Contractors face potential payment uncertainty as a result of the current congressional inability to agree to increase the federal government’s debt ceiling. The government reached the official debt limit months ago, on January 19, 2023. Yet by all appearances it continues to operate “as normal.” The appearance of normalcy is due to the government’s considerable cash reserves and its use of certain “extraordinary measures” (such as not paying into trust funds). Without further borrowing, however, the cash reserves will shrink, eventually forcing the government to make hard choices. That day may now come as soon as June 1, 2023.
Should political brinkmanship around raising the debt ceiling reach beyond the “X” day, the government may need to determine who gets paid and who gets furloughed. Government contractors may find themselves in line after higher-priority spending obligations, such as interest rate payments to U.S. bond holders, military salaries, civil servants’ pay, unemployment benefits, Social Security checks, Medicare benefits, federal law enforcement expenses, and funding for the courts. Contractors should therefore take stock now of their plans to weather the possible financial shortfalls.
Treasury Control of Payments
The United States has faced a similar situation in the past. In the run up to the 2011 debt limit crisis, the Federal Reserve and Treasury developed a plan to prioritize payments if the government was unable to pay all of its obligations. The transcript of a conference call between the Federal Open Market Committee and the Board of Governors of the Federal Reserve System indicates that such a plan had “evolved fairly substantially in the past week or two” prior to resolution of the 2011 impasse and only been finalized the night before. The plan, which was never implemented, applied three principles. First, principal and interest payments on Treasury securities would be made on time. Second, other payments may be delayed. Third, any payments made would be settled.
Although the plan was formalized in a special operating circular, that circular was never issued, prepared only as a contingency if a deal wasn’t struck. In September 2021, Treasury Secretary Janet Yellen’s team rejected the idea of prioritized payments under the 2011 plan. That position, however, may represent the practicalities of preventing panic, political push-back, and pre-emptive litigation by not revealing the Treasury’s plans prematurely. If no deal is struck before the extraordinary measures are exhausted, the Treasury may well revert to the 2011 gameplan as a means to mitigate the financial fallout.
Agency Control of Remaining Funds
Agencies might similarly reassess their financial priorities and seek to conserve funds by limiting less-necessary expenses if no compromise is reached. Understanding the approach agencies may take requires a quick review of agency spending mechanisms. Once Congress appropriates funds, OMB apportions those funds into Treasury accounts. When the existing apportionment is “no longer appropriate or applicable because. . . unforeseen events have occurred,” agencies may request the reapportionment of funds per OMB Circular A-11. Agencies may not obligate funds without an OMB-approved apportionment, due to the strictures of the Anti-deficiency Act. Thus, if a timely Congressional agreement is not reached, agencies may seek to quickly reapportion their funds based on projected needs and priorities. To ensure sufficient funds to pay for the most vital and immediate expenditures, including those for salaries of military personnel, agencies are likely to rebalance their Treasury Appropriation Fund Symbols (TAFS) accounts. If agencies shift unobligated funds out of procurement-related TAFS, then, despite adequate congressional appropriations, the Anti-deficiency Act would prohibit agencies from issuing new obligations (such as awarding new contracts or orders) in excess of the amount remaining in the appropriate TAFS account.
In planning for the worst, government contractors should consider two separate scenarios as they review their existing contract portfolio and pipeline. The first scenario is where the agency acts to conserve cash flow (e.g., by suspending award of future contract actions, not raising the limitation-of-funds ceiling on specific programs, or issuing stop-work orders). The second scenario is where an agency forges ahead without adequate funds to cover all of its contractual obligations. Below we outline considerations for each scenario.
Scenario I: The agency acts to conserve cash
This scenario is similar in effect to prior government shutdowns where budgets are not timely enacted. Agencies may choose not to obligate new funds unless the work is essential to sustaining the agency’s mission. This may mean halting new solicitations and pending proposal reviews, not awarding new contracts or task orders, and refusing to raise limitation-of-funds ceilings, exercise options, or issue contract extensions. Importantly, where funds are not yet obligated, contractors must avoid acting as a volunteer; the government has no obligation to cover unfunded activities.
