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Termination For Default--Consideration

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Note: The question below was posted on the blog section by member TWorthington. I've transferred it here for him:

"In college, I learned that if a contract (not necessarily a federal contract) is defaulted on, there must be something of value given from the defaulting party to the other party (the party that was wronged). However, in reading a post by Vern Edwards that directed me to Administration of Government Contracts, I understood that it is up to the contracting officer whether to require consideration if, for example, the delivery date is not met. However, I have heard from my peers that even though consideration is often not required, it should always be required if the contractor does not deliver on time. Can anyone definitively clear this up for me? The posts by Vern Edwards and others are not 100% clear on this matter.

My specific situation is this: a contractor had to purchase new equipment to fulfill the contract, and the equipment was delivered late. The delivery to the government will be 3 weeks late. Once the item (which was repaired and rejuvenated for around $30,000) is delivered to the government, it will sit in our warehouse room for another month or two before it can be reinstalled. Should I require consideration? Am I required to seek consideration? Because of the relative small price tag, even $500 would be a significant hit to the contractor?s profit margin. Thank you."

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Guest Vern Edwards
Note: The question below was posted on the blog section by member TWorthington. I've transferred it here for him:

"In college, I learned that if a contract (not necessarily a federal contract) is defaulted on, there must be something of value given from the defaulting party to the other party (the party that was wronged). However, in reading a post by Vern Edwards that directed me to Administration of Government Contracts, I understood that it is up to the contracting officer whether to require consideration if, for example, the delivery date is not met. However, I have heard from my peers that even though consideration is often not required, it should always be required if the contractor does not deliver on time. Can anyone definitively clear this up for me? The posts by Vern Edwards and others are not 100% clear on this matter.

My specific situation is this: a contractor had to purchase new equipment to fulfill the contract, and the equipment was delivered late. The delivery to the government will be 3 weeks late. Once the item (which was repaired and rejuvenated for around $30,000) is delivered to the government, it will sit in our warehouse room for another month or two before it can be reinstalled. Should I require consideration? Am I required to seek consideration? Because of the relative small price tag, even $500 would be a significant hit to the contractor?s profit margin. Thank you."

TWorthington: I don't know which of my alleged posts you are talking about and I don't know who the "others" are that you mentioned. I don't what I supposedly said or the context in which I supposedly said it. I will assume from your question that you are new to government contracting.

Untimely delivery without a legally viable excuse is a breach of contract (default). Under the American common law of contracts, which applies to government contracts, if a party to a contract (the seller) materially breaches that contract without a legally viable excuse, the other party (the buyer) is freed of its obligations to the seller and is entitled to compensation for its damages. Thus, the buyer need not pay for any late-delivered goods and can recover any damages that it has suffered.

The buyer has a choice, however. It does not have to seek damages in court. It has options. It could negotiate a new bargain and modify the contract--e.g., agree to a later delivery date in exchange for a reduced price. Or it could simply waive the default, accept the late-delivered goods, and pay the original price. If the buyer decides to negotiate a new delivery date and modify the contract, the common law requires that he or she obtain something of value in return in order to seal the deal. In our legal system, that something of value is called "consideration." The law does not say what or how much the buyer must seek. It is enough that the buyer thinks that whatever it gets in return for the time extension is valuable. If the buyer decides to waive the breach and pay the original price for the late-delivered goods it will in theory have paid more than the late-delivered goods are worth and will be giving money away, since the original price was predicated upon timely delivery. But that's okay with the law if it's okay with the buyer--a buyer is free to give its money away.

Now suppose a government contractor fails to deliver on time and does not have an excuse. (See FAR 52.249-8( c) and (d) about defaults by subcontractors.) The CO can (a) terminate for default and seek damages, (B) negotiate a new delivery date in return for a lower price or for something else of value and modify the contract to that effect, or ( c) waive the late delivery and pay the original price.

If the CO decides to negotiate a new delivery date and modify the contract, then he or she is required by our legal system to obtain something of value, called "consideration," in return for the time extension. See Cibinic and Nash, Formation of Government Contracts 3d, 248 - 49:

The requirement for consideration flowing to the Government is supported not only by the common-law rules but also by the rule that Government officials generally do not have the authority to give up vested rights of the Government without receiving consideration. Simpson v. United States, 172 U.S. 372 (1899). See also Aviation Contractor Employees, Inc. v. United States, 945 F.2d 1568 (Fed. Cir. 1991); Metzger, Shadyac & Schwartz v. United States, 12 Cl. Ct. 602 (1987); and Joseph Packard's Sons Co., ASBCA 13585, 73-1 BCA ? 10,026. The major exception to this rule is P.L. 85-804, 50 U.S.C. ?? 1431-35, which authorizes executive agencies to make or amend contracts without consideration when to do so would facilitate the national defense. See FAR Part 50.

