Sequestration and its Impact on the Construction Industry

by Baker Donelson
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Pursuant to the Budget Control Act of 2011, sequestration is the process by which automatic across-the-board spending cuts are being imposed on government programs. Because Congress was unable to reach an agreement by its March 1, 2013 deadline to avoid these spending cuts, sequestration has become a reality. Sequestration requires $85 billion in automatic spending cuts. The construction industry is one sector that is likely to be hit hard by these spending cuts.

On March 26, 2013, President Obama signed a continuing resolution that will fund the federal government, including construction programs, through September 30, 2013. The continuing resolution includes the sequestration spending cuts, but provides some agencies with the flexibility to move funds around between various accounts which should allow some agencies to avoid making drastic cuts to their construction activities.
While the government works on finding a solution to the budget crisis, government construction contractors need to consider how their future and existing contracts may be affected by sequestration.

Future Contracts

One of the biggest impacts of sequestration will be on future government contracts. As a direct result of the budget cuts, government agencies will reduce the number of contracts awarded to construction contractors and bids in progress may be put on hold, stalled or canceled. However, it is important to note that many infrastructure accounts funded through trust funds and subject to obligation limits are exempt from the sequestration spending cuts. Another likely effect of sequestration is that agencies will move away from time and material contracts and instead look to award more contracts on a fixed price basis.

The uncertainty going forward in terms of where agencies will choose to cut their budgets will make it difficult for construction contractors to plan for the future. It may prove risky for contractors to spend time preparing bids for work that may never come to fruition. In his February 27, 2013 Memorandum for the Heads of Executive Departments and Agencies, Controller Danny Werfel explained that “agencies should only enter into new contracts or exercise options when they support high-priority initiatives or where failure to do so would expose the government to significantly greater costs in the future.”

Existing Contracts

The most important thing for a government contractor to figure out is how its existing contracts are being funded and the status of the funding for any work yet to be performed.

For existing fully funded contracts, if the funds have already been obligated and the project is expected to stay within its budget, then sequestration will likely not have a strong impact. The Anti-Deficiency Act, 31 U.S.C. §1341 et seq., prevents an agency from incurring obligations in excess of its available funds. As a result, the funding for a contract awarded prior to 2013 should already be obligated.

Sequestration, however, will likely have a large impact on multiyear and incrementally funded contracts that extend beyond one fiscal or budget year. As a result of the spending cuts, an agency may not have the funds to pay contractors for future phases of work. Agencies may choose to terminate a contract for convenience as an alternative to stopping a project when the funds ultimately run out. Many government contracts have an Availability of Funds clause which limits the government’s liability to pay up to the amount funded. A contractor must be careful to meet the notice provisions required by these clauses when it considers stopping work. Depending on the clause’s language, the contractor may be entitled to additional compensation if it has no choice but to stop work due to lack of funding, including pursuing claims for delay damages.

The sequester will also likely result in slower government administration of existing contracts and make it more challenging to complete contracts on schedule. In the coming months, government agencies will require civilian employees to take unpaid leave. As a result agencies may take longer to answer questions from contractors, respond to various requests or conduct reviews. This may increase the length of time needed to complete certain contracts, which will raise costs and potentially create delay claims.

Contractors also need to be prepared for the fact that agencies may choose to “de-scope” contract performance through deductive changes orders and may ask contractors to lower their contract price which will impact profits. Agencies may also take unilateral action to reduce or return obligated funds that have not yet been spent if they do not consider the project critical.

Modifications and Claims

It is also important to consider how sequestration may affect contract modifications and claims. A modification or change order may not be issued unless there are funds appropriated and available to pay. A contractor should ask the agency to provide funding information before the extra work is performed in order to avoid being a “volunteer” who has no right to payment. In a similar fashion, funds to pay claims may be tougher to find. A contractor may end up having to take the claim through the disputes process to obtain payment from the Judgment Fund which is unaffected by sequestration. Agencies will likely take a more in-depth look at change order pricing, requests for equitable adjustment and termination proposals.

Conclusion

Federal construction programs will be cut by several billion under the mandatory spending cuts that took place on March 1, 2013. There are a variety of ways that agencies may choose to deal with these reductions and government construction contractors need to be prepared.

The government continues to work towards finding a replacement for the sequester, but for now, government construction contractors need to look carefully at the funding status of their projects. Hard decisions may need to be made about stopping work when future funding is not in place. Will there be more public private partnerships (“PPPs”) as a result? No one has a crystal ball, but we may see PPPs as the path to the future.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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