(a) In the negotiation or determination of any settlement, the TCO shall not allow profit if it appears that the contractor would have incurred a loss had the entire contract been completed. The TCO shall negotiate or determine the amount of loss and make an adjustment in the amount of settlement as specified in paragraph (b) or (c) below . . . .The contractor faces two dilemmas where the government asserts that it would have suffered a loss had the contract been completed. First, the contractor is denied a profit on the costs incurred prior to termination. Second, the contractor will not even recover all of its costs, but instead the contractor will be forced to bear its portion of the loss. The philosophy behind this adjustment is that no contractor should be in a better position than it would have been had the contract been completed.
If the termination settlement is on a total cost basis, the total costs incurred on the contract are reduced by the percentage equal to the loss it would have realized on full completion. If the settlement is on an inventory basis, the loss percentage is applied only against the costs incurred on the terminated portion of the contract, exclusive of costs allocable to completed end items accepted by the government.
A contractor should remember the following points where the government attempts to apply the adjustment for loss formula:
- The government bears the burden of proving that the contractor would have suffered a loss if the contract were completed. Often, the government has a difficult time proving the loss would have occurred.
- The government must act in good faith when making the loss determination. A coerced settlement may not be upheld.
- Where the government is responsible for the cost increase, the adjustment for loss formula will not apply.
- The formula also does not apply where the contractor would have been excused from performing the contract because of the impossibility of performance.
- The adjustment for loss should not apply where the contractor is entitled to an equitable adjustment in contract price which would take the contract out of a loss position.
In several of the above numbered instances, the importance of the changes clause becomes magnified. The various theories and principles which normally entitle the contractor to an equitable adjustment will also provide the basis for the contractor to prevent the government's successful implementation of the adjustment for loss formula.
It also is important for the contractor to keep in mind that the termination settlement may be limited by the total contract price. If the contractor's costs exceed that price, the contractor must consider the changes clause as a means to increase the price so as to avoid the application of the price ceiling.