Download - Sequestration Brief

7/30/2019 Sequestration Brief

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SEQUESTRATIONANDBUDGET CUTS

SURVIVAL STRATEGIESFOR CONTRACTORS

November 9, 2012

Government Contracts . . . Federal Law & PolicyDLA Piper LLP

Washington, D.C.


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AGENDA

Sequestration and the Fiscal Cliff

Debt Valley

Government Strategies for Reducing Contract Spending

Contractor Actions to Mitigate Risks of Sequestration andBudget Cuts

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How d id w e ge t t o the f i sc a l c l i f f?

US federal debt is at historic levels

At the end of 2008, debt equaled 40 percent of the Gross Domestic

Product (GDP) slightly above the 40-year average of 37 percent At the end of 2011, debt was roughly 70 percent of GDP highest

percentage since shortly after World War II

In 2011, political parties locked horns about raising the debt ceiling

Poison Pill Solution: raise the debt ceiling and agree on $1.2 trillionin budget cuts for FY2013-FY2021 but if commission does notagree, sequestration of $1.2 trillion would be imposed in January2013 and Bush-era tax cuts would expire

Sequestration = uniform, across-the-board cuts in all covered federalaccounts, equally split between defense and non-defense accounts

Exempted accounts include Social Security, Medicaid, Veterans, andmilitary pay Medicare cuts capped at 2%

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What is t he f isc a l c l i f f?

The combination of sequestration cuts and tax increases thatare scheduled to go into effect January 2013 absent an

agreement by the President and Congress Also, debt ceiling must be raised again early in 2013 and FY13

Continuing Resolution expires in March 2013

The total of all spending reductions and tax increases would

be $607 billion

According to the Congressional Budget Office, the U.S.economy would slide into a "significant recession" as a result

of the spending cuts and tax increases Economy would shrink by 2.9 percent in the first half of 2013 and by 0.5

percent for the whole year

Unemployment rate would likely increase from 7.8% to 9.1% in the nearterm

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How w ould the f isca l c l i f f af fec t j obs

w i th government c ont rac t o rs?

Congressional Research Service issued report on October 1, 2012entitled Sequestration: A Review of Estimates of Potential JobLosses

Summarizes studies related to Defense, Education, FAA, NIH, and SSA Study commissioned by Aerospace Industries Association included

the following estimates:

2.1 million jobs lost throughout entire economy in FY2013 277,000 federal civilian jobs 469,000 prime contractor jobs 433,000 subcontractor/supplier jobs 959,000 induced jobs i.e., jobs throughout economy supported by workers in

above categories spending their paychecks

In private sector, manufacturing jobs (223,000) most affected by defense

cuts professional and business-service jobs most affected bynondefense cuts

Largest job losses estimated in California, D.C., Maryland, Texas, andVirginia

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How w ould seques t ra t i on am oun ts be

ca lcu la ted?

Define the required spending cuts:

Total reduction required = $1.2T

Savings on debt service = $216B

Total spending cuts required = $984B

Spending cuts divided by nine years in sequestration period (FY-13-21) =$109.4B per year

Divide between defense and nondefense = $54.7B for each

Define the covered accounts to be cut: For FY13, identify FY13 funds already obligated from 10/112 to 1/2/13

cuts must be allocated to remaining FY13 budgets

Apply exemptions and special rules

For FY13 only, allocate the required spending cuts across thecovered accounts using a uniform percentage

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What i s t he es t im at ed magn i tude o f

t he requ ired seques t ra t ion c u t s?

September 14, 2012: Office of Management & Budget (OMB)estimated the effects of sequestration as:

9.4% cut for defense 8.2% cut for non-defense

But OMB used FY13 Continuing Resolution as basis forcalculation. If Presidents actual budget is used, effects could

be slightly higher: 10.1% cut for defense

8.2% cut for non-defense

Also, since cuts must be allocated to the remaining threequarters of the FY13 budgets, the cuts for balance of FY13have been estimated as:

12.25% cut for defense

11.20% cut for non-defense7


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At w hat l evel w ould the sequest rat i on

c u t s be app lied?

