The Government Subcontractor's Guide to Terms and Conditions

THE GOVERNMENT

SUBCONTRACTOR’S GUIDE

TO TERMS AND CONDITIONS

THE GOVERNMENT

SUBCONTRACTOR’S GUIDE

TO TERMS AND CONDITIONS

Kenneth R. Segel

8230 Leesburg Pike, Suite 800

Vienna, VA 22182

(703) 790-9595

Fax: (703) 790-1371

www.managementconcepts.com

Copyright © 2009 by Management Concepts, Inc.

All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by an information storage and retrieval system, without permission in writing from the publisher, except for brief quotations in review articles.

Printed in the United States of America

Library of Congress Cataloging-in-Publication Data

Segel, Kenneth R.

The government subcontractor’s guide to terms and conditions / Kenneth R. Segel.

p.cm.

ISBN 978-1-56726-232-2

1. Subcontracting--United States. 2. Government purchasing--Law and legislation--United States. 3. Public contracts--United States. I. Title.

KF869.3.S44 2009

346.7302’3--dc22

2008027622

10    9    8    7    6    5    4    3    2    1

ABOUT THE AUTHOR

Kenneth R. Segel is Division Manager of Contracts at L-3 Communications in Anaheim, California. He previously was the Director of Contracts for AT&T in Columbia, Maryland. He has 22 years of government, commercial, domestic, and international experience in contracting. Throughout his career, Mr. Segel has managed contracts, subcontracts, and purchasing and pricing departments.

Mr. Segel has a master’s degree in public administration from San Diego State University, where he graduated magna cum laude.

In memory of Audrey Ann Kuntz

CONTENTS

Preface

Acknowledgments

Introduction

Chapter 1: Payment Terms

Chapter 2: Acceptance of Products, Services, or Data

Chapter 3: Arbitration/Alternative Dispute Resolution

Chapter 4: Assignment of Contract

Chapter 5: Audit Rights

Chapter 6: Limitation of Liability

Chapter 7: Non-Disclosure Agreement

Chapter 8: Elements of a Properly Worded Non-Disclosure Agreement

Chapter 9: Set-Off – or Offset

Chapter 10: Changes

Chapter 11: Cost Reporting

Chapter 12: Fee Payment (CPFF Government Contracts)

Chapter 13: Force Majeure (Excusable Delay)

Chapter 14: Formation of Contract

Chapter 15: Government Federal Acquisition Regulation Flow-down Provisions

Chapter 16: Governing Law and Venue of Jurisdiction

Chapter 17: Key Personnel

Chapter 18: Liquidated Damages

Chapter 19: Record Retention for Future Audit

Chapter 20: Shipping Terms of Sale – Free on Board

Chapter 21: Rights in Data

Chapter 22: State and Local Taxes

Chapter 23: Termination for Convenience

Chapter 24: Termination for Default

Chapter 25: Time Is of the Essence

Chapter 26: Warranty

Chapter 27: Insurance and Its Relationship to Indemnification

Chapter 28: Indemnification

Chapter 29: Evaluation of a Patent/Copyright Indemnification Provision and Standard Indemnification Language

Chapter 30: Buyer’s Indemnification of Seller

Chapter 31: Government’s Indemnification of Seller

Chapter 32: Wrapping Up the Indemnification Provision

Appendix: Flow-down Provisions and Clauses

Acronyms

Glossary

Index

PREFACE

When I started my career in contracts management 22 years ago, my manager handed me a new request for proposal from a prime contractor, asked that I review the terms and conditions and get back with her later in the day with my findings. I panicked. I was fresh out of college and had no formal training in contract law at the time. Several questions immediately came to mind: (a) What specific terms and conditions should I be addressing? (b) How was I going to decipher what constitutes a favorable provision from one that is unfavorable? (c) Are there specific clauses that I should be addressing? (d) How should I deal with any potentially damaging provisions, provided that I could ascertain what constitutes harmful language?

To my dismay, I could not locate a book in publication addressing this topic. Like many others before me, I learned the process of reviewing and negotiating terms and conditions through trial and error and with help from senior staff members. This initial experience prompted me to keep a log of terms and conditions of concern, risk mitigation techniques, lessons learned, and legal references for quick review as I gained knowledge along the way.

