[Federal Register: June 2, 2005 (Volume 70, Number 105)]
[Notices]
[Page 32306-32310]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02jn05-38]
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DEPARTMENT OF DEFENSE
Contract Financing: Performance-Based Payments
AGENCY: Department of Defense (DoD).
ACTION: Response to public input.
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SUMMARY: The Director of Defense Procurement and Acquisition Policy
(DPAP) recently completed an internal assessment regarding the use of
performance-based payments as a method of financing for DoD contracts.
This assessment has resulted in recommendations for revisions to
policy, guidance, and training on the use of performance-based
payments.
FOR FURTHER INFORMATION CONTACT: Mr. David Capitano, DPAP Policy
Directorate, by telephone at (703) 847-7486, or by e-mail at
david.capitano@osd.mil.
SUPPLEMENTARY INFORMATION: As part of the internal assessment, DPAP
published a Federal Register notice on September 9, 2004 (69 FR 54651),
requesting the views of interested parties on what they believe are
potential areas for improving DoD's use of performance-based payments.
Seven sets of public comments were received in response to the DPAP
request.
The DoD internal assessment resulted in 47 recommendations for
revisions to the Federal Acquisition Regulation (FAR), the Defense FAR
Supplement (DFARS), the DoD User's Guide to Performance-Based Payments
(User Guide), and DoD training programs. The anticipated completion
dates for these actions are as follows:
FAR Revisions--Final FAR Rule: July 2006
DFARS Revisions--Final DFARS Rule--August 2006
Revised User Guide--August 2006
Revised DoD Training Programs--August 2006
A summary of the public comments and the DPAP responses are as
follows:
A. Training on Methods of Designing Performance-Based Payment
Milestones
Comment: One respondent states that the greatest needs are for
training of contracting officers and requiring activity personnel on
the methods of designing performance-based payment milestones that are
(1) truly performance based and (2) tied effectively to incentives,
where appropriate. The training should also emphasize the ``preferred
method'' status of performance-based payments, and the collaborative
effort (between contracting officers and the requiring activity/end
user) that is necessary to design effective and meaningful performance-
based payment schemes.
DPAP Response: DPAP plans to amend the current DoD training
materials to address the design of milestones and to emphasize the
preferred status of performance-based payments.
B. Performance-Based Payments as the Method of Preferred Financing
Comment: One respondent believes that progress payments are
preferable over performance-based payments. While progress payments are
based on costs incurred, milestones for performance-based payments are
highly influenced by the contractor and are skewed in their favor. The
number of milestones on many programs may be greater than the line
items on a contract, and the fact that the milestones are negotiated/
established at the beginning of the contract does not take into account
the fact that the contract changes over the lifetime. This makes many
milestones dubious and/or unnecessary as the contract matures. This
respondent also states that the time necessary to establish these
milestones requires a number of additional negotiations during the life
of the contract, which adds time to administration rather than
streamlining the effort. While establishing milestones is supposed to
flag problem contracts when a milestone is missed or not billed, the
respondent believes that the loss position in a progress payment
catches many more people's attention, since a single milestone could be
lost in a myriad of milestones established in the contract. As such,
the respondent believes that the policy of utilizing performance-based
payments as the financing vehicle of choice is a bad idea.
[[Page 32307]]
Another respondent states that DPAP should issue policy stating
that performance-based payments are the preferred method of financing
on fixed-price contracts when the contractor concurs.
A third respondent states that progress payments are easier for the
contract specialist because all the contract specialist has to do is
make sure the FAR and DFARS progress payment clauses are in the
solicitation. Conversely, performance-based payments are a tremendous
amount of extra work. General milestones are included in the
solicitation, and once award is made, detailed performance-based
payment milestones must be negotiated. The respondent asserts that, in
most cases, the milestones cannot be finalized in a competitive
procurement. Depending on who gets the award, manufacturing processes
may be different and events occur at different times. The respondent
believes that, having used performance-based payments on five
contracts, the experience will make it easier to use such payments in
the future.
