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March 04, 2024 Feature

New Rules, Pre-Existing Contract: A FAR-Reaching Issue?

Christopher G. Griesedieck Jr. and Michael T. Francel
The normal rule is for legislation and regulations to be applied prospectively to events and agreements which occur later. . . . This is particularly true of directives dealing with the substantive aspects of contracts; it would be a rare regulation which would even seek to modify, to the contractor’s detriment, substantive rights in an agreement already consummated.

Lockheed Aircraft Corp. v. United States, 426 F.2d 322, 327–28 (Ct. Cl. 1970).

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The US Court of Claims’ assumption in 1970 that the federal government would rarely seek to apply new rules to preexisting contracts has not aged well. In recent years, the federal government has increasingly sought to insert brand new clauses into its contractual arrangements with private industry.

This article first addresses basic principles relevant to, and traces the development of, this new phenomenon and then discusses a specific problem raised by it. The federal government is increasingly requiring the insertion of new Federal Acquisition Regulation (FAR) clauses into existing contracts when the government exercises an option to extend performance. This approach ignores that options that purport to add new terms (or that are conditioned upon the contractor’s acceptance of new terms) are invalid.

Ultimately, whether it is desirable to apply new requirements to existing contracts by inserting contract clauses through options is a policy question beyond the scope of this article. But procurement law sets important ground rules that federal policymakers and government contractors alike need to bear in mind as this situation arises more frequently.

The Government May Not Apply New FAR Clauses to Existing Contracts Without Appropriate Consideration for the Contractor

The general rule is that courts and boards of contract appeals do not read new versions of FAR and FAR supplement clauses into federal contracts. Rather, the version of the clause that the parties incorporated into the contract at execution is the one that applies unless a modification to the contract inserts a more recent version. This rule is consistent with the presumption that regulations do not apply retroactively. Indeed, even a statute purporting to retroactively modify preexisting federal contracts may breach those contracts.

The FAR acknowledges these principles by dating standard contract clauses and requiring the dates to appear in the contract. In addition, the FAR states that, “[u]nless otherwise specified,” “FAR changes apply to solicitations issued on or after the effective date of the change” and “[c]ontracting officers may, at their discretion, include the changes in any existing contract with appropriate consideration.” This rule reflects a recognition not only of the presumption that regulations apply prospectively, but also that modifications unsupported by consideration are unenforceable, including situations in which the party receiving no consideration is the contractor.

The Road to Retroactive Application of New Policies to Existing Contracts

The government’s readiness to apply new FAR clauses retroactively—such that interim and final rules in the Federal Register increasingly direct contracting officers to incorporate them into existing contracts—appears to have grown substantially in recent years.

In 2009, the Federal Acquisition Regulatory (FAR) and Defense Acquisition Regulations (DAR) Councils noted that they had “resisted applying new requirements to existing contracts, and the Councils do not recommend doing so now.” In the past, the government also typically confirmed that modifications to incorporate new clauses into existing contracts had to be bilateral and further had to compensate the contractor, including through an adjustment in the contract price. For example, in 2010, the government stated: “FAR 1.108(d) requires that any application of a new procedure to existing contracts must be bilaterally negotiated and involve adequate consideration.” In some instances, the government would, however, “encourage” contracting officers to apply new FAR clauses to existing contracts.

Multiple federal agencies have since adopted a more aggressive posture. This has included “strongly encourag[ing]” retroactive application for stated policy reasons, omitting express statements that modifications under FAR 1.108(d)(3) must include consideration for the contractor, adding administrative requirements for contracting officials before they may forgo incorporation of a new clause, and finally mandating (rather than encouraging) the insertion of new FAR clauses into existing contracts. In some cases, the government has spelled out explicit consequences if the contractor refuses to accept the new clause.

The Government May Not Condition Exercise of an Option on Inserting New Clauses

Contracts with the federal government frequently include option clauses granting a “unilateral right . . . by which, for a specified time, the Government may elect to purchase additional supplies or services called for by the contract, or may elect to extend the term of the contract.” FAR Subpart 17.2 governs the application of option clauses.