After 22 years of development, I accomplished the daunting task of drafting a book that walks even the most junior contracts administrator through reviewing and negotiating a government contractor’s terms and conditions. The contracts professional learns in easy-to-understand language how to review and negotiate onerous terms and conditions that could be financially costly and potentially damaging to the seller. Seller is defined in this book as one who sells a product or services to a government contractor.

This book addresses the party negotiating on behalf of a seller/subcontractor—such as a contracts administrator, salesperson, or program manager—with a government prime contractor or lower tier government subcontractor.

A subcontractor should not be confused with the prime contractor. A subcontractor is defined as an individual, company, partnership, or association that contracts with a buyer (prime contractor or lower tier subcontractor) to design, develop, design and manufacture, or manufacture items that are designed specifically for use in a government application. The prime contractor, on the other hand, contracts directly with the government.

When a prime contractor, subcontractor, and possibly a lower tier subcontractor, wish to work with one another on a government-funded effort, the parties must negotiate the terms and conditions dictating the agreement between the parties. Typically, buyer will submit to seller a request for proposal and/or a subcontract containing buyer’s standard terms and conditions along with any government flow-down provisions. Flow-down provisions are rules and regulations found in the Federal Acquisition Regulation (FAR) or the Defense Federal Acquisition Regulation (DFAR) that a government contractor must include in their supplier subcontracts.

Buyer-imposed terms and conditions often lend buyer more rights than they would otherwise be granted under the Uniform Commercial Code (UCC), Common Law, or the Code of Federal Regulations (CFR). It is thus incumbent on seller to mitigate potential risks associated with contractual terms and conditions, since many pose a financial risk to seller, expose proprietary information to a potential competitor, and/or give up rights and data that should have remained with seller and/or been jointly shared by seller and buyer.

This book quickly guides the seller through the process of reviewing and negotiating a contract to mitigate risk and help the parties reach an equitable agreement. The chapters are set up to walk the reader through the review and negotiation process with ease by pointing out the most common and damaging terms and conditions. A definition of these terms and conditions is provided, along with examples that are worded similarly to the terms and conditions commonly found in a buyer’s contract. This helps the seller easily pick them out of a proposal or contract. The second section of each chapter talks about the risks associated with each term and condition; here, the reader learns the potential threat associated with each term and condition if left unmitigated. A third section with responses walks through simple mitigation techniques the seller may use to reduce or possibly eliminate the associated risks. Finally, a reference guide provides the reader with a list of FAR regulations and UCC codes related to the terms and conditions mentioned or discussed at length in the book.

Combining these four facets—definition, risk, response, and reference—provides the seller with a firm understanding of what to look for when reviewing the terms and conditions of a proposal or contract, coupled with simple instructions on how to mitigate risks and where to find answers in the FAR and UCC.

While all terms and conditions noted in this book should be carefully analyzed by the seller, indemnification stands out as the most important and potentially harmful. Because of the complexity and importance associated with risk management as it applies to indemnification provisions, considerable emphasis is added to help the reader understand indemnification provisions, including how to review, disseminate, and mitigate these provisions. Chapters 27–32 are devoted to the indemnification process.

A list of acronyms often found in solicitations and contracts is provided after Chapter 32.

The appendix at the end of the book acts as a FAR reference guide, providing (1) the clause number and date, (2) the title of the provision/clause, (3) a general description of the provision/clause, and (4) a description of which rules and regulations flow the requirement down from the government to the prime contractor and from the prime contractor to the subcontractor. The appendix is a quick and easy tool to use to ascertain whether a particular clause or provision will pose a concern for the seller.

I hope that this guide will help clarify the many terms and conditions that a contracts manager or administrator negotiating on behalf of a seller or subcontractor must address every day.

Kenneth R. Segel

Anaheim, California

ACKNOWLEDGMENTS

I wish to thank Frank Baleno, subcontracts manager at AT&T, and Patricia Morgan, contracts manager at AT&T, for taking time to review, edit, and provide valuable feedback for the book.

I’d also like to thank my father, Nathan Segel, retired director of purchasing and associate professor of procurement, for the countless hours he spent reviewing and commenting on the manuscript.

