The long running sequestration saga took another turn last week when the Obama administration’s Office of Management and Budget (OMB) announced that the government will cover any liability and expenses that government contractors incur as a result of following the administration’s advice to not issue Worker Adjustment and Retraining Notification Act (WARN Act) notices to its employees regarding the possibility of layoffs due to sequestration-mandated budget cuts. According to OMB, any expenses for failure to issue WARN Act notices would be an “allowable cost” under a government contract being performed by a contractor.

This opinion is the latest effort by the administration to try to mitigate any fallout from the looming sequestration cuts. Republicans have charged that the administration’s legal guidance is politically motivated and is on shaky legal authority.

Sequestration is a process of automatic cuts to the federal budget that will be triggered on January 2, 2013, if a specially-created bipartisan congressional committee cannot agree to its own budget cuts before that date. Sequestration was made part of a deal between President Obama and Congress reached to resolve the debt-ceiling crisis and avert a default on the U.S. government’s sovereign debt.

If sequestration occurs and the automatic cuts take place, government contractors will inevitably feel the sting. The federal government pays private sector contractors over $500 billion per year (roughly 14 percent of the federal budget) so needless to say, across the board cuts will necessarily reduce the pool of money that is available to be spent on the goods and services provided by government contractors. The defense industry figures to be especially hard hit and experts estimate that defense contractors could shed as many as one million jobs if the sequestration cuts take effect.

On July 30, 2012, the DOL issued a legal memorandum which said that the WARN Act did not apply to potential layoffs by federal contractors as a result of the impending sequestration cuts. The WARN Act requires any company with at least 100 employees to provide written notice to its employees at least 60 days before ordering a plant closing or mass layoffs. However, WARN Act notices are not required when the layoffs are the result of “business circumstances that were not reasonably foreseeable as of the time that the notice would have been required.”

Based on this exception, the DOL found that the possibility of layoffs due to sequestration was too speculative (i.e., not reasonably foreseeable) to trigger an obligation to issue WARN Act notices by government contractors. The DOL posited that it remains far from certain the sequestration will even occur and, even if it does, there is no way to know, at this point, which government contracts will be eliminated due to the cuts. Thus, according to the DOL, no single company has sufficient knowledge of impending layoffs such as would require that company to issue WARN Act notices to its employees.

Despite the DOL’s guidance, many contractors indicated that they would issue WARN Act notifications to their employees anyway, fearful that the DOL’s opinion will not protect them from exposure in suits filed by terminated employees for failing to abide by the WARN Act. In order to assuage the contractors’ fears of WARN Act liability and to “further minimize the potential for waste and disruption associated with the issuance of unwarranted layoff notices,” the OMB declared that a contractor could charge any WARN Act liability found by a court, as well as any attorney’s fees, to the contract it was performing as an allowable cost.

The OMB’s memorandum is rather thin on legal authority and it is not clear on what grounds it has based its determination that any WARN Act liability would be an allowable cost. The penalty for violation of the WARN Act is that the employer must pay all affected employees back pay for the period of the violation up to 60 days. However, the FAR specifically excludes back pay as an allowable cost unless certain exceptions apply, none of which appears to be applicable in this case. Thus, it would seem that any direct liability for violation of the WARN Act does not meet the FAR definition of an allowable cost. Furthermore, while the FAR generally treats legal fees as an allowable cost, legal fees incurred as a result of illegal or improper business practices cannot be charged to the contract. Any liability for a contract under the WARN Act would, by definition, be the result of an illegal practice, and thus not allowable.

Most likely, the administration’s guidance with regard to sequestration and the WARN Act will provide sufficient cover to protect contractors from any liability they may face for not providing sufficient notice to their employees of impending layoffs. However, contractors should be aware that while the DOL’s opinion that WARN Act notices are not required seems to have strong basis in relevant precedent, the OMB’s guidance that any WARN Act liability can be charged as an allowable cost is far more controversial from a legal standpoint. Contractors should keep these considerations in mind when determining whether and how to communicate to their employees the likelihood that downsizing will occur as the result of sequestration.