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Exercising Options: There is more to it than just the FAR.

Vern Edwards

32,088 views

In Government contracting under the FAR, a contract option is an offer contained in a contract that Government can accept in accordance with its terms, and that the contractor cannot revoke, until the acceptance period has expired. See also the definition of option in FAR 2.101.

The recent Federal government budget problems and the government shutdown have caused confusion with respect to the exercise of annual options in service contracts. I want to try to clear up some of that confusion.

A Primer On Contract Options

When a Government contract contains an option, the option is an offer that the Government can accept or reject. Acceptance of the offer is called "exercising the option."

The most common options in Government contracting are offers to (1) deliver additional quantities of supplies or (2) provide services for an extended period. It is the options in service contracts that are at issue.

In the main, options have two contractual components: (1) an option line item that describes the offer with reference to product specification, service statement of work, product or service pricing, and delivery date or performance period, and (2) an option clause that describes the rights and obligations of the parties with respect to exercise of the option. A standard rule of contract interpretation says that a contract must be interpreted as a whole. Thus, any attempt to answer questions about a contract option must consider both the terms of the contract line item and the terms of the applicable option clause.

FAR provides five standard clauses that stipulate the rights and obligations of the parties with respect to options. There are two standard clauses for supply contracts: FAR 52.217-6. Option for Increased Quantity (MAR 1989) and FAR 52.217-7, Option for Increased Quantity--Separately Priced Line Item (MAR 1989). There are two standard clauses for services contracts: FAR 52.217-8, Option to Extend Services (NOV 1999) and FAR 52.217-9, Option to Extend the Term of the Contract. In addition, there is FAR 52.237-3, Continuity of Services (JAN 1991), which requires a contractor to provide phase-in training and best efforts to “effect an orderly and efficient transition to a successor. While the latter clause is a kind of option, it is a special case, and I am omitting it from the remainder of this discussion.

FAR Subpart 17.2 describes two standard service contract options: (1) the so-called -8 option, named after its standard clause, FAR 52.217-8, which provides for short term extensions of up to six months, supposedly for use when award of a new contract is delayed, and (2) the so-called -9 option, named after its clause, FAR 52.217-9, which is the common "annual" extension option (although extensions need not be for a full year).

Exercising Options

When it comes to exercising a contract option (i.e., accepting the option offer), it is well established in Government contracting case law that an option must be exercised “in exact accord” with its terms. See System Planning Corp. v. U.S., 107 Fed. Cl. 710 (2012), quoting the U.S. Court of Appeals for the Federal Circuit in Freightliner Corp. v. Caldera, 225 F.3d 1361 (Fed. Cir. 2000):

“For an option order to be effective, the Government must exercise the option in exact accord with the terms of the contract.” Freightliner Corp. v. Caldera, 225 F.3d 1361, 1366 (Fed. Cir. 2000); see also Arko, 553 F.3d at 1379.

See also DeMarco Dirzo Development Co. v. U.S., 69 Fed. Cl. 262 (2005):

[T]he United States Court of Appeals for the Federal Circuit has held that “to properly exercise [an] option, the government's acceptance of the offer had to be in exact accord with the terms of the contract[.]” New England Tank Indus. of New Hampshire, Inc. v. United States, 861 F.2d 685, 687 (Fed.Cir.1988); see also Uniq Computer Corp. v. United States, 20 Cl.Ct. 222, 231–32 (1990) (quoting A. Corbin, CORBIN ON CONTRACTS, A COMPREHENSIVE TREATISE ON THE WORKING RULES OF CONTRACT LAW § 264) (1963) (The exercise of an option “must be unconditional and in exact accord with the terms of the option.”) (emphasis added)) (quoting Civic Plaza Nat'l Bank v. First Nat'l Bank of Dallas, 401 F.2d 193 (8th Cir.1968)) (“The acceptance of an option, to be effective, must be unqualified, absolute, unconditional, unequivocal, unambiguous, positive, without reservation, and according to the terms or conditions of the option ... An acceptance of an option must be such a compliance with the conditions as to bind the parties, and if it fails to do so it binds neither.” (emphasis added)). Therefore, as a matter of law, an attempted exercise of an option is ineffective, unless it is in “exact accord” with the terms of the option. See Lockheed Martin IR Imaging Sys., Inc. v. West, 108 F.3d 319, 323–24 (Fed. Cir. 1997) (holding the “partial exercise” of an option improper); International Telephone and Telegraph, ITT Defense Communications Div. v. United States, 197 Ct.Cl. 11, 453 F.2d 1283 (1972) (holding that a contracting officer's telegraphic notice that was sent on last date for giving notice, but not received until following morning, and contracting officer's oral notice on last date for notifying contractor was insufficient as a matter of law to “exercise an option,” where the contract provided that the contracting officer must notify the contractor of the exercise of an option, in writing, not later than a specified date); Uniq Computer, 20 Cl.Ct. at 231 (citing S. Williston, A TREATISE ON THE LAW OF CONTRACTS § 61D (3d ed.1957) (“This requirement is strictly construed.”).