Law requires percentage reduction to be uniformly applied toeach program, project or activity (PPA) as defined by

appropriation laws Congress: the most specific level of budget items identified in

DoD appropriations act and related budget justification documents

DoD: 2500+ individual line items below the departments

procurement accounts

OMB: did not issue guidance need more time to work withagencies

Bottom Line:

PPAs vary widely in size and scope, providing agency officialseither very limited or substantial discretion in making cuts

E.g., Littoral Combat Ship (LCS) Program: one PPA is $1.45B, and

other PPAs are as low as $1M8


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PPAs Wit hin t he LCS Progra m ($1.785B)

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Littoral Combat Ship (LCS): $1,785M

Detailed budget line items

constrain DoD flexibility ontaking reductions

Lump sum appropriationallows degree of flexibility

Level of budget detail within PPAs defines how much flexibility there is for

program managers


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What t ypes o f fund ing and c on t rac t s

w ou ld be a ffec t ed by seques t ra t ion?

Affects all discretionary and mandatory spending (unlessexempted) for FY2013-FY20-21

For DoD, also affects all unobligated balances from prior years Unobligated balances consist almost entirely of Procurement and

RDT&E funding

So cuts to DoD Procurement and RDT&E accounts increaseproportionately from roughly $21.4B to $26.1B

Will affect contracts signed on or after October 1, 2012

Will not affect current contracts funded with FY12 funds

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What s t he process fo r sequest ra t ion?

OMB will determine percentage cuts for defense andnondefense accounts

OMB will apply cuts at the program, project or activity level OMB will impound the sequestered funds by issuing an

apportionment to each agency

OMB and agencies can shift funds between programs (i.e.,

reprogram) if authorized by existing law Agencies will decide how and when to implement cuts in

each program, project, or activity without further OMBguidance

Personnel actions (furloughs, reductions in force)?

Reprogramming?

Contract actions (deferral of awards, stop work orders, reductionsin scope, terminations, etc.)?

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What s t he l i k e l ihood t ha t

seques t ra t ion occ urs?

Obamas win coupled with Democratic gains in Senate give SenateDemocrats increased leverage when negotiating with House Republicansduring the upcoming Lame Duck session of Congress

Given Obama victory, it is more likely that sequestration will be addressedand avoided at least in its current form -- during the Lame Duck session

Possible Scenarios:

Mini-sequester: Most likely smaller package of cuts (e.g., $100 billionover 10 years)

Kicking the can: Less likely a short-term punt to avoid sequestrationand seek a potential deal in 2013

Congressional Democrats seem unlikely to support this, even ifrevenue issues are addressed

Cliff dive: Remote possibility Congressional leaders and mostmembers of both parties want to avoid sequestration

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What s t he im pac t o f the e lec t ion on

DoD?

FY 13 Defense Authorization bill is likely to pass during the Lame Duck DoDAuthorization is becoming more relevant now that earmarks are gone

A second Obama term ensures a build down in the defense sector

Strategic Realignment: New defense strategy calls for increased focus in Asia-Pacificregion will lead to increased resources and movement of troops to Asia Pacific

Secretary Panetta has said 60% of naval assets will be based in the Pacific by2020

Afghanistan Winding Down: Congressional leaders on both sides agree that USforces should exit Afghanistan total withdrawal by 2014 or continuing presence?

Doing more with less: Large, expensive weapons programs are ripe for budget cuts increased competition for defense contractors pressure to achieve programobjectives faster and cheaper

More special operations troop levels cut by 100,000 Frank Kendall, Undersecretary of Defense for Acquisition, will be issuing new

instructions for the acquisition system (Better Buying Power 2.0)

Revised BRAC proposal possible?

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What i f sequest ra t ion doesn t happen?

Government contractors are rightly focused on the potential disasterof the Fiscal Cliff

But even if we dont go over the Cliff, we clearly are headed forsignificantly reduced levels of federal spending i.e., Debt Valley

Spending on federal contracts increased from $205.6B in FY00 to a peakof $541.2B in FY08 then declined slightly over the next three years to$536.8B in FY11

Former Head of Office of Federal Procurement Policy (Dan Gordon): Youmay see significantly lower figures spent on contracts, but that only takesus back to 2004-2008. Its not a disaster for contractors or government tospend $400 billion a year on contracts.

