1 the debt ceiling, sequestration and the fiscal cliff national contract management association old...

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The Debt Ceiling, Sequestration and theFiscal Cliff

NATIONAL CONTRACT MANAGEMENT ASSOCIATIONOLD DOMINION CHAPTER

November 14, 2012

Paul A. DeboltVenable LLP

575 7th Street, N.W.Washington, D.C. 20004

[email protected]

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Current Environment■ The Budget Control Act (BCA) of 2011 included $900

billion in budget deficit cuts.▬ More than half of the $900 billion ($487 billion) comes from defense spending.

■ Defense spending will decrease to approximately 13% of the budget in 2017 without sequestration. ▬ 2013: $571 billion ▬ 2014: $560 billion ▬ 2015: $561 billion ▬ 2016: $574 billion ▬ 2017: $581 billion

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Sequestration■ Scheduled to occur on January 2, 2013.

■ Would result in another $500 billion in defense cuts over the next decade.

▬ Eligible defense programs will be cut by $54.7 billion in FY13.

▬ Since the cuts will not occur until the second quarter of FY13, the defense cut for the rest of the year would be 12.25%.

■ President Obama is willing to allow sequestration to occur unless Republicans agree to raise tax rates for the wealthy.

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Legal Definition Of SequestrationA permanent cancellation of budget authority

Functional Definition for the 2013 SequesterAutomatic, indiscriminate, across-the-board budget cuts to force reductions in spending to a level previously defined by Congress

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Practical Definition for 2013A gun Congress holds to its own head to force program advocates with different priorities to compromise on steps to close our structural fiscal deficit and agree on steps they do not like, for fear of having their own fiscal priorities harmed in case of a stalemate

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BASIC PRINCIPLES

1. If sequestration occurs, the automatic, indiscriminate spending cuts will be divided equally between eligible defense programs and eligible non-defense programs.

2. The principal difference between this process and the Gramm-Rudman sequestration is that Defense was largely held harmless in 1986, but now nearly all Defense appropriations are considered discretionary spending and are subject to mandatory, across-the-board reductions.

3. Many domestic entitlement programs are protected from cuts. Social Security and Medicaid are exempt and cuts in Medicare are limited to 2%. Appropriations for the Veterans Administration also are exempt.

4. The sequester is large: in FY2013, $54.7 billion each from defense and non-defense spending.

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THE SEQUESTRATION PROCESS

PROCESS FOR ADMINISTERING SEQUESTRATION

Step 1: OMB starts with the deficit reduction amount established by the statute -- $1.2 trillion

Step 2: OMB subtracts 18% of that amount for interest on the debt

Step 3: OMB divides the remainder (an estimated $942 billion) by 9, to allocate the spending cuts to each of the 9 covered years

Step 4: OMB divides that amount by 2, to establish the amount to be cut separately from defense and non-defense programs and accounts

Step 5: OMB calculates the uniform amount each eligible program in the defense and non-defense categories must be cut

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THE CRITICAL CONSIDERATION – TIMING

Unless the parties agree on a mega-fiscal deal and simultaneously repeal or delay the sequester required by current law, sequestration will be ordered on January 2, 2013 – one day before the expiration of the Bush tax cuts.

No amount of planning can offset the adverse effects of sequestration. It cannot be “managed.” Sequestration is a doomsday device to force the parties to reach agreement on a long-term fiscal plan.

The structure of the sequestration law may put significant pressure on Defense hawks to part ways from Fiscal Conservatives who will not accept income tax increases under any circumstances. If they cannot repeal, amend, or defer sequestration, Defense hawks may face a difficult political choice whether to accept a revenue component in a comprehensive fiscal policy law to avoid a major cut in the national security budget.

This helps explain why the House Armed Services Committee has been most active in pointing out the potentially disastrous effects of sequestration.

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ADMINISTERING THE SEQUESTRATION -- OMB AND THE AGENCIES

It is impossible to exaggerate how complicated this process would be.

The basic rule is that the same percentage reduction must apply to each “Program, Project or Activity” as defined by appropriations laws.

•There are 2,500 Programs at the Department of Defense alone, and thousands more elsewhere in the government. The implementation process will be broken down into thousands of separate analyses.

•It is difficult for agencies to determine what constitutes a “Program, Project or Activity” and at what level Congress intended the uniform percentage cut to apply. Appropriations bills vary greatly from each other.

