The United States reached its debt limit in January 2023, and since then has been using "extraordinary measures" to avoid defaulting on its financial obligations, including Social Security, Medicare, salaries for military and federal civilian employees, and payments to government contractors. Treasury Secretary Janet Yellen has stated that the U.S. could default on its financial obligations as soon as June 1 if Congress does not act to raise the current debt ceiling.
As the U.S. has never defaulted before, the exact repercussions are unknown. The Government will need to prioritize which bills to pay and Congress's failure to raise the debt ceiling could directly impact federal contractors in several ways.
For those contracts still in the acquisition phase, contractors may see those acquisitions delayed as the federal government will need to determine whether they have the funds to pay for new contracts. If the government reaches the point where it furloughs employees in program and contracting offices, the government will likely face delays in finalizing solicitations, evaluating proposals, and making award decisions. For those contracts that have recently been awarded, contractors might see a delay in start dates while the agency sorts out which programs to prioritize.
Agencies may take actions to try to conserve funds, such as issuing modifications to delay work, issuing stop work orders, terminating contracts for convenience, or deciding not to exercise contract options or award new task orders. This would be similar to the impacts felt by contractors during a government shutdown resulting from failure to appropriate funds to keep the government open. If a contractor is issued a stop work order, it must stop work and instruct its subcontractors to do the same. The government is not required to reimburse a contractor for any work done while a stop work order is in effect. Any such work is performed "at risk" to the contractor. Contractors should document all stop work orders, identify the impact of any stop work orders, and mitigate costs. Contractors should keep detailed accounting records of any financial impacts caused by modifications to delay or stop work orders, segregating the accounting for these costs where possible. Contractors should capture all time spent on winding down and starting back up these contracts, even on firm fixed-price contracts. Contractors are permitted to seek an equitable adjustment for costs incurred as a result of a delay or stopping the work, reassigning personnel, and restarting contract performance. Documentation is key to show that the contractor followed instructions from the government and mitigated its damages with respect to its employees, subcontractors, and vendors. Contractors should be prepared to seek reimbursement for these added costs once government funds are flowing again.
However, unlike a government shutdown, where the funds have not been appropriated and non-essential government work must cease, there is no requirement when faced with a default for the government to direct contractors to stop work. Not every agency, activity, or program will be impacted the same way. In most situations, contractors will be required to continue contract performance, which means that they may need to work at risk as contract payments from the government are delayed.
While the Prompt Payment Act does require the government to pay interest on late or missed payments, contractors will need to strategize how to pay their employees and meet their other financial obligations, as there may be a gap in time where they are not getting paid as expected.
There are several things that contractors can do to proactively prepare for the consequences of a default:
- Contractors should act now to make sure that they have cash or liquid assets on hand if needed, determine if there are ways to preserve or increase cash reserves, and understand the terms of their lines of credit.
- Prime contractors should review their subcontracts to determine whether they are obligated to pay their subcontractors even if they don't receive timely payments from the government.
- Subcontractors should review their subcontracts to determine whether they are obligated to continue working if their prime contractor is unable to make payments.
- Contractors with incrementally funded contracts should review their Limitations of Funds provisions and be aware of funding status and notice requirements.
- Contractors should initiate discussions with contracting officers about potential delays, stop work orders, impending funding limits, and contract priorities.
- Contractors should submit invoices as soon as the contract allows. If the contract has milestone payments, contractors should discuss with the contracting officer whether they can modify the contract to allow for partial payment for work that has been completed.
- Contractors should document all costs associated with stop work orders or modifications to delay work or other contract changes.
While no one is able to predict what will happen if the government defaults and is unable to pay its bills, Contractors can and should take steps to prepare for the potential that the government will delay contract payments or issue stop-work orders.
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