Federal policymakers have begun treating the exercise of options—which extend the period of performance for existing federal contracts—as “new” contracts into which procuring agencies are free to insert new FAR clauses. But any option exercise that alters the terms of the option, or conditions the option’s exercise on the contractor’s acceptance of new terms, is invalid—regardless of whether federal policy requires the terms. Contractors facing this scenario should consider objecting to avoid waiving their rights and, if needed, performing under protest and seeking an equitable adjustment as compensation for any increased costs.

In the past few years, several significant compliance policies have required insertion of new contract terms when options are exercised. Consider the following five examples:

  1. Prohibition on Contracting with Entities Using Certain Telecommunications Equipment (Section 889, Part B): In July 2020, the government issued an interim final rule amending the FAR to implement Section 889(a)(1)(B) of the 2019 NDAA, which prohibits the government from entering into a contract with an “entity that uses any equipment, system, or service that uses covered telecommunications equipment or services as a substantial or essential component of any system, or as critical technology as part of any system.” In addition to requiring contracting officers to “modify, in accordance with FAR 1.108(d), existing indefinite delivery contracts to include the FAR clause for future orders, prior to placing any future orders” and to “include the provision at 52.204-24, Representation Regarding Certain Telecommunications and Video Surveillance Services or Equipment, in all solicitations for an order, or notices of intent to place an order, including those issued before the effective date of this rule, under an existing indefinite delivery contract,” the interim final rule stated that, “[i]f exercising an option or modifying an existing contract or task or delivery order to extend the period of performance, contracting officers shall include the clause” and that, “[w]hen exercising an option, agencies should consider modifying the existing contract to add the clause in a sufficient amount of time to both provide notice for exercising the option and to provide contractors with adequate time to comply with the clause.” To date, a final rule implementing Section 889 has yet to be issued.
  2. Minimum Wage for Contractor Employees: In 2014, President Obama signed an executive order establishing a minimum wage for employees of federal contractors. The E.O. ordered procuring agencies to include a clause requiring payment of the minimum wage in “new contracts, contract-like instruments, and solicitations.” The Department of Labor’s (DOL) rule implementing the clause clarified that “the unilateral exercise of an option clause under an existing contract does not qualify as a ‘new contract’ for purposes of the Executive Order.” This conclusion was consistent with case law (and the FAR) establishing that exercising an option generally does not create a new contract. But the government changed tack in 2021 when President Biden issued an executive order increasing the contractor minimum wage. The new E.O. stated that the increased wage applied to the “exercise of an option on an existing contract or contract-like instrument.”
  3. Contractor Vaccine Mandate: During the COVID-19 pandemic, President Biden issued an executive order requiring federal contractors to ensure their workforces were vaccinated and implement other safety protocols, including masking. This contractor vaccine mandate expressly applied to the “exercise of an option on an existing contract or contract-like instrument.”
  4. TikTok Ban: In June 2023, the government amended the FAR to implement the “No TikTok on Government Devices Act,” which prohibited “having or using the social networking service TikTok” on “any information technology used or provided by the contractor under a contract, including equipment provided by the contractor’s employees.” The rule stated: “If exercising an option or modifying an existing contract or task or delivery order to extend the period of performance, contracting officers shall include the clause.”
  5. Supply Chain Removal Orders: In October 2023, the FAR Council issued an interim rule requiring contractors to comply with future orders from the Federal Acquisition Security Council (FASC) to not use identified information technology and other devices or services in performing federal contracts. The rule included the same language regarding application to options as the TikTok ban.

These policy rollouts overlook that under longstanding federal procurement law, an option purporting to alter the terms of the contract is invalid. “‘It is well settled that to properly exercise [an] option, the government’s acceptance of that offer ha[s] to be unconditional and in exact accord with the terms of the contract being renewed.’” The FAR itself states that, “[b]efore exercising an option, the contracting officer shall make a written determination for the contract file that exercise is in accordance with the terms of the option.” “The inclusion in the exercise of an option of a provision(s) departing from the original contract provisions, makes such option exercise invalid.” The government therefore cannot lawfully condition the exercise of an option on the addition of new contract terms. That the clause purportedly added by the option is required by regulation does not change the fact that the option will be invalid.

