The Case for a Cost Limitation Clause
A monthly expenditure profile is a critical element in establishing PBP event values. Unfortunately, accurately predicting expenditures can be more difficult than accurately estimating the total cost of a contract. Unless the item being procured has been bought in the same quantity and the same delivery schedule, and the monthly expenditures (actual) for those prior buys shows a consistent expenditure pattern, it can be difficult predicting the monthly cash flow requirements for a given contract. In a contract financed with progress payments, accurately predicting cash flows is not necessary because actual cost, not projected costs, will ...view middle of the document...
Some contractors may be concerned that the FAR does not require such language. While that is true, there is nothing in FAR that prohibits it and the language is consistent with the FAR limits on PBPs:
FAR 32.1004(b)(2) states:
Total performance-based payments must—
Reflect prudent contract financing provided only to the extent needed for contract performance
Since PBP are contract-financing payments, which by definition are intended to assist the contractor in paying the cost incurred in performing the contract, there can never be a “need” for financing payments to exceed the cost incurred.
FAR 32.1004(b)(3) states:
the contracting officer must ensure that—
(i) The total contract price is fair and reasonable, all factors considered; and
(ii) Performance-based payment amounts are commensurate with the value of the performance event or performance criterion, and are not expected to result in an unreasonably low or negative level of contractor investment in the contract.
The “contractor investment” in a contract is the amount of the contractor’s money that is tied up in paying the cost incurred in performing the contract prior to contract completion. A “negative level” of contractor investment occurs when the contractor has received more through financing payments than he has cost incurred. The cost limitation language simply prevents a negative level of contractor investment from occurring.
Some contractors may also express concern that the cost limitation “violates the intent” of PBPs by tying payments to cost incurred, requires contractors to maintain an adequate accounting system and adds significant administrative effort to PBPs. This concern is unwarranted on all counts:
1. Payments are not tied to cost incurred as they are in progress payments. Cumulative payments are merely limited by total cost incurred. This limitation only comes into play as warranted.
2. The vast majority of contractors has adequate accounting systems and will continue to maintain those systems whether they utilize PBPs or not. Any contractor with a cost-type or other flexibly priced contract such as FPIF is required to have an adequate accounting system. Furthermore, even in those rare instances where a contractor does not otherwise have a requirement for an adequate accounting system, an agreement can be reached on how to implement the language.
3. The implementation of the cost limitation language does not add significant administrative effort. It is very simple. As each request for a PBP is made the contractor identifies the total cost incurred per its accounting records. The cost incurred data is usually readily available in the accounting system. If cumulative PBPs are equal to or less than cumulative cost incurred, payment proceeds normally. If cumulative payments would exceed cumulative cost incurred, the amount beyond the cost incurred is withheld until the next month when the comparison to cost incurred...