* * *

Cases in which consideration is not present may arise under different fact situations... In Government contracts this most often occurs when the Government modifies a contract to benefit the contractor but receives no additional or different promise or performance in return.

Do you understand? The common law of contracts and judicial precedent about the authority of public officials requires that the CO get something in return for extending the delivery date through contract modification. Is that 100 percent clear to you now?

There is no rule about the form or quantity of the consideration. All that is required is that the government consider it to be of value. The law does not require that the value of the consideration received by the government be commensurate with the value to the contractor of the time extension. The nature and amount of consideration is up to the CO. If the CO offers the contractor a later delivery date, then the contractor's return offer of a lower price is the consideration needed to bind the parties. The consideration need not be a price reduction. It could be something else of value to the government.

If the CO decides to accept an offer of a lower price in return for later delivery, how much of a price reduction should the CO seek? The answer is: enough to ensure that the price for the new delivery date is fair and reasonable. If the CO decides to accept an offer of something else in exchange for later delivery at the original price, then the CO must ensure that the price is fair and reasonable for the original goods at the later date plus whatever else the contractor offers. The CO has discretion, but his or her judgment is subject to review. The CO is charged with safeguarding the interests of the United States in its contractual relationships. (See the first sentence of FAR 1.606-2, Responsibilities.) An inspector general might want to know what the CO got in return for the time extension and might want to know why the CO thinks that the price (original or new) is fair and reasonable. The CO must have an answer.

If the CO decides to ignore (waive) the default and pay the original price, then he or she arguably is not fulfilling his or her obligation under FAR 1.602-2. Why should the taxpayer pay the price of timely delivery for untimely delivery? How would the CO explain that to an inspector general? What do you think the reaction would be if the CO said that he or she decided to pay the original price because "even $500 would be a significant hit to the contractor?s profit margin"? Why should the CO care about the profit margin of a contractor that didn't keep its promise to the government and didn't have a legal excuse? Why should that contractor receive any profit?

In conclusion, you asked if the CO must obtain consideration when the contractor delivers late? The answer is YES if the CO is going to negotiate a new delivery date and modify the contract. The answer is yes because our legal system requires the CO to obtain consideration when modifying a contract in order to seal the deal. How much consideration should the contracting officer seek? Enough for the CO to fulfill his or her duty under FAR 1.602-2 to safeguard the interests of the United States in its contractual relationships. Do you understand now why that is so?

The CO need not obtain consideration if (a) the contractor has a legally viable excuse for nonperformance, or (B) the CO decides to terminate for default, or ( c) the CO decides to waive the default without getting anything in return. If the CO decides to waive the default without getting anything in return he or she had better document the file to explain how that decision safeguards the interests of the United States.

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Vern,

A contracting officer is not legally required to obtain new consideration if he/she establishes a new delivery schedule. See Administration of Government Contracts, Fourth Edition, p. 965, quoting Free-Flow Packaging Corp., GSBCA 3992, 75-1 BCA P 11,332:

It is a well-established principle in Government contract law that while the Default clause gives the Government the absolute right to terminate the contract upon failure of the contractor to make timely delivery of the procurement item, the clause permits the Contracting Officer to exercise his right to use discretion in deciding whether to immediately terminate the contract, or any part thereof, or, among other things, to allow the contractor to continue performance under a new delivery schedule. No new consideration is necessary to support what the Default clause already permits the Contracting Officer to do.

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Guest Vern Edwards
Vern,

A contracting officer is not legally required to obtain new consideration if he/she establishes a new delivery schedule. See Administration of Government Contracts, Fourth Edition, p. 965, quoting Free-Flow Packaging Corp., GSBCA 3992, 75-1 BCA P 11,332...

Don: This is what I said:

Now suppose a government contractor fails to deliver on time and does not have an excuse. (See FAR 52.249-8( c) and (d) about defaults by subcontractors.) The CO can (a) terminate for default and seek damages, (B) negotiate a new delivery date in return for a lower price or for something else of value and modify the contract to that effect, or ( c) waive the late delivery and pay the original price.

If the CO decides to negotiate a new delivery date and modify the contract, then he or she is required by our legal system to obtain something of value, called "consideration," in return for the time extension.

I then said:

The CO need not obtain consideration if ... ( c) the CO decides to waive the default without getting anything in return.

