The Debate Over NDAA Preference For Fixed-Price Contracts

Preference for Fixed-Price Contracts

The Senate bill includes a preference for fixed-price contracts, including fixed-price incentive fee contracts, in the Defense Federal Acquisition Regulation Supplement not later than 180 days after the NDAA’s enactment. The Senate bill includes the following specific recommendations to establish a preference for fixed-price contracts:

• any undefinitized contract must be awarded on a fixed-price level of effort basis;

• contracts for foreign military sales must be of firm fixed-price, unless the secretary of defense certifies that a different type of contract is in the best interest of the U.S. taxpayers;

• acquisitions of commercial items may not use cost-type contracts and should use fixed-price contracts to the maximum extent practicable;

• the Air Force will receive limited funds for the Joint Surveillance Target Attack Radar System recapitalization program unless the Air Force uses a fixed-price contract for engineering and manufacturing development; and

• contracts or agreements executed under the pilot program, “commercial solutions opening pilot program”, must be fixed-price, including fixed-price incentive fee.

Further, a DOD contracting officer would have to obtain approval to use a cost-type contract either from the service acquisition executive, for a contract entered into by a military service, or from the undersecretary of defense for acquisition, technology and logistics, for a defense agency contract that is in excess of $50 million if entered into before Oct. 1, 2018, $20 million for contracts entered into between Oct. 1, 2018, and Sept. 30, 2019, and $5 million for contracts entered into on and after Oct. 1, 2019.

Unintended Effects?

The Senate Armed Services Committee wants to reallocate risk between the government and the contractor by shifting from cost-type contracts to fixed-price contracts, but some critics believe that its proposals likely will hinder innovation and increase costs. The SASC’s underlying rationale for preferencing fixed-price contracts and penalizing cost-type contracts is that cost-type contracts generally use unique government accounting and financial systems, which create an expensive barrier to entry and limit the competitive pool to traditional defense contractors.

The Obama administration objects to the NDAA’s penalties for the use of cost-type contracts and preference for fixed-price contracts.[2] The administration believes that the penalties would unnecessarily constrain the government’s flexibility to tailor contract types for a given requirement. The penalty provision also would create a complex financial transaction process that would require extremely burdensome procedures.

DFARS already dictates when and why the government should use certain contract types. It also has protections for nontraditional, small business, and commercial contractors, including exemption from the DOD’s Cost Accounting Standards.[3] Stripping the military department and defense agencies’ flexibility to craft incentives in contracts likely will reduce their ability to promote innovation and accountability.

Increased emphasis on fixed-price contracting may stifle innovation because contractors will provide the cheapest and simplest solution, rather than the innovative approaches that cost-type contracts can bring to bear. There are major programs that warrant cost-based contracting. Cost contracts reduce the contractor’s risk and encourage the contractor to invest in innovative solutions. Cost-type contracts also offer a level of fiscal oversight generally not available for fixed-price contracts.

The SASC argues that the DOD will be able to develop and implement guidelines that will create the appropriate flexibility to support the research and development necessary for defense innovation and cutting-edge military technology under fixed-price vehicles. The mandatory preference for fixed-price contracts, however, could result in fixed-price incentive contracts evolving to resemble cost-type contracts as agencies attempt to build in added incentives and innovation clauses.

The SASC’s efforts to reform defense acquisitions would allocate increased risk to the contractor while demanding increased value and innovation in a less flexible environment. Continue to monitor the status of the NDAA legislation as it moves forward through Congress.

—By Charles A. Blanchard and Paul Pompeo, Arnold & Porter LLP

Charles Blanchard is a partner in Arnold & Porter's Washington, D.C., office and former general counsel of the Air Force and the Army. Paul Pompeo is a partner in the firm's Washington office and former vice president and general counsel for the government division of Johnson Controls Inc.

Emma K. Dinan contributed to this article. She is a Columbia Law School graduate employed at the firm and not admitted to the bar.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] S. 2943, 114th Cong. (2016).

[2] Statement of Administration Policy, S. 2943 - FY17 NDAA, Executive Office of the President, June 7, 2016.

[3] See our analysis of other concerning FY17 NDAA provisions at Senate Proposes Yet Another Cost Accounting Standards Board for Government Contractors and House Bid Protest Reform Vs. Senate Bid Protest Reform.