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The Bona Fide Needs Rule

B. 6.  Replacement Contracts 

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In an early decision, the Comptroller of the Treasury was asked whether fiscal year 1902 funds, originally obligated under a contract but unexpended because of contractor default, could be used in the following year to continue the original object of the contract. The Comptroller stated:

“A contract was properly made within the fiscal year 1902, and it would seem that any part of the consideration of that contract which failed of use owing to the default of the contractor could still be used in carrying out the object of the original contract within the meaning of [31 U.S.C. § 1502(a)]. Appropriations are made to be used and not to be defeated in their use, and it would be a narrow construction to hold that a default on a properly made contract would prevent the use of the appropriation for the object for which it was made and for carrying out which the contract was executed.”

9 Comp. Dec. 10, 11 (1902). This marked the beginning of the replacement contract theory.

In its traditional form, the rule is well settled that, where it becomes necessary to terminate a contract because of the contractor’s default, the funds obligated under the original contract are available, beyond their original period of obligational availability, for the purpose of engaging another contractor to complete the unfinished work. 60 Comp. Gen. 591 (1981); 55 Comp. Gen. 1351 (1976); 44 Comp. Gen. 623 (1965); 40 Comp. Gen. 590 (1961); 32 Comp. Gen. 565 (1953); 2 Comp. Gen. 130 (1922); 21 Comp. Dec. 107 (1914); B-160834, Apr. 7, 1967; B-105555, Sept. 26, 1951; A-22134, Apr. 12, 1928.

Implicit in the rule is the premise that the original contract validly obligated then current funds. See 34 Comp. Gen. 239 (1954). In addition, the rule is based on the notion that the default termination does not eliminate the bona fide need of the fiscal year in which the original contract was executed. 44 Comp. Gen. 399, 401 (1965). In accordance with 31 U.S.C. § 1502, amounts from the appropriation available at the time the original contract was entered would remain available to fund costs properly chargeable to that appropriation. See B-242274, Aug. 27, 1991. Accordingly, the replacement contract seeks only to meet the agency’s preexisting and continuing need relying on the budget authority obligated by the original contract.

In order for funds to remain available beyond expiration for a replacement contract, three conditions must be met:

  • A bona fide need for the work, supplies, or services must have existed when the original contract was executed, and it must continue to exist up to the award of the replacement contract. E.g., 55 Comp. Gen. 1351, 1353 (1976); 34 Comp. Gen. 239, 240 (1954). If a terminated contract is found to have been improperly made to fulfill a need of a fiscal year other than the year against which the obligation was recorded, it would also be improper to charge that same appropriation for obligations incident to a replacement contract. 35 Comp. Gen. 692 (1956). In addition, if contracts made in a subsequent fiscal year do not satisfy a continuing need for the goods and/or services provided under the original contract from a prior fiscal year, then the subsequent fiscal year contracts are not replacements and those contracts are not chargeable to the prior fiscal year appropriation. See B-242274, Aug. 27, 1991.
     
  • The replacement contract must not exceed the scope of the original contract. If it does, it is a new obligation and must be charged to funds currently available for obligation at the time the replacement contract is entered into. E.g., 44 Comp. Gen. 399 (1965); B-181176-O.M., June 26, 1974.
     
  • The replacement contract must be awarded within a reasonable time after termination of the original contract. E.g., 60 Comp. Gen. at 593. Excessive delay raises the presumption that the original contract was not intended to meet a then existing bona fide need. The same result may follow if there is unwarranted delay in terminating the original contract. 32 Comp. Gen. 565 (1953).

At one time, the replacement contract rule was mostly (but not exclusively) limited to the default situation. E.g., 24 Comp. Gen. 555 (1945), overruled by 55 Comp. Gen. 1351. It has, however, been expanded. In 34 Comp. Gen. 239 (1954), a default termination was found to be erroneous and was converted to a termination for convenience by agreement of the parties to permit settlement of the contractor’s claim for damages. The decision held that, in view of the original termination, the funds originally obligated were available for the timely execution of a new contract for the performance of the unfinished work.19 A further question in that case was whether the replacement contract rule was affected by the newly enacted 31 U.S.C. § 1501(a), which requires that contractual obligations be supported by a binding agreement in writing executed prior to expiration of the appropriations availability. The decision held that the original contract met these requirements. 34 Comp. Gen. at 241.

In a later case, a contract for flooring repairs was awarded in fiscal year 1975, obligating fiscal year 1975 funds, conditioned upon a determination from the Small Business Administration (SBA) that the contractor qualified as a small business. SBA found the contractor not to be a small business. Concluding that the original award was sufficient to support an obligation under 31 U.S.C. § 1501(a), the Comptroller General applied the replacement contract rule and held that the funds obligated for the contract in fiscal year 1975 could be used to resolicit in fiscal year 1976. 55 Comp. Gen. 1351 (1976).

In 66 Comp. Gen. 625 (1987), however, the Comptroller General declined to extend the rule in a situation involving a voluntary modification that reduced the scope of a contract. The Navy had contracted for the construction of 12 ships. The contractor encountered financial difficulties and filed for reorganization under Chapter 11 of the Bankruptcy Act under which the contractor could, with court approval, reject the contract. See 11 U.S.C. §§ 365(a) and (d)(2). To avert this possibility, the Navy agreed to a contract modification that, among other things, reduced the number of ships to be provided from 12 to 10. The question was whether the funds originally obligated for the 2 ships deleted by the modification were available after expiration to fund a reprocurement. GAO concluded that they were not because there had been no default, nor was there an actual rejection under the Bankruptcy Code. “[T]he modification was an essentially voluntary act on the part of the Navy, and as such is beyond the scope of the replacement contract rule.” Id. at 627. Therefore, any replacement contract for the 2 deleted ships would have to be charged to appropriations current at the time it was made.

