(Editor’s Note. There has been a flurry of legislation proposals in response to numerous media reports criticizing payment of award fees to contractors for substandard work. A recent commentary in the Nov. 15 issue of Government Contractor written by David Gallagher of the Sheppard, Mullen Richter and Hampton law firm highlights the developments of this “hot” issue.)
Historically, a contractor could count on getting the award or incentive fees on cost type contracts that it had bargained for. So long as it had met certain minimum requirements spelled out in the contract and in negotiated award fee agreement, it could earn a certain amount from the available fee pool. However, new legislation threatens to undermine this practice. Now the new Congress has sent a message that states the government will no longer pay award fees for merely satisfactory performance. Rather award fees will be reserved for circumstances in which the contractor “truly deserves it” and when the contract requirements are clearly exceeded. The author believes such a policy is “two-faced: potentially allowing the government to underperform on its contractual promises while requiring a defense contractor to overperform to earn an award fee.”
Recently the Defense Department and Industry have come under fire from numerous sources criticizing the use of award or incentive fees for merely “satisfactory” or substandard performance. In December 2005, the GAO issued a report stating that paying award fees for “acceptable, average, expected, good or satisfactory” performance was “undermining the effectiveness of fees as a motivational tool” and was a “waste of taxpayer funds.” GAO was critical of DOD payment fees even though total program costs or schedules had slipped past the baseline. GAO stated that rather than focusing on acquisition outcomes such as delivering fielded capability with established cost or schedule baselines, DOD placed emphasis on less important things like responsiveness of contractor management to feedback from DOD, quality of contractor proposals or timeliness of contract data requests. Consequently, GAO recommended that DOD tie fees in new award and incentive fee contracts to acquisition outcomes.
DOD largely agreed with GAO’s recommendation but also took the position that it is fair to pay a portion of award fee for “satisfactory” performance. In March 2006 Deputy Undersecretary of Defense James Finley issued a memo encouraging DOD to structure its new award-fee contracts in ways that would focus the government’s efforts on both meeting or exceeding cost, schedule and performance requirements as well as “achieving desired program outcomes.” Finley indicated that unsatisfactory work should not be rewarded with a fee, satisfactory work should receive “some” fee while excellent performance should earn more. In testimony Undersecretary of Defense Kenneth Krief testified on April 5 that award fees should recognize exemplary performance but also serves two other purposes: (1) to give DOD access to the best resources and technologies, the department must ensure its contractors make “a reasonable return on DOD contracts” and (2) shares the risk of contract performance when there are numerous variables affecting contract performance. He also warned against tying award fees to undefined terms – if the government does not define what is “satisfactory” then it is not a good idea. Kreig’s testimony was followed by GAO head David Walker who stated that continuing to award “some” fee for satisfactory performance was “indicative of DOD’s resistance to change.”
Congress has enacted legislation that basically ignores Krief’s counsel in both the 2007 Appropriation Act and the 2007 Authorization Act that contains provisions prohibiting award-fee payments for unacceptable contract performance and leaves open the issue of whether award fees are appropriate for satisfactory performance. Section 814 of the Authorization Act required DOD to issue guidance, with detailed implementation instructions on the appropriate use of award and incentive fees. Examples of what the guidance should include are:
Ensure new contracts using award fees are linked to acquisition outcomes which will be defined in terms of program cost, schedule and performance.
Provide guidance on circumstances where a contractor’s performance will be judged as “excellent” or “superior” and the percentage of available fee to be paid for such performance.
Establish standards for determining the percentage of available fee, if any, to be paid for “average”, “expected”, “good” or “satisfactory.”
Provide direction of circumstances, if any, when award fees not earned in one period can be “rolled over” to another.
Though there is nothing inherently objectionable about these requirements – in fact most contractors would probably agree as long as award-fee conditions are spelled out in the contract – the author expresses concern over how these guidelines are implemented. He asks what does “satisfactory” mean and how far above “satisfactory” must a contractor perform to earn fee? If satisfactory means meeting expectations, then the contract must spell out carefully what they are rather than relying on arbitrary expectations of a CO. He expresses concern that though the legislation allows payment of fees for satisfactory work, it creates an opening for COs to deny awards for merely “average” work. He states that “satisfactory” is not a bad word, especially if the term is intended to reflect achieving basis contract requirements. If the legislation is misused to force contractors to perform above and beyond contract requirements, it is bad policy because it may impose unreasonable burdens on a contract when such requirements exceed levels spelled out in a contract. He fears that Congress and the public, in their fear of “greedy defense contractors bilking the public,” may forget that a viable defense base must make a profit to provide a reasonable return on its assets, cover inevitable financial risk and recoup normal business expenses that may be unallowable under FAR cost principles. Otherwise there may very well be unintended consequences of having only a small roster of companies providing only satisfactory work and all other companies pursuing more profitable investment opportunities elsewhere.
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