DPAP Response: Performance-based payments generally require more
up-front work than progress payments. However, this is offset by the
reduced administrative effort that results from the elimination of cost
verifications. In addition, performance-based payments increase
competition, since some commercial firms do not have accounting systems
that are acceptable for progress payments. As such, performance-based
payments should continue to be the preferred method of financing. To
emphasize this preferred status, the FAR may need to provide a more
assertive requirement for the use of performance-based payments. For
example, when a contractor proposes performance-based payments but the
contract includes progress payments, the FAR could require a
contracting officer to document in the contract file why performance-
based payments were not used. DPAP has recommended that this issue be
addressed as part of the FAR case to review/revise the current FAR
coverage on performance-based payments.
C. Indefinite-Delivery/Indefinite-Quantity Contracts
Comment: One respondent notes that establishing performance-based
payments under indefinite-delivery/indefinite-quantity contracts at the
``contract'' level rather than the ``order'' level results in an
administrative quagmire for both the Defense Contract Management Agency
and the Defense Finance and Accounting Service. The respondent
recommends this issue be addressed as it has in the areas of progress
payments. The respondent asserts that the similarity of each is
highlighted at FAR 32.1001(c) and (d), Policy. These provisions state,
in pertinent part, that ``Performance-based payments are fully
recoverable, in the same manner as progress payments * * *.'' The
provisions further state ``For Government accounting purposes, the
Government should treat performance-based payments like progress
payments based on costs under Subpart 32.5.'' The respondent recommends
adding a paragraph to FAR 52.232-32, Performance-Based Payments, that
is substantially the same as that at FAR 52.232-16(m), Progress
Payments.
DPAP Response: FAR coverage may be needed to address indefinite-
delivery/indefinite-quantity contracts, particularly with regard to if/
how performance-based payments are established (i.e., contract vs.
order level). DPAP has recommended that this issue be addressed as part
of the FAR case to review/revise the current FAR coverage on
performance-based payments.
D. Lesser of Cost and Performance Payment
Comment: One respondent states that FAR 32.1002 sets forth the
basis or bases upon which performance-based payments might be made,
none of which involve cost. There are instances where contract
provisions have been included where performance-based payments are
limited to the lesser of a specified performance-based payment schedule
amount or incurred costs. The respondent asserts that this is
inconsistent with the intent of performance-based payments.
DPAP Response: The benefits of performance-based payments are
significantly reduced when there is a requirement to use the lesser of
cost or the value of the performance payment. DPAP has recommended that
this issue be addressed as part of the FAR case to review/revise the
current FAR coverage on performance-based payments.
E. Responsible Official for Reviewing/Approving Performance-Based
Payments
Comment: The respondent notes that, under FAR 32.1007(a), the
contracting officer responsible for administration of the contract
shall also be responsible for review and approval of performance-based
payments. Where contracts are administered by other than the Procuring
Contracting Officer (PCO), the contract administration function of
reviewing and approving/disapproving contractors' requests for either
performance-based payments or progress payments are normally not
retained by the PCO, but delegated to the Administrative Contracting
Officer (ACO). However, there have been instances where review and
approval of performance-based payments are not delegated to ACOs,
notwithstanding the delegation of all other contract administration
functions. The respondent asserts that this is an inefficient practice,
given the ACOs' presence in or proximity to contractor manufacturing
facilities, and familiarity with contractors' business and other
systems. The respondent recommends that FAR 42.302(a) (or alternatively
DFARS 242.302) require that performance-based payments be delegated to
the ACO, unless the PCO can demonstrate compelling circumstances as to
why the function should not be delegated.