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OMB ACTIONS

1.Determine the percentage cut for defense and civilian Programs.

2.Determine how to apply that cut to each separate Program.

3.Implement the spending reductions by issuing an “apportionment” to each agency that reduces by the applicable percentage the amount of available budgetary resources that may be obligated.

An apportionment is a legally binding order, enforceable by criminal sanctions against responsible agency officials, that forbids the agency from spending appropriated funds at a rate faster than the President dictates.

The President can decide to front load or back load the reduction in available resources through apportionment.

4. Transfers. OMB will discuss with the agencies utilizing existing authority, which is limited, to shift funds among Programs to the extent previously authorized by Congress..

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WHAT WILL THE AGENCIES DO?

The agencies will have enormous discretion in determining how to allocate reductions within any given Program to implement the sequester.1.Determine how to implement the uniform reduction by imposing the percentage determined by OMB to each Program.

2. Exercise its discretion in making cuts within each Program. Options include:

-- Ramp down level of outputs (e.g. grants, loans, number of fighters procured)-- Allocate cuts between personnel actions -- furloughs (terminations cost money) -- and contract expenditures that support functions within a Program.-- Allocate cuts among contracts that support each function.

3. Transfer funds among Programs, if previously authorized by Congress, to reduce adverse effects of sequester.

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THE OPTIONS IN THE LAME DUCK SESSION

1. A law that reduces the future deficit by $1.2 trillion or more, and also cancels the sequestration.

2. A law that delays the sequester into the normal period for adoption of a Reconciliation Act. The law also could delay the expiration of the Bush tax cuts.

This approach would defer implementation, in order to avoid pushing the country over the Fiscal Cliff, and provide time for thorough consideration of a comprehensive fiscal compromise. It also would preserve the essence of the compromise in the 2011 Debt Ceiling bill by keeping the potential tax increases and sequestration tied together.

3. Some combination of Options 1 and 2, which would include a partial step forward towards resolution of the structural fiscal deficit plus a deferral of the tax increases and sequestration.

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THE FISCAL CLIFF

Congress and the President could deadlock. The sequestration would be ordered, and the tax increases would occur. The country would fall off the Fiscal Cliff.

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THE WORST POSSIBLE OUTCOME -- NEGOTIATING AFTER SEQUESTRATION IS ORDERED

Allowing the doomsday tax increase and sequestration device to go into effect, and seeking to negotiate a long-term fiscal policy during the resulting time of extreme uncertainty, would be the worst possible outcome.

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THE ADVERSE EFFECTS OF SEQUESTRATION

• When the President orders the sequestration, nothing will happen at first. There is no cut that the agencies need to make on Day 1. Their obligations are to make major cuts in obligations by the end of the quarter (apportionment) and end of the Fiscal Year (the statute).

• This is like the period when Wile E. Coyote has run off the cliff but does not recognize it.

• Every day the agencies wait before imposing cuts would increase the size and abruptness of the reductions that would have to be taken later, if the policy process deadlocks again.

• Negotiations in this climate of escalating uncertainty would be highly risky.• Contractors would continue to perform on contracts funded with prior year

appropriations. Their ability to obtain future work, on which subsequent hiring and capital outlay decisions depend, would be adversely affected.

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At a minimum, certain adverse reactions might be felt immediately, and to an ever increasing degree, beginning when sequestration is ordered:

-- Agencies likely would greatly reduce all new contract awards, and the exercise of options scaled back. Price renegotiations may be common-- Productivity among agency employees, who face the risk of significant furloughs (terminations cost money), could fall.-- Major parts of a fragile economy would not be able to plan their operations even in the short term.-- Financial markets would respond in adverse, unpredictable ways.

THIS WOUND WOULD BE ENTIRELY SELF-INFLICTED

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WHAT ARE THE POTENTIAL EFFECTS OF SEQUESTRATION ON

GOVERNMENT CONTRACTORS?

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POTENTIAL EFFECTS OF SEQUESTRATION ON GOVERNMENT CONTRACTORS

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▬ What’s the potential impact on my company?▬ Crystal ball aspect to all of this

WHAT DOES THIS MEAN FOR GOVERNMENT CONTRACTORS

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– Service contractors will likely suffer more than manufacturers

– Procurement delays for non-essential goods and services

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What does this mean for Government contractors?

