet making specific plans for Sequestration

• Legislation is pending to require agencies to disclose how they

plan to handle potential across-the-board spending cuts

• With no formal, publicly announced plan, contractors are left to

navigate the risks and realities of Sequestration

• Sequestration and contract impacts may give rise to new contract

disputes and litigation, with eventual decisions by the Courts and

Boards of Contract appeals

• Contractors should exercise caution, but should also take steps

now to mitigate risks and manage strategically

Near Term Effects – Contractor Layoffs

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• Reports that contractors may need to issue layoff notices as early as

November 2012 should be viewed skeptically.

• Worker Adjustment and Retraining Notification Act, 29 U.S.C. §§ 2101-

2109 (1994) (―WARN Act‖)

Requires employers to issue 60 days advance written notice to affected

employees or their union representatives (see id. at § 2102(a))

Defines ―employers‖ as businesses having 100 or more employees, (excluding

part-time) or 100 or more employees working at least 4,000 hours (Id. at §

2101(a))

―Mass layoffs‖ can be as few as 50 people at a single site (see id. at §

2101(3)(B)

• Not required for layoffs ―caused by business circumstances that were not

reasonably foreseeable‖ 29 U.S.C.A.§ 102(b)(2)(A)(Supp. 1998)

There is precedent that government contract termination may fall within the

exception, depending on circumstances (the A-12 termination). There should

be more than merely a layoff possibility.

Tests include ―commercially reasonable business judgment‖ and ―sudden‖

circumstances ―outside of the employer’s control.‖

Near Term Effects – Contractor Layoffs, cont’d

• Whether to issue a WARN Act notice must be subject to careful

consideration, and may not be the ―conservative‖ or ―least risk‖

approach

Such a notice could cause workforce disruption, leading critical

employees to depart

Potential adverse impacts on continued performance, creating

termination for cause excuse

Longer term risks to future contracts and competitions

(workforce resources, performance ratings, task orders, etc.)

Think about potential strategic business effects, and consult

with employment counsel and HR professionals

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Long-Term Effects – More Disputes

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• In the context of heightened budget pressures, contractors have

already observed increased enforcement activity to secure

repayments or to limit cost recoveries, which may escalate further:

Inspector General or DOJ referrals, DCAA audits, suspension and

debarment actions.

• With fewer federal funds available, performance issues once

resolved as routine contract administration matters (e.g., requests

for equitable adjustments, change orders, economic price

adjustments, delay claims, etc…) may increasingly lead to more

litigation.

Long-Term Effects – Accounting, Cost & Pricing

(AC&P) Considerations

• Extensive contract terminations or scope restructurings could impact

AC&P

– Shift of causal/beneficial relationship of costs

• impact indirect costs rates

• allocations of home office expense or G&A under CAS

– Reduced contract efforts could precipitate:

• Segment closure adjustments under CAS 413; reorganizations or

spin offs (FAR 31.205-27)

• Facility costs: depreciation (CAS 409/FAR 31.205-11); idle

facilities/capacity (FAR 31.205-17)

• Change in cost accounting practices – cost impacts

• Compensation: Severance/Mass Severance (FAR 31.205-6(g));

Deferred compensation (CAS 415); relocation costs (FAR 31.205-

33)

• Pricing and Compliance Implications 9

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• How might contracts change during Sequestration?

Agencies have various tools to reduce contract obligations, depending

on the type of contract and the individual facts

For prospective contracts, agencies have broad rights to:

• Cancel a solicitation,

• Decline to exercise an option, and

• Not allot additional funding to cost-reimbursement contracts, even if the

contractor has expended costs in preparing a bid or proposal

For current contracts, agencies retain flexibility and may, for instance:

• Reduce contract scope pursuant to FAR ―Changes‖ clause,

• Cancel multi-year contracts if funds are not available for contract

performance for a subsequent program year,

• Suspend or delay performance, or issue stop work orders,

• Opt not to purchase more than the minimum under an IDIQ contract, or

• Terminate contracts for the Government’s convenience

• Not renew programs

Sequestration – Uncharted Waters

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• Are delays caused by Sequestration excusable?

Excusable delays (e.g., FAR 52.212-4(f), 52.249-8(c), and 52.249-14)

Contractor is liable for default unless non-performance is caused by an

occurrence beyond the reasonable control of the Contractor and

without its fault or negligence

FAR examples include:

• acts of God or the public enemy,

• acts of the Government in either its sovereign or contractual capacity,

• fires, floods, epidemics, quarantine restrictions,

• strikes,

• freight embargoes, and

• unusually severe weather.

Contractors must notify the Contracting Officer in writing as soon as

reasonably possible after the commencement of any excusable delay

Excusable delays entitle contractor to additional time and/or limits

contractor liability for failing to meet the schedule

Sequestration – Uncharted Waters

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• Are delays caused by Sequestration compensable?

