Aw, those poor termination for convenience clauses! They’re always getting hauled into “court” by one of their frustrated “victims.” Truth be told, “termination for convenience” can be either friend or foe. Is it fair? Maybe the problem is not the clause but on which side of it you find yourself!
Greg Tharp unwraps reasons why and explains government standards most of us haven’t read – and perhaps would rather not! Then he pulls up one remedy that could be the “halo” – at least for any commercial contract. It’s the present value clause, but first we need to take a close look at termination for convenience before we can understand what’s behind present value...
Defined simply, a termination for convenience clause1 typically states that the owner of a business may terminate a contractor’s services at any time and for any reason at owner's convenience. The contractor will not earn the profit that was anticipated when the contract was executed. Given that, are termination for convenience clauses unfair, unreasonable? If you’re on the right side of this clause, you would say fair and reasonable. But if not, it might be bad news.
Here’s the crux of the problem. Although the termination for convenience clause has been around since the end of the Civil War when the government needed to terminate contracts entered into during wartime or when the need for this clause did not need to exist during peacetime – no one has ever clearly defined what is a fair and reasonable profit on work performed before the contract terminates.
The Congressional Research Service (CRS) report for Congress, titled Terminating Contracts for the Government’s Convenience, Answers to Frequently Asked Questions, validates the above by stating that this clause “refers to the exercise of the government's right to bring to an end the performance of all or part of the work provided for under a contract prior to the expiration of the contract when it is in the Government's interest to do so.”2
The same document also states, “As a rule, the government cannot be held liable for breach when it exercises its right to terminate contracts for convenience, because it has the contractual and/or inherent right to do so. This means that contractors generally cannot recover anticipatory profits or consequential damages when the government terminates a contract for convenience. The contractor is, however, entitled to a termination settlement, which, in part, represents the government’s consideration for its right to terminate. The composition of any termination settlement can vary depending upon which of the “standard” Termination for Convenience clauses is incorporated into the contract, among other factors. Such settlements typically include any costs incurred in anticipation of performing the terminated work and profit thereon. Some settlements are “no cost”; others are sizable.”
FAR 2.101 confirms on Acquisitions.gov -- an official website of the United States Government -- that there is no definition of what is fair and reasonable. An excerpt of FAR 2.101(a) adds “A word or a term, defined in this section, has the same meaning throughout this regulation.”3
So, obviously, the FAR does not define fair and reasonable, but how does it impact acquisitions practice?
If you review FAR 49.201(a) – again on Acquisitions.gov -- you will discover that contracts terminated for convenience (fixed price contracts) must “compensate the contractor fairly for the work done and preparations made for the terminated portions of the contract, including a reasonable allowance for profit.”4 Even with this, we still do not know what is fair for terminated contracts for convenience.
Further refining the question is the requirement of FAR 12.403(a)5 stating that “the government terminate a contract for commercial items for…the convenience of the government.” But this too leaves unanswered the question of how to fairly compensate contractors for terminated commercial item contracts for convenience. We still lack any clue as to what is fair!
Fair Compensation in the FAR
In the absence of any empirical evidence, one could suggest the answer is in FAR 12.403(d)(i)(B)(ii) in that fair compensation involves “any charges the contractor can demonstrate directly resulted from the termination. The contractor may demonstrate such charges using its standard record keeping system (including GAAP).”
While the FAR does not preclude using analytical tools or methods to determine the amount of settlement of commercial item contracts terminated for convenience, the usage of the word “may” implies that the contractor has the discretion of using generally accepted accounting principles (GAAP) to prove that its settlement costs represent fair compensation. (See Kingdomware Technologies, Inc. v. United States)6 which does not make FAR 12.403(d)(i)(B)(ii) a mandatory rule that all contractors must follow, but rather a discretionary rule.
This suggests that some contractors could simply choose not to use GAAP to demonstrate termination claims, because the contractor has not met the requirement to prove fair and reasonable compensation for cost recovery in commercial item contracts. FAR 49.201(a) uses the word “should” to say that the contractor should be fairly compensated for work and preparations associated with terminating contracts for convenience.
Alternative readings of FAR 12.403(d)(i) are unpersuasive.
