You've Just Been Terminated for Convenience, Now What?

General Termination for Convenience Considerations

In a fixed-price contract, the Government has the right to terminate performance “in whole” or “in part” if the Contracting Officer determines that “termination is in the Government’s interest.” See FAR 52.249-2 Alternate I (for construction).  This determination must be made in good faith and may be overturned where the Government is found to have abused its discretion. See Kalvar Corp., Inc. v. U. S., 211 Ct. Cl. 192, 543 F.2d 1298, 1301–1302 (1976); accord T & M Distributors, Inc. v. U.S., 185 F.3d 1279, 1283 (Fed. Cir. 1999) (“We do not scrutinize de novo whether termination was the best course. In the absence of bad faith or clear abuse of discretion, the contracting officer's election to terminate for the government's convenience is conclusive.”); Krygoski Const. Co., Inc. v. U.S., 94 F.3d 1537, 1541, 41 Cont. Cas. Fed. (CCH) ¶ 76985 (Fed. Cir. 1996) (“When tainted by bad faith or an abuse of contracting discretion, a termination for convenience causes a contract breach.”).  The Contracting Officer initiates a termination for convenience by delivering to the contractor “a Notice of Termination specifying the extent of termination and the effective date.” Id.

In the event you receive a notice of termination, there are a few things you should do immediately, the first and most of obvious of which is stop working on what they have directed you to stop work on.  Next, you will need to understand the scope of the termination order, i.e., does it call for a full or partial termination.  In the event of a partial termination, you must also consider the scope of the remaining work and how it impacts any subcontracts and orders for materials, equipment, etc.  To the extent the termination order eliminates the need for certain subcontracts, materials and equipment, those arrangements should be terminated immediately in accordance with the terms of the subcontract or purchase orders, which hopefully include appropriate termination for convenience clauses. FAR 52.249-2(b)(1)-(3).   If the termination only partially impacts a subcontract or materials/equipment orders, your written notice of termination should be provided in accordance with the terms of the subcontract but should also describe the nature of any work that will remain intact. Id.  The goal here is mitigation and reimbursement—contractors should not continue accruing costs for work that has been terminated and for which costs may no longer be recoverable.

Upon termination, Federal Acquisition Regulation (FAR) 52.249-2 contemplates that the Contractor attempt to settle its subcontractor claims. These settlements must be in general conformity with the policies and principles relating to settlement of prime contracts in FAR subparts 49.2 or 49.3. See FAR 49.108-3.  Such negotiated settlements “must be supported by accounting data and other information sufficient for adequate review by the Government.” See FAR 49.108-3.  All settlements must be approved or ratified in accordance with the directions of the terminating contracting officer.  Additionally, within 120 days of the termination, “the Contractor shall submit complete termination inventory schedules.” FAR 52-249(c).

Termination Proposal

In addition to the above-referenced items, the contractor will be primarily responsible for preparing a termination proposal that focuses on the contractor’s recoverable costs.  The termination proposal must be submitted within one year of the termination notice.  In a termination for convenience context, a firm fixed-price contract is essentially converted into a cost reimbursement contract, which allows the contractor to recover costs of its work performed up to the date of termination, certain costs that continue after termination, as well as reasonable settlement expenses; it may also permit payment of a reasonable profit on the work performed. See FAR 52.249-2, (g)(2); see also Alternate I (SEP 1996) (g)(1) (applicable to construction contracts). Further, the FAR provides that the “use of business judgment, as distinguished from strict accounting principles, is the heart of a settlement.” Compare FAR 52.249-2(i) with FAR 49.201(a).

Although a fixed-price contractor typically is not required to document its costs of performance, the contractor has the burden to prove its termination costs “with sufficient certainty” so that the amount determined is “more than mere speculation.” See Lisbon Contractors, Inc. v. United States, 828 F.2d 759, 767 (Fed. Cir. 1987).  The use of estimates is sufficient when accounting records are unavailable, although the contractor still has the burden to demonstrate that estimates used have a reasonable basis in fact. See Appeal of Tagarelli Bros. Const. Co., Inc., ASBCA No. 34793, 88-1 BCA ¶ 20363.

The following are categories of costs that might be implicated in the preparation of a termination for convenience proposal: 

Pre-contract/Initial Costs

Depending on when the Government exercises its right to terminate for convenience, a contractor could find itself having incurred substantial costs in anticipation of a contract award and out of necessity to comply with the anticipated contract’s delivery schedule.  Where the incurrence of such costs was necessary, they are allowable to the same extent as they would have been if incurred after the date of the contract. 

Initial costs – starting and preparatory costs – that are not fully absorbed over the life of the contract due to the termination may also be recoverable. See FAR 31.205-42(c).  These can include idle time and training, and the lack of experience with the particular product or manufacturing process that occur at the inception of a project which, had the contract been fully performed, would have been spread over the full performance period.  The Armed Services Board of Contract Appeals has approved recovery of such costs under the rationale that:

[A] contractor bidding a fixed price per unit of work for a number of units must include in that fixed unit price all the costs of all the units knowing all the while that the cost experienced during the manufacture of the earlier units will be greater than on the later units. Therefore, lest the contractor is to lose the portion of such costs as yet unrecovered through the price paid for delivered items, it must be permitted to recover it as part of the cost of terminated work.