Compensable delay is a subset of excusable delay

Entitles the contractor to both additional time and a price adjustment

Compensable delays generally include:

• Acts of the Government in its contractual, but not sovereign,

capacity

• Contract contingencies for which the contract assigns the risk to the

Government (e.g., differing site conditions, delayed change orders)

• Federal Circuit precedent has held that to recover damages for a

Government-caused delay, the contractor must prove:

The extent of the delay

That the delay was proximately caused by Government action

That the delay harmed the contractor

When both parties contribute to a delay neither can recover absent clear

apportionment of the delay and the expense attributable to each party

Sequestration – Uncharted Waters

Sequestration – Uncharted Waters

• Does Sequestration fall within “force majeure” clauses?

• FAR does not define force majeure

Addressed in other FAR clauses (e.g., FAR 52.212-4(f), 52.249-8(c),

and 52.249-14)

• Force majeure provisions are common in subcontracts and commercial

supplier agreements, which may affect the parties’ obligations in the event

of certain ―unforeseen‖ circumstances

• Force majeure provisions are commonly tailored, depending on the nature

of the contract. They typically cover more than merely ―acts of God.‖

• Force majeure provisions often apportion business risks equitably between

the parties, and describe the parties’ respective responsibilities in the case

of unforeseen events

• Study the contract clause language! Force majeure provisions do not

always relieve parties fully of their mutual obligations should they

encounter something ―beyond their reasonable control.‖

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Recommendations for Contractors

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1. Ensure compliance and continued contract performance

• Suggestions to prepare for the worst by scaling back and slowing down to

mitigate risk may in fact create greater risks

• Federal contract obligations remain in force until formally ended/changed

and contractors must continue performance as required--maintain key

personnel, performance milestones and delivery schedules

• Contractors cannot and should not scale back contract performance

unless directed by the CO

Consider written communications with the CO to confirm that,

notwithstanding impending Sequestration risks, contract performance

should continue unabated

• Avoid actions that disrupt or prevent future contract performance

• DO NOT give the Government a reason to terminate contracts for Cause

or Default

Agency does not pay the contractor for work performed under the

contract, and may later seek to recover re-procurement costs

Recommendations for Contractors

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2. Assess contract portfolio

• Review current contract requirements Examine order exercising/canceling options against Sequestration’s current timeline

Examine prime/subcontract mix - subcontracts to large primes with larger programs

may be more secure than smaller prime contracts that may be allowed to expire or

even terminated

Review Forward Pricing Rate Agreements (FPRA) and Award Fee; budget reductions

may impact pricing and fee calculations

• Review prospective bid/proposal schedule for future contracts Assume that non-mission essential contracts will be phased out, non-renewed, options

will not be exercised or even terminated

Focus on work supporting core Government missions

Recognize that service contracts are often the first targeted and agencies may

increasingly in-source various services

Be aware that current contracts may be extended versus issuing new solicitations

Note that agencies have broad discretion in cancelling solicitations prior to contract

award, and contractors must generally show that cancellation was in bad faith or

otherwise unreasonable in order to recover the costs of preparing bids or proposals for

canceled solicitations

Recommendations for Contractors

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3. Prepare to mitigate financial consequences

• As disruptions in contracts and cash flow begin -- contractors

with heavy debt loads will face significant risk

• Invoice the Government now for all current amounts the

contractor seeks to recover under each contract

• Confirm that record-keeping and accounting practices are

current and up to date—essential to T for C claims

• Where possible, begin preparing claims to recover contract

costs

With mass contract reductions, and potentially thousands of

contract claims, the claims process will likely take even longer

• Evaluate potential aggressive cost reductions now before

automatic spending cuts set in

– Are there preferable descoping options that could be presented to

the contracting officer when sequestration hits?

Recommendations for Contractors

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4. Enhance ability to make wise judgments

• Wise judgments depend on information and expertise

• Continue communication with Agency customer and

Government policy leaders

• Stay informed through business organizations, political groups

and trade associations

• Have an experienced board of directors/advisory board in

place to help make solid judgments about what to do when

the Government’s decisions take effect

• Ensure access to experienced professionals to help make

decisions and/or respond to Government actions

Government contracts

Employee/HR/personnel

Investment/business

Audit/CPA

Thank you and good luck!

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Caitlin K. Cloonan Counsel

Caitlin.Cloonan@aporter.com

Northern Virginia

Suite 900

1600 Tysons Boulevard

McLean, VA 22102-4865

+1 703.720.7021

+1 703.720.7399 (fax)

Mark D. Colley Partner

Mark.Colley@aporter.com

Washington, D.C.

555 12th Street, NW

Washington, D.C. 20004-1206

+1 202.942.5720

+1 202.942.5999 (fax)