Defence contract disputes and risk allocation in USA

Disputes and risk allocation

How are disputes between the government and defence contractor resolved?

Disputes between the DoD and a contractor regarding matters of contract performance are covered under the Contract Disputes Act, 41 USC Chapter 7. The CDA is implemented and incorporated into the FAR at Subpart 33.2 (Disputes), and ultimately into each contract through the use of the mandatory contract clause FAR 52.233-1. Contract disputes often begin as a request for equitable adjustment. If an REA is not resolved, it can be converted into a certified claim, which then must receive a Contracting Officer’s Final Decision (COFD). The COFD can then be appealed and litigated at either the Armed Services Board of Contract Appeals, Civilian Board of Contract Appeals, or the Court of Federal Claims.

For disputes regarding matters of contract formation, bid protests (also referred to as ‘challenges’ outside the United States) can be filed by disappointed offerors at either the GAO under jurisdiction of the Competition in Contracting Act, 31 USC section 3556, and FAR 31.104; the Court of Federal Claims under jurisdiction of the Tucker Act, 28 USC section 1491(b), as amended by the Administrative Dispute Resolution Act of 1996 and FAR 31.105; or with the procuring agency under FAR 33.103. Protests for issues regarding the solicitation should be raised before contract award, and protests regarding award decisions have strict timelines requiring them to be filed soon after award.

To what extent is alternative dispute resolution used to resolve conflicts? What is typical for this jurisdiction?

Alternative dispute resolution (ADR) is available as part of the disputes process described above. At the GAO, ADR exists in the form of outcome prediction and the agency’s ability to take corrective action prior to a decision by the GAO. At the Court of Federal Claims, the ADR Automatic Referral Program utilises early neutral evaluation, mini-trials, settlement judges and third-party neutrals. At the Boards of Contract Appeals, the parties can agree to enter into either binding or non-binding ADR. Many companies operating as prime contractors under a defence and security contracts prescribe ADR in their standard terms and conditions with subcontractors. Of course, those terms and conditions are subject to negotiation between the prime and subcontractor.

What limits exist on the government’s ability to indemnify the contractor in this jurisdiction and must the contractor indemnify the government in a defence procurement?

The federal government generally refuses to indemnify government contractors because the Anti-Deficiency Act, 31 USC section 1341, prohibits an officer or employee of the United States from creating any unfunded obligation for the government, which includes blanket indemnification of contractors. Nonetheless, several statutes provide authorisation for the government to do so in narrow circumstances, some of which arise in the defence and security context, for example:

• the National Defense Contracts Act, 50 USC section 1431, as implemented by Executive Order 10789 (this provides indemnification under defence contracts for unusually hazardous or nuclear risks);
• 10 USC section 2354 (this provides indemnification for unusually hazardous defence research and development);
• the Atomic Energy Act, as amended by the Price-Anderson Act of 1957, 42 USC section 2210(d) (this provides indemnification for the risk of a substantial nuclear incident);
• the Federal Aviation Act, as amended, 49 USC section 1531 et seq (this provides indemnification for aircraft operations risks necessary to carry out US foreign policy); and
• the National Aeronautics and Space Act, as amended, 42 USC 2458b (providing for indemnification for damages related to the launch, operation or recovery of space vehicles).

Government contractors can also raise a legal defence for tort liability in state and federal law suits known as the ‘government contractor defence’. While not an indemnification or absolute defence, this legal argument can protect contractors in cases where third parties sustain injuries from defects in products or equipment supplied or built to specifications under a government contract. This legal defence has also been successfully used to protect contractors providing services to the government. The government does not typically require contractors to indemnify the government. However, the government does often require that contractors obtain insurance or demonstrate self-­insurance as set forth in clauses such as FAR 52.228-5, -7 and -8, and DFARS 252.247-7007. The government also frequently requires irrevocable letters of credit and performance and payment bonds from contractors, as set forth in FAR 52.228-14, -15 and -16.