As the Federal Circuit explained in Freightliner:

As option holder (optionee), the Government possesses what is generally called a power of acceptance. The option binds the optionee to do nothing but grants it the right to accept or reject the offer therein in accordance with its terms within the time and in the manner specified in the option. In order to bind the optionor, “the notice by which the power of an option holder is exercised must be unconditional and in exact accord with the terms of the option.” Nothing less will suffice, unless the optionor waives one or more of the option's terms. It is settled that the exercise or “acceptance of an option, to be effectual, must be unqualified, absolute, unconditional, unequivocal, unambiguous, positive, without reservation, and [strictly] according to the terms or conditions of the option.” Civic Plaza National Bank v. First National Bank in Dallas, 401 F.2d 193, 197(8th Cir. 1968); Holly Corp., ASBCA No. 24975, 83-1 BCA ¶ 16,327 at 81,164-65; see Corbin on Contracts § 264 (1963); Williston on Contracts §§ 61B, 61D (3d ed., 1957).

Do not confuse this common law rule, which requires the contracting officer to exercise the option in exact accord with the terms of the contract, with the rules in FAR 17.207 about exercising options, which are internal rules of the Government, not terms of a contract.

If a contracting officer fails to comply with FAR 17.207, the Government can declare the exercise of the option to be invalid on the ground that the CO exceeded his or her authority. Thus, if the CO exercises an unpriced and unevaluated option without first complying with FAR Part 6 (see FAR 17.207(f)0, the Government could repudiate the exercise without breaching the contract. But if the exercise was in accord with the exact terms of the contract, failure by the CO to otherwise comply with FAR 17.207 will not be grounds for the contractor to successfully argue that the exercise of the option was invalid. See Freightliner again, in which the contractor argued, among other things, that the CO had not complied with FAR 17.207(f) in exercising the option and for that reason the exercise of the option was improper and ineffective. The court rejected that argument, saying:

In order for a private contractor to bring suit against the Government for violation of a regulation, that regulation must exist for the benefit of the private contractor. See Cessna, 126 F.3d at 1451; Rough Diamond Co. v. United States, 173 Ct. Cl. 15, 351 F.2d 636, 640–42 (Ct.Cl.1965). If, however, the regulation exists for the benefit of the Government, then the private contractor does not have a cause of action against the Government in the event that a contracting officer fails to comply with the regulation. See Cessna, 126 F.3d at 1451–52; Rough Diamond, 351 F.2d at 642. Furthermore, each regulation must be analyzed independently to determine whether it confers a cause of action upon the private contractor. See Chris Berg, Inc. v. United States, 192 Ct. Cl. 176, 426 F.2d 314, 317 (Ct. Cl. 1970) (explaining that it is not “possible to determine that all of ASPR [predecessor to DAR] was or was not made for the benefit of bidders”).

* * *

On appeal, Freightliner contends that TACOM's failure to comply with FAR § 17.207(f) rendered TACOM's option exercise ineffective. When TACOM issued the P00051 modification, the FAR regulation provided as follows:

Before exercising an option, the contracting officer shall make a written determination for the contract file that exercise is in accordance with the terms of the option, the requirements of this section, and Part 6. To satisfy requirements of Part 6 regarding full and open competition, the option must have been evaluated as part of the initial competition and be exercisable at an amount specified in or reasonably determinable from the terms of the basic contract.

FAR § 17.207(f) (1989).

The above regulation explains that, before exercising an option, a contracting officer must satisfy the requirements in FAR § 17.207(f) and FAR Part 6; otherwise, the Government must treat the option order as a “sole source” procurement and justify it under an exception to the requirement of obtaining supplies under full and open competition. See FAR § 6.101 (1989). Freightliner asseverates that, because TACOM failed to satisfy the conditions in FAR § 17.207(f) and did not obtain approval for the sole source justification, the P00051 modification was an ineffective option order. TACOM responds that, even if it violated FAR § 17.207(f), that regulation was not enacted for the contractor's protection, and Freightliner therefore cannot avoid its contractual obligations based on an alleged violation of that regulation.

