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Monday, January 7, 2013

Contract Types: A Legal Overview

Kate M. Manuel
Legislative Attorney

Federal procurement contracts are commonly divided into two main types—fixed-price and costreimbursement— that primarily differ as to whether the government or the contractor assumes the risk of increases in performance costs (e.g., wages, materials). With a fixed-price contract, the contractor assumes this risk because it agrees to provide goods or services to the government for a certain price established at the time of contracting. If the performance costs exceed this price, the contractor generally cannot, absent a price adjustment clause, recover more money from the government. Rather, it must perform the contract at a loss, or default on the contract. In contrast, with a cost-reimbursement contract, the government assumes the risk of increases in performance costs because it agrees to repay the contractor for allowable, reasonable, and allocable costs of performing certain work, up to a total cost specified in the contract. Additionally, under certain types of cost-reimbursement contracts, the contractor may be entitled to profit in the form of fixed fees or incentive or award fees.

Other types of contracts are also recognized. For example, the various types of incentive contracts—fixed-price incentive contracts, cost-plus-incentive-fee contracts, cost-plus-award-fee contracts—are often characterized as occupying a middle ground between fixed-price and costreimbursement contracts because the parties share the risk by basing the contractor’s profits, in part, on the cost or quality of its performance. In addition, there are time-and-materials and laborhour contracts, wherein the government pays the contractor hourly rates for labor and/or the costs of materials; indefinite-delivery contracts, wherein the contractor agrees to deliver goods or services at future dates unspecified at the time of contracting; letter contracts, which are used prior to the execution of a formal (i.e., definitized) contract; and basic and basic ordering agreements, which contain terms applicable to future contracts or orders between the parties.

The use of certain contract types is prohibited or required in certain circumstances: (1) cost-plusa- percentage-of-cost contracts are absolutely prohibited; (2) cost-reimbursement contracts cannot be used to acquire commercial items; and (3) contracts resulting from sealed bidding must be firm-fixed-price or fixed-price with an economic price adjustment. Outside of these restrictions, however, selection of the contract type for a particular procurement is generally within the contracting officer’s discretion. The contracting officer typically decides on the contract type prior to issuing a solicitation. However, particularly in negotiated procurements, selection of the contract type can be “a matter for negotiation” between the procuring activity and the contactor.

The types of contracts used by federal agencies have long been of interest to Congress and the executive branch, as they have sought to optimize the types of contracts used to acquire particular goods or services. Early on, the use of cost-plus-a-percentage-of-cost contracts—which provide for the government to reimburse contractors’ costs and pay them a percentage of these costs as an allowance for profit—prompted concern among Members of the Continental Congress on the grounds some contractors ran up their costs in order to recover larger fees. Such contracts were later prohibited and, more recently, concerns have centered upon the use of other types of “cost reimbursement” contracts. President Obama articulated a “preference for fixed-price type contracts” in his March 4, 2009, memorandum on government contracting, and the Department of Defense (DOD)—the largest procuring agency—amended its regulations in 2011 to require contracting officers to “give particular attention” to the use of fixed-price incentive (firm target) contracts, especially for acquisitions moving from development to production. However, more recently, DOD has indicated that it would be “refining its guidance” to emphasize the use of the other contract types where appropriate for the product or services being acquired.

Date of Report: December 20, 2012
Number of Pages: 21
Order Number: R41168
Price: $29.95

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