Can the government agree to limit the contractor’s liability under the contract? Are there limits to the contractor’s potential recovery against the government for breach?

Yes. Government limitations of contractor liability are standard contract clauses at FAR 52.246-23, -24 and -25, which are utilised in procurements over the simplified acquisition threshold (generally US$250,000). The government also uses a very simple limitation of government liability clause at FAR 52.216-24 for letter contracts, where the government issues an abbreviated contract for expediency in the anticipation of finalising a full contract at a later date. On the other hand, contractors are limited in their recovery against the government for breach, based on the form of pricing in the contract.

The federal government uses a variety of contract types, including fixed-price, cost-type and time-and-materials contracts. Under a fixed-price contract, the government’s liability will usually be limited to the total contract price, unless the contract contains a price adjustment clause and the government either constructively or actually changes the contract. Under cost-type and time-and-materials contracts, the government is generally liable for actual allowable costs incurred by the contractor in performance of the contract but only up to a ceiling amount. Cost-type and time-and-materials contracts must contain either the limitation-of-costs or limitation-of-funds clause, at FAR 52.232-20 and 52.232-22, respectively. These clauses, discussed further below, limit the total liability of the government in order to comply with the Anti-Deficiency Act described above.

Is there risk of non-payment when the government enters into a contract but does not ensure there are adequate funds to meet the contractual obligations?

No. As discussed above, the Anti-Deficiency Act prohibits the US government from undertaking contractual liabilities in excess of the funds obliged to the contract. In other words, the US government’s contractual liability to a contractor is tied to the funds obliged to the contract.

With respect to fixed-price contracts, the government will oblige funds in the amount of the contract price. With respect to cost-­reimbursable contracts, the government may ‘fully fund’ the contract before the contractor begins performing work or ‘incrementally fund’ the contract during contract performance. Even in the latter situation, the contract does not authorise the contractor to perform work and incur costs in excess of funds obliged to the contract.

The Limitation of Costs clause at FAR 52.232-20 applies to fully funded contracts. The Limitation of Costs clause requires a contractor to notify the government when it expects in the next 60 days to have spent 75 per cent of the estimated cost, or expects expenses to be greater or substantially less than previously estimated. The clause allows variations in the number of days (between 30 days and 90 days) and variations in the percentage (between 75 per cent and 85 per cent).

The Limitation of Funds clause at FAR 52.232-22 applies to incrementally funded contracts. The Limitation of Funds clause requires a contractor to notify the government that it is coming to the end of obliged funding, and send notification to the contracting officer that obliged funds will be spent within the next 60 days. As discussed above, there is a risk of non-payment if a contractor performs work and incurs costs in excess of the funds obliged to the contract.

Under what circumstances must a contractor provide a parent guarantee?

Before entering into a contract with the US government, a contractor must qualify as a ‘responsible source’ to perform the contract (see FAR 9.104). Under this procurement rule, the contracting agency will conduct a pre-award survey to evaluate the contractor’s financial condition and to determine if the contractor has ‘adequate financial resources to perform the contract, or the ability to obtain them’ (see FAR 9.104-1(a)).

If the contractor does not have adequate financial resources, it must provide ‘acceptable evidence’ of its ability to obtain adequate financial resources to perform the contract (see FAR 9.204-3(a)). In some cases, this acceptable evidence may consist of a letter of credit setting aside immediately available funds in the event of a contractor default. In other cases, the contractor may ask the contracting agency to rely on the financial position of the contractor’s parent corporation. In these situations, the contracting agency will likely require a financial guarantee from the contractor’s corporate parent.

In addition, a contracting agency will likely require a corporate parent guarantee if the contractor is a new entity formed solely to perform the contract. A corporate parent guarantee may not be an option if the parent is a foreign company (see Betakut USA Inc, Comp Gen Dec B-234282, 89-1 CPD paragraph 432 (a contracting agency declined to accept a corporate parent guarantee owing to the difficulty of making collections from a foreign company in the event of the subsidiary’s default)).