- First, FAR 12.403(d)(i)(B)(ii) does not specifically identify what is a standard record keeping system -- it could conceivably be non-GAAP; neither is GAAP defined in FAR 2.101.
- Second, there is no specific mention of commercial items in FAR 12.403(d)(i)(B)(ii). Neither the fact that it fails to identify a standard record keeping system nor that it fails to mention commercial items has any bearing on this matter, if the requirement of FAR 12.403(d)(i) is discretionary or mandatory.
So, this is what we are left with: without a definition of fair compensation in commercial item contracts terminated for convenience requires that parties use the net present value to determine fair compensation in commercial item contracts.
In an effort to determine if present value is currently being used for commercial item contracts, you can conduct a literature review7 of existing documentation, but this does not apply if present value is currently being used for other contracting functions.
For instance, the General Services Administration uses a “Present Value Analysis Model”8 for lease proposals that do not pertain to commercial items or to termination of contracts. The General Services Administration’s model only takes into account the variables (e.g. utilities) which go into rental agreements. Chapter 9 of the contract pricing guide discusses net present value in relation to cost price and analysis, but this does not address net present value for commercial item contract cost recovery.
In conclusion, there is no existing documentation that addresses net present value usage in commercial item contract cost recovery.
Why use FASB Concept Statement No. 7?
Due to a lack of existing literature on the usage of net present value in commercial item contracts, one should refer to FASB (Financial Accounting Standards Board) Concepts Statement No. 7. 9 You would do this to calculate present value of actual costs completed to determine the amount of cost to be recovered. This, in turn, allows the amount of contractor recovery to be calculated with certainty as required by Lisbon Contractors, Inc. v. United States, 828 F.2d 759, 765 (Fed. Cir. 1987).10 Because FASB Concept Statement No. 7 conforms to GAAP, which is followed by most organizations, it should be considered an authoritative source to use when calculating present value of actual cost.
Present value clause in the contract?
At this point, we have no resolution that fits all purposes, and this looks like a problem. Is it? Not having documentation on a net present value clause for commercial item contracts terminated for convenience means we still have rationale for having a present value clause based on policy goals of the FAR.
So far, so good, but a policy goal of the FAR is uniformity. Which means contractors cannot use net present value (a type of analytical method) just because FAR 12.403(d)(i)(B)(ii) only includes the word “may” rather than “shall” which the Supreme Court had defined as “discretionary” in Kingdomware Technologies v. United States.
The drafters of the FAR required “coordination, simplicity and uniformity in the Federal acquisition process.”11 Requiring net present value in all cases of government contracting furthers this goal: failing to do this would result in different interpretations and contradictory results far too often, and some contractors would elect to use net present value analysis and some would not do so.
Inevitably, court decisions will differ on the same sets of facts if contractors use GAAP as a standard of acceptance for fair compensation merely because using the term may promote doubt about whether or not the contractor should use net present value analysis as promogulated by GAAP. A contractor using the net present value clause does not risk a court not finding fair compensation in terminations for convenience because of the usage of the word “shall” in the clause.
Net present value clause in the contract?
The term “net present value” means the present value of cash payments generated by a commercial item or items. You can calculate present value by using a discount rate determined by an actuary. The actuary is selected by the government in accordance with GAAP. And the probable result shall be determined by conducting an alternatives analysis.
Two alternatives are possible:
- Contractors will calculate cost recovery or charges from commercial item terminations based on net present value or fuzzy net cash flow;
- Contractors not using the net present value clause risk a court not finding fair compensation in terminations for convenience because of how the word “may” is used in FAR 12.403(d)(i)(B)(ii).
A final policy benefit served by consistently enforcing the usage of present value in termination of commercial item contracts is this: if the net present value is defined by using either alternative 1 or alternative 2, as identified in FASB Concept Statement No. 7, and if that value is uniformly required -- all contractors will know which path to take before a court gets involved. Contractors will calculate cost recovery or charges from commercial items based on net present value or fuzzy net cash flow and know the definition of net present value.
