WHAT IS SEQUESTRATION?
Under the Budget Control Act of 2011, P.L. 119-28 (August 2, 2011), funding for a variety of federal programs will be reduced by nearly $1 trillion over the ten years from 2012 through 2021. The Act also established the now-infamous “Super Committee” (officially the Joint Select Committee on Deficit Reduction) which, it was hoped, would come up with legislation reducing deficits by $1.2 trillion over that period. In an effort to foster compromise, the Act included a “Sword of Damocles” in the form of a “Sequestration” procedure – automatic, largely across-the-board spending cuts to both defense and non-defense programs that would kick in if the Super Committee failed to reach an agreement that could pass both houses. Because the members of the Joint Committee were unable to reach a compromise, Sequestration is presently scheduled to occur starting in January 2013 (i.e., four months into FY 2013).
Congress can avoid these automatic cuts, but this would take the Democrats and Republicans agreeing to a plan that likely would require a mix of spending cuts and revenue raisers. Will they? With this being an election year, not much is expected before or after the election. However, lightning may strike at the 11th hour, i.e., in the first days of the new session; but remember other things will be on Congress’ short list – such as the expiration of the Bush tax cuts and the need to raise the debt ceiling.
HOW MUCH $$ WILL BE CUT?
If Sequestration occurs in FY 2013, $54.7 billion would be cut from defense spending and an equal amount would be cut from non-defense spending. It is estimated that such cuts would decrease defense spending by 10%-15%. Although certain “mandatory” spending programs, such as Social Security, Medicaid, Food Stamps, Veterans’ benefits and federal retirement are exempt and reductions in Medicare payments, Community and Immigrant Health and Indian Health Services are limited to 2%, it is estimated that non-defense discretionary programs will be reduced by 8.5%.
Cuts will affect both mandatory (entitlement) programs and discretionary programs. Indeed, about $16.2 of the $54.7 billion to be cut from non-defense spending will come from mandatory spending programs of which there are many. In contrast, since mandatory spending is less than 1% of all defense spending, almost all of the defense cuts will affect discretionary programs.
For FY 2013, Sequestration will involve across-the-board, proportional reductions in the funding provided for each non-exempt discretionary program. In subsequent years, the Appropriation Committees will decide how to live within the limits established for overall defense spending. Medicare providers will continue to receive only 98 cents on the dollar while the remaining amount of the $54.7 billion in required annual non-defense cuts will be applied proportionally to (a) other non-exempt mandatory spending programs and (b) overall non-defense discretionary funding. Because the future cuts to Medicare will take a growing share of the $54.7 billion, over time, other non-defense programs will feel a declining share of the reduction.
WHEN WILL THE DETAILS OF THE CUTS BECOME AVAILABLE?
One of the first signs of the Sequestration will come toward the end of FY 2012 when OMB, after determining the percentage of cuts to be applied to defense and nondefense programs, will start issuing apportionments to each agency thereby precluding the agency from spending more than OMB has allotted to it. Some have already asked OMB to release an account-by-account analysis of the cuts and their effect on personnel, contracts, operations and maintenance, and research activities.
HOW WILL SEQUESTRATION IMPACT HOLDERS OF EXISTING FEDERAL CONTRACTS?
Under traditional federal contracts, agencies, faced with a “depleted checking account,” can legitimately exercise their contractual authority to “de-scope” them, i.e., temporarily suspend, stretch-out or reduce required contract performance, or even terminate the contract. (Most of these actions would, of course, require the government to provide some compensation to the contractor in the form of an equitable adjustment.) Such being the case, it is likely in the contractor’s interest to complete as much work as possible on a project before the agency takes any contractual action to de-scope the work.
WILL FEDERAL GRANTS, COOPERATIVE AGREEMENTS, & OTHER DIRECT PAYMENT PROGRAMS BE IMPACTED?
Unlike traditional federal contracts, there are many grants, cooperative agreements, direct payment programs, and non-traditional contracts where an agency’s payment reduction, because the relevant appropriation account will become exhausted if full payment were made, is simply a breach for which the government would be liable. (The same is true if an agency refuses to pay for services rendered, goods provided (and, pursuant to traditional contracts, fails to fund an equitable adjustment) because the there is no money in the relevant account.)