In order for a private contractor to bring suit against the Government for violation of a regulation, that regulation must exist for the benefit of the private contractor. See Cessna, 126 F.3d at 1451; Rough Diamond Co. v. United States, 173 Ct. Cl. 15, 351 F.2d 636, 640–42 (Ct. Cl. 1965). If, however, the regulation exists for the benefit of the Government, then the private contractor does not have a cause of action against the Government in the event that a contracting officer fails to comply with the regulation. See Cessna, 126 F.3d at 1451–52; Rough Diamond, 351 F.2d at 642. Furthermore, each regulation must be analyzed independently to determine whether it confers a cause of action upon the private contractor. See Chris Berg, Inc. v. United States, 192 Ct. Cl. 176, 426 F.2d 314, 317 (Ct. Cl. 1970) (explaining that it is not “possible to determine that all of ASPR [predecessor to DAR] was or was not made for the benefit of bidders”).

Read holistically, FAR § 17.207 is designed to ensure that a contracting officer exercises an option to fulfill existing needs, see FAR § 17.207( c )(2) (“The requirement covered by the option fulfills an existing Government need ....”), and that exercising the option presents the most cost effective manner of fulfilling that need, see FAR § 17.207(d) (“The contracting officer, after considering price and other factors, shall make the determination....”). The regulation does not proscribe the contracting officer from taking a particular action, rather it provides the Government with a mechanism for maintaining orderly business transactions. In particular, FAR § 17.207(f) serves as an internal operating procedure that requires a contracting officer to document the reasons for exercising the option and the procedural steps taken in doing so. FAR § 17.207(f) exists to ensure that the contracting officer acts in the best interest of the government; it therefore does not exist for the benefit of the contractor. Cf. Cessna, 126 F.3d at 1452 (holding that a regulation which prevented a contracting officer from obligating funds before they were appropriated constituted an internal operating procedure existing for the benefit of the government). Accordingly, we hold that, even if TACOM failed to comply with FAR § 17.207(f), it would not render the P00051 modification ineffective.

The part of the first sentence of FAR 17.207(f) that states: “the contracting officer shall make a written determination for the contract file that exercise is in accordance with the terms of the option,” serves merely to ensure that the CO complies with the common law rule. But even though FAR 17.202 makes FAR Subpart 17.2 inapplicable to some contracts, such as construction and research and development contracts, the common law rule still applies to them.

Bottom line: Except as provided by the express terms of the contract, e.g., a Changes clause, the Government cannot unilaterally change the terms of an option without the contractor’s assent.

FAR 17.207, "Exercise of options."

After reminding COs that they must exercise options in exact accord with their terms, FAR 17.207(f) goes on to remind COs of other conditions that must be met prior to the exercise of a contract option. You can read them for yourself, but I want to emphasize two:

(1) The exercise of the option must satisfy the requirements of FAR Part 6 with respect to full and open competition.

(2) The option must be exercisable in an amount stipulated in the contract or otherwise determinable from the contract terms.

The first reminds the CO that he or she must have complied with the Competition in Contracting Act (CICA) with respect to the option. The second is necessary for such compliance, because CICA requires that price be an evaluation factor in every CICA competition. A CO’s failure to comply with FAR 17.207 won’t excuse the contractor from performance, because FAR 17.207 was not written for the benefit of contractors. However, a bid protester can use such a failure as grounds to protest the exercise of an option. (Think of it this way: contractors complain about breaches of contracts; protesters complain about violations of regulations and solicitation terms.)

Questions at Wifcon Forum

As I said, the budget turmoil has caused some confusion about the exercise of options. Some of that confusion is reflected in a 14 November 2013 post to Wifcon Forum under the heading “FAR Clause 52.217-8 and -9”:

I was hoping to get some insight on the interpretation regarding the following statement, which was posted in one of the Army Contracting Directorate regarding FAR Clause 52.217-8 and 52.217-9:

In accordance with FAR Clause 52.217-8, Option to Extend Services, the contract may be extended, at the Government’s sole discretion, for a period of up to six (6) months, exercisable in increments of not less than one (1) month. If the contract contains an unexercised option period, the Government may elect to exercise the option pursuant to FAR Clause 52.217-9, Option to Extend the Term of the Contract, during any short-term extension. The short-term extension(s) shall be subtracted from the total duration of the immediately succeeding option period that may follow as a result of the exercise of the option pursuant to FAR Clause 52.217-9 so that the combination of the short-term extension(s) and the option will not exceed 12 months duration. [Emphasis added.] If the Government exercises one or more short term extensions in accordance with FAR Clause 52.217-8 and this instruction or an option period pursuant to FAR Clause 52.217-9, or any combination thereof, the contract as extended shall be deemed to include this extension instruction and FAR Clause 52.217-8; thus, the authority to extend services pursuant to FAR Clause 52.217-8 and this instruction may be exercised at the end of the base period and at the end of each option period.

