What is the standard to apply when calculating an equitable adjustment for a deductive change?

We have a situation where a change was made to a construction contract that reduced the quantity of an estimated quantity CLIN by approximately 50%. The contractor submitted a REA for the change. The REA was for a share of the cost savings that resulted from the deleted work. Essentially, the contractor is saying that he is entitled to share in the cost savings because he found a way to do the work more efficiently than originally planned.

I've never seen an approach to a deductive change like this. Is it proper?

By joel hoffman on Tuesday, December 19, 2000 - 05:09 pm:

Anon, who initiated the change to the construction contract - the Government or the Contractor?

1. If the Contractor initiated the change and the contract is over a threshold amount of $100k, the Value Engineering - Construction Clause (52.248-3) is in the contract. There is a very liberal view held by the Courts and Boards that contractor initiated changes resulting in savings should be treated as "VECP's", to the extent possible. Thus, the Contractor would be entitled to share in any cost savings, plus there would be no reduction in the contract amount for 'profit'on the cost savings. You treat it as a deductive change (described below) but do not include any profit in the gross savings. Then you split the savings, as prescribed in the clause (usually %55
to Contractor and 45% credit to Government).

2. Now, if the Government initiated the change, AHHHH that's a horse of a different color, as they say. There are three approaches to pricing such a deductive change. Nash and Cibinic's Administration of Government Contracts covers this in detail. However, here is an outline of some major points. I won't discuss the third approach, where the work is considered to be "severable", because it appears to me that this is not such a case. Deleting 50% of a CLIN quantity probably makes this a case of "non-severable work".

a. The first method is what I call the "take it off the top" pricing method. An equitable adjustment for deleting non-severable work is treated as a "deductive change" under the Changes Clause.

The credit is generally based on the cost (including directs plus G&A and other applicable indirects and overheads) that it would have cost the contractor to do the work, had there been no change. This cost is adjusted for any costs that are already expended or will be unavoidable for the cancelled work; also adjusted for any additional costs which were/will be incurred by the change to delete the work. Remember, that deducting 50% of a CLIN might result in the contractor not recouping all of its mobilization costs or other fixed costs. If so, the credit must consider these sunk costs.

To the net savings is added an allowance for profit (unless it is clear that there would have been no profit, had the work been done). The Government does not pay profit for work not performed, so the profit allowance is included in the credit.

The contract unit price is only significant in discerning whether or not there would have been a loss on the deleted work.

Administratively, the mod would include a deduction for all the deleted work at the unit price, plus an adjustment bid item for the difference between the value of the deleted CLIN amount and the equitable adjustment. This will either be a credit to the Government or a lump sum CLIN, depending upon the amount of the equitable adjustment.

b. If the deleted work is a very large share of the contract scope of work, the contractor might successfully argue that the adjustment should be treated as a "partial termination", rather than as a deductive change. In that case, you are going to price the adjustment, using a "bottoms up" pricing method. I would avoid this method. You essentially start by subtracting the entire CLIN amount, then allow the contractor allowable and allocable costs plus profit on the work performed, plus any costs plus profit, if any on the work not performed. That is an oversimplification - Part 49 Termination for Convenience procedures apply - profit is not paid on all costs and there are many other wrinkles. You might alternatively only start by subtracting the CLIN amount (quantity times unit price) for the deleted work, then do the bottoms up procedure for incurred costs on the deleted work. Unless the deleted work is such a large share of the contract that it could constitute a cardinal change to the scope, I would not agree to treating it as a "partial termination".

I have probably confused you but different pricing approaches apply, depending upon each situation. Happy Sails! Joel

By joel hoffman on Tuesday, December 19, 2000 - 05:19 pm:

Anon, after rereading your question, I sense that the Contractor says it could do the work for less than the unit price - thus he/she says you cannot take a credit for the full value of the deleted work. In that case, the first approach I described would be applicable. If the Contractor can show that the cost plus profit to complete the deleted work is less than the contract amount for the deleted work, he/she is right.

The administrative means to show the price change on the modification is to delete the remaining work under the applicable CLIN at the unit price, then provide for a lump sum CLIN for the difference. In short, the Contractor keeps that as a "windfall".

By joel hoffman on Tuesday, December 19, 2000 - 05:26 pm:

Anon, clarification to the last message - I meant you'd use the first approach under a deductive change, if the Government initiated deletion would cost the Contractor less to perform than the contract unit price (I didn't mean that you'd treat it as a "value engineering change proposal", unless the Contractor initiated it). Happy Sails!