The basis for this conclusion is not all that complicated. In the great rush to “cut spending” Congress, as it is wont to do, lost sight of the fact that, while not providing sufficient money to an agency will prevent it from making any further payments to contractors, grantees, etc., valid obligations of the federal government will nevertheless remain enforceable in the courts. The precept that lack of funding does not void a valid underlying obligation is not only a long-standing one in appropriation law but is one that has recently been reaffirmed by the Supreme Court. The Court also made it clear that purporting to make the government’s payment obligation “subject to the availability of appropriation” as many contracts and grants do, does not void the government’s obligation to make full payment merely because, at some point after the agreement is consummated, funds in the relevant appropriation account become exhausted.
That said, some grantees, direct payment recipients and holders of co-operative agreements and non-traditional federal contracts, etc. will be able to take the federal government to court and recoup money improperly denied them as a result of the Sequestration.
HOW WILL SEQUESTRATION IMPACT FIRMS HAVING CONTRACTS WITH GRANTEES WHOSE FUNDS ARE CUT?
While grantees, including those local and state governments receiving federal funds for large mass-transit projects and the like, may be able, through litigation, to recoup money improperly denied them by the Sequestration, the rights and responsibilities of companies contracting with those grantees is going to be governed by the terms of the companies’ contracts with the grantees as supplemented by state law. In this regard, it is possible that in the face of a cutback in funding due to the Sequestration, the grantee could assert that it has been absolved of any duty to continue performance under the contract, i.e. that such performance has been made impracticable by the occurrence of a contingency (a substantial cutback in funding due to Sequestration), the nonoccurrence of which was a basic assumption of the contract. Such a defense, if successful, could leave the contractor high and dry.
HOW WILL SEQUESTRATION IMPACT FUTURE CONTRACTS AND GRANTS?
Because of reduced spending, it is anticipated that there will be a decrease in the number of federal contracts let each year as agencies cut programs. (The number of contracts awarded by state and local entities funded in whole or in part with federal funds is also expected to decline.) This will likely increase both competition for this work and the filing of bid protests by bidders unsuccessful in obtaining it. (Such a procedure is unavailable for institutions denied a grant or co-operative agreement.) Additionally, the type of contracts used by the federal government is likely to change, i.e., the percentage of cost-reimbursement and time and material contracts will likely decrease while the use of fixed-price contracts is likely to increase. In best value procurements, prospective contractors should expect a greater emphasis on price both in the weighting of factors and in the tradeoff process, i.e., federal agencies may be less inclined to find that higher technical score/higher cost offerors are worth the increased cost and opt instead to make awards to lower score/lower cost offerors.
So, too, it is anticipated that the number and/or the size of federal grants will decrease in future years. This in turn will reduce the number and size of contracts performed in whole or substantial part with federal grant funds.
KEY POINTS TO CONSIDER
- Absent Congressional action, starting in January 2013, Sequestration requires mandatory, vi r tual ly across- the-board spending cuts. These cuts will come equally from defense and non-defense spending. For FY 2013 the total cuts will be $109 billion.
- Many traditional procurement contracts may be reduced in scope, temporarily suspended, stretched-out or even terminated for convenience. (Most of these actions will require the government to provide compensation in the form of an equitable adjustment.) Contractors need to plan the work and their contractual agreements with those possibilities in mind.
- In contrast to traditional federal contracts, the federal agencies’ payment reduction on grants, cooperative agreements, direct payment programs, and nontraditional contracts will simply constitute a breach for which the government will be liable. (The same is true if an agency fails to pay for services rendered, goods provided (or, pursuant to a traditional contract fails to pay for an equitable adjustment) simply because there is no money “available.”)
- While grantees, including local and state governments receiving federal funds for masstransit projects, etc., may be able, through litigation, to recoup money improperly denied them by the Sequestration, the rights and responsibilities of companies contracting with those grantees will be governed by the terms of the companies’ contracts with the grantees as supplemented by state law.