Government contracts include provisions that allow agencies to terminate agreements for convenience, meaning the contract can be canceled when it is in the government’s interest, all without any fault on the part of the contractor. Although this right is built into most contracts under FAR 52.249, terminations can still have significant financial and operational consequences.
Work that has already been performed may go uncompensated, planned expenditures may become unrecoverable, and resources allocated for the contract may suddenly become idle. These disruptions can create cash flow issues and long-term financial strain if termination settlements are not handled properly.
Properly understanding Federal Acquisition Regulation, or FAR, cost principles is essential to securing fair compensation. Contractors are entitled to recover incurred costs, a reasonable profit on completed work, and termination-related expenses, but failing to follow regulatory procedures can lead to unnecessary financial losses.
Claiming All Allowable Costs
When a contract is terminated for convenience, FAR Part 31 allows contractors to recover all incurred costs, provided they don’t exceed the total contract price. The framework acknowledges that contractors commit substantial resources to performance and should not bear the financial burden of an early termination.
Unlike modifications or equitable adjustments, which require proof of entitlement, a termination for convenience effectively transforms a fixed-price contract into a cost-type contract for settlement purposes. The main requirement is that claimed costs meet the standards of reasonableness, allocability, and allowability under FAR regulations.
Recoverable costs include direct labor, materials, subcontractor settlements, and administrative expenses associated with termination. Post-termination obligations, such as ongoing lease payments and idle labor costs, may also qualify. Contractors frequently overlook these continuing expenses, which can lead to substantial financial losses.
Documentation is central to full recovery, which is why settlement proposals should clearly outline claimed costs, supported by a justification narrative that aligns with regulatory requirements.
Charging Indirect Costs as Direct Costs
A termination for convenience disrupts standard cost allocation practices, often requiring adjustments to how expenses are classified. Under normal circumstances, indirect costs are distributed across multiple contracts based on established allocation methods.
However, when a contract is terminated, certain indirect costs may be reclassified as direct costs to reflect their direct association with the terminated portion of the work. This adjustment allows for fairer compensation while maintaining compliance with FAR guidelines.
Reallocatable indirect costs may include office expenses related to termination activities, engineering labor, quality assurance, production control, and purchasing costs specific to the contract’s terminated scope. Other qualifying expenses include supervisory personnel costs, factory supplies, freight charges, and travel directly tied to the affected contract.
Proper documentation and adjustments to indirect cost pools prevent double counting and mitigate the risk of claim reductions. Compliance with Cost Accounting Standards (CAS) is essential, particularly for contractors managing multiple federal contracts with varying cost structures.
Avoiding Loss Adjustments
A termination for convenience does not automatically guarantee full reimbursement for costs that a firm incurs. If a contract is projected to end at a loss, the government may apply a loss adjustment formula under FAR to reduce the final settlement amount.
The reduction is based on the percentage of the anticipated loss, meaning contractors facing higher projected deficits will see a greater reduction in compensation. Proactively addressing loss adjustments can help protect financial recovery.
Submitting equitable adjustment claims before termination is one approach to increasing the contract price, which can reduce or eliminate loss adjustments. The government bears the burden of proof when applying a loss calculation, and it must provide clear, quantified evidence of the projected loss.
Providing an estimate to complete without a strategic benefit may weaken a claim, as agencies often rely on these estimates to justify any reductions. Careful handling of termination negotiations can prevent unnecessary financial setbacks caused by improper loss calculations.
Requesting Partial Payment
Waiting for a final settlement after a termination for convenience can create financial strain, especially when outstanding costs continue to accumulate. Partial payments provide an opportunity to recover a portion of incurred costs before the settlement process is completed, helping maintain cash flow and reducing pressure to accept an unfavorable agreement.
Contractors may request partial payments for 100% of completed deliverables prior to termination, up to 90% of direct costs associated with termination inventory, labor, and other allowable expenses, and 100% of approved subcontractor settlements already paid. Under FAR 49.112-1(a), contracting officers are required to process these requests promptly.
Any delays in submitting a partial payment request can lead to cash flow challenges, increasing the risk of financial instability. Accessing available funds during the settlement process helps sustain operations and prevents premature acceptance of government settlement offers that don’t fully compensate for incurred costs.
Seeking Professional Assistance
Handling a termination for convenience settlement involves intricate financial and legal considerations, making expert guidance an essential part of the process. Regulations under FAR allow contractors to recover settlement expenses, including legal, accounting, and administrative costs associated with claim preparation.
These expenses play a significant role in securing full compensation, particularly when government auditors and contracting officers seek to limit settlement payments. Any missteps during settlement can lead to costly financial consequences over time.
Some of the more common errors that can occur include failing to claim all allowable costs, accepting improper loss adjustments, and under-documenting expenses, resulting in disallowances.
Experienced government contract accountants and consultants provide the necessary expertise to overcome these various challenges. Working with them can help strengthen compliance with FAR regulations, supports future negotiations, and increases the likelihood of recovering all entitled costs.
Protect Your Contractual Rights
Proactive management of termination settlements plays a fundamental role in recovering fair compensation and preventing any potential financial setbacks from occurring. Having a well-documented and strategic approach in place strengthens settlement negotiations and reduces the likelihood of encountering disallowed costs.
To assist with this, Diener & Associates provides government contract accounting and compliance services, assisting businesses with termination settlements to maximize recoverable amounts.
Contact the team at 1-(703)-386-7864 or set up a consultation on our website. Having expert guidance and support helps contractors avoid financial losses and take care of the many complexities of government contract terminations with the utmost confidence.