What Hitting the Debt Ceiling Might Mean for Federal Contractors

The United States is likely just weeks away from the federal government reaching the maximum debt ceiling. The U.S. Department of the Treasury is not permitted to expend funds beyond the current debt limit (because it has no such funds to expend), even if the government is legally obligated to make those payments and Congress has authorized appropriations for such expenditures. This will impact the Treasury Department's ability to pay all sorts of obligations, including interest payments on bonds, Social Security payments and payments to contractors for work already performed.

Background

Some form of a limit on federal government debt has been in existence since the inception of the U.S. government. Prior to World War I, Congress consolidated all of the methods the U.S. could accumulate debt into a single debt limit (commonly known as a debt ceiling), which has since been raised dozens of times (often without controversy). Recent years have seen increased brinkmanship around the debt ceiling. For example, the federal government in 2011 narrowly missed a debt ceiling crisis. Even that near miss was costly, however. The U.S. Government Accountability Office (GAO) found that another debt ceiling impasse in 2013 caused market disruption and increased borrowing costs for the federal government.

Should the debt limit be reached, the Treasury Department would be able to make payments only as additional revenues come in and may attempt to prioritize payments. This means some payments will be delayed, potentially for a lengthy period of time, if the debt limit is not increased. While the Treasury Department is known to be working on a plan to prioritize certain types of payments, it has not released the specifics of that plan and such a plan has to be approved by the president and may be met with court challenges. If such a plan is eventually implemented, payments to bond holders would likely be prioritized above all others.

Unlike a government shutdown, where funds have not been appropriated and work must stop, contractors, in most cases, would likely be required to keep performing even if faced with the uncertainty of future payment from the federal government. Service contractors and product sellers would face their own unique challenges. For service contractors, continued performance means continued obligations to pay worker salaries and benefits. This includes, for instance, requirements to pay certain workers under federal pay laws such as the Service Contract Act (now known as the Service Contract Labor Standards) and the Davis-Bacon Act. Failure to pay wages and benefits to workers under these acts in a timely fashion could result in violations of these laws, leading to debarment. This issue can also cascade down the supply chain, causing numerous businesses to default on their obligations to their employees and other expenses necessary to their continued operation. Product providers face a different shade of a similar problem as they can face lawsuits from suppliers if they fail to pay for products down the supply chain. No matter what they sell to the federal government, all contractors will need to make difficult choices with respect to expenses that they will continue to incur.

Strategic Considerations for Contractors

Because the federal government has never breached the debt ceiling before, the full range of calamitous impacts on contractors is not fully known. Even so, contractors should expect that payments would be delayed and contract awards or orders would be put on hold.

The following is a high-level and non-exhaustive list of considerations as we approach (and potentially hit) the debt ceiling:

• Prime contractors should inventory their prime contracts and subcontracts to determine how the various parties to the agreements are paid and the impact of nonpayment from the federal government. Prime contractors should also be aware that statutory interest may be available for delayed payments if that occurs.
• Contractors also often provide Discounts for Prompt Payment (see, e.g., Federal Acquisition Regulation (FAR) clause 52.232-8). A delay in government payment could result in these discounts being rescinded. Contractors should examine their contracts for any such discounts.
• Contractors should also review their contracts for Limitation of Funds provisions and clauses (i.e., FAR 52.232-22 in circumstances where they have an incrementally funded cost-reimbursement contract) and, if they are included, be mindful of current funding status and notice obligations.
• Payment terms of subcontract agreements should be reviewed to determine if they are "pay-when-paid" or if the prime contractor may be obligated to pay a subcontractor even if payment from the government is delayed. For example, parties to subcontract agreements should catalog whether payments under those agreements must be made irrespective of whether a payment for that work was received from the federal government.
• Contractors should determine whether it is possible to suspend work because of the debt ceiling impasse. Though not permitted by contract, a contractor should dialog with the relevant contracting officers to see whether they would be willing to issue a stop-work order or otherwise temporarily halt work. Though this does not prevent contractors from accumulating ongoing expenses (such as rent), it may allow them to prevent expenses from accumulating as rapidly and survive an impasse. Needless to say, the workers subject to a temporary layoff will suffer egregious financial harm in many circumstances.
• Contractors with contracts from the General Service Administration's (GSA) schedules program may be able to utilize some of the inflation-induced flexibility to avoid many of these issues. GSA has given contractors the flexibility, in some cases, to remove and reinstate products and services to their schedules. In that instance, contractors can remove offerings from their schedules and return them when a debt ceiling impasse is resolved. Prior to taking this extraordinary action, however, contractors should consult with the relevant guidance to ensure they can utilize this flexibility.
• Contractors should ensure invoices are submitted expeditiously, understand their cash position and potentially seek additional borrowing flexibility to allow for a period of time when they will not receive payment for services performed or products sold. It is important for contractors to keep as up to date as possible with their own payment obligations to avoid a compounding issue such as labor law violations and contract disputes with subcontractors.
• If there are costs associated with a contracting officer-directed change, contractors should document those expenses and seek recovery for them as soon as practicable. Each situation will be different, and whether a recovery is possible will be dependent on the individual contact and contracting officer instruction.

Conclusion

Finally, it is important to note that unlike a government shutdown, breaching the debt ceiling does not lead directly to government facilities closing or government personnel becoming unavailable. Even so, various agencies in the federal government may make choices to do so in an effort to minimize additional obligations. This could also include stop-work orders or other curtailment of contracts. These scenarios may trigger the Excusable Delay provision(s) in contracts, which might be available as a defense to alleged performance failures. It might also trigger Government Delay provisions, including in construction contracts, which might afford a contractor adjustment to schedule and/or contract price.

From sequestration to government shutdowns, contractors have been faced with numerous headwinds that tested the strength of their business, but a breach of the debt limit would be uncharted territory. Never before, however, have contractors had to deal with continued performance without the promise of timely payment. In case the unprecedented does occur, contractors immediately should take stock of their contracts, employees and obligations and make strategic decisions to account for this growing possibility.

Holland & Knight's Government Contracts Group will continue to monitor debt ceiling developments and provide further information as necessary. In the meantime, please feel free to reach out to the authors or your Holland & Knight attorney for further information.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.