ShawnT

Performance-based payments law vs. reg

9 posts in this topic

10 USC 2307 (b) (2) states "Performance-based payments shall not be conditioned upon costs incurred in contract performance but on the achievement of performance outcomes listed in paragraph (1)."  

DFARS 252.232-7012 Performance-Based Payments–Whole-Contract Basis has a table that is to be completed for supporting data.  Item (2) requests "Total costs incurred to date;"  

Can anyone offer a rationale why the DFARS require this information when the statute prohibits the use of it?

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DoD has been ignoring the FAR, the statute, and the express direction from Congress for years.

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On 4/21/2017 at 8:58 AM, ShawnT said:

10 USC 2307 (b) (2) states "Performance-based payments shall not be conditioned upon costs incurred in contract performance but on the achievement of performance outcomes listed in paragraph (1)."  

DFARS 252.232-7012 Performance-Based Payments–Whole-Contract Basis has a table that is to be completed for supporting data.  Item (2) requests "Total costs incurred to date;"  

Can anyone offer a rationale why the DFARS require this information when the statute prohibits the use of it?

here_2_help may be correct that DOD is ignoring the FAR, the statute, and Congress, but that is not why DFARS 252.232-7012 asks for total costs incurred to date.

The clause prescribes a procedure for calculating a performance-based payment as follows, starting with this:

Quote

At no time shall cumulative performance-based payments exceed cumulative contract cost incurred under this contract. To ensure compliance with this requirement, the Contractor shall, in addition to providing the information required by FAR 52.232-32, submit supporting information for all payment requests using the following format

Emphasis added.

The clause then prescribes a calculation:

1a. State the negotiated value of all previously completed performance-based payment(s) event(s);

1b. State the negotiated value of the current performance-based payment(s) event(s);

1c. State the cumulative negotiated value of performance-based payment(s) events completed to date (1a) + (1b);

2. State the total costs incurred to date;

3. State the amount from (1c) or (2), whichever is less;

4. State the cumulative amount of payments previously requested; and

5. Determine the payment amount requested for the current performance-based payment(s) event(s) (3) - (4)d

In other words, the performance-based payment is to be:

a. the difference between the negotiated value of the performance based payment events completed to date and the amounts previously requested

or

b. the difference between the total costs incurred to date and the amounts previously requested, whichever is less.

Why whichever is less? See DFARS 232.1001:

Quote

(a)  As with all contract financing, the purpose of performance-based payments is to assist the contractor in the payment of costs incurred during the performance of the contract. Therefore, performance-based payments should never exceed total cost incurred at any point during the contract.

Emphasis added.

Thus, as quoted above, the clause says: "At no time shall cumulative performance-based payments exceed cumulative contract cost incurred under this contract." That limitation does not violate the statute or FAR.

Performance based payments are contract financing, but are not advance payments, which are given before performance. That's why the statute does not allow the determination of a performance based payment based on incurred cost, because incurred cost is not necessarily commensurate with performance. If the contractor is overrunning, a performance based payment calculated on the basis of incurred cost might not, in fact, reflect performance. It would be in advance of performance. However, the statute does not say that you cannot limit a performance based payment to incurred cost when the contractor is underruning. Such a limitation is consistent with the concept of payment based on performance. 

That is why DFARS asks for incurred costs.

 

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Vern,

I am afraid that I do not follow the logic.  I am hung up on the language of the clause that states "(b)(i) At no time shall cumulative performance-based payments exceed cumulative contract cost incurred under this contract."  The statute states that "Performance-based payments shall not be conditioned upon costs incurred in contract performance".  Black's Law defines condition as "A clause in a contract or agreement which has for its object to suspend, rescind, or modify the principal obligation."  The negotiated payment amount is modified when the amount paid is limited to incurred costs irrespective of the negotiated amounts.   Thus, my concern that the DFARS clause is contrary to the plain language of the statute.  