Question: Can this be done? Excercising [sic] -9 and then cut it short and use -8?

The poster later explained:

[T]he situation is the result of the customer anticipation of not needing the services due to budget issues among other reasons. Anyways, we are at the point when we need to exercise the 2nd option period. Contracting office proposed we exercise -8 for 2-months and once customer confirms they need the service, -9 would be excercised [sic] following its respected [sic] period (PoP on option is idnetifed [sic] in Section F - 12-month periods).

As I interpret the post, the question is whether the Government can exercise the 52.217-8 option for two months and then the 12-month 52.217-9 option for 10 months.

The answer is no, unless the CO first modifies the 52.217-9 option with the contractor’s assent. Any attempt to exercise the 52.217-9 option for less than the stipulated 12 months would violate the common law of contracts and constitute a cardinal change -- a breach of contract -- which would entitle the contractor to refuse to perform or which would be handled as a constructive change entitling the contractor to an equitable adjustment, depending on which version of the Disputes clause, FAR 52.233-1, is in the contract. See FAR 33.213, “Obligation to continue performance.”

The fact that the 52.217-8 option plus a 10-month extension under the 12-month 52.217-9 option would equal 12 months is to no avail, because a 12-month 52.217-9 option stipulates performance for a period of 12 months and must be exercised in exact accord with its terms. The 52.217-8 option and the 52.217-9 option are different terms and presumably are under separate line items for the purposes of pricing and proposal evaluation. (According to the GAO, 52.217-8 options must be priced and the prices must be evaluated in order for exercise to be CICA-compliant. See Major Contracting Services, Inc., GAO Dec. B-401472, 2009 CPD ¶ 170 (Sep. 14, 2009), reconsid. denied, 2009 CPD ¶ 250 (Dec. 7, 2009).) One cannot combine the 52.217-8 option and the 52.217-9 option in order to satisfy the time requirement of the 52.217-9 option.

Perhaps some practitioners think that because paragraph ( c ) of the 52.217-9 option limits “the total duration” of the contract, that the 52.217-8 option cannot be used to extend the contract beyond that total duration. They reason that exercise of the 52.217-8 option prior to exercise of a 52.217-9 option requires that any excess time be deleted from the 52.217-9 option, justifying exercise of the 52.217-9 option for less than its stipulated period. To illustrate: Suppose that the Government has one remaining 52.217-9 option for a 12-month extension. According to paragraph ( c ) of the 52.217-9 clause, the total duration of the contract cannot go beyond the end of the final 52.217-9 option. Thus, if the Government exercises the 52.217-8 option first, for two months, then exercises the 52.217-9 option, it may do so for only 10 months. Not true. See the decision of the Court of Appeals for the Federal Circuit in Arko Executive Services, Inc. v. U.S., 553 F.3d 1375 (2009):

Arko argues first that the government's attempt to require services pursuant to FAR 52.217–8 after the fifth year of the contract exceeded the time limits of the contract. This argument is based on Arko's contention that FAR 52.217–9( c ), which states that “the total duration of this contract, including the exercise of any options under this clause, shall not exceed five years,” is an absolute bar to provision of services more than five years after the beginning of performance. This interpretation, however, ignores the phrase “including the exercise of any options under this clause.” The presence of this phrase suggests that the five-year limit includes the options discussed in the FAR 52.217–9 clause—which are the four one-year renewals discussed in F.4.1 and F.4.2—but does not include options to extend services, such as FAR 52.217–8, that are not under the clause.

More importantly, construing the up to six months of extended services authorized by FAR 52.217–8 as allowable in addition to the five years of performance under FAR 52.217–9( c ) is consistent with the purpose of FAR 52.217–8. According to another provision of the FAR:

Award of contracts for recurring and continuing service requirements are often delayed due to circumstances beyond the control of contracting offices. Examples of circumstances causing such delays are bid protests and alleged mistakes in bid. In order to avoid negotiation of short extensions to existing contracts, the contracting officer may include an option clause (see 17.208(f)) in solicitations and contracts which will enable the Government to require continued performance of any services within the limits and at the rates specified in the contract.

48 CFR § 37.111.

There is more to an option than the option clause, 52.217-8 or 52.217-9. The option clause merely states the terms for exercising the option. The option line item and other option terms of the contract, such as the specification or statement of work and the stipulation of the option performance period, are also part of the option. The option line item and other option terms must be read together with the option clause, and reading the line item and the clause together and applying the common law, a CO cannot exercise a 12-month option for 10 months, even if he or she exercises the 52.217-8 option for two months, because when it comes to exercising either option, they are different terms of the contract. A CO cannot read them together to arrive at a different interpretation of either of them than is clearly spelled out in the contract.

