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.