Fixed Price Contracts = More Risks for Contractors By Wayne Clark, CPA The Obama administration’s agenda includes increasing the use of fixed price contracts. For small contractors who are used to performing in a T&M or cost-plus environment, this represents a profound shift in the performance of contracts and the risks involved. In order to be successful both financially and performance-wise, you need to understand the risks and the strategies to help mitigate them. When are fixed price contracts appropriate? A firm-fixed-price contract is suitable when there is a clearly defined scope of work and minimal uncertainty in the design, specifications or costs of performance. However, contracts where the scope of work is intentionally left vague, or is better suited for a T&M or cost-plus contract, are now being awarded as fixed price contracts. The contractor’s price proposal and profits proposed should adequately reflect the increased level of risk being assumed. How does the contractor protect itself against a poorly written fixed price contract? The first step is to include any assumptions in the cost and technical proposals including the expected maximum quantities. The contractor can then reference the proposal section(s) to support the contractor’s position that the level of effort in the statement of work has been exceeded and the contractor is due additional compensation. The second step is to carefully review the SOW before signing the contract. The absence of a maximum quantity or detailed specification will make it more difficult for the contractor to propose and document that the level of effort contemplated at award was exceeded. Finally, submitting questions as part of the RFP process can help define the scope of work and reduce uncertainties in the performance of the contract. Changes to Fixed Price Contracts The most problematic changes are unanticipated contract changes that occur during the performance of the contract as well as “scope creep” when the contracting officer requests additional items. These changes require the contractor to initiate the changes process. Examples include government-caused delays, defective specifications and a constructive change. A constructive change occurs when the contractor exceeds the level of effort in the SOW. For example, the SOW specifies IT support for 200 government users. If the contractor is actually providing support to 500 government users, this would constitute a constructive change for which a contractor should be compensated. Is the contractor entitled to a contract increase if the SOW is exceeded or changed? The answer was likely “yes” a number of years ago when the Total Cost Method was accepted by the courts. The contractor simply provided proof that the original cost proposed was $3 million and the actual costs are $4 million. It was assumed that the entire $1 million cost increase was the result of government actions or inactions identified by the contractor. Today the answer is “maybe.” The current standard established by courts is the Modified Total Cost Method. Under this method the contractor must prove that the $1 million cost increase was caused by the government and not by a low bid or contractor inefficiencies. How do I prepare a compliant request for equitable adjustment (REA)? The Modified Total Cost Method treats the additional work as a “cost reimbursable” contract. The contractor’s accounting system must be able to identify and segregate the additional direct costs as well as support the indirect cost allocations. The accounting system should have the capability to track direct costs by contract or task and allocate indirect costs using system supported indirect rate calculations. The CO may allow unit rates from the original contract bid. This approach is more applicable to goods and commercial services contracts, including GSA schedule-based contract awards. Final Thoughts 1. Many change clauses, including 52.243-1—fixed price contracts, give the contractor 30 days to assert the right to a contract increase (equitable adjustment). 2. Requests for Equitable Adjustments should be supported by accounting records. The contractor should establish a separate charge code in its accounting system as soon as possible to accumulate costs to support any REA’s. The courts have ruled that if a contractor that has the ability to segregate the REA costs and fails to do so, the REA amount can be reduced or denied in total. 3. When a dispute arises regarding contractor compensation, unlike a commercial contract, the contractor has a duty to continue to perform until the dispute is resolved or the CO directs the contractor to stop work (FAR 52.233-1). 4. The applicable FAR clauses will vary for commercial and non-commercial awards. Commercial awards include all GSA schedule-based contract awards. Wayne Clark, CPA, is a Senior Manager with Federal Strategies Group, LLC. He provides government contract and management consulting, M&A advisory, forensic accounting and expert testimony to the government contracting industry. He can be reached at WayneC@FedStrat.com.