Did the ASBCA get performance and delivery incentives wrong?

[FrankJon]

On 9/19/2024 at 1:24 PM, Vern Edwards said:

The judge did not rule that incentives are impermissible in FFP service contracts. She only ruled that the deduction provision in the contract in question was not an incentive, it was an impermissible penalty.

I don't assert that the Board ruled it, but that the Board erred in stating that subpart 16.4 "does not apply" without further analysis. In my view, the paragraph I quoted in the OP evidences a misunderstanding of what it means to combine FFP contract type with incentives. I say this because:

1. The judge cites only to FAR 16.401(a) when considering the question, conspicuously omitting FAR 16.202-1; and
    
2. The judge mentions "fixed-price incentive contracts," but these are defined at FAR 16.403, and have no bearing on the facts of this case or the Government's argument. This tells me she is seeking evidence that the contract type is other than FFP simply because she hasn't considered the language at FAR 16.202-1.

I've thought about this paragraph quite a bit over the past week. Unless the judge is using "fixed-price incentive contracts" in some widely accepted generic sense that I'm unaware of, I still don't see how this paragraph can be interpreted any other way.

On 9/19/2024 at 1:24 PM, Vern Edwards said:

But see Footnote 3, in which I think she was trying to say that negative incentives are permissible if they meet the requirements of FART Parts 16 and 37.

Or, as Professor Nash points out, perhaps they would have been permissible if the Board had been willing to consider them as delivery incentives. But that would have required applying subpart 16.4.

Appreciate the robust discussion, all, and looking forward to the article, Vern.

[Vern Edwards]

22 hours ago, FrankJon said:

I don't assert that the Board ruled it, but that the Board erred in stating that subpart 16.4 "does not apply" without further analysis. In my view, the paragraph I quoted in the OP evidences a misunderstanding of what it means to combine FFP contract type with incentives. I say this because:

1. The judge cites only to FAR 16.401(a) when considering the question, conspicuously omitting FAR 16.202-1; and
    
2. The judge mentions "fixed-price incentive contracts," but these are defined at FAR 16.403, and have no bearing on the facts of this case or the Government's argument. This tells me she is seeking evidence that the contract type is other than FFP simply because she hasn't considered the language at FAR 16.202-1.

I've thought about this paragraph quite a bit over the past week. Unless the judge is using "fixed-price incentive contracts" in some widely accepted generic sense that I'm unaware of, I still don't see how this paragraph can be interpreted any other way.

@FrankJon I think you're wa-a-a-y too focused on what that judge said about FAR 16.4. Forget about it. The decision cannot be cited as precedent.

Here are the interesting questions:

• What is a "negative" performance incentive?
• What does it (should it) look like on paper?
• How does it (should it) work?

A fixed-price cost incentive is designed to discourage the incurrence of cost by offering a payoff in return for cost avoidance. It's just a cost incentive, not a "negative cost incentive". The lower the cost, the higher the profit. So why are we talking about "negative" performance incentives and price deductions? It's the word "negative" that's causing confusion.

Why not just a fixed-price "performance incentive"? Why not set an optimal target level of performance and an acceptable level of performance below target, with a range of cash bonuses running upward from acceptable to optimal? Anything below minimally acceptable is breach, which means that the contractor is not entitled to any payment for rejected work, and may be liable for damages, if any. That's a deterrent, not an incentive.

To me, "negative performance incentive" sounds like a contradiction in terms. It is a phrase that some unknown bureaucrat thought up without explaining what they meant. Why not just "performance incentive"?

I think that any "negative performance incentive" that deducts from a firm-fixed-price will be vulnerable to challenge as a penalty. It's not an incentive. It's a threat.

[C Culham]

1 hour ago, Vern Edwards said:

To me, "negative performance incentive" sounds like a contradiction in terms. It is a phrase that some unknown bureaucrat thought up without explaining what they meant. Why not just "performance incentive"?

Based on my limited research I would agree.  I would further propose that the term be removed from the FAR as it seems the references that led to its creation are now rescinded.

It seems that the term appeared in the FAR 16.402-2 in 1997.  Reference 62 FR 44815 , Aug. 22, 1997.

Its genesis was most likely from OFPP Policy Letter 91-2, Service Contracting.  Reference - Federal Register Vol. 56 No. 72 Published April 15, 1991, page 15110.   Of note the OFPP Letter did not include the term "negative performance incentive" but did use "deduction schedule" and its variation.  The policy letter has since been rescinded.

