Subcontractor Settlements Post Termination for Convenience

June 15, 2024 Sareesh Rawat, Esq.

As a sovereign and a contracting party, the government holds the prerogative to terminate a government contract, either partially or completely, whenever it is in its best interest. While a contractor may pose certain challenges to the CO’s decision to terminate a contract, it is generally accepted that the government’s rights in this regard are practically limitless. The Federal Acquisition Regulation (FAR) outlines the methods through which the government may settle contracts it terminates for its convenience. Specifically, under FAR § 49.103, the government may settle contracts terminated for convenience through negotiated agreement, CO’s determination, costing-out under vouchers for cost-reimbursable contracts, or through a combination of these methods. Typically, when the government exercises its right to terminate a contract for convenience, it enters into a settlement agreement with the prime contractor. In turn, prime contractors are required to settle any subcontractor termination settlement proposals.

Once the government issues a notice terminating a contract for convenience, the prime contractor must terminate all subcontracts related to the terminated portion of the prime contract. Under FAR § 49.104, prime contractors are required to settle all outstanding liabilities that arise out of the termination of subcontracts and promptly notify the CO of any legal proceedings that may be instituted by a subcontractor. Additionally, FAR § 49.108 generally outlines the parties’ rights, obligations, and procedures pertaining to subcontractor settlement proposals. Notably, FAR § 49.108-2(b) makes it abundantly clear that the government’s rights to terminate the contract for convenience are unaffected by a prime contractor’s failure to include an appropriate termination clause in a subcontract. Therefore, contractors should review the termination clause of their subcontract agreements to ensure their rights are adequately protected in case of a termination for the government’s convenience.

While subcontractors may achieve privity of contract for subcontractor claims in some situations, they generally have no contractual rights against the government upon the termination of a prime contract. However, depending on the circumstances, a subcontractor may have rights against the prime contractor or an intermediate subcontractor, as applicable. Importantly, subcontractors may not typically request the government to withhold funds from the prime contractor that are due to them as subcontractors for the performance of their portion of the terminated contract. However, in certain situations, if a prime contractor assigns its interest in the terminated subcontracts to the government, the government may directly settle any subcontractor claims under the assigned subcontract following a termination for convenience. Such a direct settlement of subcontractor claims is rare as the CO typically only requires the prime contractor to assign its interest in a terminated subcontract to the government if he determines that such an assignment is in the government’s best interests. In fact, it is much more common for prime contractors to settle any subcontractor claims in general conformity with the policies and principles relating to the settlement of prime contracts as stated in FAR § 49.108-3.

After a termination settlement is reached with the subcontractor, prime contractors are required to submit a settlement agreement to the CO, who promptly reviews the terms of the settlement to determine whether the subcontract termination was due to the government’s termination of the prime contract. Therefore, subcontractor settlement proposals must be sufficiently detailed to affect an adequate review by the government. The FAR requires that the basis and form of subcontractor settlement proposals to be generally acceptable to the prime contractor and be supported with accounting data and other relevant information. Under specific circumstances, the prime contractor may obtain prior authorization from the CO to settle subcontractor proposals under $100,000 without the CO’s approval or ratification. In all other cases, FAR § 49.108-3(c) mandates the CO to determine whether the subcontract termination settlement is reasonable in amount, allocable to the terminated portion of the contract, and arrived at in good faith. Upon completion of its review, the CO notifies the contractor of his approval or ratification, or in cases where the settlement approval is denied, the reasons for the disapproval.

Despite the best efforts of all parties, there may be situations in which the prime contractor is unable to reach a settlement with the subcontractor. Furthermore, this inability to settle may in-turn delay the settlement of the prime contract. In such situations, FAR § 49.108-6 authorizes the CO to settle with the prime contractor by excepting the subcontractor settlement proposal from the prime contract settlement either in whole or in part. The rights of the government and the prime contractor are reserved with respect to the subcontractor proposal in such prime contract settlements. Finally, in rare cases, the CO may determine that it is in the government’s best interest to aid the prime contractor in the settlement of a subcontract. In such unusual cases, the government may enter into an agreement with the prime and subcontractor to cover the settlement of the subcontract. Notably, however, such an agreement does not provide the subcontractor any additional rights against the government upon the termination of the prime contract.

While a termination for convenience may not be desirable for contractors and subcontractors performing on federal contracts, they must nevertheless be prepared for such an outcome. Both prime and subcontractors should be aware of the general framework of terminations for convenience of federal contracts, along with the specific procedures for submission and approval of settlement proposals as outlined in the FAR. By understanding the rights and obligations of the various stakeholders in such situations, both prime and subcontractors can be prepared to settle subcontracts effectively and efficiently post termination for convenience. By following procedures outlined in the FAR and contacting counsel when in doubt, contractors can avoid unfavorable post-termination outcomes including potential litigation.

