Following the award, the government issues a notice to proceed directing the contractor to begin contract performance. The contract or the notice of award may provide a specific date for issuing the notice to proceed, in which case the government has an express duty to issue the notice to proceed by that date. If a date of issuance is not specified, the government still has an implied duty to issue the notice to proceed within a reasonable time. Claims adjudicative forums have held that damages for the government’s unreasonable delay in issuing the notice to proceed may be recovered under the suspension clause. Such damages may include unabsorbed overhead, which are indirect costs that can no longer be charged through the application of the contractor’s overhead rate to its direct costs due to the delay in performance. As set forth in the seminal Armed Services Board of Contract Appeals (ASBCA) decision issued in 1960, the Eichleay formula is the exclusive method for calculating unabsorbed overhead damages due to a period of government-caused delay when contract performance has commenced. However, there may be situations in which the contract is terminated for the government’s convenience without commencement of performance following a period of government-caused delay in the issuance of the notice to proceed. In such cases, while the Eichleay formula may not be used to determine the contractor’s unabsorbed overhead damages due to a lack of allocability, the contractor’s recovery is not altogether barred.
In Nicon, Inc. v. United States, 331 F.3d 878 (Fed. Cir. 2003), the Federal Circuit held that even with the inapplicability of the Eichleay formula in cases involving a convenience termination following a government-caused delay without the commencement of performance, contractors may still recover damages for unabsorbed overhead costs as part of their termination settlement, provided a reasonable allocation method is available based on the applicable facts. The Army Mobile District Corps of Engineers awarded the underlying $1.4 million contract for the repair of a dormitory at the MacDill Air Force Base in Florida. The contract award was protested, which suspended performance before the repair work commenced. The protest was later dismissed 107 days following the award, but the government did not issue a notice to proceed. The Army then terminated the contract for convenience 288 days following the award without ever issuing the notice to proceed. The contractor submitted a termination settlement proposal which, among other costs, included unabsorbed overhead. The contractor used a modified version of the Eichleay formula to calculate the unabsorbed overhead costs of $387,513 for the 288-day period. The contracting officer (CO) later denied the unabsorbed overhead portion of the contractor’s claim in its entirety. In the suit that followed at the Court of Federal Claims (COFC), the government was granted summary judgment with the COFC holding that the Eichleay formula could not be modified as proposed by the contractor.
In the appeal that followed, the Federal Circuit agreed with the COFC on the inapplicability of the Eichleay formula, noting that the contractor had no actual contract billings or days of performance to utilize in the formula. However, the Federal Circuit held that the inapplicability of the Eichleay formula did not mean that a contractor who was required to remain on standby due to a government-caused delay but was never allowed to begin performance may not receive some of its unabsorbed overhead costs as part of the termination settlement by a different method of allocation. The Court noted that the overall purpose of a convenience termination is to fairly compensate the contractor by making it whole for the costs incurred in connection with the terminated work. In this regard, the cost principles in Federal Acquisition Regulation (FAR) Part 31 had to be utilized in the assertion, negotiation, or determination of costs relevant to termination settlements, but subject to the general fairness principles in FAR 49.201(a). Furthermore, while the termination for convenience clause did not specifically list unabsorbed overhead costs, such costs were also not excluded and could be categorized as initial costs and preparatory expenses as contemplated under the FAR convenience termination clause for fixed-price contracts. Similarly, the cost principles in FAR Part 31 did not prevent the award of unabsorbed overhead damages, provided they were appropriately allocable and allowable. Therefore, while the Eichleay formula could not be applied to calculate the contractor’s unabsorbed overhead damages due to a lack of performance in this case, nothing prevented the government from exercising business judgment to determine the allocability of the unabsorbed overhead damages using a different methodology, while adhering to the applicable fairness principles in the convenience termination context.
Even in the absence of a specified date in the contract for issuing the notice to proceed, the government has an implied duty to issue the notice within a reasonable time. After commencement of contract performance, the Eichleay formula is the exclusive method to determine the contractor’s unabsorbed overhead damages due to government-caused delay in issuing the notice to proceed. However, the Eichleay formula may not be used when the contractor did not commence performance before the contract was terminated for convenience. In such situations, the contractor may still recover unabsorbed overhead costs as part of its termination settlement provided the indirect costs are allocable and allowable. A potential avenue to recover unabsorbed overhead damages in such cases is through an equitable adjustment under the suspension of work clause. To obtain recovery, the contractor must still establish the existence of a government-caused delay before the termination for convenience. Of course, if the contractor played a part in causing the delay or if the delay was beyond the government’s control, recovery may be barred. Finally, although the Eichleay formula may be inapplicable, the contractor must still meet the prerequisites to its application. That is, the contractor must show that it was on standby and unable to take on replacement work during the delay caused by the lack of notice to proceed. After all, it is the obligation to remain ready to perform, when combined with an inability to take on other work, which justifies recovery by preventing the contractor from mitigating its unabsorbed overhead costs during the government-caused delay in the issuance of the notice to proceed.
This Federal Contract Claims Insight is provided as a general summary of the applicable law in the practice area and does not constitute legal advice. Contractors wishing to learn more are encouraged to consult the TILLIT LAW PLLC Client Portal or Contact Us to determine how the law would apply in a specific situation.