Additional review raises more issues. FAR 32.1001(e) prohibits the use of performance-based payments for cost-reimbursement line items and since the DFARS clauses do not expressly reject this, I assume that it is a restriction followed by DoD COs and is only applied to FFP type contracts.  DFAR 252.232-7012 Performance-Based Payments–Whole-Contract Basis (a)  states "Performance-based payments shall form the basis for the contract financing payments provided under this contract, and shall apply to the whole contract."  A contract will identify a final achievement of acceptance or a similar performance based finishing point.  Can a contractor rely on the definition of contract financing payment in FAR 32.001 that says such payments end before acceptance to get a final payment that is not limited to costs incurred despite the clause applying to the whole contract?  If so, how does the -7012 clause adjust the final payment if the contractor has underan the FFP contract?  

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ShawnT,

I think you cut your definition search a word short - look up the definition of the term "conditioned upon" and think about how that term is distinct from a limitation.  Then I'm confident you'll understand the difference/nuance and Vern's logic.

Edit: Even alternative definitions of "conditioned" might be worth considering, such as American Heritage Dictionary's (https://ahdictionary.com/word/search.html?q=condition)

Conditioned: To make dependent on a condition or conditions: Use of the cabin is conditioned on your keeping it clean.

The PBPs are dependent on performance outcomes, but limited by actual costs incurred.

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Well, Shawn, I'm glad that you made your last post. My first response to you was based on the final rule in the Federal Register of March 31, 2014, 79 FR 17931, which is when DOD added the incurred cost ceiling in DFARS 252.232-7012. Here, in part, are DOD's responses to comments about the rule:

Quote

Comment: One respondent claimed that the rule effectively converts fixed-price contracts into cost-type contracts by focusing on incurred cost as opposed to completion of a subset of fixed price tasks.

DoD Response: This rule does not convert fixed-price contracts with PBPs into cost-type contracts. The rule merely provides a tool for determining a mutually beneficial financial arrangement using performance-based payments. The focus on incurred costs simply provides a check to prevent the contract from being in an advance payment scenario.

Here is another:

Quote

Comment: One respondent stated that the rule effectively eliminates contractor incentives to perform early and below anticipated costs, and in essence treats PBPs as a form of cost-type, not-to-exceed interim payment because it implements a policy that states: “At no time will cumulative performance-based payments exceed cumulative costincurred on this contract.”

DoD Response: PBPs are a form of contract financing and not incentive payments. FAR 32.1004(a)(2)(iv) specifically states: “Because performance-based payments are contract financing, events or criteria shall not serve as a vehicle to reward the contractor for completion of performance levels over and above what is required for successful completion of the contract.” PBP financing that provides the contractor the opportunity to receive payments up to 100% of cost incurred, so long as they are less than 90% of the contract price, can be considerably more advantageous than customary progress payments, which cannot exceed 80% of costs incurred (or 85% of costsincurred for small businesses). The DoD PBP analysis tool will enable both sides to determine the financial value of the improved cash flow provided by PBPs on a given contract.

And another:

Quote

Comment: A number of respondents expressed concern with limitation of performance-based payments to only costs incurred. The respondents believe that this limitation reduces or eliminates the incentive to use performance-based payment financing arrangement and therefore shifts favor to progress payments. The incurred cost limitation eliminates the certainty that a contractor has in obtaining an agreed-to PBP milestone price, and concentrates on a contractor's incurred cost profile which shifts focus from performance and delivery to cost incurred in association to a milestone.