So its important to see the big picture and take actions not just tosurvive the potential Fiscal Cliff, but to survive and thrive in DebtValley

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What gu idanc e has Govt prov ided so

far regarding sequest ra t ion?

Contract Spending

Anecdotal evidence of agencies deferring orders and contract awards waiting to see what happens with sequestration

Sept. 25, 2012: Deputy Secretary of Defense sent memo to DoD officialswarning them to continue normal spending and operations and performmissions without taking any steps that assume sequestration will occur.

Advising Employees of Potential Layoffs

July 30th, DoL: Possibility of sequestration does not trigger obligationunder WARN Act to advise employees of mass layoffs or plant closings

Obligations under State laws or Collective Bargaining Agreements?

Sept. 28th, OMB & DoD: if sequestration occurs and contractor followsDoL guidance, employee compensation costs for WARN Act liability andrelated litigation costs would be allowable costs

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How c an t he Government reduce con t rac t

spend ing? And how c an con t rac t o rs respond?

Prospective Work

Cancel Solicitations

Govt has broad discretion unless cancellation is a pretext or sham Help customer find alternative contract vehicle with attractive pricing?

Identify potential for future restart and stay close to customer?

Delay Issuance of Solicitations or Contract Award

Govt has broad discretion, but cannot delay award indefinitely

Stay close to customer and closely monitor solicitation changes

Be attuned to pricing increases and competitive changes during delays

Use Fixed-Price Contracts Rather Than Cost-Type Contracts

Fixed-Price contracts are required for most FAR Part 12 contracts

Fixed-price contracts are not appropriate for R&D or other situations inwhich pricing and performance risks are unknown (see FAR Part 16)

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Prospective WorkCont.

Place Heightened Value on Price in Competitive Acquisitions

This ishappening and will continue even if best value evaluation Identify price to win based on competitive analysis

Get creative: monetize and highlight life-cycle savings and value-addedfeatures identify cost-savings and value-engineering options foragency consideration

Obtain Cost-Related Data and Negotiate Thin Margins

Obtaining cost-related data is typically prohibited in FAR Part 12procurements and in competitive FAR Part 15 procurements

But Govt has ability to request cost-related data if it cannot otherwise

determine a fair and reasonable price Need to make good judgments about providing cost-related data

Develop alternate solution that includes a mix of comparable pricingand high-level cost data?

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Prospective WorkCont.

Decline to Place Orders Under ID/IQ Contracts

Govt has broad discretion to stop issuing orders, without any further

obligation, once minimum quantity is reached on ID/IQ contract Can make pricing on competitive ID/IQs risky need reliable Govt

estimate Include express assumption in proposal and incorporate proposal into

contract?

Decline to Exercise Options Govt typically has unilateral right to exercise option periods broad

discretion to recompete early or acquire work through another contractor perform work within agency only limit is bad faith

Option exercise must be in strict accordance with contracts terms (e.g.,timing and form of notice) escape hatch for repricing of unfavorable

option? Prior to exercising option, Govt must determine that option is the most

advantageous in terms of need, price and other factors basis forchallenging option award to competitor?

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Existing Work Commercial Item Contracts

Agree With Contractor on Changes to Contract

In most commercial-item contracts, Govt cannot unilaterally directchanges in the work or the contract

Rather, changes may be made only by written agreement of theparties (FAR 52.212-4(c))

This is a critical distinction from non-commercial-item contracts itsignificantly limits Govts ability to change commercial-item contracts

Order a Partial or Complete Termination of the Contract

In most commercial-item contracts, Govt can unilaterally terminate anypart of the contract. (FAR 52.212-4(l))

Such termination is valid unless Govt acts in bad faith

Contractor would be entitled to a % of the contract price equal to the %of work performed prior to termination, plus other unrecoveredcosts/charges that have resulted from the termination

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Existing Work Non-Commercial-Item Contracts

