04.08.11

Note: On February 24, 2011 Argy issued a Client Alert regarding an anticipated Government shutdown, which was set to occur on March 4, 2011. With the extension of continuing resolutions, the Federal Government extended funding through April 9, 2011.  This Client Alert serves as an update to the February 24th alert.  To see the original alert, please click here.

The current continuing resolution, which has provided short-term funding for Federal Government agencies for 2011, is set to expire at 12:01 a.m. on April 9, 2011.  Without the extension of the continuing resolution or the passage of a 2011 budget appropriations bill, the Federal Government is expected to shut down those Federal programs and functions not deemed essential.  “Essential” activities are primarily those efforts associated with defense and national security or otherwise necessary to protect life and property.  During a shutdown “non-essential” Government personnel would be furloughed.   The furlough would last until another appropriations bill is signed into law.

In the event of a shutdown, the possibility exists that Government personnel responsible for the basic functions that are critical to the day to day operations of Government contractors could be included in the furlough.  Government functions that could be considered “non-essential” potentially include program management, procurement, contract administration, receiving and inspection functions as well as functions related to the review, approval and payment of contractor invoices.  This would have a significant impact on contract performance and financing.

The financing ramifications of a shutdown can go well beyond the contracts that are directly impacted by the shutdown.  The furlough of Government employees would not necessarily be limited to those directly associated with the contracts issued under programs that are deemed “non-essential”.  As such, it is important to note that upon a shutdown, the financing and cash flow implications would impact Government contractors beyond those that have contracts that are put on hold.  This is especially true in today’s environment where many Department of Defense contractors no longer have direct billing privileges and require advance review and approval of invoices prior to payment by the paying office.

In light of the impact on the Government contract industry, it is suggested that contractors consider the following as preemptive measures to mitigate the financial impact of a shutdown.

• By now contractors should have identified the contracts in their existing backlog that would be impacted by a shutdown.  Not all contracts will necessarily be impacted to the same extent.  Factors such as the contract type, the funding status and whether the contract is performed under an “essential” program will influence whether any individual contract is directly impacted by a shutdown.
• For those contracts that are potentially impacted by a shutdown, contractors should have already reached out to their Contracting Officers (COs) to obtain guidance and clarification on expectations of performance during a shutdown.  To the extent that any such communications have occurred they should be documented.  While it is the responsibility of COs to issue stop-work orders, as necessary, or otherwise provide instructions to their contractors regarding activities impacted by a shutdown, contractors should take the initiative to ensure that they proactively obtain guidance from their COs.  Contractors who have not already reached out to their COs should do so immediately.
• Contractors should proactively plan for contingency activities for direct program staff that are impacted by a shutdown.  Options to consider include using any shutdown time to address training requirements, encouraging impacted staff to use leave or paid time off during the shutdown period, utilizing impacted staff to facilitate internal programs and functions that would otherwise be procured or outsourced, and re-deploying staff to non-Government programs.  (See related HR Consulting client alert.)

In the event that a shutdown goes on for an extended period of time, contractors may be faced with their own decisions as to whether they should furlough or layoff employees.  These actions should be a last resort, especially in light of the fact that the duration of any Government shutdown would be uncertain. Additionally, a layoff of staff would put an organization at a disadvantage when the shutdown is over and contract performance recommences. When considering how to address staff impacted by a shutdown, contractors should make strategic decisions on how best to be prepared for responding to both existing and new work once the shutdown is over.

• Contractors that collateralize their Government receivables to finance operations should contact their finance and lending institutions to discuss the implications of the shutdown on their loans and lines of credit.  Borrowing availability can be compromised due to delays in the collection of receivables as a result of the shutdown.  To avoid significant financing ramifications, waivers and/or amendments of existing financial covenants may need to be obtained.  In addition, new loans may need to be acquired in order to cover normal operating costs. 
• During a shutdown contractors should routinely evaluate cash flow and prioritize expenditures, as necessary.  To mitigate cash flow issues resulting from a shutdown, contractors should look to the potential re-negotiation of payment terms with their suppliers.  For example, some contractors have moved to “pay when paid” payment terms with their subcontractors and major vendors.
• Prime contractors should develop a plan for providing notification and instructions to subcontractors, as necessary.  Prime contractors may have to issue stop-work orders to their subcontractors.  Alternatively, if the Government expects work on a contract to continue during a shutdown, prime contractors should ensure that their subs are fulfilling their performance obligations by providing clear instructions.  In turn, subcontractors should seek instructions and direction from their primes.
• If a stop-work order is issued under a contract, contractors should separately track associated shutdown costs as these costs may be recoverable.  Costs that should be tracked separately include labor for staff that would otherwise be working on a contract, costs associated with ramping up and ramping down during a shutdown as well as allocable facilities costs for staff that would otherwise be working at Government facilities.

As it relates to costs, contractors with flexibly priced contracts or contracts priced based on cost-build up should be aware that contracts put on hold would likely result in actual indirect rates exceeding provisional and forward pricing indirect rates.  As such, when the Government resumes normal operations, contractors should consider whether updates to existing provisional and forward pricing rate agreements are necessary.

• Finally, contractors should seek necessary legal advice to address any unique aspects of the shutdown and the impact on individual contracts.    

A Government shutdown poses a number of uncertainties for contractors. Expectations related to performance requirements and recovery of costs on any individual contract will depend upon the unique set of circumstances associated with the contract.  Nonetheless, proactively preparing for and addressing the impact of a shutdown will allow contractors to mitigate operational and financial ramifications.

Should you have any questions about the impact of a Government shutdown on your organization you may contact Sajeev Malaveetil, Principal, at 703.770.1060 or at smalaveetil@argy.com.

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