The Current Situation

After months of contentious debate, Congress and the Obama Administration have yet to reach an agreement to raise the current $14.3 trillion ceiling on the public debt. Unless an agreement is reached and legislation passed by August 2nd, according to Treasury Department officials, the U.S. will exceed the statutory dollar limit on Government borrowings, resulting in the United States defaulting on its debt obligations. As the deadline looms less than a week away, Democrats and Republicans are at loggerheads – with the issue of added tax revenue, as an ingredient of any debt reduction plan, creating the partisan impasse.

While the political parties continue to try to hammer out a deal trading a debt ceiling increase for spending cuts (and increased tax revenue, if the Democrats have their way), Congressional leaders are working on potential backup plans for an agreement to raise the debt ceiling independent of any terms for debt reduction. None of the current initiatives appear to be a sure thing. Months ago the risk of the U.S. cracking the debt ceiling and defaulting on its financial obligations was virtually unimaginable. Today, however, the public failure of our leaders to come to an agreement on what historically has been a “housekeeping matter” has raised the fears of the business and financial communities, as well as ordinary citizens, that our politicians could cause an unprecedented selfinflicted economic calamity.

What Will Happen If The Debt Ceiling Is Not Raised?

If no legislative agreement is reached by the August 2nd deadline and the debt ceiling is breached, the Federal Government will not have sufficient cash to pay its financial obligations in full, including interest due on existing debt. This first-ever default by the U.S. would create a “very severe financial shock” with “a calamitous outcome” for the national and global economies, according to Federal Reserve Chairman, Ben Bernanke.

In this worst case scenario, most financial experts agree that interest rates on Treasury bonds would immediately rise, pushing all interest rates higher – including rates for new mortgages, credit cards, car loans, and small business loans – eventually affecting prices across the economic spectrum. Although no one knows for sure, scholars warn that a resulting loss of confidence in U.S. Treasuries and the U.S. dollar could put the international financial markets into a tailspin, and deal the national and international economies a withering blow. The extent of the long-term damage to the country’s economic well-being is difficult to guess.

What Will Government Agencies Do, If The Worst Happens?

In the event of default, the U.S. Government would immediately need to slash spending by 44%, according to the Bipartisan Policy Center. To do so, the Obama Administration would have make painful choices about which of its bills to pay with its limited cash flow. Although the President has not revealed any specific plans, many commentators predict that the Government would place contractors after other high-priority spending obligations, such as interest rate payments to U.S. bond holders, military salaries, civil servants pay, unemployment benefits, Social Security checks, Medicare benefits, federal law enforcement expenses, and funding for the courts.

At the same time, Government agencies would have to conserve available funding, for example, by (i) delaying award of new contracts and task/delivery orders, as well as the exercise of contract options; (ii) issuing stop work orders and other directions to slow current expenditures, (iii) delaying progress payments and other contract expenditures without expressly authorizing the contractor to suspend or stop work, (iv) declining to obligate cash to contracts funded on an incremental basis, and/or (v) refusing to increase the estimate cost specified in cost-reimbursement contracts. Agencies also would be expected to cut-back on operational expenses – and, in particular, personnel costs – by limiting work attendance and pay to essential employees and activities.

Thus, along with interrupted contract payments, contractors could encounter difficulties performing their contracts, as a result of what effectively would be a partial Government shutdown. Also, to be clear, the Government’s cash shortage would jeopardize payments and funding for contracts of all kinds – both fixed price and cost reimbursement type contracts – notwithstanding the designation of appropriated funds within the Federal budget.

What Should Contractors Do To Mitigate The Problem?

Contractors should get ready for the disruption of contract activities and payments, in the event we crack the debt ceiling. The following practical steps should be taken, while we continue to hope for a resolution on Capitol Hill before the August 2nd drop-dead date:

  1. Identify solicitations with source selection decisions scheduled for August, and expect delays in contract awards if the debt ceiling is not raised.
  1. Identify contracts with options due in August and review the terms for the Government’s option exercise. The failure of the Government to exercise an option in strict accordance with its terms could entitle you to an equitable price adjustment under the Changes clause.
  1. Ask your Government customers about their plans for contract performance if the debt ceiling is not raised, and specifically whether agency personnel, facilities and equipment will be available after August 2nd; and work cooperatively with the agencies to mitigate performance disruptions.
  1. If the worst happens on August 2nd and the Government customer issues a stop work order or otherwise directs a work suspension or slow down, make sure you keep accurate records of any disruption you encounter.
  1. Keep track of any other delays, disruption, and/or work-around accommodations you’re forced to endure as a result of Government personnel, facilities or equipment being unavailable or late. In this way, you’ll be better prepared to demand reimbursement for the added costs caused by these constructive changes, once things get back to normal.
  1. Identify any contracts that rely on incremental funding and determine whether it could become necessary to notify the Contracting Officer and then stop work, in order to avoid incurring costs beyond the amount obligated by the Government to the contract. Under the Limitation of Funds clause for incrementally funded cost-reimbursement contracts (which often is tailored for use in large fixed-price contracts as well), the Government is not obligated to reimburse a contractor for costs incurred in the absence of sufficient funds. If obligated funds are not sufficient to cover a contractor’s ongoing performance and termination liability, you are required to “take a vacation” until funds become available.
  1. Identify any contracts for which you’re approaching the cost ceiling under the Limitation of Costs clause, and decide whether to stop work. The Government is not obligated to reimburse a contractor for costs beyond the stated ceiling, and you should not expect the Government to increase the contract ceiling during a cash crisis. Any performance beyond the ceiling is as a volunteer.
  1. Take note of any and all late contract payments so that you can recover any Prompt Payment Act interest to which you’re entitled.