Notably, the FAR and DAR Councils appear to be aware of this case law. In 2016, when implementing President Obama’s Fair Pay and Safe Workplaces executive order, the Councils declined to apply the new requirement retroactively. They reasoned that “[t]here is no need for the Councils to make the rule applicable to contracts awarded before the rule, nor is it necessary to risk voiding the Government’s right to exercise a unilateral option by attempting to add these clauses to an existing contract.”

More recently, when implementing the 2021 minimum wage E.O., the government again appears to have recognized the problem. But rather than acknowledging that inserting new terms into a contract as part of an option exercise renders the option invalid, the FAR Council attempted a work-around. It ordered contracting officers to seek “bilateral modifications” but noted that, “if the contracting officer is unable to incorporate the clause in an existing contract through bilateral modification, then the contracting officer shall decline to extend, renew, or exercise the option on the existing contract.” This approach does not fix the fundamental issue. As noted, agencies may not condition an option’s exercise on the contractor’s acceptance of new terms.

Responding to Procuring Agencies Seeking to Incorporate New FAR Clauses at Option Exercise

How a contractor should respond to a contracting officer tying option exercises to the contractor’s acceptance of new contract terms will depend on the circumstances. That said, there are some general principles that provide relevant guidance.

First, most contractors will choose to perform the option under protest rather than repudiate the option and refuse to perform. This is because most federal contracts incorporate the standard Disputes clause, which burdens the contractor with a duty to proceed with performance diligently even when the contractor is in a dispute with the procuring agency regarding performance. Absent an exception, the duty to proceed applies even where the government has issued an invalid option exercise.

The main exception to this duty—that the government’s unilateral changes to the contract’s terms were so significant as to constitute a “cardinal” change such that the government has materially breached the contract—can be difficult to prove. Most contractors proceed with performance as directed while a dispute is pending, rather than risk a finding that the government’s actions breached the contract, but not so drastically as to eliminate the duty to proceed. Such an adverse finding could mean that the contractor’s failure to perform pending a dispute constitutes a breach of contract—potentially subjecting the contractor to a host of consequences, such as negative past performance ratings, termination for default, payment of excess reprocurement costs or other damages, and even suspension or debarment from contracting.

Second, recognizing that most contractors will continue to perform notwithstanding an invalid option exercise, courts and boards have used the “constructive change” and “equitable adjustment” doctrines to make the contractor whole for the extra costs of the performance. As one board of contract appeals has explained:

The acceptance of an option, to be effectual, must be unqualified, absolute, unconditional, unequivocal, unambiguous, positive, without reservation, and according to the terms or conditions of the option. . . . An acceptance of an option must be such a compliance with the conditions as to bind both parties, and if it fails to do so it binds neither. . . . In the context of Government contracts, however, the optionor is at substantial peril in asserting its right to avoid further performance in the face of Government insistence thereon. Therefore, it is generally held that the Government’s insistence upon continued performance after an ineffective exercise of its option, particularly over the protest of the contractor, constitutes a constructive change for which the contractor may be compensated by way of an equitable adjustment . . . or for the reasonable value of the items provided.

Thus, “[t]he ineffective attempt to exercise an option gives a contractor the right to recover the costs it incurred in performing that work plus a reasonable profit on those costs.”

Third, a contractor can forfeit its right to such an equitable adjustment if it does not promptly provide the government notice that it is only performing the invalid option under protest.

In summary, if a procuring agency demands that a contractor perform an option despite the addition of a new FAR clause, the prudent contractor will consider informing the contracting officer that it is performing the option under protest and demanding an equitable adjustment as compensation, including via a claim under the Disputes clause. Various factors will drive this decision, including the expense of compliance with the new FAR clause.

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    Christopher G. Griesedieck Jr.

    Venable LLP

    Christopher G. Griesedieck Jr. is counsel at Venable LLP and based in Washington, DC. Griesedieck Jr. focuses on government contracts and grant-related matters such as claims, requests for equitable adjustment, and bid protests.

    Michael T. Francel

    Venable LLP

    Michael T. Francel is counsel at Venable LLP and based in Washington, DC. Francel focuses on government contracts and bid protests before the US Government Accountability Office and the US Court of Federal Claims, as well as at the agency level.