This Federal Procurement Insight is provided as a general summary of the applicable law in the practice area and does not constitute legal advice. Contractors wishing to learn more are encouraged to consult the TILLIT LAW PLLC Client Portal or Contact Us to determine how the law would apply in a specific situation.

Related Insights

Achieving Privity of Contract for Subcontractor Claims

January 27, 2024 Sareesh Rawat, Esq.

Subcontractors under U.S. federal contracts cannot generally sue the government directly as they lack privity of contract with the government. Privity refers to a legal concept describing a relationship or nexus between contracting parties. The government often utilizes a two-tiered contracting system for procurements where it enters into a contract with the prime contractor that, in turn, contracts with subcontractor(s) to fulfill contractual requirements. Thus, in a federal contract, the government only has a privity of contract with the prime contractor, creating a legal buffer between the government and the subcontractor. Since subcontractors are not in privity with the government, the government does not waive its sovereign immunity, and subcontractors may not bring direct claims against the government.

However, as with most rules in U.S. federal contracting, the no subcontractor privity rule has its exceptions. These exceptions require that subcontractors looking to bring direct claims against the government must first establish a privity of contract with the government. That is, the contractor must successfully demonstrate that it explicitly or implicitly entered into a contract with the government.

Common Challenges to Terminations for Convenience

February 20, 2024 Sareesh Rawat, Esq.

One of the unique privileges enjoyed by the U.S. Government as a contracting party under a federal contract is its authority to terminate the contract at any time, regardless of the contractor’s fault. Known as termination for convenience, the contracting action allows the Government an exclusive and almost unlimited right to terminate a government contract unilaterally. When terminating a contract for convenience, the Government may terminate the contract entirely or choose to make partial terminations with practically no limitations on the extent, type, or profitability of the portion of the contract being terminated.

While contract termination is seldom a cause for celebration for the contractor, a convenience termination is still greatly preferred over termination for default. This is because of the simple reason that a convenience termination indicates that the Government terminated the contract in its own best interests rather than due to the contractor’s fault. This allows contractors to receive the costs they incurred in performing the contract up to the point of termination, along with any profits on the completed work, if applicable. Under convenience termination, contractors can also recover any costs expended in delivering the termination proposal.

Severin Doctrine Applicability for Pass-Through Software Manufacturer Claims

May 14, 2024 Sareesh Rawat, Esq.

While there are ways in which subcontractors may achieve privity of contract, they may not generally bring direct claims against the Government due to a lack of privity. Therefore, subcontractor claims against the Government are typically asserted by prime contractors as pass-through claims. However, prime contractors may only bring such pass-through claims if they meet the requirements of the Severin Doctrine. First articulated by the Court of Claims in 1943, the Severin Doctrine bars pass-through subcontractor claims unless the prime contractor itself remains liable to claims by the subcontractor. While the Severin Doctrine has evolved through its application to various pass-through claims scenarios, at its outset, it barred the assertion of pass-through claims unless the prime contractor either reimbursed the subcontractor due to the Government’s fault or was at least liable to make such a reimbursement in the future.

Based on the principles of sovereign acts immunity and privity of contract as applied to government contracts, the Severin Doctrine requires the prime contractor to have at least some demonstrable exposure to subcontractor liability. To prevent pass-through claims through this affirmative defense, the Government typically points to any provisions in the subcontract that tend to exculpate the prime contractor from liability to the subcontractor. When entering teaming arrangements, contractors should be aware that if the subcontract agreement contains a clause completely or specifically exonerating a prime contractor from liability to the subcontractor for pertinent damages, then the prime contractor may not assert a related pass-through claim against the Government. Prime contractors are similarly barred from asserting pass-through claims if the subcontract specifically extinguishes prime contractor liability upon the meeting of certain requirements, such as the subcontractor being granted additional time or the acceptance of final payment.

Jurisdictional Considerations in Appeals Challenging Terminations for Default

June 7, 2024 Sareesh Rawat, Esq.

The government may terminate a federal contract if the contractor fails to meet its contractual obligations. The contracting officer (CO), in such cases, issues a final decision terminating the contract for default and outlines the reasons for the default. In the event of a termination for default, the government is only liable to the contractor for the portion of the contract that was already performed. While the CO may exercise discretion to terminate a contract for default, such a decision is appealable to the Board of Contract Appeals or the Court of Federal Claims (COFC) pursuant to the Contract Disputes Act (CDA). The CO’s decision to terminate may be set aside by the adjudicative forum if it is arbitrary, capricious, or constitutes an abuse of the CO’s discretion. For instance, a decision to terminate for default may be arbitrary and capricious if there is a lack of nexus between the CO’s decision to terminate the contract for default and the contractor’s performance on the contract. In such situations, while the concerned adjudicative forum may lack the ability to provide injunctive relief, it may nevertheless convert the CO’s default termination to one for the government’s convenience.

Subcontractor Settlements Post Termination for Convenience

TILLIT LAW Federal Procurement Insights