Most importantly, I wish to thank my wife, Candace, and daughter, Brittany, for their support and understanding during the innumerable hours I spent writing at home.

INTRODUCTION

A simple handshake solidified deals when communities were small and people knew one another in business circles and in social settings. Breaking the terms of a contract resulted in social and professional ostracism. Over the years, business relationships have grown too large and complex to base a contract on a simple handshake, hence the need for a well-written contract.

A contract serves many purposes, some obvious, such as defining the product or service to be delivered. A less obvious reason is offering applicable terms and conditions that, if negotiated properly, address many unforeseen problems that could arise. These terms and conditions serve to protect the parties, by apportioning liability through indemnification provisions, for example, and flowing down appropriate statutes and regulations.

Keep in mind that the United States and most other countries legally recognize the terms and conditions negotiated and codified in a contract signed by two or more parties. Hence, while the rights and obligations called out in the contract make up the terms of the agreement and are subject to the limits imposed by relevant statutes, these terms and conditions potentially nullify any rights that seller and buyer normally enjoy under the Uniform Commercial Code (UCC) or Common Law. These terms and conditions are generally written in favor of the party who drafts the contract. After all, it is in the drafter’s best interest to mitigate risk by writing carefully worded terms and conditions. For example, buyer might include a liquidated damages provision written with their interests in mind. Liquidated damages are the monetary amount of damages owed to the other party when a contract is breached.

Early in my career as a contracts administrator, I was assigned a major contract supplying a variety of services to a naval base. One of the services provided was trash abatement. The liquidated damages provision read as follows:

Contractor shall ensure that trash and debris will not accumulate against the compound’s fence; contractor shall pay buyer liquidated damages in the amount of 5 percent of contractor’s daily fixed cost associated with this effort for each calendar day that the trash remains against the fence.

This provision did not allow seller a grace period to clean-up the debris prior to enforcement of the monetary damages. The naval base was located in the desert where high winds were prevalent. The contracting officer’s technical representative (COTR) would walk the grounds at 5:00 a.m. after a night of strong winds documenting the amount of debris collected at the bottom of the fence, then proceed to invoke the liquidated damages provision. In this instance, buyer’s liquidated damages provision was written in their favor; enforcement of this provision meant lower profit margins for my employer. That example is minor in comparison with monetary damages that may culminate when a contract turns bad and buyer seeks compensatory damages for serious issues, such as day-today slips in completing a major construction project.

As exemplified above, it is necessary to mitigate risk associated with contractual terms and conditions to protect the interests—particularly the financial interests—of seller. While these risks are usually equitably arbitrated through legal remedies found in either the UCC (when selling goods and services) or Common Law (when working services contracts), remember that the terms and conditions incorporated into the contract potentially nullify any rights that seller would otherwise enjoy under these laws. Accordingly, it is to seller’s advantage to mitigate potential risks associated with doing business with buyer by applying the simple risk transfer techniques found in this book.

Prior to getting into the main topic of this book—the review and negotiation of terms and conditions—the reader should become acquainted with offer and acceptance, as these terms play a vital role in the negotiation process.

A contract is formed when one party (buyer)—the entity procuring the goods or services—makes an offer, which is accepted by the other party (seller)—the entity providing the goods or services. A contract is formed once seller accepts buyer’s offer. It is important to understand that upon consent, seller accepts a contract including its terms and conditions. It is also important to recognize that commencement of work constitutes acceptance of a contract.

Seller should not assume that an offer remains open indefinitely. A general rule is that buyer may revoke an offer at any time prior to seller’s acceptance. In the event that buyer terminates an offer, seller no longer has the legal authority to accept the offer. Therefore, any contractual relationship that may have taken place is no longer binding.

Agreement is often reached after several rounds of negotiations. Seller will commonly respond to buyer’s initial offer with a counteroffer. A counteroffer is defined as an offer made by a seller who has rejected a prior offer. The counteroffer constitutes a rejection of buyer’s terms and conditions or a portion thereof. This terminates buyer’s power to accept the contract, provided that buyer does not agree to the changes made by seller. Buyer then typically proceeds to counter seller’s offer. This is commonly referred to as the