Any attempt to exercise an option based on terms different than those specified in the contract would constitute a counteroffer. The contractor can agree to or reject the counteroffer. However, if the contract agrees to accept the counteroffer, the CO will have conducted a sole source negotiation, which must be justified and approved in accordance with FAR Part 6. See Magnavox Electronic Systems Co., GAO Dec. B-231795, 88-2 CPD ¶ 431 (Nov. 2, 1988):

The FAR also provides that an agency may exercise an option only if the exercise accords with the terms of the option. FAR § 17.208(f). An agency is not permitted to negotiate with the awardee to reduce the option price stated in the contract if price competition for the option quantity is available. Varian Associates, Inc., B–208281, Feb. 16, 1983, 83–1 CPD ¶ 160, aff'd in relevant part sub nom Department of the Army—Reconsideration, B–208281.2, July 12, 1983, 83–2 CPD ¶ 78. [Footnote omitted.]

Presumably, the same would apply to any attempt to negotiate an option period of performance.

The solution to the problem posed in the original Wifcon Forum post would be to exercise the 12-month option and then terminate the contract for convenience if the requiring activity later decides that it does not need 12 months of services.

When Can COs Use The 52.217-8 Option?

A related matter that came up in the thread was whether the exercise of the 52.217-8 clause has to be consistent with the purposes stated in FAR 37.111, which states:

Award of contracts for recurring and continuing service requirements are often delayed due to circumstances beyond the control of contracting offices. Examples of circumstances causing such delays are bid protests and alleged mistakes in bid. In order to avoid negotiation of short extensions to existing contracts, the contracting officer may include an option clause (see 17.208(f)) in solicitations and contracts which will enable the Government to require continued performance of any services within the limits and at the rates specified in the contract. However, these rates may be adjusted only as a result of revisions to prevailing labor rates provided by the Secretary of Labor. The option provision may be exercised more than once, but the total extension of performance thereunder shall not exceed 6 months.

In other words, must the agency be in a tight spot in order to exercise the 52.217-8 option, or can it do so for its convenience? I think that the answer ought to be that an agency can exercise the option only when “circumstances beyond the control of contracting officers” delay award of a contract. But, as pointed out by Don Mansfield in one post in the thread, the Armed Services Board of Contract Appeals has ruled that regulatory purposes do not restrict the use of the 52.217-8 clause, since the clause says nothing about those purposes. See Griffin Services, Inc., ASBCA No. 52280, 02-2 BCA ¶ 31943 (Aug. 2, 2002).

In Griffin, the contract included the 52.217-8 option and some 52.217-9 options. It was badly priced and the contractor did not want the Government to exercise the 52.217-9 option. The CO failed to provide timely notice of intent to exercise, and the contractor refused to waive the deadline without a price adjustment. The CO then used the 52.217-8 clause to extend the contract for several months. The contractor filed a claim, arguing that the exercise of the option was not based on circumstances beyond the CO’s control. The board rejected that argument:

[T]he appellant seems to confuse what may have motivated the Government to provide for a standard clause extending contract services, and the expression of contractual intent which the language conveyed. As the Supreme Court has recently reminded in a unanimous opinion, when the Government enters the marketplace by way of contract and does business with its citizens, its rights and duties are governed generally by the law applicable to contracts between private individuals. Franconia Associates v. United States, 122 S. Ct. 1993, 2001 (U.S. 2002). Thus, we look to contract rules, not regulatory rules, for the interpretation of this clause.

The plain, objective, language of the Option to Extend Services clause is not limited as to the reasons for its use.

Conclusion

When Congress shut down the Government, it put at risk virtually every annual extension option in every Government contract, to the extent that those options could not be exercised in exact accord with their terms. COs punted, and it appears that everyone who did got away with it, at least as far as we know. But no CO should be deluded about the rules. The solution to such funding hiccups is not the wacky one proposed by the Army contracting director, but to write terms that would permit the CO to make unilateral adjustments to option terms in response to future funding delays and shutdowns.

When answering questions about the proper exercise of options, begin with the terms of the contract, which should include (1) the terms of the option itself (i.e., the offer to perform) and (2) the terms of the applicable contract clause, and then remember that COs must adhere to both the common law rules about options as well as the requirements of FAR Subpart 17.2 and FAR supplements.

For a general discussion of the legal issues associated with the exercise of options, see Nibley and Armstrong, The Government’s Exercise of Options, Briefing Papers (July 2013). It’s must-reading.




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