Deputy Secretary of Defense Patrick Shanahan announced on Monday, October 1, 2018, that the U.S. Department of Defense (“Department” or “DoD”) was withdrawing its proposal that would have made sweeping changes to the rules that govern the release of progress payments to contractors under DoD contracts. In rescinding the proposed rule, Deputy Secretary Shanahan cited to a lack of coordination within the Department that led to a premature release of the proposed amendments.

Under its proposed rule, DoD would have amended policy relating to progress payments and performance-based payments for DoD contractors by reducing the customary progress payment rate for large contractors from 80 percent to 50 percent of incurred costs. Increased payments—up to 95 percent of incurred costs—would have been tied to measures such as work quality and on-time delivery. A finding of fraud or criminal offense involving the contractor, even if related to a different project, would have reduced the rate to 25 percent of incurred costs. Small business contractors would have continued to receive a base rate of 90 percent of incurred costs under the proposed rule.

According to the Department, these changes were intended to align with the preference for use of performance-based payments expressed by Congress in Section 831 of the 2017 National Defense Authorization Act. DoD claimed such revisions were needed to “reset” progress payment rates to better align with lower interest rates, and avoid furthering what it described as the “unintended consequence of the past practice associated with providing contract financing in excess of what was necessary.”

Many lawmakers and the majority of the defense industry[1] disagreed, raising concern that the rule misconstrued the preference for use of performance-based payments expressed in Section 831. They also worried that contractors would be unable to receive the increased payment rates conditioned on performance, as the criteria for receiving such rates were subjective and not adequately tied to actual contractor performance. Ultimately, the rule as proposed would have made it more difficult for businesses to do work with the DoD, and according to the proposal’s opponents, led to a stifling of defense contractor investment in innovation.

Rescission of the proposed rule offers at least a temporary win for defense contractors, who typically rely on progress payments to maintain necessary cash flow up and down the defense supply chain, including the cash flow needed to maintain innovative research and development activity. And while an updated set of proposed changes to the progress payment rules seem likely in the future, pressing pause on revisions offers contractors an opportunity to take an active role in helping to frame the Department’s policy on progress payments. Deputy Secretary Shanahan left the door open for continued discussion, providing lawmakers and industry the opportunity to engage in efforts to improve the progress payment system and reduce administrative burden on both contractors and the Department, alike. To better meet the preferences set in Section 831, the stakeholders involved will need to focus on payments that meaningfully align with contractor achievement and performance outcomes, in a way that is objective and provides a measure of predictability and reliability to contractors. Developing a rule that would achieve these goals would best serve both the Department and the contractors on which the Department relies, as well as the public’s interest in maintaining the United States’ national security in an increasingly challenging environment.