■ Decrease in the number of contract awards and the $ value of the awards

■ Even greater reliance on contract vehicles that place less risk on Government, i.e., firm-fixed price contracts

■ Increased terminations for convenience■ Increased use of low cost / technically acceptable contract

solutions – will this be the end of best value procurements?

■ Government restructuring of existing contracts

© 2012 Venable LLP

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What does this mean for Government contractors? (con’t.)

■ Increased Government reluctance to exercise options■ Increased tension / disputes between primes and their

subcontractors■ Increased tension / disputes between contractors and

DCMA / DCAA as the Government questions more costs■ Increases in both contractor and Government claims

(stop-work orders, deductive change orders, constructive changes, cost-allowability, quantum for valid claims)

© 2012 Venable LLP

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What does this mean for Government contractors? (con’t.)

■ DOJ continuing to treat as fraudulent issues, which were previously treated as contract administration issues

■ Increase in bid protest litigation

© 2012 Venable LLP

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WHAT’S A GOVERNMENT CONTRACTOR TO DO?

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Potential Strategies forMitigating the Impact of

Sequestration on your Company

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STEPS COMPANIES SHOULD TAKE AT THE MACRO LEVEL:

• Remember, you are a hostage in this drama. Be proactive.

Public discussion of possible preemptive issuance of WARN notices was the first major effort to generate countervailing pressure on the Administration and its Congressional Supporters.

• Reach out to agency policy officials directly or through trade associations.

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STEPS YOU SHOULD TAKE AT THE MACRO LEVEL: (continued)

Talk, Talk, Talk

Stay in close touch with your Customers within the agency.

• Emphasize the importance of your contracts to the program.

• Obtain information about the agency’s plans for your contracts.

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Maintain a favorable relationship with their customer agencies, within the parameters of ethics regulations, to foster a positive relationship.

Keep abreast of agency developments impacting their contracts; however, understand that the agencies may not know sequestration’s impact on a contract until late in the process.

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STEPS YOUR COMPANY SHOULD TAKE AT THE MACRO LEVEL: (continued)

– Assess the impacts that sequestration may have on your company’s accounting practices

– Review and update accounting and record-keeping practices

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– Determine whether your company is required to issue WARN Act notices to your employees

– Determine whether there are any applicable state laws that require your company to issue a similar notice

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WARN ACT

WARN Act requires most employers with 100 or more employees to give 60 days’ notice of plant closings or mass layoffs

Mass layoffs– Labor cutbacks impacting 500 or more employees– Cutbacks impacting 33% of the workforce if your company

has less than 500 employees

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Follow the money; where is Government spending likely to remain constant or increase

– Cybersecurity– Intelligence– Health care

Consider developing or purchasing capabilities in areas of continuing government focus.

KEY: Surround yourself with a good team!

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STEPS COMPANIES SHOULD TAKE AT THE MICRO LEVEL:

Conduct a vulnerability assessment

– How much of your existing contract portfolio has been funded?

– How do your subcontracts or teaming agreements address the impact of less work in calculating parties’ workshare?

– Review existing contracts for potential cost growth or schedule slippage

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STEPS COMPANIES SHOULD TAKE AT THE MICRO LEVEL: (continued)

– Review your contracts to determine what clauses will be relevant to issues arising from sequestration.

– Review performance assessments to identify and resolve problems quickly.

– Contractors cannot afford to take the blame for government-caused problems.

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– Ensure employees know the terms of your company’s prime contracts and subcontracts — scope creep; notice provisions; requirements to continue performance

– Ensure employees know the difference between apparent v. actual authority

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STEPS YOU SHOULD TAKE AT THE MICRO LEVEL: (continued)

• If it appears that one of your company’s contracts will be eliminated or reduced, develop company proposed restructuring strategies and present them to the Agency.

• TRY TO AVOID THE AGENCIES UNILATERALLY ESTABLISHING THE REDUCTION IN SCOPE.

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STEPS CONTRACTORS SHOULD TAKE AT THE MICRO LEVEL: (continued)

Monitor contract performance– Cost– Schedule– Identify the root cause of any problems– Document problems

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Review current contracts for any potential, legitimate requests for equitable adjustments or claims. FILE THEM!

Consider not delaying filing claims or REAs solely to maintain goodwill.

Document claims as extensively as possible.

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File invoices for amounts currently owed by the government.

Do not unilaterally decide to slow down work.

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THE SEQUESTRATION PROCESS

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QUESTIONS/COMMENTS

THANK YOU VERY MUCH!

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