There was also a guide published by OFPP, Final Edition was October of 1998 entitled "A Guide to Best Practices for Performance-Based Service Contracting".  Also now rescinded it used "negative performance incentive" and provided basic examples of same at Chapter 3.  

An archive copy of the guide can be found at the following link.  Of note copies that I did find on the web in my search carried this note at the end.  

1. Reprinted from the Nash & Cibinic Report, April 1995 by permission of Ralph C. Nash.

https://georgewbush-whitehouse.archives.gov/omb/procurement/pbsa/guide_pbsc.html

 

[Don Mansfield]

@FrankJon, It's a very common mistake to assume that a contract with an incentive is an incentive contract. I've made the same mistake. Judges make mistakes. It was this judge's turn to make that mistake. Fortunately, that mistake was not consequential in this case.

[Vern Edwards]

7 minutes ago, Don Mansfield said:

@FrankJon, It's a very common mistake to assume that a contract with an incentive is an incentive contract. I've made the same mistake. Judges make mistakes. It was this judge's turn to make that mistake. Fortunately, that mistake was not consequential in this case.

So, what's an "incentive contract"?

[Don Mansfield]

10 minutes ago, Vern Edwards said:

So, what's an "incentive contract"?

A compensation arrangement described in FAR part 16 that contains a cost incentive (or in the case of a contract with multiple incentives--a cost incentive or constraint).

[Voyager]

3 hours ago, Vern Edwards said:

How does it (should it) work?

I sense a lot of confusion about this concept's terminology within the halls of government.  If that is the case, how do you think the commercial marketplace sees these negative performance incentives terms?

Based on @C Culham's research, if these negative incentives are a governmental concept stemming from PBSA policy, then we should not rely on that in court.  We therefore should not negatively incentivize or deduct our FFP contracts' prices.  Instead, we can use the longstanding contractual practice of withholds.  Sure, withholds are small sums and are usually clawed back, but not until the government has extracted some stipulated performance improvement.  They do work as a matter of principle, and they also may be addressed in CPARS, making them doubly effective.  They may also work practically, because they strike at the heart of a contractor's business.

What do I mean by the heart of a contractor's business?  In America, contractors strategize their profit margin on obtaining invoiced sums as early as possible, because we live under Capitalism and those sums can be invested wisely to obtain dividends on your negotiated profit.  Consider this scenario:

• FFP proposal arrives in May 2024 including multiple subcontract quotes, each with 4% escalation in year 2 and 3s' performances 
• Prime contract awarded in September 2024; subcontracts subsequently awarded FFP
• Prime contract says any invoice for periods where X performance measure is not met will include a withhold
• Invoice for August 2025 performance received, withhold decreases contractor's accounts receivable that would have made 7% returns on investment in stock market
• Meanwhile, accounts payable goes up in October 2025 to cover 4% cost of subcontract escalation

As you can see, withholds have a ripple effect and, while your boss won't understand you fighting policy reviews for a nonstandard clause stipulating $15K off each invoice, your contractor counterpart sure will.  There is a host of case law on withholds to help guide your contract crafting.  See my prior post in this thread.  If T&M, see the FAR 52.232-7 payment clause's terms allowing withholds too.

Too often on the government side we don't see this time value of money (some may say we don't see the value of money at all, given our national debt!).  

[Vern Edwards]

1 hour ago, C Culham said:

It seems that the term appeared in the FAR 16.402-2 in 1997.  Reference 62 FR 44815 , Aug. 22, 1997.

The phrase "negative incentive" appeared in the DOD/NASA Incentive Contracting Guide in October 1969, without detailed explanation, but with an illustration, on pages 110 and 182. 

The phrase "negative incentive" made its first appearance in the FAR System in 1992, when NASA added it to its FAR Supplement. 7 Fed. Reg. 53681-01, Nov. 12, 1992, in connection with award fee incentives.

The phrase "negative performance incentive" was added to the FAR in 1997.

The first appearance of the phrase "negative incentive" in the Federal Register in any context was in 1965, but not in relation to procurement (acquisition, contracting).

1 hour ago, C Culham said:

Of note the OFPP Letter did not include the term "negative performance incentive" but did use "deduction schedule" and its variation. 