Now see Administration, p. 964 - 965:

(2) Negotiating A Schedule Extension

If continued performance by the defaulting contractor is desired, a revised delivery schedule should be negotiated with the contractor to clearly establish the contractor's obligation and to avoid the complications that would arise if a waiver was subsequently found. The preferred method of establishing a new schedule would be the negotiation of a time extension supported by consideration from the contractor, Comp-Con Tech. &n Mfg., Inc., ASBCA 21150, 78-1 BCA ? 13,152...

If the contractor refuses to furnish consideration for a delivery extension, the contracting officer apparently can establish a new deliver schedule without consideration. See Free-Flow Packaging Corp., GSBCA 3992, 75-1 BVA ? 11,332"

"It is a well-established principle in Government contract law that while the Default clause gives the Government the right to terminate the contract upon failure of the contractor to make timely delivery of the procurement item, the clause permits the Contracting Officer to exercise his right to use discretion in deciding whether to immediately terminate the contract, or any part thereof, or, among other things, to allow the contractor to continue performance under a new delivery schedule. No new consideration is necessary to support what the Default clause already permits the Contracting Officer to do. It is also a principle of law that a waiver of a delivery date can be inferred from the Government's behavior after the contractor fails to make delivery as promised. Acceptance of a new delivery date can be established by agreement or the parties or by acts of the Government. Here again, acceptance by the Government can be implied from the circumstances."

Thus, according to Administration, the CO will need consideration if he is going to negotiate a new delivery date and modify the contract. However, the CO is not going to require consideration if he waives the delivery schedule and agrees to accept delivery at a later date without modifying the contract. In that case, the CO will pay the original price for late delivery.

Again, when a contractor fails to deliver a CO can (a) terminate, (B) waive the delivery schedule (i.e., accept late delivery at a later date--a new schedule), or ( c) negotiate a new schedule and modify the contract. As I said, if the CO negotiates a new schedule and modifies the contract he or she needs consideration. If the CO negotiates a new price, then he or she has gotten consideration.

As I said, the CO does not need consideration in order to waive the default and accept late delivery (a new schedule). By accepting a late delivery the CO is agreeing to pay the original price for something less than originially bargained for.

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Guest Vern Edwards

I want to add this:

If the Government waives its right to terminate, the CO can reestablish the government's right to terminate by notifying the contractor of a new delivery date (it must be reasonable) or by reaching agreement with the contractor about a new date. Late delivery reestablishes the right to terminate. If the late delivered goods do not conform to specification, the government can terminate for default. Of course, reestablishment after waiver will require the government to pay the original price.

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Vern,

From Administration:

If the contractor refuses to furnish consideration for a delivery extension, the contracting officer apparently can establish a new delivery schedule without consideration.

In this circumstance, couldn't the CO establish the new delivery schedule by means of a contract modification? If so, wouldn't this constitute a contract modification without consideration?

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Guest Vern Edwards

Don:

Yes. The CO can waive the original delivery date and establish a new date, by modification, without obtaining consideration. And he can do so unilaterally. I thought I made that clear in my post, when I said that the CO can waive and accept late delivery without consideration, but I can see I was not clear. My explanation was unclear, at best. Thanks for pointing it out.

A CO can establish a new date without consideration if he is willing to pay the original price for the late-delivered goods. As the authors of Administration say, "The preferred method of establishing a new schedule would be the negotiation of a time extension supported by consideration from the contractor," but, yes, the CO can waive the original date and establish a new delivery schedule without consideration. He does not have to get anything in return for the waiver to be binding. The legal theory is that this is possible because the CO does not have to enforce the original contract.

As I said earlier, however, if the CO decides to waive the default and pay the original price, then he or she arguably is not fulfilling his or her obligation to protect the taxpayer. Why should the taxpayer pay the price of timely delivery for untimely delivery? I want to point out that in both of the cases cited in Adminstration, Free-Flow Packaging Corp., GSBCA 3992, 75-1 BCA ? 11,332 and Gillet Mach. Rebuilders, Inc., ASBCA 28,341, 89-3 BCA ? 22,021, the government agreed to waive the original date without getting anything in return only to have both contractors fail to meet the newly established delivery date and default anyway.

Thanks again.

TWorthington, are you clear, or have I only made it all the more murky?

Vern

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Guest Vern Edwards

Don:

Here's a question for you:

Background. A CO is administering an FFP supply contract worth $10 million. The contract required delivery of the item one year after contract award. Ten months have passed and the COTR tells the CO that she doesn't think the contractor is going to be able to deliver on time because a subcontractor won't be able to finish its work on time. The COTR tells the CO that she does not believe that the subcontractor's delay is excusable.