DPAP Response: FAR 32.1007(a) requires that the contracting officer
responsible for administering the contract also be the one responsible
for reviewing and approving the performance-based payments. However,
FAR 42.302(a)(12) is a function that may be retained by the PCO, i.e.,
not delegated to the ACO. Thus, the ACO could administer most of the
contract, but the PCO could retain the review/approval function for
performance-based payments. In such cases, the contracting officer
responsible for administering the contract would not be the same as the
contracting officer responsible for reviewing/approving performance-
based payments. DPAP has recommended that this possible inconsistency
in the existing FAR provisions be addressed as part of the FAR case to
review/revise the current FAR coverage on performance-based payments.
F. Valuation of Performance-Based Payment Events
Comment: One respondent recommends that valuation of performance-
based payment events receive increased emphasis, because the respondent
believes it continues to be a weakness of contracting officers.
DPAP Response: The User Guide currently discusses the need for
valuations to be commensurate with work performed, but does not include
specific examples. DPAP plans to amend the User Guide and training to
provide examples of inappropriate valuations (e.g., front or back-
loading of payments).
[[Page 32308]]
G. Increased Education and Emphasis on Use of Performance-Based
Payments
Comment: One respondent notes the reluctance of some PCOs to
include performance-based payments, even when the contract is a good
candidate for use of such payments. This respondent recommends more
education and emphasis on the use of performance-based payments.
Another respondent also recommends more education. This respondent
asserts that ``contractors and DoD Buying Commands truly are unaware of
the benefits of performance-based payments and especially how to
structure a performance-based payment contract to achieve the mutual
benefits performance-based payments provide. Progress payments are most
acquisition personnel's (Government and private) comfort zone. They
understand them and have used them for years.'' This respondent
suggests increasing education via a ``Performance-Based Payment Road
Show'' presented by the Office of the Secretary of Defense (OSD), with
assistance from DoD personnel who have a wealth of performance-based
payment experience and knowledge. This respondent suggests
presentations by OSD personnel to contractors would also be beneficial.
DPAP Response: Increased training will facilitate the use and
effectiveness of performance-based payments. DPAP will review the
current training plan and revise it as necessary to maximize the
effectiveness of DoD's performance-based payment training.
H. Advantages/Disadvantages of Performance-Based Payments
Comment: One respondent identifies the following advantages and
disadvantages of performance-based payments:
Advantages of Performance-Based Payments
Performance-based payments drive the Program Team to focus
on performance events and consequently the related performance-based
payments billing.
Performance-based payments help maintain the program
schedule. Progress payments do not provide an insight into schedule
performance.
Performance-based payments provide the contractor an
opportunity for increased cash flow; if the billing event is completed
ahead of schedule, then payment is received earlier.
Performance-based payments reduce the cost of
administration and streamlined oversight. Progress payments require a
separate system approval by the Government. Material Management and
Accounting Systems are not required for performance-based payment
contracts.
Disadvantages of Performance-Based Payments
Use of performance-based payments requires the agreement
of both parties to the contract. This complicates the source selection
process and can disadvantage the offeror seeking the use of
performance-based payments.
Additional effort is required to track each performance-
based payments event due date and monitor completion status of each
event. This is particularly difficult in a production build
environment. The performance-based payments billing schedule is often
made more complicated than necessary.
Despite the Government's policy that performance-based
payments is the preferred method of financing, certain contracting
officers have not fully adopted the practice. This puts the contractor
offering performance-based payments at a disadvantage in a competitive
source selection, and could even cause the offeror to be declared non-
responsive.
DPAP Response: DPAP is in the process of updating the User Guide.
As part of this update, each of these potential advantages and
disadvantages will be reviewed and, as appropriate, included in the
Guide.
