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Is the government's current philosophy to use liquidated damages (the stick) less and opt. for terms that reward (the carrot) contractor's performance?

I view liquidated damages as a clause to provide the Government monetary relief from a contractor's delayed or deficient performance through reasonable price adjustment under a stipulated contractual formula. It?s not supposed to be punitive. It is what it is. Also, I do not think it?s appropriate to use LDs as a carrot. IMO, those carrot instances (I feel like bugs bunny) could potentially create an acceleration issue. Regards.

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I agree with Charles...liquidated damages are used on a case-by-case basis to ensure the Government is adequately covered in the event that a contractor does not meet the terms and conditions of the contract with respect to delivery or period of performance. They should not be used to penalize a contractor.

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Guest Vern Edwards

Liquidated damages are a predetermined measure of the probable damages that the Government will suffer if the contractor breaches the contract. They are supposed to compensate the Government for the harm it suffers. They are not a price adjustment. See FAR 11.501(B).

I know of no change in policy.

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I have FAR 52.211-11 (Liquidated Damages) in a service contract where we may default. The blank line in paragraph (a) for amount of monetary damages is left blank, as the clause is incorporated by reference only. Is the clause null when not completed? FAR 52.249-08 (Default, Fixed Price) is also incorporated by reference. Is it usual for both clauses to be present?

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Is the government's current philosophy to use liquidated damages (the stick) less and opt. for terms that reward (the carrot) contractor's performance?

DFARS 236.270 discusses the prohibition in 10 USC 2858 for DoD to pay more to complete a project early, absent Agency Head approval. Thus the DoD can't offer a bonus or pay a bonus or direct the contractor to complete the project early if it will cost more, absent such approval.

I have seen though where our command within Army have included award fee provisions that would reward the contractor for proactive management of the project schedule to mitigate delays and other impacts to the schedule in order not to slip the completion date. These were for Army and Air force Projects of high importance that could not tolerate slippage.

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I believe the two clauses are mutually exclusive, since liquidated damages would still allow the contractor to complete the contract, albeit with some kind of penalty.

So yes, you could have both; but, for the liquidated damages clause, only if the Contracting Officer made the determination that the Government would be harmed in the event of untimely performance and was able to establish a F&R liquidated damages amount. If the Government was not going to suffer any measurable harm for the delayed performance, the clause should not be there.

Besides, how can one enforce a liquidated damages clause when there was no amount/rate/terms agreed to?

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  • 1 month later...
DFARS 236.270 discusses the prohibition in 10 USC 2858 for DoD to pay more to complete a project early, absent Agency Head approval. Thus the DoD can't offer a bonus or pay a bonus or direct the contractor to complete the project early if it will cost more, absent such approval.

I have seen though where our command within Army have included award fee provisions that would reward the contractor for proactive management of the project schedule to mitigate delays and other impacts to the schedule in order not to slip the completion date. These were for Army and Air force Projects of high importance that could not tolerate slippage.

This prohibition applies only to contracts funded by a Military Construction Appropriations Act. It seems to me that if you have another kind of contract, and you want to use a "carrot and stick," you should see if you can find an appropriate incentive plan. For instance, if you have an FFP-type contract for, say, commercially-available body armor, and timely delivery is of the essence of the contract (i.e., the Government really means it this time), you can use delivery incentives pursuant to FAR 16.402-3. (See also, e.g., Fixed-Price Contracts with Economic Price Adjustment (FAR 16.203-1(B); Fixed-Price Incentive Contracts (FAR 16.204); Cost-Plus-Incentive-Fee Contracts (FAR 16.304).)

Here's my question, though: if you use delivery incentives IAW FAR 16.402-3(a), does that mean you can apply both positive (i.e., give something) and negative (i.e., take something) incentives? (C.f. FAR 16.402-3(B), requiring incentive arrangements to specify the application of a "reward-penalty structure" in the event of delays beyond the contractor's control.) My reading is, yes! Provided there is a "carrot" incentive, and you can also have a "stick" incentive. The issue I have (and hence my question) which such "negative" delivery incentives is that a negative delivery incentive is essentially a penalty for late delivery.

Does this mean that penalties are cool (shock!) as long as the incentive structure also contemplates a reward?

~Sully

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Guest Vern Edwards

The prohibition against penalties is a prohibition against punitive damages for breach of contract. Penalties are not cool. A positive/negative delivery incentive might work like this:

Delivery date: Mar 1, Price: $1,030,000

Delivery date: Apr 1, Price $1,020,000

Delivery date: May 1, Price $1,010,000

Delivery date: Jun 1, Price: $1,000,000

Delivery date: Jul 1, Price: $990,000

Delivery date: Aug 1, Price $980,000

Delivery date: Sep 1, Price $970,000

Delivery on Sep 1 would be acceptable. Delivery after Sep 1 would be breach (default).