By Anonymous on Wednesday, December 20, 2000 - 11:57 am:

Joel--

It was a Government initiated change. The contractor's REA was provided as per your example. It showed that the cost plus profit to complete the deleted work was less than the contract amount for the deleted work.

I'm confused over this method of adjustment because of my definition of profit, i.e., what's remaining after all operating expenses are met. Applying that definition the contractor's "windfall" would actually be profit on work not performed.

Am I missing something?

By joel hoffman on Wednesday, December 20, 2000 - 02:43 pm:

Anon- from my understanding of what you said, the Government initiated a CHANGE to the scope of work, deleting about 50% of the estimated quantity of a unit priced CLIN on a construction contract.

In my opinion, the basis of the credit to the Government is the cost to the contractor had it done the deleted work (had there been no change) plus an allowance for profit. If this is less than the contract price, the contractor would keep the difference. The Government cannot simply deduct the entire contract price as the credit. Equitable adjustments for Changes are generally priced on the "cost" impact to the Contractor , not on the contract price or "value".

E-mail me with your phone number and I will be happy to discuss or get more facts. Happy Sails! Joel


Please consider reviewing

By Anonymous on Wednesday, December 20, 2000 - 03:01 pm:

Joel--

By "per your example" I meant the first approach you described for a deductive change due to a Government initiated deletion.

By Eric Ottinger on Wednesday, December 20, 2000 - 04:57 pm:

Anon,

A few extra thoughts in addition Joel's excellent answer--

Take a look at the coverage in the CON 210; Government Contract Law Course which you can access in the Deskbook.

http://web1.deskbook.osd.mil/default.asp


10-3. "The prevailing view appears to be that profit is an allowable factor, but that the amount of profit will be determined by the facts in each case. Profit, like any other factor in an equitable adjustment, is subject to negotiation and agreement between the parties. The amount will be dependent upon the character of the work involved; each case must be examined in light of its peculiar facts. The profit included in an equitable adjustment need not be related to that established in the basic contract or in any previous equitable adjustments on that contract. The test is not whether the change is additive or deductive (i.e., increases the work or decreases the work); the character of the change is the determining factor."

You need to distinguish the negotiated profit from the profit that the contractor actually earns. If the contractor has achieved some additional profit by performing more efficiently than the parties anticipated at the date of the handshake, I don’t blame the contractor for wanting hold on to some of this.

Of course, if I were the contractor, that is the story that I would tell you. You need to determine what the truth is.

Eric

By joel hoffman on Thursday, December 21, 2000 - 07:22 am:

Anon, have you or any of your technical people done an analysis or independant Government estimate (required by FAR if the action exceeds ($100,000) of what the deleted work would cost the Contractor to perform? In other words, what is the Government's estimate of the probable "actual" net savings in cost plus an allowance for profit? That is the credit you are due. You are not automatically due the "contract value" of the contract unit price times the estimated quantity of the deleted work. Sorry, I don't think I can express it any simpler, myself.

NOW - Please be clear about this. Was the work "deleted" by a change in the actual scope of work to be performed or was it merely an underrun in the actual amount of work which has to be performed - without changing the statement of work?

If there was just an "underrun" in the unit priced work, we need to discuss a totally different approach to the contract price adjustment.

By joel hoffman on Friday, December 22, 2000 - 12:31 pm:

I found this in the Army Judge Advocate General (JAG) School materials under 'Contracts':

Pricing Contract Adjustments (Clauses which provide for "Equitable Adjustments")

Pricing Formula.

1. The basic "equitable adjustment" formula is the difference between what it would have reasonably cost to perform the work as originally required, and what it reasonably cost to perform the work as changed, plus a reasonable profit. Pacific Architects and Eng'rs, Inc. v. United States, 203 Ct. Cl. 499, 491 F.2d 734 (1974) (contractor could not use an equitable adjustment to convert a loss contract into a profitable one); Bruce Andersen Co., ASBCA No. 29412, 89-2 BCA  21,872 (deductive change).

3. Deleted work is priced using the costs avoided because the contractor does not have to perform the deleted work, then add an allowance for profit to the credit. Anderson/Donald, Inc., ASBCA No. 31213, 86-3 BCA  19,036 (measure of deductive change is costs saved). This generally is the difference between the estimated costs, and the actual costs, of performing the changed work. But see Condor Reliability Servs, Inc., ASBCA No. 40538, 90-3 BCA  23,254 (deletion of a loss item). Happy Sails! Joel