The concept of a "deduction schedule" first appeared in Air Force Regulation 400-28, Base Level Service Contracts (26 September 1979), which OFPP adopted as its A-76 Supplement, Pamphlet No. 4. However, the concept there was based on the Inspection of Services clause. The OFPP Pamphlet, which is available at Wifcon, provided as follows:

Quote

 

Deductions For Non - Performance . Through the Inspection

of Services clause , the government can deduct from a

contractor ' s payment an amount equal to the services not

provided .

a . To do this , the contract administrator must know the

major cost categories in the contract and the percentage of

cost each service output represents . The percentage cost of

each service is found in deduct analysis ; see chapter 2 ,

paragraph 2 - 9 . An example of how the deduct formula works is

shown in figure 5 - 3 .

b . Suppose the bid schedule showed the monthly contract

price for vehicle operations , maintenance , and analysis as

shown . The percentage cost of the service output is then

found by looking at the Performance Requirements Summary

Technical Exhibit in the contract statement of work . In the

example , the percentage cost of quality of completed work is

10 percent . This is then multiplied by $ 100 , 000 to obtain

the maximum amount to deduct .

c . If completed work was unsatisfactory during the

month ( that is , did not meet performance values ) and the

percent of the sample found bad was 20 percent , $ 2000 would

be deducted from the payment normally due the contractor .

Deduct Formula (Example)

If : Quality of completed work is unsatisfactory

(AQL of 6 . 5% exceeded )

Contract price and : is $ 100,000 per month

and : Quality of completed work deduct percentage is 10 %

and :

and :

Sample size is 50

Number of defects in the sample is 10 (Reject number is 8 )

Then : Deduction from the current month ' s invoice is :

= $ 100 , 000 Contract price

x Deduct percentage

. 10

$ 10 , 000

X Percent of sample defective

Deduction $ 2 ,000

Figure 5 - 3 . Deducting for Non - Performance .

d . This amount for quality of completed work is deducted

because the contractor failed to provide reliable , uniform

services within the assigned performance values . Although

some completed work may have met the standard during the

month , the acceptable quality level was not met and at least

20 percent of the observations were defective . Hence , the

total quality performance requirement has not been achieved .

As a consequence , the service output is unsatisfactory .

See today's inspection of services clause, 52.246-4, paragraph (e). That procedure is not an incentive, and it is not the procedure used in the ASBCA case. The deductions reflect damages suffered by the government. And they are subject to challenge as punitive rather than reasonably compensatory.

I wrote about all this long ago. SEE:

Edwards, NONCONFORMING SERVICES: What Are The Government's Rights Under Fixed-Price Service Contracts? 22 NO. 4 Nash & Cibinic Rep. ¶ 22. (April 2008)

Edwards, SERVICE CONTRACT QUALITY: We''ve Got More Thinking to Do. 22 NO. 3 Nash & Cibinic Rep. ¶ 20. (March 2008)

Edwards, CALCULATING PRICE REDUCTIONS WHEN SERVICES ARE DEFECTIVE, 20 NO. 5 Nash & Cibinic Rep. ¶ 23 (May 2006)

 

 

 

[Vern Edwards]

Just now, Don Mansfield said:

A compensation arrangement described in FAR part 16 that contains a cost incentive (or in the case of a contract with multiple incentives--a cost incentive or constraint).

That's not an official definition. FAR Parts 2 and 16 do not define "incentive contract. Why can't we call a contract that has any kind of an incentive an "incentive contract"? 

[Vern Edwards]

11 minutes ago, Voyager said:

We therefore should not negatively incentivize or deduct our FFP contracts' prices.

Why not? See, e.g., FAR 52.246-4(e):

Quote

 

(e) If any of the services do not conform with contract requirements, the Government may require the Contractor to perform the services again in conformity with contract requirements, at no increase in contract amount. When the defects in services cannot be corrected by reperformance, the Government may-

(1) Require the Contractor to take necessary action to ensure that future performance conforms to contract requirements; and

(2) Reduce the contract price to reflect the reduced value of the services performed.

That would be a right of any party that is the victim of a breach. You simply have to know what you're doing when you calculate your damages ("reduced value"). See, e.g., 

APPEAL OF -- FAMILY ENTERTAINMENT SERVICES, INC., 17-1 BCA P 36876 (A.S.B.C.A.), ASBCA No. 61157, 2017 WL 5194983, October 24, 2017.

But youy gotta know what you're doing.