I do not recommend this. I'm only showing how it might work.

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Mr. Edwards -

Thank you for your post and your example; however, I still have three points which require further clarification.

My first point in response is that a "negative delivery incentive," as I outlined the concept in my earlier post, would not be "punitive damages." The "negative delivery incentive" would be agreed-upon by the parties at the time of contract and amounts to a formulaic reduction in price, up to a stipulated maximum, for untimely delivery in exchange for the implied promise that the Government will not immediately terminate for default, at least not until the reduction in price reaches the max. The "punitive damages" are intended to penalize the Contractor for its failure to perform, the amount of which could be either determined by formula or expressly stated; such damages are assessed after termination by default for Contractor's failure to deliver on time, and throughout my course of studies I have never seen a common-law court or tribunal uphold such a penalty (although they seem to be very popular in many civil law systems). The negative delivery incentive, though seemingly a penalty at first glance, is in fact an agreement by the parties that, in the event of late delivery, the total price would be reduced at a rate established by the parties at the time of contract; the positive delivery incentive is the opposite, an agreement by the parties that early delivery would increase the total price at a party-established rate.

This brings me to my second point: your example seems only to contain positive delivery incentives (i.e., bonuses for early delivery on top of the $970,000 price for timely delivery). There do not seem to be any negative incentives; just decreased positive incentives. Perhaps my problem (as I suspect) is that I don't know what a "negative delivery incentive" is.

It seems to me that a "reward-penalty structure" suggests a sort of "sliding-price delivery-incentive" structure that would use positive incentives (bonuses) for early delivery (up to a stipulated max) and negative incentives (reductions in price; penalties, if you insist) for late delivery (up to a stipulated max, at which point the contract is terminated for default with no penalties assessed pursuant thereto; however, because the Government waited until the stipulated max before terminating the contract for default, the Contractor would still be obligated to pay the maximum amount required by the delivery incentive structure). If such a thing is not a "negative delivery incentive," then what is a negative delivery incentive?

My third point is that your example does not seem to directly apply to my FFP hypothetical. Although I noted that a reward-penalty delivery-incentive structure is available for contract types other than FFP, my example of an acquisition for commercially-available body armor was an FFP contract with delivery incentives. So, to be responsive, the example you gave of positive delivery incentives should be:

Delivery date: Mar 1, Price: $970,000 (plus $60,000 incentive);

Delivery date: Apr 1, Price: $970,000 (plus $50,000 incentive);

Delivery date: May 1, Price: $970,000 (plus $40,000 incentive);

Delivery date: Jun 1, Price: $970,000 (plus $30,000 incentive);

Delivery date: Jul 1, Price: $970,000 (plus $20,000 incentive);

Delivery date: Aug 1, Price: $970,000 (plus $10,000 incentive); and

Delivery date: Sep 1, Price: $970,000. Now, for the sake of argument, I will include the negative delivery incentives (applied by the Government in lieu of terminating for default, up to a stipulated maximum which I set at the inverse of the positive incentive amounts but over a shorter amount of time, roughly two weeks):

Delivery date: Sep 3, Price: $970,000 (minus $10,000 incentive);

Delivery date: Sep 5, Price: $970,000 (minus $20,000 incentive);

Delivery date: Sep 7, Price: $970,000 (minus $30,000 incentive);

Delivery date: Sep 9, Price: $970,000 (minus $40,000 incentive);

Delivery date: Sep 11, Price $970,000 (minus $50,000 incentive); and

Delivery date: Sep 13, Price $970,000 (minus $60,000 incentive). After this point, the Government terminates for default; the "grace period" is over.

I know you do not like the Q/A grilling-sessions, so please feel free to put a stop to this if you feel this is going that way. If anyone else has any helpful suggestions, I would be immensely appreciative. I am embarrassed to admit that I was unable to find a case on-point; there were lots of cases about liquidated damages clauses being misused to create de facto penalties, but none about the use of a reward-penalty structure consisting of positive/negative delivery incentives.

~ Sully

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Guest Vern Edwards
Mr. Edwards -

My first point in response is that a "negative delivery incentive," as I outlined the concept in my earlier post, would not be "punitive damages."

I understood what you were saying. What you are talking about is not new. Negative incentives and the distinction between them and liquidated damages and penalties have been discussed for many years.

This brings me to my second point: your example seems only to contain positive delivery incentives (i.e., bonuses for early delivery on top of the $970,000 price for timely delivery). There do not seem to be any negative incentives; just decreased positive incentives. Perhaps my problem (as I suspect) is that I don't know what a "negative delivery incentive" is.

I should have made it clear that the stipulated firm-fixed-price price would be $1,000,000. The CO would obligate $1,000,000. Delivery on September 1 would not be considered late. Now it should be clear that there are both positive and negative incentives in my example.