Appeal of Lockley Mfg. Co., Inc., ASBCA No. 21231, 78-1 BCA ¶ 12987.

Costs Continuing After Termination

Contractors are also entitled to recover costs continuing after termination that “despite all reasonable efforts by the contractor...cannot be discontinued immediately after the effective date of termination.” FAR 31.205-42(b).  The test for whether these costs are recoverable includes consideration of whether the costs continued due to the contractor’s negligent or willful failure to discontinue them.  Common examples of these types of costs include idle facilities/capacity costs and employee labor and severance costs.  Idle facilities and capacity costs refer to the contractor’s plant, land, or equipment, and other costs such as maintenance, repair, rent, and other related costs.  If the facility is not completely idle, the cost is considered idle capacity, i.e., underutilization of a partially used facility.  Employee compensation also continues after a termination, until employees can be reassigned to other work or if they are needed to wind up the terminated contract. 

Rental Costs

Costs associated with unexpired leases should also be included in a termination settlement proposal.  However, these too are limited by the common sense rule that a contractor has the obligation to mitigate its damages, and must make reasonable efforts to minimize costs to the Government.  Rental costs are recoverable for the contract period before termination and “such further period as may be reasonable.” FAR 31.205-42(e)(1).

Delay Costs

In the lead up to a termination for convenience, a contractor might also have faced various delays.  Costs associated with these, i.e., the increased cost of performance at a later time, disruption, and unabsorbed overhead, and leading up to the termination should also be claimed.  In Nicon, Inc. v. United States, the United States Court of Appeals for the Federal Circuit considered a contractor’s damages for unabsorbed overhead. See Nicon, Inc. v. United States, 331 F.3d 878, 885 (Fed. Cir. 2003).  In that case, the contractor had been awarded a contract for a building repair and, after nearly ten months of delay during which the contractor was unable to start work, the Government ultimately terminated the contract for convenience.  The court found that where all the requirements for entitlement to home office overhead were met and a reasonable allocation method was available based on the particular facts of the case, there was no bar to awarding such overhead damages in a termination for convenience settlement.

Settlement Costs

Expenses incurred in preparing and negotiating the termination settlement proposal, terminating and settling subcontracts, and disposing of termination inventory are also recoverable as costs incurred by reason of the termination for convenience.  These include professional services such as legal and accounting, as well as the time spent by a contractor’s in-house personnel that is attributable to preparing the termination settlement proposal.  These costs should be tracked contemporaneously through time sheets wherever possible as directly incurred in furtherance of the termination for convenience. 

Special Considerations for Partial Terminations for Convenience

A slightly different situation occurs where a contract is partially terminated for convenience and certain non-terminated work remains to be performed.  In such a case, the contractor may file a proposal with the Contracting Officer for an equitable adjustment of the price(s) of the continued portion of the contract where the partial termination impacts that remaining work.  The relevant FAR clause, 52.249-2(l), expressly authorizes an equitable adjustment in the price of the continued portion of a contract that has been partially terminated for the Government’s convenience where the contractor establishes the increased costs, work or schedule changes sought arose as a result of the termination. See Wilner v. United States, 24 F.3d 1397, 1401 (Fed. Cir. 1994) (noting that a contractor must establish liability, causation and resultant injury to receive an equitable adjustment, and the contractor bears the burden of proving the amount of that adjustment). 

In a partial termination situation, the equitable adjustment is for the increased cost of the continued work due to the partial termination.  For example, in one case, a contract that originally contemplated the overhaul and repair of 100 aircraft engine doors was partially terminated for convenience, and the contractor was ordered to terminate all actions necessary for the reassembly of eighty doors.  The contractor sought an equitable adjustment to the contract price for the continuing work under the contract involving reassembly of the remaining twenty doors.  The Board looked for “proof of a clear causal nexus between the reduction in quantity [occasioned by the termination for convenience] and any increased costs.” In re Appeal of Aeronca, Inc., ASBCA No. 51927, 03-2 BCA ¶ 32261.  When the contractor sought to recover its “learning curve” costs, however, the Board found the contractor had not established that any increased per unit costs were attributable to the reduction in quantity, and denied recovery. Thus, to recover the claimed increased costs, you must document and be able to establish that these costs are causally connected to the reduced work scope occasioned by the termination for convenience.    

Final Thoughts

In addition to the mitigation efforts, preparation of the termination proposal and any request for equitable adjustment of the remaining work in a partial termination, a contractor should also consider whether there any other changes or cost impacts suffered prior to the termination.  To the extent the Government may have changed or otherwise breached the contract prior to termination, this may give rise to another basis for recovery.

While terminations for convenience may be disappointing in that a contractor loses the opportunity to finish a job that it either started or worked very hard to procure, it should not be financially debilitating.  Contractors that follow the dictates of FAR 52.249-2, appropriately mitigate the incurrence of further costs after termination, and adequately track and account for costs incurred or that will be incurred to continue performance following a partial termination, generally should be made whole and be able to avoid substantial losses.