CLIENT ALERT: Sequestration Looks Likely - Additional Concerns

February 20, 2013
Alan I. Saltman

In August 2012, we published a White Paper detailing what Sequestration is, estimated cuts to both defense and non-defense spending as a result of sequestration, and the potential impacts of sequestration on future government contracts and grants. Following the issuance of Office of Management and Budget’s (“OMB”) breakdown of exempt and non-exempt budget accounts and a preliminary estimate of the funding reduction that would be required across non-exempt accounts, we provided an update to our first White Paper.

As you know, in January, lawmakers approved a deal that delayed these across-the-board cuts until March 1, 2013.

While the head of the Congressional Budget Office has estimated that sequestration will cost the economy some 750,000 jobs this year, it appears extremely likely that this time around Republicans and Democrats will be unable to reach an agreement to avoid sequestration. Perhaps sensing this, government agencies have begun to prepare.  (Something that they did not do in November and December of last year).  For example, last month, new defense contracts dropped from $36.3 billion in December to only $12.1 billion in January. While this coincides with the military’s winding down two wars, it also does reflect the looming sequestration. Additional consequences of a sequestration include the Air Force’s issuing a directive to its major commands requiring them to cut spending in advance of sequestration. The directive requires the commands to freeze civilian hiring, cancel nonessential travel and reduce base repair expenditures. Additionally, the Army and the Navy have also announced hiring freezes and warned that furloughs were possible. A memo issued by the Navy’s Deputy Assistant Secretary for Budget stated that Navy commanders, for example, should assume that one-day-per-week furloughs will begin the week of April 16 and will continue through the end of the fiscal year. Similar cutbacks have been announced in civilian agencies. Over and above this, planning for the possibility of sequestration has consumed much of the time and attention of agency management personnel. This, plus the uncertainty that the agencies are feeling about funding levels for the rest of the fiscal year, is slowing down and, in some instances, postponing important agency decisions.

As discussed previously, we anticipate that if sequestration occurs, there will be a fair number of suspensions and terminations of existing contracts. For these actions, contractors will generally be entitled to compensation. An effect of sequestration on which we have not previously focused is the problem that contractors will begin to experience as the contracting officers and their representatives simply become unavailable, as a result of furloughs or consolidations, to promptly respond to situations that require government approvals and direction in the course of contract performance. While in normal situations such delays in administration would be compensable, we fear that the government will argue that delays that are the result of the sequestration are much like cases regarding government shutdowns when Congress fails to pass a budget, and do not result in government liability.

The best advice we can provide in this regard is one that you’ve probably heard before — document any and all delays that you experience as well as the impact that it has on your operations. If the impact is substantial enough, it may be worth attempting to recover. In any event, by documenting the delay, you will be in the best position possible to obtain more time within which to perform your contract.