First, this “minimizes administrative operating costs” as required in FAR 1.102,12 by having the government spend less time and money in oversight functions (such as an audit) to ensure that contracting officers fairly compensate contractors in terminations since it is mandatory to do so and not optional.
Second, the litigation costs associated with determining the fair compensation of commercial items terminated for convenience will decrease given that net present value is defined, and the calculation of cost recovery is mandatory using net present value through the usage of the word “shall” in the clause.
These policies point toward a future construction of the FAR that absolutely requires us to use net present value to calculate cost recovery in commercial item contracts.
Much value in using present value clause
On a commercial item contract, the lack of agreement on what is fair and reasonable compensation to the contractor is an obvious problem. The lack of current literature addressing cost recovery in commercial item contracts plus the lack of mandatory usage of techniques in cost recovery in terminating contracts for commercial items -- makes this a real concern for the government because it is not being consistently applied.
I propose using a present value clause. It will assist contracting officers in determining the present value of commercial item contracts and add a variety of policy benefits surrounding the construction of the FAR. In fact, the present value clause should be incorporated into all commercial contracts, including both domestic and foreign contracts, as either a class or individual FAR deviation on contracts and modifications undertaken on or after publication of this article.
This will allow the opportunity for contracts containing this clause to be tried in the Armed Services Board of Contracting Appeals, Civilian Board of Contracting Appeals, and or other courts as appropriate. Also, by incorporating the present value clause into commercial item contracts, contractors will be fairly and reasonably compensated on work performed on commercial item contracts before contract termination which incentivizes them to do business with the government.
- Article expanding on clause definition:Does Your Contract Contain A Termination For Convenience Clause?
- Terminating Contracts for the Government’s Convenience, Answers to Frequently Asked Questions, CRS Report for Congress, Prepared for Members and Committees of Congress, Feb 3, 2015.
- Financial Accounting Standards Board of the Financial Accounting Foundation., Statement of Financial Accounting Concepts No. 7 Using Cash Flow Information and Present Value in Accounting Measurements, May 15, 2018
- Legal Information Institute report titled 48 CFR 49.201 - General.
- 48 CFR 12-403 - Termination
- General Services Administration. (2019). Policies and Tools Present Value Analysis Model.Retrieved December 20, 2019. See also Kingdomware Technologies Inc. vs United States, a syllabus and Legal Information Institute report 48 CFR 12.403 - Termination
- Literature review – How to write a literature review- article defining and explaining how to do one.
- Malone, L.K. (March 2018). Recovery When The Government Terminates for Convenience.December 16, 2019
- Mason, Arnie Bruce. “Implied-in-Fact Contracts Under the Federal Acquisition Regulation: Why Pacord Got It Wrong.” William & Mary Law Review41, no. 2: 709-739. Accessed December 20, 2019, from https://scholarship.law.wm.edu/cgi/viewcontent.cgi?article=1521&context=wmlr
- Lisbon Contractors, Inc. v. United States, 828 F.2d 759, 765 (Fed. Cir. 1987). Retrieved December 20, 2019, from https://casetext.com/case/lisbon-contractors-inc-v-us
- Supreme Court of the United States. (October Term, 2015). Kingdomware Technologies, Inc. v. United States. Retrieved December 20, 2019, from https://www.supremecourt.gov/opinions/15pdf/14-916_6j37.pdf
- ACQUISITION.GOV1.102 Statement of guiding principles for the Federal Acquisition System
ABOUT THE AUTHOR
Greg Tharp has over 15 years of experience as a librarian and researcher, including research positions with Harvard Medical School, and Tufts University. He previously served as a member of the State of Connecticut Library Advisory Council on Library Planning and Development. He is a member of the American Library Association, Massachusetts Library Association, ARMA International, IAACM, and the National Contract Management Association. Tharp’s area of expertise is information policy.
Tharp holds an Advanced Certificate in Archives Management from Simmons University, a Master of Library Science from Southern Connecticut State University, and a Bachelor of Science from Sacred Heart University where he was elected to Phi Eta Sigma and received the Passion for Learning Award. Additionally, he received acquisitions training at Defense Acquisitions University, Federal Acquisitions Institute, American Graduate University, and the University of Virginia. He also received human resources training at HR University.