Default, Dispute, and Termination in Government Contracts

Introduction to Government Contract Termination

In government contracting, the government — through a contracting officer acting as its agent — enters into a legally binding agreement with a contractor. The contractor is a seller who delivers goods or services, and the government as the buyer pays for those services as agreed upon in the contract. However, situations arise in which agreements may be terminated in order to settle disputes between the contracting agents and the contractor. Normally, the government may terminate a contract either for the default of the contractor or for its own convenience (Kathuria, 2009). The Federal Acquisition Regulations (FAR) define termination for convenience as the exercise of the government's right to terminate a contract when doing so is in the government's best interest.

Termination for Default

The government has the right to terminate a contract when a contractor fails to meet its contractual obligations (Rumbaugh, 2010). For the government to terminate on grounds of default, there must be documented failures along with an explanation for those failures. It is well established that there must be an actual failure of performance for a contract to be terminated for default (Loulakis, 2003). The default clause requires the contractor to transfer title of any delivered goods to the government upon termination. In turn, the government pays for all goods and services already delivered.

Government contracts provide the following bases for termination for default. First, a contract may be terminated if the contractor fails to perform delivery within the time specified in the contract. Second, it may be terminated if the contractor fails to make adequate progress, thereby endangering overall performance. Third, the government may terminate a contract for default if the contractor refuses to perform any provision stated in the contract (Rumbaugh, 2010).

In practice, the government — after issuing a cure notice — directs the contractor to stop further work on the project. The government then terminates for default if the contractor has failed to fulfill its contractual obligations by the termination date (Robert, 2004). In one illustrative case, the outstanding work represented 43% of the contractor's required performance at the time of termination.

Consequences and Remedies of Contract Termination

Termination of a contract, whether for default or for the government's convenience, carries consequences for both parties, and remedies must be rendered accordingly. When the government terminates for default, the consequences fall on the contractor, who becomes liable for any excess costs the government incurs in re-acquiring the services. The remedies available to the government in this situation include payment of liquidated damages (compensation for actual, known loss), payment of unliquidated damages, and additional re-procurement costs. In contrast, when the government terminates a contract for convenience, it must pay the contractor for any costs and profits related to the stop-work order and to the termination itself (Loulakis, 2003).

The government may also offer a no-cost settlement in lieu of formal termination, allowing the contract to run to completion. This approach is most common where the undelivered balance is less than $5,000. Additionally, the government bears the responsibility of issuing written notice to the contractor upon termination. It should be noted that under termination for convenience, the government does not pay damages to the contractor.

A clear distinction must be drawn between excess re-procurement costs and liquidated damages — both remedies available when the government terminates a contract for default. Excess re-procurement costs are the additional costs the government incurs as a direct result of the default termination, whereas liquidated damages apply in situations where there is prior knowledge of the actual loss suffered. In either case, the disputing parties must agree upon the amount payable.