Analyzing Procurement Contract Risks
Supply Chain Case Study on: “Identifying Contract Risks and
Contingency Planning”
by Jimmy Alyea
This case study’s thesis is that “the Defense Supply Center
Columbus (DSCC) was justified in terminating for default an indefinite-delivery
purchase order (IDPO) contract at a firm fixed price (FFP) when New Era
Contract Sales (New Era) failed to supply coupling tubes as required by a June
29, 2006, delivery order.
Contract performance.
When New Era, a government contractor, made delivery on a
July 6, 2004, IDPO received from DSCC for coupling tubes, a contract was
formed. The contract obligated New Era
to supply parts for two years at a firm fixed price. New Era’s pricing to DSCC was based on a
two-year quote from its supplier, Harrison.
New Era’s contract with DSCC contained a standard supply contract
default clause but no price adjustment clause.
When New Era received DSCC’s second IDPO on June 30, 2006,
it found that Harrison had been sold and its new owner would not honor the
original price quote. On July 5, 2006,
New Era asked DSCC to cancel its contract with no liability for either party
because its supplier refused to honor the quoted pricing due to an increase in
material costs. When DSCC refused, New
Era asked to negotiate a new price based on a new supplier’s higher price
quote. DSCC again refused and terminated
the contract for default when New Era did not fill the order. New Era appealed the decision to the Armed
Services Board of Contract Appeals (ASBCA) based on the provisions of the
default clause, Federal Acquisition Regulation (FAR) 52.249-8.
FAR 52.249-8.
The clause stated DSCC’s default contract rights but
provided an exception for contractor liability if the following occurred: “If
the failure to perform is caused by the default of a subcontractor at any tier,
and if the cause of the default is beyond the control of both the Contractor
and subcontractor, and without the fault or negligence of either . . . .unless
the subcontracted supplies or services were obtainable from other sources in
sufficient time for the Contractor to meet the required delivery schedule.”
New Era’s opposing view of the thesis.
New Era believes that its nonperformance is excusable under
FAR 52.249-8. The refusal of its
subcontractor’s new owner to honor the original price quoted to New Era was
“beyond its [New Era’s] control and without its fault or negligence.” Similarly, the subcontractor’s refusal to
perform was also “beyond its [the subcontractor’s] control and without its
fault or negligence” because Harrison had quoted an unusually low price two
years ago and because the present cost of titanium had increased
dramatically. As a result, New Era’s
subcontractor would have only been able to supply product from its distributor
at a cost/unit of more than three times the original contract price. New Era states that as a small business
owner, it could not absorb the resulting $23,904.66 loss.
New Era also asserts that it had taken “all reasonable
action” to perform the contract by looking for alternative sources from which
to obtain the product in time to meet the contract delivery date. However, since none of these alternative
suppliers carried stock of the needed item and produced only on an “as-needed
basis,” this option would not have enabled New Era to deliver in a timely
manner. Although DSCC offered to extend
the delivery date in exchange for a $510.18 contract price reduction, New Era
believed it should not have had to incur this extra cost because DSCC did not
respond for eight months to New Era’s request to cancel the contract without
liability because it could not perform.
Because these unforeseen circumstances regarding pricing and
product availability were beyond its control, New Era asserts that it was not
negligent in its nonperformance of DSCC’s June 29, 2006, order and should be
discharged without liability from its contract with DSCC.
DSCC’s supporting view of the thesis.
New Era entered into a binding IDPO contact when it
fulfilled DSCC’s July 6, 2004 delivery order, obligating itself to honor the
offered prices for two years. As the FFP
contract contained no price adjustment clause, New Era accepted the risk of
increased prices from its subcontractor.
Thus, New Era’s claim that a price increase was beyond both it and its
subcontractor’s control was not a basis on which to abandon performance under
the contract’s default clause. New Era
and its subcontractor did not take “all reasonable action” to perform because
they could have provided the ordered parts, even though at a loss.
DSCC seeks affirmation from ASBCA of its decision to
terminate New Era’s contract for default and to recover costs from having to
reprocure from a new source. The Board
found New Era in default of the contract and affirmed DSCC’s actions and
request for reimbursement for additional procurement costs. The Board stated that renegotiating a
contract because of a supplier’s price increase would defeat the purpose of a
firm-fixed-price contract, which was to protect DSCC from price
variations. It also noted that DSCC had
grounds for termination when New Era notified it on July 5, 2006, that it could
not make delivery on DSCC’s second order.
Implications.
Lessons for contract managers include the importance of
protecting against contract risk and of making contingency plans. New Era should have taken the time to
understand the contract terms, particularly the implications of filling the
first order of an IDPO contract at a FFP, as well as the consequences of
default and the lack of a price escalation clause. It should have also locked its supplier into
a contractual agreement as to pricing and the subcontractor’s liability for
default, instead of depending solely upon a price quote. New Era would have ultimately been better off
had it performed the contract at a loss and then brought suit against its
supplier. Good advice for contract
managers would be to expect the best but plan for the worse, and when in doubt,
seek legal advice quickly before a problem escalates.
Copyright 2012 James L. Alyea. All Rights Reserved.
Case Study Reference:
“IDENTIFYING CONTRACT RISK AND CONTINGENCY PLANNING” by Jack
Horan, Contract Management, Aug., 2009. Retrieved from
http://www.mckennalong.com/media/site_files/1140_August%202009.pdf