DoD Response: PBPs are a form of contract financing and not incentive payments. FAR 32.1004(a)(2)(iv) specifically states: “Because performance-based payments are contract financing, events or criteria shall not serve as a vehicle to reward the contractor for completion of performance levels over and above what is required for successful completion of the contract.” Furthermore, FAR 32.1004(b)(3) states that the contracting officer shall ensure that “Performance-based payment amounts are commensurate with the value of the performance event or performance criterion, and are not expected to result in an unreasonably low or negative level of contractor investment in the contract.” These requirements limit the PBP payments to only costs incurred. However, PBP financing that provides the contractor the opportunity to receive payments up to 100% of cost incurred (so long as they are less than 90% of the contract price) can be considerably more advantageous than customary progress payments, (which cannot exceed 80% of costs incurred or 85% of costs incurred for small businesses). The DoD PBP analysis tool will enable both sides to determine the financial value of the improved cash flow provided by PBPs on a given contract. PBPs require the contractor to successfully complete a PBP event in accordance with the completion criteria specified in the contract before being paid. Therefore, the contractor's focus will be on successfully performing those events in a prompt and efficient manner. Since the purpose of all contract financing is to assist the contractor in paying the contract cost incurred during contract performance, and given that in accordance with FAR 32.104(a), contract financing is intended to be provided “only to the extent actually needed for prompt and efficient performance,” the proposed rule appropriately links PBPs with cost incurred to ensure that financing is not provided to a greater extent than intended by the FAR.

So what about 10 U.S.C. § 2307(b)(2), which states:

Quote

Performance-based payments shall not be conditioned upon costs incurred in contract performance but on the achievement of performance outcomes listed in paragraph (1).

It turns out that the above sentence was added to 10 USC 2307 by the National Defense Authorization Act of 2017, P.L. 114-328, December 23, 2016, about four months ago and more than two years after DOD promulgated the incurred cost limitation in March 2014.

So is there a conflict between the DFARS and the statute? Yes. You were right about that, and I was wrong. I assumed that the sentence was in the statute when DOD promulgated the incurred cost rule and that the rule reflected DOD's interpretation of the statute. That was not the case. Stupid of me. I know better. Thank you for insisting.

As you can see from the comments in the Federal Register, my explanation for DOD's rationale was correct--the idea behind the incurred cost limitation was to prevent performance-based payments from becoming advance payments, and DOD did not violate any statute when it imposed the rule. But my assumption about DOD's interpretation of the statute was unfounded. There was no apparent conflict in the statute for them to interpret when they issued the incurred cist rule. It appears that industry complained about the rule to Congress and Senator McCain (or someone else) agreed with them and added the sentence to the statute, ostensibly to override DOD's incurred cost limitation. I'm still researching the legislative history in an effort to understand what prompted the change and its specific intent.

I have checked, and DOD has not issue a proposed rule to change the DFARS. We'll have to wait to see what they're going to do. It's going to take them a while to work through all the new rules required by P.L. 114-328.

BTW, if any reader is a Westlaw user, Westlaw's text for 10 USCA 2307(b)(2) is incorrect. It says: "Preference for performance-based payments shall not be conditioned upon costs incurred in contract performance but on the achievement of performance outcomes listed in paragraph (1)." The phrase "Preference for" is not in the actual statute. I verified this through comparisons with the public law and other sources for the code, including the U.S. House of Representatives site.

Thanks, Shawn, for pursuing the issue. It prompted me to do some interesting research.

For what it's worth, I think DOD's policy is sound and consistent with the original intent behind PBP, but the law is the law. I think DOD can insist on compliance with the current clause if it's already in a contract, but I do not think that DOD can do so under contracts solicited and awarded after the effective date of the statute.

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Vern and ShawnT,

I don't think this issue is that clear - conceivably, valid arguments could be made on either side based on which definitions are chosen.  For instance, let's consider that the language in 10 USC 2307(b) says nothing about performance based payment amounts - it uses the term "performance based payments," which based on the following definition of payment, could mean the issuance of the PBP:

Quote

PaymentThe act of paying or the state of being paid.

That definition along with the alternative definitions of "conditioned upon" or "condition" would be consistent with an interpretation that the PBP criteria governing when a payment shall be issued cannot be tied to costs incurred, but the amount expended can still be limited by costs incurred to avoid unintended advance payments.

Vern makes an interesting assumption that industry lobbied for the change which may very well be true; however, could it also be possible that there was a push within the Government to be more restrictive and/or explicit that PBP criteria cannot be tied to costs incurred based on misuse by agencies?