The CO checks around and decides that the COTR's story is believable. It does not look like the contractor will be able to deliver on time. The CO does not want to wait two months to find out, so he calls the contractor. The contractor tells the CO that he is making every effort to deliver on time, but that he is facing difficulties. The contractor obviously doesn't want to say that he won't be able to deliver on time out of fear of anticipatory breach, but it's clear that he is worried. The CO decides that instead of waiting to see what happens, he wants to plan ahead so that the user can plan in turn. He approaches the contractor about the possibility of negotiating a new delivery schedule. The contractor says that he is open to the idea. The CO would like to negotiate the modification before the current delivery date, so that there is no default. The parties do not discuss consideration.

Question: Must the CO obtain consideration in order to modify the delivery date? Or can the CO modify the delivery date without consideration, citing the default clause as authority?

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Vern,

I'm going to assume that you're talking about a noncommercial contract and that the prime contractor cannot obtain the required supplies and services from another subcontractor.

I think that in order for the CO to exercise her authority under the Default clause, one of the three situations described at FAR 52.249-8(a)(1) must apply. These are:

The Government may, subject to paragraphs ( c ) and (d) of this clause, by written notice of default to the Contractor, terminate this contract in whole or in part if the Contractor fails to?

(i) Deliver the supplies or to perform the services within the time specified in this contract or any extension;

(ii) Make progress, so as to endanger performance of this contract (but see paragraph (a)(2) of this clause); or

(iii) Perform any of the other provisions of this contract (but see paragraph (a)(2) of this clause).

Paragraph (a)(1)(ii) seems that it would apply to the situation that you described. If so, then I think that the CO could establish a new (later) delivery date without having to obtain consideration. If not, then the clause doesn't apply and the CO would not have this authority.

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Guest Vern Edwards
Vern,

I'm going to assume that you're talking about a noncommercial contract and that the prime contractor cannot obtain the required supplies and services from another subcontractor.

I think that in order for the CO to exercise her authority under the Default clause, one of the three situations described at FAR 52.249-8(a)(1) must apply. These are:

Paragraph (a)(1)(ii) seems that it would apply to the situation that you described. If so, then I think that the CO could establish a new (later) delivery date without having to obtain consideration. If not, then the clause doesn't apply and the CO would not have this authority.

Thanks, Don. Your assumptions are sound. I interpret your answer to mean that if the clause does not apply the CO must obtain consideration to change the dates. I agree. Although I think that failure to make progress might be hard to prove if the contractor does not concur.

Vern

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Thanks, Don. Your assumptions are sound. I interpret your answer to mean that if the clause does not apply the CO must obtain consideration to change the dates. I agree. Although I think that failure to make progress might be hard to prove if the contractor does not concur.

Vern

I have one more question. Does the consideration a contractor offers have to be on the contract involved or can the contractor offer consideration for a different contract?

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Guest Vern Edwards

Under the law of contracts, I think that would be okay. But I think the answer is no for a government contract, although I cannot point you to any express prohibition in statute or regulation. I suspect that appropriations law would require that benefits flow to specific appropriations, and that you can't pay for something under one appropriation that will benefit something under a different appropriation. Along those lines, see FAR 15.402(B), which requires COs to price each contract independently.

But I am not certain. You should put your question to your attorney.

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Under the law of contracts, I think that would be okay. But I think the answer is no for a government contract, although I cannot point you to any express prohibition in statute or regulation. I suspect that appropriations law would require that benefits flow to specific appropriations, and that you can't pay for something under one appropriation that will benefit something under a different appropriation. Along those lines, see FAR 15.402(B), which requires COs to price each contract independently.

But I am not certain. You should put your question to your attorney.

Thank you for the answer, it does help.

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All,

This is a complicated topic! To answer your question Vern - I'm still not 100% clear, but it seems clear that there isn't a cut and dry answer... However, here's what I understand:

*The contract can be modified by extending the delivery date without consideration from the contractor

*If the contract is modified without consideration, America's tax dollars may not be being spent as they should be

*This may be in violation of the principal behind FAR 1.602-2

*If an IG were to review this contract, I'd better have a good explanation

Please correct me if I am wrong. I appreciate your thoughtful response to my question; you are correct in that I am fairly new to contracting - about 18 months.

Question: How can a contracting officer accept a new schedule without modifying the contract? I thought those things went hand in hand...

Thank you,

TW

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Guest Vern Edwards

If the contractor has already defaulted, you can waive the government's right to terminate for default and to seek damages and accept a new delivery schedule without getting consideration either by exchange of letter or by contract modification on SF 30. That is called reestablishing the delivery schedule. If the contractor delivers in accordance with the new delivery schedule you will then pay the contractor the original contract price, which means that you will pay the price you initially agreed to for delivery on the earlier date.

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