I. Performance-Based Payments ``Required'' Rather Than ``Preferred''
Comment: One respondent notes that the FAR language stating
``performance-based payments are the preferred Government financing
method when the contracting officer finds them practical'' provides
considerable discretion for the Contracting Officer to include progress
payments, which are much easier to include in the solicitation. The
respondent recommends revising FAR 32.1001(a) to require performance-
based payments. The respondent asserts that there should be very few
circumstances where progress payments are used. This respondent states
that the OSD(AT&L) policy letter of November 13, 2000, requested that
performance-based payments be the sole financing method by fiscal year
2005. The respondent recommends that OSD(AT&L) issue an update to the
November 13, 2004, policy letter. The letter should emphasize
performance-based payments as the ``mandatory'' form of contract
financing.
DPAP Response: It is not advisable to mandate a particular form of
contract financing. However, the FAR could provide a more assertive
requirement for the use of performance-based payments. In particular,
the FAR should be reviewed to determine whether more emphasis should be
added to the ``preferred'' use of performance-based payments. For
example, when a contractor proposes performance-based payments, but the
contract includes progress payments, the FAR could require a
contracting officer to document in the contract file why performance-
based payments were not used. DPAP has recommended that this issue be
addressed as part of the FAR case to review/revise the current FAR
coverage on performance-based payments.
J. FAR 52.232-28, Invitation To Propose Performance-Based Payments
Comment: One respondent states that FAR 52.232-28, Invitation to
Propose Performance-Based Payments, requires the contracting officer to
include evaluation criteria in competitive solicitations. The
respondent believes this not only increases the complexity of the
evaluation, but also discourages offerors from proposing performance-
based payments due to the potential downgrading of the proposal. The
respondent recommends revising FAR 52.232-28 to delete Alternate I,
thereby eliminating the penalty for offering performance-based
payments.
DPAP Response: The regulations should not penalize or discourage
contractors that propose performance-based payments. DPAP has
recommended that this issue be addressed as part of the FAR case to
review/revise the current FAR coverage on performance-based payments.
K. Facilitating Implementation of Performance-Based Payments
Comment: One respondent states that use of performance-based
payments can be facilitated if performance-based payments discussions
between the PCO and the contractor begin immediately after a proposal
is submitted. A PCO may require additional detail (expenditure profile
by contract line item) or may want to talk to the ACO. By the time pre-
award negotiations begin, the PCO should be well aware of the
performance-based payments financing request with no opportunity for
``delay pending availability of supplemental data or outstanding
questions.'' In certain situations, it may be feasible to delegate
responsibilities for establishing the performance-based payments
criteria to the ACO. This respondent states that performance-based
payments can be further facilitated by requiring a detailed
performance-based payments plan and
[[Page 32309]]
supporting expenditure profile to be submitted with the proposal.
DPAP Response: DPAP plans to amend the User Guide and training to
emphasize the need to address performance-based payments as early in
the acquisition process as practical, including during pre-award
negotiations.
L. Developing Performance-Based Payment Billing Events
Comment: One respondent recommends updating the DoD Guide on
Performance-Based Payments to provide additional examples on how to
develop billing events. Emphasis should be on milestones relative to
the expenditure profile, and not individual contract line item prices
and schedules. A second respondent recommends mandatory training on how
to establish payment criteria.
A third respondent recommends issuing guidance stating that, as
part of the acquisition planning and contract formation process, each
performance-based payments event shall be formulated so that it is
objective, quantifiable, and as easy to measure as possible. For
example, tying performance-based payments events to already defined
program reviews, tests, or manufacturing plan milestones or other
events on the integrated program schedule for manufacturing activities
is often the best course. For services, tying performance-based
payments events to program reviews, key performance milestones, or
other suitable events is good business practice. This respondent also
notes that defining a performance-based payments event as ``100%
completion'' of tasks should be avoided, since there are frequently
minor action items left open even when a major milestone is otherwise
considered accomplished. This respondent recommends revising FAR
32.1007(d), which prohibits payment of performance-based payments for
incomplete performances to address cases where the milestones are
materially met, but not by a 100 percent standard. This respondent
recommends that FAR be revised to ``allow for Contracting Officer (CO)
discretion for payment of partial amounts of performance-based payments
when a specified milestone is not met.'' This respondent states that
this change would address those instances when a milestone is not
achieved by a very small margin.