 

Quote

 

Based on all of the discrepancies, all of which were provided to FES, the government determined that FES was responsible for maintaining 3,897 acres in Cycle 1 but only completed 3,088.6 acres, which resulted in 79.3% of the work being accomplished. For Cycle 2, the government determined that FES was responsible to maintain 3,897 acres but only accomplished 2,792 acres, for a total of 71.7% accomplished. For Cycle 3, the government determined that FES was responsible to maintain 3,897 acres but only accomplished 2,636.1 acres for a total of 67.6% accomplished. For each area and cycle, the government provided a more detailed breakdown to properly charge the deductions, based on the number of acres not performed in each cycle, each schedule, each service, and each level to be performed, which matched the way the pricing was set forth in the contract. (Finding 24)

 

The government was actually very generous to FES by limiting the amount of deductions. The government did not deduct money for FES's failure to submit daily reports and other written deliverables required by the contract (gov't br., attach, at 12). The government did not deduct the amount associated with additional hours it spent to administer the contract based on meeting multiple times for the same discrepancies or the time government employees spent performing grounds maintenance. The government allowed multiple extensions and changed the period of performance based on when Mr. Johnson asserted that FES could complete performance (finding 14). And the government provided multiple deficiency reports that clearly notified FES of what aspects of the contract were not being met (finding 19). Yet, FES still failed to meet the requirements of the contract. Accordingly, we hold that at no time did the government abuse its right, pursuant to the contract, to inspect the work performed and deduct an appropriate amount for the work that was not performed.

 

 

 The deduct was about $82,000.

[Don Mansfield]

20 minutes ago, Vern Edwards said:

Why can't we call a contract that has any kind of an incentive an "incentive contract"? 

That wouldn't be consistent with the FAR's use of "incentive contract".

FAR 16.401(a) distinguishes incentive contracts from FFP contracts:

Quote

Incentive contracts as described in this subpart are appropriate when a firm-fixed-price contract is not appropriate...

FAR 16.202-1 permits the use of incentives based on factors other than cost:

Quote

The contracting officer may use a firm-fixed-price contract in conjunction with an award-fee incentive (see 16.404) and performance or delivery incentives (see 16.402-2 and 16.402-3) when the award fee or incentive is based solely on factors other than cost. The contract type remains firm-fixed-price when used with these incentives.

Given FAR 16.401(a), such contracts are not incentive contracts. So, you can have contracts with incentives that are not "incentive contracts" as that term is used in the FAR.

Also, see FAR 16.402-1(a):

Quote

No incentive contract may provide for other incentives without also providing a cost incentive (or constraint).

 

[Retreadfed]

On 9/21/2024 at 8:39 AM, C Culham said:

Why "common law"?  Afterall the discussion is regarding a contract written pursuant to the FAR for a negative performance incentive.  

When an appeal is presented to a contract appeals board, the board is engaged in contract interpretation to resolve the dispute.  As has been held many times by  the appeals boards and courts, contract interpretation is a question of law.  In the Red Bobtail appeal, because there is no statute that authorized the deductions/penalty at issue, the ASBCA applied the common law rule against penalties imposed by contract to help resolve the issue.

[Vern Edwards]

Just now, Retreadfed said:

When an appeal is presented to a contract appeals board, the board is engaged in contract interpretation to resolve the dispute.  As has been held many times by  the appeals boards and courts, contract interpretation is a question of law.  In the Red Bobtail appeal, because there is no statute that authorized the deductions/penalty at issue, the ASBCA applied the common law rule against penalties imposed by contract to help resolve the issue.

Everyone should know that the Red Bobtail decision cannot be cited as precedent. From page 1:

Quote

RBT elected to pursue this appeal pursuant to the Board’s Rule 12.2, Small Claims (Expedited) procedure. Accordingly, this decision shall have no precedential value, and in the absence of fraud shall be final and conclusive and may not be appealed or set aside. 41 U.S.C. § 7106(b)(4)-(5).

 

[Voyager]

1 hour ago, Vern Edwards said:

Why not?

A big reason is because you are now discussing deductive changes, and per FAR 1.602-2(d), a Contracting Officer's Representative: "(5) Has no authority to make any commitments or changes that affect price, quality, quantity, delivery, or other terms and conditions of the contract nor in any way direct the contractor or its subcontractors to operate in conflict with the contract terms and conditions."

In the case of the withholds, the duty may be delegated to a COR for swiftness of action, which, if I am right about the time value of money, really matters to this concept.

A deductive change, on the other hand, would require CO time and expertise and negotiations "to reflect the reduced value of the services performed" as you quoted from the clause above.  Pricing the deleted work has its own host of case law and its own subheading in Administration of Government Contracts.  It usually occurs toward the end of the contract after forbearance and extensions, unless the two parties plan for it.  That's a tall order for this acquisition workforce.

I guess given contract law and these standard FAR clauses, every contractor signs up for a deductive change and/or a withhold in theory, but the smart CO will solicit a nonstandard clause anticipating and describing one or both of these action in practice.

