Analysis of FAR Subpart 16.6: Time-and-Materials, Labor-Hour, and Letter Contracts

Overview

FAR Subpart 16.6 prescribes policies and procedures for contract types used when it is impossible to estimate the extent or duration of work with any reasonable degree of confidence. It specifically covers Time-and-Materials (T&M) and Labor-Hour (LH) contracts—which are neither fixed-price nor cost-reimbursement—as well as Letter Contracts, which serve as preliminary instruments to initiate immediate work.

Key Rules

• Pricing Structure: T&M contracts consist of direct labor hours at fixed hourly rates (inclusive of wages, overhead, G&A, and profit) and materials at actual cost (plus allowable indirect costs).
• Labor-Hour Distinction: A Labor-Hour contract is identical to a T&M contract except that the contractor does not supply materials.
• Mandatory Ceiling Price: Every T&M and LH contract must include a ceiling price that the contractor exceeds at their own risk.
• The "Last Resort" Rule: T&M and LH contracts may only be used if the Contracting Officer (CO) prepares a Determination and Findings (D&F) proving that no other contract type is suitable.
• Letter Contract Definitization: Letter contracts must be definitized (converted to a final contract type) within 180 days of award or before 40% of the work is completed, whichever occurs first.
• Liability Caps: For letter contracts, the Government’s maximum liability is generally limited to 50% of the total estimated cost of the definitive contract until it is definitized.

Responsibilities

• Contracting Officer (CO):
  • Must prepare and sign a D&F for T&M/LH contracts.
  • Must conduct a price analysis before increasing any ceiling price.
  • Must ensure appropriate Government surveillance is in place to prevent contractor inefficiency.
  • Must assign priority ratings to letter contracts when appropriate.
• Head of Contracting Activity (HCA):
  • Must approve T&M/LH D&Fs if the base plus option periods exceed three years.
  • Must approve the use of a letter contract and any Government liability exceeding 50% prior to definitization.
  • Must approve a CO’s price determination for letter contracts if the parties fail to reach an agreement during definitization.
• Contractor:
  • Must ensure labor meets the specific qualifications defined in the contract.
  • Assumes all risk for costs incurred above the established ceiling price.
  • Must submit timely price proposals and certified cost or pricing data for letter contract definitization.

Practical Implications

• High Oversight Requirement: Because T&M and LH contracts provide no profit incentive for the contractor to work efficiently (since they are paid by the hour), the Government must exercise much higher levels of surveillance than it would for a Firm-Fixed-Price contract.
• Emergency Utility: Letter contracts are powerful tools for "undefinitized" urgent needs, such as natural disasters or immediate military requirements, allowing work to start before price negotiations are finished.
• Inter-organizational Transfers: Rules regarding "common control" (transfers between divisions or affiliates) are strict to prevent "profit-on-profit." Unless the service is a commercial product/service, the transferring entity generally cannot include profit in its rate.
• Ceiling Price Management: Contractors must be vigilant about "burn rates." Once the ceiling price is hit, the Government is not obligated to pay further, and the contractor is not obligated to continue, potentially leading to project work stoppages if the CO does not increase the ceiling via a formal D&F and modification.