Simplifying contract terms for commercial items means walking a fine line

Joseph J. Petrillo is a lawyer at Washington law firm Petrillo and Powell.

Since 1995, federal contracts for commercial items have had special clauses intended to simplify the contracts. The fear was that the usual long clauses would scare off companies that were not accustomed to dealing with the government.

The definition of "commercial item" is extensive. But one example is a product that is customarily used by the public or non-governmental entitles for other-than-governmental purposes and has been sold, leased or licensed to the public or offered for sale, lease or license. It also refers to services if they are installation, maintenance, repair, training, or "other" services in support of a commercial item and the source provides similar services to the public under similar terms and conditions.

In some ways, those special provisions reflect commercial practices. Certainly, they are shorter than the standard versions. And sometimes they can be a better deal for the government, although a worse one for the contractor. Both parties need to understand the nuances of these provisions before entering into a contract.

For example, compare the termination-for-cause provision in a commercial-item contract with the standard default clause. Under the standard clause, when the contractor fails to make progress or fails to perform — except for a late delivery — the government must notify the contractor and give it at least 10 days to fix the problem before terminating the contract. However, commercial-item contracts omit the notice-and-cure procedure. The omission is puzzling, especially because a cure provision is fairly common in commercial contracts.

A second departure from the usual practice is the lack of an authorization and consent provision. Its omission means that, unlike other government contracts, a patent holder who establishes infringement can get an injunction that would prevent a commercial-item contractor from performing.

Another area in which things vary is termination for convenience. That is the government’s extraordinary power to end a contract, in whole or in part, at any time and without notice. Ordinarily, that would be a breach of contract. Both standard and commercial-item contracts give the government that special right.

However, the clauses differ in how they compensate the contractor. The standard contract clause essentially converts a fixed-price contract to a cost-plus one. Extensive and rather complex rules state how to compute and recover those costs. But the regulations state the terminated contractor must be made whole.

By contrast, commercial-item contracts have streamlined rules for convenience termination. A contractor can recover only two amounts:

• A percentage of the contract price that reflects the percentage of the work performed.
  
• Reasonable charges that result from the termination. The government has no audit rights, and the contractor need not observe cost-charging rules.

A recent decision by the Armed Services Board of Contract Appeals shows that those streamlined provisions mean less compensation for the contractor than the standard rules. The case of Red River Holdings concerned a Defense Department lease for a cargo ship. Using the power to terminate for convenience, the government ended the lease two months early and did not pay the last two months’ rent. The contractor claimed as additional termination costs the loan payments it made to finance the ship for those remaining two months. Alternatively, the contractor claimed depreciation and certain expenses to outfit the ship.

The board ruled that the government owed the contractor nothing more. Paying the rent through the end of the shortened lease met the obligation to pay a percentage of the contract price. And the board held that the reasonable charges resulting from the termination were limited to settlement expenses. That is a term of art that means the administrative costs of closing out subcontracts, submitting a termination claim to the government, and storing and disposing of unused contract inventory. Because the costs claimed did not fit into that narrow category, the contractor was out of luck.

The bottom line is that commercial-item contracts are a mixed bag. They come across as simpler, and that’s meant to encourage more companies to do business with the government. But appearances can deceive.