The clock is ticking on sequestration, bringing with it a possible increase in federal contract terminations as agencies prepare to cope with steep automatic cuts.

Even if sequestration does not occur as scheduled on Jan. 2, there is likely to be a rise in contract terminations—for convenience or default—in the unusually harsh budget environment, according to William J. Spriggs, contracts attorney.

Agencies may look more closely at terminations as a tool at their disposal, along with partial terminations, stop-work orders, solicitation cancellations, non-exercise of options, minimum orders or revisions in performance, among others.

“Whether sequestration happens or not, there will be some slowdown happening. There will be more terminations, no question, in light of the budget situation,” Spriggs told Set-Aside Alert.

Congress and the White House agreed to sequestration in last year’s fight over the debt ceiling. If it goes forward, discretionary defense would see a 9.4% cut in fiscal 2013, while non-defense discretionary accounts would be cut by 8.2%, according to the latest White House report. Congress may stop the sequester but action is unlikely before the election.

One way the budget cuts will affect contractors is through the exercise of the termination for convenience clause in their contracts, Marsha Lindquist, president of Granite Leadership Strategies Inc., told Set-Aside Alert.

More terminations for convenience, along with temporary stop-work orders, are “likely to happen” under severe budget cut scenarios, Lindquist said, though “we have not seen it yet.”

The impact would be felt by small businesses, said John Prairie, attorney with Wiley Rein LLP. “The government is not well-prepared for sequestration, so they may have to issue stop-work orders to vendors,” Prairie said. Those orders would be temporary, but they may be followed by terminations or partial terminations, he said.

“Small business contracts may not be as big of targets for terminations because they are small,” Prairie said. “On the other hand, they could be easy targets because the small businesses do not have political muscle and are less likely to litigate.”

Most federal contracts include a termination for convenience clause allowing the government broad latitude to cancel, while also requiring payment for work to date. About $2.2 billion worth were cancelled in FY2011, according to a recent Washington Post report.

From the contractor’s point of view, terminations for convenience often are a surprise. “In my experience, it often is a secret to contractors,” Spriggs said.

Cancellations for default are less common, accounting for $162 million last year. In those cases the government claims the contractor failed to perform.

Severe fiscal conditions may cause the government to be more active in pursuing defaults, Spriggs and others suggested.

“Government might have an incentive to look for ways to terminate for default. They avoid a lot of fees that way,” Spriggs said.

Agencies may be less likely to excuse a possibly fixable problem and to consider a default termination, Prairie added.

Contractors can fight back in court to convert a default into a termination for convenience, but it typically takes up to four years to obtain such decision, Spriggs said.

Meanwhile, the winding down of contracts for Iraq and Afghanistan is increasing terminations.

The federal government terminated 13,579 contracts in FY2011, more than double the 5,692 it ended in FY2006, the Washington Post reported. The values were $2.2 billion vs. $416 million, respectively.