Termination for Convenience – Fair Compensation Principle

The “Termination for Convenience of the Government” (T4C) clause in a Government contract conveys broad rights on the Government to terminate the contract when termination is in the Government’s interest. The Government may cancel the contract simply because its needs change and regardless of contractor fault. In return for this privilege, the Government agrees to reimburse the contractor for all reasonable and allocable costs incurred in connection with performance, plus a reasonable profit on work done, as well as certain post-termination costs and settlement expenses.

The Federal Acquisition Regulation (FAR) T4C “fair compensation principle” recognizes T4Cs are unique and completely disrupt the contractor’s basic assumptions in planning for and costing contract work.  Both FAR 31.205-42, “Termination Costs,” and the Defense Contract Audit Agency (DCAA) Contract Audit Manual recognize that terminations for convenience recognize that it is appropriate to apply sound business judgment in determining what is considered “fair” compensation to a contractor and whether the mechanical, by-the-book application of cost principles may be inappropriate. The FAR Cost Principles are not applied strictly in determining the allowability of costs in termination settlements under fixed-priced traditional Government contracts. FAR 49.201(a) and FAR 49.113 require that the Cost Principles be applied “subject to” the general principle that a contractor whose contract is terminated for convenience is entitled to “fair compensation.”  FAR 49.201 guarantees a terminated contractor “fair compensation.” The fair compensation guarantee overrides the application of any other Cost Principle that would deprive the terminated contractor of “fair compensation.”

For example, in Codex Corp. v. United States, 226 Ct. Cl. 693 (1981), 23 GC ¶ 239, the Court of Claims (predecessor to the U.S. Court of Appeals for the Federal Circuit) held that a terminated contractor is entitled to recover otherwise unallowable precontract costs if nonpayment would deprive it of fair compensation. In Kasler Electric Co., DOTCAB 1425, 84-2 BCA ¶ 17374, 26 GC ¶ 326, the board held bid and proposal costs that were unamortized as the result of the termination to be allowable despite a conflicting Cost Principle, explaining: “A contractor is not supposed to suffer as the result of a termination for convenience of the Government, nor to underwrite the Government’s decision to terminate.”

The cost of money (imputed cost of capital for facilities used on contract performance) must usually have been included in the original cost proposal to be recoverable on contracts. If the termination settlement proposal is the first cost proposal (e.g. the contract was awarded on a competitive basis, no cost or pricing data was originally submitted) then cost of money can and should be included to maximize a T4C recovery. Appeals Boards have allowed cost of money under the “fair compensation” principle even when all the cost contract record keeping requirements were not met.