As an initial step, contractors may seek guidance from the Contracts and Acquisition functions at each agency where they hold an active contract or have a pending proposal. In particular, contractors might ask about agency plans for contract performance if the debt ceiling is not raised, and specifically whether agency personnel, facilities, and equipment will be available. Finally, contractors can work cooperatively with the agencies to mitigate performance disruptions.
The following are practical steps contractors may take to prepare should a midnight solution for the borrowing debate not be found:
- Identify solicitations with source selection decisions scheduled during the fourth quarter of the fiscal year and anticipate delays in contract awards.
- Identify contracts with options due in the fourth quarter and review the terms for the government's option exercise. The failure of the government to exercise an option in strict accordance with its terms could entitle the contractor to reprice the option.
- Identify contracts that rely on incremental funding and determine whether it may become necessary to notify the Contracting Officer and then stop work to avoid incurring costs beyond the amount obligated. Under the Limitation of Funds clause (which often is tailored for use in large fixed-price contracts), the government is not required to reimburse a contractor for costs incurred beyond the amount obligated. If the obligated funds are insufficient to cover a contractor’s ongoing performance and termination liability, the contractor is required to “take a vacation” until funds become available.
- Identify cost-type contracts that approach the Limitation of Costs clause ceiling and decide whether to stop work. The government is not required to reimburse a contractor for costs beyond the stated ceiling, and the contractor should not expect the government to increase the contract ceiling during a cash crisis. Any performance beyond the ceiling is as a volunteer.
- Where funds are obligated, agencies may act to stop the bleed from particular funding accounts. Agencies may issue stop work orders on less essential contracts to conserve cash for more essential work. Where agencies issue stop-work orders, the contractor must stop work. If affected, be sure to keep accurate records of any disruption you encounter.
Scenario II: The agency forges ahead despite funding shortfalls
Somewhat trickier is where agencies choose to press ahead, despite a lack of cash. A contracting officer may elect not to issue stop work orders, and either permit or require the work to continue, even in the absence of funds. If this happens, the contractor must choose between observing its legal right to halt performance or satisfying the customer at its own risk.
Arguably, if the government fails to pay properly submitted invoices in the absence of a dispute, the contractor may refuse further performance on a theory of material breach. As recently as 2013, the ASBCA has—at least in dicta—recognized the general proposition that a material breach by the government, in not paying when or as required, excuses a contractor’s obligation to perform. The justification to discontinue performance is well established where the government’s failure to make payments renders a contractor financially incapable of proceeding with the work. Even where continued performance remains possible, the government’s antecedent breach in failing properly to pay the contractor may justify the contractor’s abandonment of the contract and shield it from default.
Whether or not they elect to continue work despite interrupted payments, government contractors should keep track of all delays, disruption, or work-around accommodations they are forced to endure as a result of government personnel, facilities, or equipment being unavailable or late. In doing so, government contractors will be better prepared to seek reimbursement for the added costs caused by these constructive changes once things get back to normal.
Ultimately, no one knows what will occur should the government prove unable to pay its bills. The U.S. government has never defaulted and hopefully never will. In any scenario, contractors may prepare for the uncertainty ahead by accumulating sufficient cash in hand to continue core operations and pay their own bills. Contacting preferred financial institutions to ensure adequate access to credit in the event of a default may prove equally important by providing a financial lifeline. Having a plan in place on how best to weather the brewing storm promotes internal confidence. Finally, working with industry groups to express the importance of a timely resolution may motivate members of Congress to find common ground and avoid the storm all together.
 Whether this principle remains good law in all circumstances is an open question, particularly where a contract includes the Alternate I version of the Disputes clause at FAR 52.233-1.