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A Government Accountability Office report last spring and a Senate Armed Services Committee hearing this September concluded that 26 defense weapons programs (out of 54 reviewed) are costing more (40 percent more) and taking longer (20 percent longer) than planned. Fingers have also been pointed at troubles in the Pentagon’s information technology programs. And a number of major defense contracts are being formally restructured. What is happening here? And what can counsel do about it? Among the key causes cited have been the increasing size and complexity of defense programs and the reliance on technologies that are not “mature” to meet requirements that are not well defined. The increased wear and tear on existing weapons caused by combat operations in Iraq and Afghanistan, and budget constraints projected to require defense cuts of $10 billion to $15 billion a year on planned spending over the next five years, have exacerbated the difficulties. While contractors can’t tell the military to treat weapons more gently, and the federal budget is set by many factors outside contractors’ control, what companies can do is practice more aggressive legal review and astute contract administration. Company counsel should assume that virtually any major contract has the very real potential to become “troubled” from the moment it is awarded (if not before). KEY CHECKPOINTS Certain significant events can provide insight into the potential for trouble. Obviously, the contract proposal and award are key checkpoints, but so are schedule and cost reviews, external reviews by the agency customer, contract changes (directed or constructive), changes in management structure or personnel and any adverse action by the government that could result in the termination of all or part of the contract. Because the company’s program personnel may not always recognize early signs of trouble, counsel must be vigilant. Start with any kind of pre-award understanding. Unfortunately, program personnel too often place more weight on these understandings than can be justified by the language of the contract. High-minded concepts like “partnering with the government” or “new ways of doing business” often do not justify the kinds of reductions in cost estimates that program personnel suggest. One perennial problem, especially in the context of contracts to develop new products, is the ambiguous, incomplete or undefined specification — or, even worse, any agreement to continue preparing the specification after the contract has been awarded. This approach necessarily means that the product is being developed at the same time the concept is being conceived. For counsel, the warning lights should be flashing red. CONTRACT BY CONTRACT The various types of defense contracts raise their own particular worries. For instance, “commercial item” contracts under Federal Acquisition Regulation Part 12 warrant special consideration because the effort to “commercialize” a government acquisition is seldom entirely successful. The relevant contract language nearly always obligates the contractor to provide products or systems that are not quite commercial. Often the pre-award estimates of the cost to adjust the commercial product for government use are overly optimistic, in large part because they rely on expectations of government cooperation and performance that are never realized. Another classic red flag is the fixed-price development contract, a contract in which the company agrees to develop an entirely new product or system for a set amount, such that any cost overruns will be borne entirely by the company. Both the FAR and the Defense FAR Supplement (DFARS) limit the use of fixed-price development contracts to circumstances in which costs can be reliably estimated, and yet fixed-price development continues to generate programs burdened with cost overruns and schedule extensions. Such fixed-price development contracts also continue to require a disproportionate amount of legal support. Indeed, these contracts have such an unfavorable reputation that some government programs try to soft-peddle the concept with other names, such as “nonrecurring engineering,” that are intended to sound less ominous. MAKE AN ESTIMATE One of the most important review mechanisms used on all major defense programs is the periodic “estimate at completion” (EAC) review. The EAC itself is simply the sum of the costs already incurred on a program and the costs to be incurred to complete it. Just as program managers carefully monitor changes in the EAC, counsel should be aware that the EAC can identify early signs of trouble. Obviously, large increases in an EAC may well mean that the contract will no longer be profitable for the company or that sufficient government funds may not be available for its completion. Such increases may be a sign that the government has increased the scope of the work, that the work is being accomplished less efficiently than anticipated, or that the contractor initially misunderstood or underestimated the scope of the effort. Other, more subtle signs of trouble include contract-related activities that are measured “outside” the EAC, estimates based on unrealistic or overly optimistic schedules, recognition of significant anticipated revenues to offset cost growth, a large “undistributed budget” and significant management adjustments to “grass-roots” EACs. THE REST OF THE TEAM Difficulties with suppliers (aka “team members”), even when the relationship was initiated with the best of intentions, should draw counsel’s attention. At the outset, counsel should ensure that major subcontracts “flow down” not just the FAR/DFARS boilerplate clauses but all the relevant requirements and metrics against which the team’s performance will be judged. Just as “good fences make good neighbors,” thoroughly documented and well-managed subcontracts make good teammates. IT’S BEEN CHANGED Although counsel for government contractors are usually aware of the concept of a contract “change,” they do not always recognize the significance of these changes in the identification of troubled programs. While contract changes may be formally directed by the government, more commonly they are “constructive,” meaning they are not the result of formal government direction or contract modifications. Constructive changes come in different forms: defective specifications, unreasonable specification interpretation, government interference or failure to cooperate, government failure to disclose superior knowledge and constructive acceleration of contract performance. Unfortunately, constructive changes can adversely affect the EAC and other program metrics before program staff even recognize a problem. Indeed, whenever unexplained (or poorly explained) cost or schedule growth appears, counsel should ask whether a constructive change could be the root cause. Counsel should also be aware that the changes clause in FAR Part 12 commercial-item contracts departs dramatically from the standard FAR clause in that it does not authorize the government to make unilateral contract changes. This distinction is all too often not understood by government contracting officers, but it can be a powerful legal tool for the contractor in dealing with undefined or evolving requirements. SIGNALS FROM THE AGENCY Generally, adverse action by the government is preceded by the types of problems described above, but whether or not an early warning has been detected, adverse agency action is almost by definition a sign of a troubled program. Any decision by the government to reduce the amount of work on the contract — whether by a deductive change, a partial termination for convenience, or a partial stop-work order — is, at a minimum, a signal that the program is not proceeding as anticipated. Although program personnel will sometimes minimize the importance of a partial loss of work, very frequently this kind of action is a precursor to a more draconian government remedy — such as a cure notice, a show-cause notice or even a contract termination, whether for the government’s “convenience” or for default. Sometimes a program’s cost or schedule becomes so unrealistic that the only possible means of getting back on schedule is to replan or “restructure” the entire program baseline. Because of the potential liabilities, counsel should always be involved in these efforts. Typically, a program restructuring has the effect of wiping the slate clean in terms of claims against the government. Counsel should review any proposed release language to ensure that it preserves any claims or other rights that the company may wish to raise later and to ensure that it takes into account any possible subcontractor claims against the company. Where a release waives claims, the scope of the waiver must be carefully drafted and explained to program management. A QUICK LIST In short, counsel helping to oversee major government contracts should understand the key contract checkpoints and metrics and use this knowledge to monitor at-risk programs before they become crises. Counsel may wish to keep the following guidelines in mind: • Understand the pre-award negotiation and estimating process for all major programs.

• Review any informal commitments and understandings before a contract award, and advise clients of the risks created by those commitments. • Understand program management metrics — especially EACs and contract schedules — that can help identify significant difficulties. • Be aware of any internal and external reviews of major programs, which often provide an early glimpse of problems to come. • Treat any reduction in the scope of work as a potential indication of a serious problem. • Understand the consequences of any adverse agency action, and try to determine the significance of the action for the long-term health of the program. • If a troubled program must be restructured, ensure that program personnel understand the scope and consequences of any contractual release or waiver of claims. Often, business considerations legitimately trump legal concerns. But any such business judgment is better exercised on a fully informed basis. It is counsel’s job to make sure the client is fully aware of the legal risks that flow from a particular business decision so that a knowing trade-off can be made.

Rand L. Allen is a partner and chair of the government contracts practice in the D.C. office of Wiley, Rein & Fielding. Martin P. Willard is a partner in the D.C. office specializing in government contracts counseling and litigation.

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