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Posted on Thursday, September 06, 2018

Contractors Can Profit When the Government Improperly Exercises Options

As the Government Fiscal “New Year” October 1st approaches, September typically finds government contracting officers exercising options for another year of contract performance. Years of working with government contract clients and teaching government contracting officers have shown me that, often, neither party understands how an option is legally exercised. Nor do they realize that not following the rules to the letter invalidates the option. Specifically, government contractors do not realize that an improper option exercise may entitle them to any increased costs for the work they do following an invalid option exercise.

Because September tends to be the height of option season, now is a good time to look more closely at options: the strict compliance rule for the government properly exercising an option, the three mistakes the government typically makes that open the door to a contractor recovering its increased costs plus profit, and the contractor’s alternatives along with a warning about what a government contractor should not do.

The “strict compliance” rule

Exercising options in a government contract must follow the rule generally applied to options in general. To properly exercise an option, the government must strictly comply with the contract’s option clause.  The government’s failure to strictly comply invalidates the option.

The acceptance of an option, to be effective, must be unqualified, absolute, unconditional, unequivocal, unambiguous, positive, without reservation, and according to the terms or conditions of the option… An acceptance of an option must be such a compliance with the conditions as to bind the parties, and if it fails to do so it binds neither.”[i]

Because many government contracts often have a term of a base year and four option years, the relevant option clause typically is FAR 52.217-9, Option to Extend the Term of the Contract. Here is the critical language in this clause:

(a) The Government may extend the term of this contract by written notice to the Contractor within _ [insert the period of time within which the Contracting Officer may exercise the option]; provided that the Government gives the Contractor a preliminary written notice of its intent to extend at least _ days [60 days unless a different number of days is inserted] before the contract expires. The preliminary notice does not commit the Government to an extension.

As we will see, strict compliance with the requirements of the option clause makes sense, given the unilateral nature of an option.

Three mistakes the government makes

  1. Late preliminary notice of intent to exercise option.

One way the government does not strictly comply with this option clause is to not give the preliminary notice to the contractor the required number of days in advance of the end of the contract, typically 60 days before the contract expires.

In one case, the government signed and mailed the contractor the preliminary notice on April 6th, 60 days before the contract’s June 5th expiration date but the contractor did not receive the preliminary notice until April 13th.  By that time, the contractor was spending time lining up work to take the place of the government work. Labeling the preliminary notice of intent “an integral component” of the option exercise process, the Armed Services Board of Contract Appeals (ASBCA) held that the government’s improper option exercise entitled the contractor to its additional costs for performing the option year work under protest.[ii]

Strict compliance with this notice of intent serves a good purpose: it lets the contractor know several months in advance whether it should look for new work replacing the option work for the government.

  1. Late notice of option exercise.

Another improper option exercise involves the late delivery of the written notice of actual option exercise. If that notice is not sent in time for the contractor to receive it before the contract expires, the option is not properly exercised and the contractor is entitled to its increased costs for performing the work under protest.

An interesting point here is the legal form the notice can take. Although many options in government contracts get exercised through the contracting officer’s use of a formal contract modification, case law makes clear that this notice need not be in the form of a contract modification so long as the government’s intent to exercise the option is given to the contractor in writing before the contract expires. In one case, the contractor received a letter and unsigned bilateral modification from the contracting officer four days before the end of the contract. The modification stated that the contract “is hereby extended for the period 1 Oct 85 to 30 Sep 86 in accordance with the Second Option contained in the contract.”  The option was held to be properly exercised. According to the ASBCA, “There was no requirement that a modification be signed by 1 October 1985. What was required was that the contracting officer give written notice that the option was being exercised by that date.”[iii]

  1. Changing the contract’s terms

The option clause allows the government to unilaterally “extend the terms of this contract.”  Here’s where the contracting officer’s typical use of a contract modification to exercise an option can lead to trouble: trying to change the terms of the contract at the same time and in the same document the contracting officer’s uses to exercise the option. Contracting officers see doing so as a time-saver: since they are doing a modification to exercise the option, why not use the same document to change the contract’s terms, insert updated clauses or clauses inadvertently omitted?

