Overview
This section prescribes the mandatory procedure for adjusting termination settlements when a contractor was projected to incur a loss had the contract been completed. It ensures that the government does not pay profit on loss-making contracts and applies a proportional "loss ratio" to reduce the contractor’s recovery of costs.
Key Rules
- Prohibition of Profit: If the Termination Contracting Officer (TCO) determines the contractor would have suffered a loss upon contract completion, no profit is allowed in the settlement.
- Cost to Complete Estimation: When determining the potential loss, the TCO must estimate the cost to complete the remaining work, accounting for expected production efficiencies and other relevant factors.
- The Loss Ratio: The settlement amount (excluding settlement expenses) is reduced by multiplying it by a ratio of the Total Contract Price divided by the Total Projected Cost (total costs incurred to date plus estimated costs to complete).
- Inventory vs. Total Cost Basis:
- Inventory Basis: The adjustment is applied to the remainder of the settlement after accounting for settlement expenses and the price of accepted completed end items.
- Total Cost Basis: The adjustment is applied to the total settlement amount (minus settlement expenses) as reported on Standard Form 1436.
- Mandatory Credits: All settlements must be reduced by disposal credits, unliquidated advance payments, and progress payments previously made.
Practical Implications
- Bid Accuracy: This regulation prevents contractors from using a Termination for Convenience to escape the financial consequences of an underpriced bid or poor performance; they remain responsible for their share of the projected loss.
- Negotiation Burden: Contractors must be prepared to defend their "cost to complete" estimates during settlement negotiations, as a higher estimated cost to complete results in a harsher loss ratio and a lower final payment.