[Vern Edwards]

37 minutes ago, Don Mansfield said:

1 hour ago, Vern Edwards said:

Why can't we call a contract that has any kind of an incentive an "incentive contract"? 

That wouldn't be consistent with the FAR's use of "incentive contract".

So what? It is not an officially defined term. However, I understand your argument and acknowledge the inconsistency.

[Vern Edwards]

3 minutes ago, Voyager said:

A deductive change, on the other hand, would require CO time and expertise and negotiations "to reflect the reduced value of the services performed" as you quoted from the clause above.  Pricing the deleted work has its own host of case law and its own subheading in Administration of Government Contracts.  It usually occurs toward the end of the contract after forbearance and extensions, unless the two parties plan for it.  That's a tall order for this acquisition workforce.

I am very familiar with Administration of Government Contracts. I don't recognize the procedure you have described. If a contractor delivers unacceptable work, or fails to deliver, and if the contractor cannot cure, then the CO does not process a deductive change. He or she should reject the work, refuse to pay, and either unilaterally sets or negotiates a price reduction, depending on the how the CLINs are set up. The government is also entitled to damages if it can prove them. The contractor can file a claim if it doesn't agree with the CO.

Anyway, none of that has anything to do with negative incentives, which is what interests me.

[C Culham]

3 hours ago, Vern Edwards said:

The phrase

Thank you

[Vern Edwards]

Some extended research into negative incentives has turned up several references that include descriptions of negative performance incentives used by NASA and the Air Force in certain spacecraft hardware contracts dating back to the 1980s.

See, for example: GAO, Satellite Acquisitions: Agencies May Recover a Limited Portion of Contract Value When Satellites Fail - GAO-17-490 (June 2017), which discusses the use of negative performance incentives.

See also:Space and Missile Systems Center (SMC) Incentive Guide, March 2007. Note this:

Performance Incentives 

Quote

[T]he most desired outcome to the Government in the technology development area is usually going to be enhanced performance. It is conceivable that when looking at the utility of the technology, if we want contractors to take risks to increase performance, a performance incentive where the incentive is paid for increased performance might be appropriate. Essentially, the fee is paid for performance above a negotiated level of performance, and the fee may be reduced for performance below a negotiated level of performance. The use of a performance incentive would be a good way to motivate a contractor if competition did not exist. The problem with this approach is the danger that the contractors might be incentivized to over promise the benefits of a technology in the technology development stage. The performance must be verifiable so that the incentive does not create an unintended consequence of encouraging unwarranted optimism during performance. 

Emphasis added.

https://www.dau.edu/tools/space-and-missile-systems-center-smc-incentives-guide

It contains a lot of information about the use of negative incentives in spacecraft contracts.

See also: NASA FAR Supplement NFS 1816.402-2, Performance Incentives.

Quote

 

(b) When a performance incentive is used, it shall be structured to be both positive and negative based on performance after acceptance, unless the contract type requires complete contractor liability for product performance (e.g., fixed price). In this latter case, a negative incentive is not required. In structuring the incentives, the contract shall establish a standard level of performance based on the salient performance requirement. This standard performance level is normally the contract's target level of performance. No performance incentive amount is earned at this standard performance level. Discrete units of measurement based on the same performance parameter shall be identified for performance above and, when a negative incentive is used, below the standard. Specific incentive amounts shall be associated with each performance level from maximum beneficial performance (maximum positive incentive) to, when a negative incentive is included, minimal beneficial performance or total failure (maximum negative incentive). The relationship between any given incentive, either positive or negative, and its associated unit of measurement should reflect the value to the Government of that level of performance. The contractor should not be rewarded for above-standard performance levels that are of no benefit to the Government.

(c) The final calculation of the performance incentive shall be done when performance, as defined in the contract, ceases or when the maximum positive incentive is reached. When performance ceases below the standard established in the contract and a negative incentive is included, the Government shall calculate the amount due and the contractor shall pay the Government that amount. Once performance exceeds the standard, the contractor may request payment of the incentive amount associated with a given level of performance, provided that such payments shall not be more frequent than monthly. When performance ceases above the standard level of performance, or when the maximum positive incentive is reached, the Government shall calculate the final performance incentive earned and unpaid and promptly remit it to the contractor.

 

Emphasis added. See the contract clause at 1852.216-88 Performance incentive.

[REA'n Maker]

It is kind of funny that the literal read of "negative performance incentive" sounds like "an incentive to perform negatively".  🤨