The problem, however, is that doing so invalidates both the option and the contract change because the government is not strictly complying with the option clause. The option clause gives the government the unilateral right to “extend the terms of this contract” for another year at the price established several years before. Strict compliance with the option clause assures the contractor that it will perform the option work under the same terms and prices as originally agreed to. If the government adds or changes the work at the same time as exercising the option, the contractor is not only performing a contract with different terms; it may be forced to perform the changed work at the price the contractor had established years before for performing the work originally contracted for.

In one case, the contracting officer invalidated an option exercise when he used a contract modification to add to the contract a substitute clause and a re-worded clause.[iv] In another case, the contracting officer invalidated the option when the contract modification exercising the option made the option “subject to the availability of funding,” thereby improperly adding a condition – the availability of funding—not previously in the contract.[v]

Trying to change the contract’s terms through the improper use of an option exercise converts the ineffective option exercise into a government counter-offer that must be accepted by the contractor to be effective.[vi]

Contractor alternatives

As the case law shows, an ineffective option exercise gives contractors different options. To begin with, obviously, just because the contractor has alternatives does not mean the contractor must use one of them. Deciding to fight the government on an ineffective option exercise is a very difficult business decision. Because a contractor’s relationship with its government customer is so critical for future government work, many contractors on the receiving end of an ineffective option exercise may well decide to ignore the illegalities and simply continue to work under the ineffective option exercise and for the pre-established price. If so, the contractor is considered to have waived the improper option exercise and has lost any right to get increased costs or negotiate a counter-offer price.

The other alternative is to protest to the contracting officer the ineffective option exercise, continue to perform despite the ineffective option exercise, and ask the contracting officer for an equitable adjustment as a constructive change to the contract. “The measure of recovery is the difference between the amount incurred plus profit and the amount received for the work.”[vii]

One thing the contractor does not want to do is stop work. This seems counter-intuitive: an ineffective option exercise would seem to end the contractor’s obligation to perform and let the contractor simply walk away from further work on the contract. But that is not the case at least where the invalid option exercise involves changed contract terms. In these situations, the contractor has a duty under the contract’s Disputes clause to proceed with contract performance pending resolution of this option issue.[viii]

Regardless of the Disputes clause, continuing to perform makes the most sense under almost any circumstances. It keeps the government from terminating the contract for default, continues contractor cash-flow, and opens the door to favorable past performance ratings on which future work depends. Stopping work is a risky and costly gamble that most contractors today cannot afford.

[i] Thinkglobal, Inc. v. Department of Commerce, CBCA 4410, 16-1 BCA ¶ 36489, Sept. 9, 2016 quoting Civic Plaza National Bank v. First National Bank in Dallas, 401 F.2d 193, 197 (8th Cir. 1968).

[ii] White Sands Construction, Inc., ASBCA 51875, 04-1 BCA ¶ 32598.

[iii] Contel Page Services, Inc., ASBCA 32100, 87-1 BCA ¶ 19540.

[iv] Contract Automotive Repair and Management v. General Services Administration, GSBCA  13627, 99-2 BCA ¶ 30530.

[v] J.E.T.S., Inc., ASBCA 26135, 82-2 BCA ¶ 15,986.

[vi] 4737 Conner Co. v. United States, 65 Fed.Appx.274 (Fed.Cir. 2003).

[vii] White Sands Constructions, Inc., supra.

[viii] Alliant Techsystems, Inc. v. United States, 178 F.3d 1260 (Fed.Cir. 1999).

Berenzweig Leonard is teaming up with Red Team Consulting  for monthly newsletters featuring “Words of Wisdom” as well as upcoming contracts, key protest decisions, legal updates, events, and more. This post was published in the September 2018 “Words of Wisdom” newsletter. To sign up for our govcon newsletters, please click here.

Terry O’Connor is a Partner at Berenzweig Leonard LLPTerry and Stephanie Wilson lead the firm’s Government Contracts practice. Terry can be reached at toconnor@berenzweiglaw.com.