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The Effects of Subcontractor Default

Given many primes rely on subcontractors for the performance of their government contracts, the success or failure on a project depends heavily on whether the subs timely and properly perform their portion of the work. It is well settled that primes are responsible for the unexcused performance failures of their subs. Meaning, because the prime is the entity legally bound to the government, a performance failure by the subcontractor is attributed to the prime even absent any actual fault on its part. So in addition to incurring pecuniary losses as a result of the nonperforming sub, a prime also risks the serious penalty of a default termination by the government.

A default termination is a severe remedy with significant consequences. In addition to possibly having to pay back any money earned under the contract and pay liquidated damages, a contractor could face debarment, negative past performance history ratings, and re-procurement costs. Debarment precludes a contractor from participating in public procurements for a specified period of time and is usually referred to as a death sentence for government contractors. Past performance ratings are used in virtually every contract acquisition decision, either as a responsibility or evaluation factor, and negative history, particularly from a default termination, will heavily disadvantage a contractor’s ability to obtain future awards. And re-procurement costs may include any excess cost incurred by the government to acquire the supplies or services the defaulting contractor failed to provide. This is all to say that a failure by a sub can have crushing consequences for a prime.

Because prime contractors are subject to these liabilities and are ultimately responsible for the conduct and compliance of their subs, they not only need to have strict contractual controls and actionable protocols in place for ensuring performance, but contingency plans in the event of a default. For instance, a prime will want to ensure that the cure provision in its subcontract provides enough time for it to adhere to the similar provision in the applicable FAR default clause. If the government contract is for fixed-price supplies or services, then the prime should have accessible secondary sources for the products or services so as to avoid the loss of the excusable delay exception. Performance oversight is an obvious internal best practice for primes, but so is routine monitoring of a sub's fiscal affairs in order to get ahead of any potential performance problems resulting from deteriorating financial health.

Additionally, communication with the contracting officer before a failure to perform occurs is critical for transparency and for presenting substantial assurances that the problems will be overcome and the contract performed. If a cure notice is issued, dialogue is even more important. A prime cannot avoid default liabilities by simply saying its subcontractor failed to perform. While the FAR recognizes that delays in performance can be beyond the control of the subcontractor, they must also be beyond the control of the prime in order for the prime to be excused from default.

Defenses are available to contractors, and with a successful challenge a prime may be able to convert the termination for default into one for convenience or at least limit damages. However, primes do not want to be in a position of defending a government default (and potentially losing) because it mismanaged its subcontractors. Therefore, the best approach is to ensure appropriate sub due diligence in both selecting and monitoring.

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