Federal contractors would be among the first to experience serious financial consequences in the event Congress fails to raise the debt limit and government agencies can’t pay their bills as the fiscal year ends.

. . .

As a result, vendors [government contractors], particularly those with low cash reserves, would see dwindling bank accounts and be forced to take immediate action to stanch losses.

Labor Concerns

One common response to payment stoppages is for contractors to furlough or lay off employees, but this option could bring problems if used in the current debt limit crisis scenario. For instance, those actions may violate individual employment contracts, leading to employee lawsuits or triggering expensive termination fees.

Cy Alba, head of PilieroMazza’s government contracts practice group, said mid-sized and larger contractors could get squeezed by having to comply with the Worker Adjustment and Retraining Notification Act. The WARN Act requires companies with at least 100 employees to provide 60 days advance notice before mass layoffs or plant closings.

Carrying a large work force for two months after a contract is abruptly canceled or delayed would cause serious financial hardship for companies lacking deep pockets.

. . .

Bankruptcy Worries

Lost revenue may also lead to tightened credit, delayed loan payments, and delayed supplier payments. This, in turn, could expose vendors to a cascading series of additional financial and legal difficulties, including penalties for contract delays and breaches, loan defaults, and subcontract breaches.

Other scenarios could compound these problems, Alba said. Agencies could try to absolve themselves from liability in the event of a debt breach by invoking the “sovereign acts doctrine” that holds agencies harmless from damages and liabilities resulting from contract problems caused by government actions that are deemed “public and general.”

“This could run contractors and subcontractors into bankruptcy, ” Alba explains.

In the construction industry, for example, payment freezes could lead to Miller Act claims on a prime contractor’s construction bonds. The Miller Act requires contractors to post a payment bond for federal construction contracts exceeding $150,000. The payment bond provides a way for subcontractors and suppliers to recover payment in the event that the contractor defaults on its obligations.

“Because many bonds, especially for small businesses, are personally guaranteed, the bonding agents will seek to recover from contractors and their owners, who may, in turn go bankrupt,” Alba said.

Excerpt taken from the article “Debt Limit Breach to Squeeze US Government Contractors First” by Paul Murphy for Bloomberg Law. Visit this link to view the full article (subscription required).