Despite the differing interpretations, I'm inclined to believe my original position for now (despite a much more experienced/educated individual disagreeing with me) because payment amounts receives its own paragraph at 10 USC 2307( c ).  That would be the natural place for any language consistent with ShawnT's interpretation of the law and the language currently there does not prohibit the DoD from being more restrictive by limiting the PBP amounts to no more than the costs incurred.

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Matthew:

Some history. In 2004 DPAP sought public comments about performance based payments. See 69 FR 54651,  September 9, 2004. In 2005 it published its responses. 70 FR 32306, June 2, 2005. One comment complained about the use of an incurred cost ceiling by some offices. Here is DPAP's response:

Quote

D. Lesser of Cost and Performance Payment

Comment: One respondent states that FAR 32.1002 sets forth the basis or bases upon which performance-based payments might be made, none of which involve cost. There are instances where contract provisions have been included where performance-based payments are limited to the lesser of a specified performance-based payment schedule amount or incurred costs. The respondent asserts that this is inconsistent with the intent of performance-based payments.

 DPAP Response: The benefits of performance-based payments are significantly reduced when there is a requirement to use the lesser of cost or the value of the performance payment. DPAP has recommended that this issue be addressed as part of the FAR case to review/revise the current FAR coverage on performance-based payments.

So in 2005, DPAP appears to have been opposed to an incurred cost ceiling.

Then, in 2013, the DOD IG published a 51 page report entitled, Award and Administration of Performance Based Payments in DOD Contracts, Report No. DODIG-2013-063, April 8, 2013. The report was very critical of DOD administration of PBP and said that DOD was being unnecessarily generous by providing more "financing" than contractors needed in light of their incurred costs. See the report, pages 26 - 28. The following comment appeared on page 11:

Quote

The Director, Defense Pricing, should direct DoD contracting personnel to review all open PBP contracts to verify that the PBP amounts fairly represent the event values. If the PBP amounts are significantly higher than the contractor’s costs or engineering estimates, contracting personnel should consult their legal advisors to consider available corrective actions, including renegotiating the PBP values to ensure that they are not providing advance payments.

In 2014, DOD instituted the incurred cost ceiling, as I described in an earlier post, quoting the agency's explanations.

In it's 2005 response to public comments, DOD had said:

Quote

Performance-based payments generally require more up-front work than progress payments. However, this is offset by the reduced administrative effort that results from the elimination of cost verifications. In addition, performance-based payments increase competition, since some commercial firms do not have accounting systems that are acceptable for progress payments. As such, performance-based payments should continue to be the preferred method of financing.

But in its 2014 rule, DOD reported these comments and responses:

Quote

A. Adequate Accounting System

Comment: One respondent requested clarification on whether the proposed rule requires an accounting systemdeemed adequate by the Government.

DoD Response: FAR 32.1007(c) requires the contracting officer to determine the adequacy of controls established by the contractor for the administration of performance-based payments. Since the contractor will be required to report total cost incurred to date based on its existing accounting system, the contracting officer must consider the adequacy of the contractor's accounting system for providing reliable cost data. DFARS 232.1003-70, Criteria for use, is added to require contracting officers to consider the adequacy of an offeror's or contractor's accounting system prior to agreeing to use performance-based payments.

B. Administratively Burdensome and Costly

Comment: One respondent requested clarification regarding in what manner contractors will be required to verify, or otherwise state, total costs incurred.
 
DoD Response: Each request for a PBP will require the contractor to provide two dollar values: Cumulative value of PBPs completed to date and total cost incurred to date. For DoD verification purposes, the final rule includes the requirement for the contractor to provide access, upon request of the contracting officer, to the contractor's books and records, as necessary, for the administration of the clause.
 