Order a Suspension or Stoppage of Work

Suspension of Work clause (FAR 52.242-14) may apply to fixed-priceconstruction or architect-engineer contracts

Stop-Work Order clause (FAR 52.242-15) may apply to any negotiatedcontract

Contractor entitled to price & schedule adjustment if timely notice is

provided and costs are adequately tracked and segregated Order a Deductive Change or Partial Termination

Govt may be able to unilaterally delete portions of a contract througheither: A deductive change under an applicable Changes clause; or

A partial termination under an applicable Termination for Convenienceclause

Contractors recovery is measured differently under the two clauses, soits critical to evaluate which of these actions is appropriate

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Existing Work Non-Commercial-Item ContractsCont.

Order a Complete Convenience Termination

Govt can terminate an entire contract for convenience without anyadvance notice if in the Govts best interests

Contractor entitled to be made whole for all costs incurred prior totermination and for expenses related to termination

Termination cannot be challenged, and contractor cannot recover lostprofits, unless Govt acted in bad faith

Cancel a Multi-Year Contract

In a multi-year contract, Govt can cancel all subsequent yearsrequirements/quantities if incremental funds are not available (FAR

52.217-2)

Contractor entitled to a cancellation charge that reflects most costsincurred on the contract prior to cancellation

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Existing Work Non-Commercial-Item ContractsCont.

Elect Not to Add Funds to a Cost-Reimbursement Contract

Limitation of Cost clause (FAR 52.232-20) applies to a fully fundedcost-reimbursement contract

Limitation of Funds clause (FAR 52.232-22) applies to incrementallyfunded cost-reimbursement contract

Clauses require advance notice to Govt when contractor expects toincur 75% of, respectively, the estimated cost of the contract or thetotal amount so far allotted to the contract

Clauses also require notice when, respectively, total cost will be greaterthan previously estimated or additional funds will required to continuetimely performance

If Govt does not add funds to the contract, Govt is not obligated to paycontractor for any costs incurred in excess of the estimated cost or thetotal amount allotted to the contract

Requires contractor to carefully track, manage, and report on costs toavoid overruns that cannot be recovered

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What c an a c ont rac t o r do to

m i t igat e r isk s o f seques t ra t ion?

Understand portfolio of existing contracts

Contract types e.g., commercial item? ID/IQ? Cost-type?

Periods of performance, including option periods

CLIN structure, quantities, and pricing

Funding limits and notice requirements

Contractual clauses for changes, downscoping, and terminations

Strategic importance to company? to customer?

Evaluate Pipeline of New Work

Whats at risk? What will be delayed?

What pricing strategies/improvements are needed in future?

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Evaluate risks of contract expirations/changes/terminations

Known price risks vs. competition?

Severable or easily reduced scopes of work?

Readily available alternatives for customer (e.g., other contractvehicles, performance within agency, available funding)?

Engage With Key Customers Be a partner in helping customer evaluate and solve funding

problems

Ask for reasonable guidance and transparency on program

planning, funding, renewals, timelines, etc. Anticipate and recommend program changes where needed

protect high-margin work where possible while still accommodatingrequired changes

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Evaluate Subcontractor/Supplier Risks

Do teaming and other agreements adequately protect company in

event of changes, downscoping, and terminations? Do they allowsubstitution of lower-cost subcontractors/suppliers?

Are any subcontractors/suppliers at risk of failure in event ofchanges, downscoping, and terminations?

Closely monitor other cost and payment risks

Working at risk or as volunteer

Withholding of payments for deficiencies in business systems

Reduction in award fees

Change Control/Management

Delays and impacts due to Government furloughs or cutbacks?

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SEQUESTRATION AND BUDGET CUTS

QUESTIONS??

Contact Information:

Richard P. Rector Nathaniel J. BellGovernment Contracts Federal Law & PolicyDLA Piper LLP (US) DLA Piper LLP (US)500 Eighth Street, NW 500 Eighth Street, NW

Washington, DC 20004 Washington, DC 20004T +1 202.799.4400 T +1 202.799.4000E [email protected] E [email protected]

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