It seems to me that a "reward-penalty structure" suggests a sort of "sliding-price delivery-incentive" structure that would use positive incentives (bonuses) for early delivery (up to a stipulated max) and negative incentives (reductions in price; penalties, if you insist) for late delivery (up to a stipulated max, at which point the contract is terminated for default with no penalties assessed pursuant thereto[.]

Emphasis on "for late delivery" added. Now you've got a problem. Under an FFP supply contract, why would you pay anything if the contractor defaults? Both positive and negative incentives have to be for acceptable performance. If performance is unacceptable, then there should be no incentive, positive or negative. Don't attach negative incentives to unacceptable performance.

[H]owever, because the Government waited until the stipulated max before terminating the contract for default, the Contractor would still be obligated to pay the maximum amount required by the delivery incentive structure). If such a thing is not a "negative delivery incentive," then what is a negative delivery incentive?

I don't understand that. What do you mean by "the Contractor would still be obligated to pay"?

So, to be responsive, the example you gave of positive delivery incentives should be:

Delivery date: Mar 1, Price: $970,000 (plus $60,000 incentive);

Delivery date: Apr 1, Price: $970,000 (plus $50,000 incentive);

Delivery date: May 1, Price: $970,000 (plus $40,000 incentive);

Delivery date: Jun 1, Price: $970,000 (plus $30,000 incentive);

Delivery date: Jul 1, Price: $970,000 (plus $20,000 incentive);

Delivery date: Aug 1, Price: $970,000 (plus $10,000 incentive); and

Delivery date: Sep 1, Price: $970,000. Now, for the sake of argument, I will include the negative delivery incentives (applied by the Government in lieu of terminating for default, up to a stipulated maximum which I set at the inverse of the positive incentive amounts but over a shorter amount of time, roughly two weeks):

Delivery date: Sep 3, Price: $970,000 (minus $10,000 incentive);

Delivery date: Sep 5, Price: $970,000 (minus $20,000 incentive);

Delivery date: Sep 7, Price: $970,000 (minus $30,000 incentive);

Delivery date: Sep 9, Price: $970,000 (minus $40,000 incentive);

Delivery date: Sep 11, Price $970,000 (minus $50,000 incentive); and

Delivery date: Sep 13, Price $970,000 (minus $60,000 incentive). After this point, the Government terminates for default; the "grace period" is over.

That scheme is very bad. What you would create is a schedule of deductions for "late" delivery up to September 13, and you're calling the period running from September 3 to September 13 a "grace" period. What is that "grace period"? Is the contractor in default or isn't it? Do you mean period of forbearance? If you don't write that up carefully, a reader of the contract might consider your "grace" period to be a waiver of the delivery date. The schedule of deductions might or might not be enforceable, depending on how you explain it and write it up in the contract. A court might find it to be nothing more than an unenforceable penalty scheme that is not linked in any way to the government's damages. If you are going to consider anything after September 1 to be "late" delivery (breach? default?), then my advice is to not apply a "negative incentive" to that period of time.

In the August 1997 edition of The Nash & Cibinic Report, Prof. Cibinic wrote an article entitled, "Performance-Based Service Contracting: Negative Incentives -- Liquidated Damages, Penalties, or Both?", 11 N&CR ? 40. Here is part of what he said:

A provision whereby the parties agree on an amount or a formula by which the contract price is to be adjusted downward in the event that contract goals are not achieved could be a ?negative performance incentive,? a ?Liquidated Damages? clause, or a penalty. All three have the same goal--to motivate a promisor to perform as promised. However, only the former two are enforceable. A long-standing rule of common law is that the courts (or boards of contract appeals) will not enforce contractual penalties. The terminology used by the parties is not determinative of whether the provision will be enforced. The courts and boards will look to the substance of the provision to determine whether a penalty is involved.

He then went on to provide a "primer" on liquidated damages and to discuss some examples taken from performance work statements. In the November issue, Prof. Nash said:

Let's get very basic. Performance incentives are of two types: (1) variable incentives for varying levels of performance and (2) bonuses for achieving the result called for by the contract and penalties for not achieving that result...

The second type of performance incentive--the bonus or penalty--is a different animal...

[A]s John pointed out in Performance-Based Service Contracting: Negative Incentives--Liquidated Damages or Penalties?, 11 N&CR ? 40, these types of penalties beg to be challenged as being legally invalid.

Bottom line: If you provide for price reductions for "late" delivery, you'd better be careful how you explain what you're doing.

It is unfortunate that the term "negative incentives" ever came into use, because it confuses people. "Positive and negative" should be nothing more than a sliding scale of payment for varying degrees of acceptable performance. A "negative" incentive is not and should not be a remedy for unacceptable performance. If I were running a procurement office today, I would not permit the use of a "negative incentive" for late delivery. In fact, I would forbid use of the term "negative incentive" in acquisition plans and contracts.

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