Comment: One respondent stated a concern that the proposed rule will result in increased costs for small businesses and prevent them from competing due to the adequate business system requirement.
DoD Response: Small business will not be at a competitive disadvantage whether or not they decide that a performance-based payment funding arrangement is in their best interest. Contractors are not obligated to negotiate or accept a performance-based payment financing arrangement. However, just as with any other form of Government-provided contract financing, there will be some form of requirement for contractor business systems to substantiate the incurrence of the costs to support the contract financing payments and to protect the Government's interests. A decision not to pursue performance-based payments will not be held against any offeror in a competitive source selection.
 
The rule amended DFARS 232.1003-70 to add the following:
 
Quote

The contracting officer will consider the adequacy of an offeror's or contractor's accounting system prior to agreeing to use performance-based payments.

As for the addition of 10 U.S.C. 2307(b)(2), the following appears on page 214 of the Senate Armed Services Committee report accompanying P.L. 114-328:

Quote

The committee is disappointed in the movement of the Department to a greater reliance on cost-type contracts, progress payments, and the need for incurred cost audits performed by the Defense Contract Audit Agency that is currently woefully behind in many of its audit objectives. It was a desire to focus on achieving better outcomes for the taxpayer and reduce the unnecessary bureaucracy and compliance burden that Congress established in the Federal Acquisition Streamlining Act of 1994 (Public Law 103–355) the option of using a more commercial payments process known as performance based payments. These payments would be targeted against achievable goals and metrics rather than merely the expenditure of dollars associated with progress payments. While the Federal Acquisition Regulation in FAR 32.1001 establishes performance based payments as the preferred Government financing mechanism, the Department has become even more focused on measuring cost as an output rather than focusing on measuring outcomes for the taxpayer and rewarding contractors for meeting those performance objectives. This provision re-establishes the policy objective.

Ultimately, Section 831 of P.L. 114-328, which was inserted in the legislation as proposed by the Senate, amended 10 U.S.C. § 2307 as follows:

Quote

SEC. 831. PREFERENCE FOR PERFORMANCE-BASED CONTRACT PAYMENTS.

(a) IN GENERAL.—Section 2307(b) of title 10, United States Code, is amended—

(1) in the subsection heading, by inserting ‘‘PREFERENCE FOR’’ before ‘‘PERFORMANCE-BASED’’;

(2) by redesignating paragraphs (1), (2), and (3) as subparagraphs (A), (B), and (C), respectively;

(3) by striking ‘‘Wherever practicable, payment under subsection(a) shall be made’’ and inserting ‘‘(1) Whenever practicable, payments under subsection (a) shall be made using performance-based payments’’; and

(4) by adding at the end the following new paragraphs:

‘‘(2) Performance-based payments shall not be conditioned upon costs incurred in contract performance but on the achievement of performance outcomes listed in paragraph (1).

‘‘(3) The Secretary of Defense shall ensure that nontraditional defense contractors and other private sector companies are eligible for performance-based payments, consistent with best commercial practices.

‘‘(4)(A) In order to receive performance-based payments, a contractor’s accounting system shall be in compliance with Generally Accepted Accounting Principles, and there shall be no requirement for a contractor to develop Government-unique accounting systems or practices as a prerequisite for agreeing to receive performance based payments.

‘‘(B) Nothing in this section shall be construed to grant the Defense Contract Audit Agency the authority to audit compliance with Generally Accepted Accounting Principles.’’.

 (b) REGULATIONS .—Not later than 120 days after the date of the enactment of this Act, the Secretary of Defense shall revise the Department of Defense Federal Acquisition Regulation Supplement to conform with section 2307(b) of title 10, United States Code, as amended by subsection (a).

In conclusion, based on the foregoing, I think that it is reasonable to conclude that it was the intent of Congress to eliminate or at least modify DOD's incurred cost ceiling policy.

DPAP has opened DFARS Case 2017-D019, "Performance-Based Payments." A report is due on May 17. I don't know what they intend to do.

I have spent all the time on this that I am going to spend. In any case, it appears that ShawnT has left the building.

 

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