Cases involving the termination of erroneously or improperly awarded contracts have been less than consistent, although a clear direction now appears evident. The earliest decisions applied the replacement contract rule. Thus, 17 Comp. Gen. 1098 (1938) held, without much discussion, that funds obligated by an award to a bidder subsequently determined not to have been the low bidder could be used for an award to the otherwise low bidder in the following fiscal year. In a 1953 case, a contract had to be partially canceled because the contractor’s bid had not conformed to the advertised specifications. GAO noted that “the obligating instrument was legally defective in such a way as to render the contract voidable at the election of the Government,” but nevertheless applied the replacement contract rule. B-116131, Oct. 19, 1953. See also B-89019, May 31, 1950.

GAO’s position seemed to change with the enactment of 31 U.S.C. § 1501(a) in 1954, on the theory that a contract award found to be invalid did not constitute a binding agreement so as to support a recordable obligation. 38 Comp. Gen. 190 (1958); B-118428, Sept. 21, 1954, overruling B-116131 and B-89019. However, B-116131 was at least arguably “reinstated” by B-152033, May 27, 1964, which followed both the “voidable at the election of the government” rationale and the result of B-116131, without citing either it or the case that presumably overruled it. See also B-173244(2), Aug. 10, 1972; B-158261, Mar. 9, 1966. This latter group of cases was in turn cited with approval in 55 Comp. Gen. 1351, 1353 (1976).

The apparent direction indicated by 55 Comp. Gen. 1351 (1976) and the cases it cited was called into question by statements in 60 Comp. Gen. 591 (1981) to the effect that the replacement contract rule does not apply to terminations for the convenience of the government, whether initiated by the contracting agency or on recommendation of some other body such as GAO. Of course, the typical situation in which a replacement contract is needed following a termination for convenience is where the original contract is found to have been improperly awarded. An important clarification occurred in 68 Comp. Gen. 158 (1988), which modified 60 Comp. Gen. 591 and held the replacement contract rule applicable where a contract must be terminated for convenience, without a prior default termination, pursuant to a determination by competent administrative or judicial authority (court, board of contract appeals, GAO) that the contract award was improper. As noted previously, the bona fide need of the original contract must continue, and the replacement contract must be made without undue delay after the original contract is terminated and must be awarded on the same basis as, and be substantially similar in scope and size to, the original contract.

Logically and inevitably, the next question would be why the rule should not be the same regardless of whether the defect leading to termination is determined by an external reviewing body or by the contracting agency itself. It should make no difference, GAO concluded in 70 Comp. Gen 230 (1991). The essence of the problem—a legal impropriety in the procurement process requiring corrective action—is no different. Thus, the replacement contract rule, with its attendant conditions, applies where the contracting agency determines that a contract award was improper and terminates the contract for the convenience of the government, provided there is clear evidence that the award was erroneous and the agency documents its determination with appropriate findings of fact and law. Id. See also B-322628, Aug. 3, 2012 (finding that an agency may award a replacement grant where a grant officer discovers a defect in the competitive selection process).

It is worth noting that with regard to agencies that terminate their contracts based on improper awards, the 1991 GAO decision added a fourth condition to the three articulated earlier in this section that determine whether funds remain available in a subsequent fiscal year for replacement contracts. In addition to the existence of a continuing bona fide need, a replacement contract of the same size and scope as the original, and the execution of the replacement without undue delay, the decision added that the original contract had to be made in “good faith” before an agency could use prior year appropriations to fund a replacement contract after terminating the original for convenience due to an improper award; 70 Comp. Gen. 287, 289 (1991).

The issue of whether an agency is required to avail itself of the replacement contract rule arose in a protest submitted to GAO alleging the improper award of a contract. GAO found that the agency properly awarded the contract and that, even when available, the replacement contract rule is not mandatory on an agency. B-270723, Apr. 15, 1996. The 1996 decision stated that since the replacement contract rule “provides a mechanism to allow agencies to administer their contract effectively when there is a reason to terminate a contract, its use is solely at the government’s discretion.” Id. At least one federal district court has adopted the position that the availability of funds for a replacement contract does not require the agency to procure a replacement contract. LeBoeuf, Lamb, Greene & MacRae, L.L.P. v. Abraham, 215 F. Supp. 2d 73, 81 (D.D.C. 2002). See, e.g., B-276334.2, Oct. 27, 1997.

Footnotes 19 A 1981 case, 60 Comp. Gen. 591, drew a distinction based on whether the awarding of the replacement contract preceded or followed the conversion to a termination for convenience, suggesting that the original obligation was extinguished when the replacement contract followed the conversion to a termination for convenience, the precise sequence involved in 34 Comp. Gen. 239. Although 60 Comp. Gen. 591 cites 34 Comp. Gen. 239 several times, it does not address this point. In view of later decisions where GAO determined that an agency could award a replacement contract following a termination for convenience because of an improper award, the distinction regarding when the replacement contract is awarded would not appear to be relevant. See 68 Comp. Gen. 158 (1988). (BACK)
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