DPAP Response: DPAP plans to amend the User Guide and training to
address the development of the performance metrics, including the
targeting of milestone requirements that are integral and necessary to
completion of the contract. However, it is not advisable to provide for
partial payments of performance-based payments milestones. The solution
to this issue is in the development of the milestone metrics. If there
are minor tasks that are not an integral part of the milestone
completion, the metric for the milestone could list these minor tasks
and state that they are not part of the milestone completion
requirements. This would ensure that the parties agree up-front on what
the metrics are, rather than arguing later about ``partial payment.''
In addition, partial payment raises an issue of how to make such a
payment (how do the parties determine how much of the payment is made)
and significantly reduces the effectiveness of performance-based
payments, which are predicated on satisfactory performance of the
milestone requirement.
M. Increasing Use of Performance-Based Payments
Comment: One respondent states that current policy and regulatory
implementation of performance-based payments are generally adequate.
DoD policy clearly states that performance-based payments are the
preferred form of contract financing employed by the Government.
However, the initial effort involved in identifying objective payable
events may cause some contracting officers to remain reluctant to adopt
the use of performance-based payments. The respondent recommends
adopting a policy stipulating that, for all major fixed-price
production programs in which the end item delivery cycle exceeds 12
months, the contracting officer must obtain a waiver from the head of
the contracting activity in order to use progress payments rather than
performance-based payments.
DPAP Response: It is not advisable to require a waiver to use
performance-based payments or progress payments. This decision should
be made by the contracting officer.
N. Revising Milestones
Comment: One respondent notes that sometimes new leadership
(program manager or PCO) wishes to revise the initially established
events, which tends to negate the benefits of performance-based
payments by adding administrative effort. The respondent recommends
issuing a policy stating that previously established milestones or
criteria should remain stable unless payments are in violation of the
general restrictions on financing payments in FAR Part 32.
DPAP Response: It is not advisable to preclude the contracting
officer's ability to modify performance-based payments events. Note
that in the absence of a change in contract performance requirements,
modifying the performance-based payments events generally requires
mutual agreement of the parties.
O. Verification of Incurred Cost for Performance-Based Payments
Comment: One respondent recommends prohibiting verification of
incurred costs as part of performance-based payments. The respondent
states that one important advantage of performance-based payments is
the elimination of Government auditing of incurred costs. In addition,
it is not clear what the Government intends to do with the incurred
cost information. Regardless of the costs incurred to achieve a
performance milestone, the payment terms in the contract will prevail.
If there is a need to limit payments to a percentage of incurred costs,
the original contract terms should establish progress payments as the
correct contract payment mechanism. The respondent is concerned that
the language at FAR 32.1004(a)(3)(ii) may be causing contracting
officers to request incurred cost data for each milestone. The
respondent notes that the second sentence of this paragraph states that
``the contracting officer may request expenditure profile information
to confirm that the contractor's investment is sufficient.'' The
respondent recommends that the FAR be revised and/or guidance be issued
to make it clear that the expenditure profiles may only be requested
during the contract pre-award stage.
DPAP Response: Including verification of costs incurred as a
requirement for payment significantly diminishes the value of
performance-based payments. DPAP has recommended that this issue be
addressed as part of the FAR case to review/revise the current FAR
coverage on performance-based payments.
P. Single Financing and Liquidation Rate
Comment: One respondent recommends establishing one financing and
liquidation rate. The respondent believes that one rate will make it
much simpler for DoD and the contractor to administer, pay, and close
out contracts.
DPAP Response: It is important for the contracting officer to have
the flexibility in the negotiation of the contract financing and
liquidation rates, rather than forcing a single financing and
liquidation rate for all contracts.
