The Firm Fixed Price Profits Reduction Clause: Government Takes All the Benefits and None of the Risk?

November 11, 2016

By Isaias Alba IV

It has been well understood in the Federal Acquisition Regulation (“FAR”), and in government contracting generally, that different contract types balance the risks and rewards so as to ensure both the government and the contractor share in the risk. In Firm Fixed Price (“FFP”) contracts, the contractor takes on the risk of any cost overruns, while it can benefit from reduced costs to take home more profits. With cost reimbursable contracts, the government gains the benefit of cost underruns but bears the risk of overruns. Either way, the parties share in the risk, just in different ways.

This balance is fundamental to any arms-length transaction. In the context of government contracts, it is well established that, while the government is expected to seek out the best prices through competition, it is not in the business of using its weight and buying power to run companies out of business or to take advantage of small businesses by destroying any ability to profit. Indeed, for small- and mid-sized businesses, profits are often the only way owners get a paycheck; a check that is often lower than many of the people the company employs at the beginning stages of even successful companies. As it turns out, however in this environment of fiscal austerity, the government is looking for ways to cut costs, often squeezing its contractors, including small businesses which are least equipped to withstand the squeeze.

One such squeeze is what I will call a “FFP Profits Reductions Clause” in contracts, so that the government can prohibit cost overruns, as with a traditional FFP contract, while at the same time demanding that it be reimbursed for any cost underruns. This not only destroys the balance of risk, but also can destroy balance sheets of small businesses the government claims it seeks to protect. These clauses are not found in the FAR, indeed the policy found in the FAR and the Small Business Act run contrary to the “Profits Reductions Clauses,” but are, instead, agency constructs melding cost reimbursable concepts with FFP contracts.

Specifically, an agency may seek a FFP to perform some analysis work. As part of the RFP, the government will request that the offeror provide hourly rates and a total number of hours the contractor believes it will take to perform the work. So far this all seems reasonable. However, the government will also include a provision in the contract—again, not from the FAR, which states that, for any hours not worked or for hours where an employee may be on jury duty or military leave—the government shall not pay the contractor for that time. This clause applies even if the work is being covered by other personnel or by the owner himself/herself, and even if the deliverable is provided to the government on time and with glowing reviews for the work performed. You read that right: the government, through these clauses, punishes small businesses for hiring men and women in the National Guard or U.S. Military Reserves, or for the contractor’s employees taking time off for jury duty, even when the government receives a stellar deliverable on time, and at the cost agreed to in the FFP proposal.

We have seen a number of clients shocked by government demands for price reductions after the fact or simply refusing to pay invoices because of leave taken by contractor employees due to military service or jury duty when these clauses are used. Unfortunately, when a clause such as this is in your contract, especially where you submitted a number of hours with a proposal, contractors may be stuck with this inequitable result. Thus, you need to be wary of any clause, even in a FFP contract, that limits your ability to bill for personnel time. It seems that the “firm” in FFP has been removed and instead the government is trying to replace that with a “profits reductions clause,” especially for small businesses. And, astonishingly, those who hire veterans still in the U.S. Military Reserves, and those in the National Guard, are at an increased risk for punishment by the government under these types of clauses. So, review contracts carefully before signing and make sure that contingency amounts are built into proposals where the RFP contains such a clause.

About the author: Cy Alba is a partner with PilieroMazza and is a member of the Government Contracts and Small Business Programs Groups. He may be reached at ialba@pilieromazza.com

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