[[Page 32310]]
Q. Financing Rates Should Provide Financing Incentives for Performance-
Based Payment Use
Comment: One respondent recommends that the financing rates for
performance-based payments offer incentives above that which could be
achieved with the no-risk, administratively burdensome 80 percent
progress payment option. The FAR currently states that performance-
based financing must be prudent and must not exceed 90 percent of the
contract price. The respondent asserts that there have been numerous
situations where the actual performance-based payments rates awarded
provide lower effective financing than the 80 percent progress payment
option. This trend is a disincentive for contractors to accept the
risks associated with meeting performance-based financing events. The
respondent recommends that DPAP issue guidance to the field advising
PCOs to use performance-based payments rates that offer true financial
incentives. The guidance should state that the 90 percent rate will be
used on an ordinary basis and that lower rates should be used only when
significant justification exists.
DPAP Response: Providing performance-based payments financing at or
below the effective rate for progress payments inhibits the use of
performance-based payments. DPAP has recommended that this issue be
addressed as part of the FAR case to review/revise the current FAR
coverage on performance-based payments.
R. Use of Production Lead Times In Lieu of Performance Events
Comment: One respondent recommends permitting performance-based
payments based on production lead times for mature programs with
reliable production processes, rather than using performance events.
The respondent states that this is a common commercial practice and is
appropriate in situations when the lead times and production processes
are well known. The respondent asserts that this would result in a
contract that is both simple to award and simple to administer, since
the effort to validate and approve events would be eliminated.
DPAP Response: The passage of time is not an acceptable
performance-based event, even when the lead times and production
processes are well known. When the production processes are well known,
it should not be difficult to establish objective performance
milestones in a manner that requires minimal validation effort.
S. Eliminate Requirement To Bill at Contract Line and Accounting
Classification Reference Number (ACRN) Level
Comment: One respondent recommends simplifying the contract
administration and payment process by eliminating the requirement for
contractors to bill and for the Defense Finance and Accounting Service
(or other payment offices) to pay performance-based payments financing
requests by contract line and ACRN. The respondent asserts that
performance-based payments financing should be treated the same as
progress payment financing by having the DoD payment systems allocate
the billing amount to all ACRNs on the contract. The respondent asserts
that adoption of this recommendation would eliminate the need for
preparation of complex billings and the maintenance of manual
spreadsheets by the contractor and DoD.
DPAP Response: The current DFARS case, Payment and Billing
Instructions (DFARS Case 2003-D009), addresses the respondent's concern
(proposed rule published at 69 FR 35564 on June 25, 2004). This case
will revise the DFARS to provide the contracting officer with twelve
options, including the ability to have the payment office allocate the
costs at the contract line item/ACRN level.
T. Segregation of Billings Into Multiple Invoices
Comment: One respondent recommends permitting billings to be
segregated into multiple invoices where a problem with a funding
source, accounting station, or foreign military sales customer is
expected to delay payment. The respondent believes that this option
provides contractors with the ability to receive payment on time for a
portion of the billing when problems arise with a particular funding
source, accounting station, or foreign military sales customer, while
also minimizing reconciliation efforts and the risk of expiring funds.
DPAP Response: DPAP has established a DFARS case to address
instances in which a portion of the invoice is payable but other
portions are not due to problems with a funding source, accounting
station, or foreign military sales customer.
U. Corrected or Delayed Billings of Prior Month Do Not Preclude New
Billings
Comment: One respondent recommends that guidance be issued stating
that a corrected or delayed billing from a prior month does not
preclude a contractor from issuing a new billing for performance-based
payment events achieved in a subsequent month.
DPAP Responsee: DPAP plans to amend the User Guide and training to
address the processing of current invoices when there are corrected
and/or delayed billings from a prior period.
Michele P. Peterson,
Editor, Defense Acquisition Regulations System.
[FR Doc. 05-10910 Filed 6-1-05; 8:45 am]
BILLING CODE 5001-08-P