Did the ASBCA get performance and delivery incentives wrong?

FrankJon said:

Do others agree that the ASBCA in this case fundamentally misunderstands the use of performance/delivery incentives in a FFP contract, or am I missing something?

I think you are missing something.  The parties were in dispute as to the nature of the deductions added to the contract post award.  The contractor contended they were liquidated damages and the government contended they were incentives.  The Board did not say the deductions could not be incentives or that the contract could not contain incentives.  Instead, it merely held the government had not proved its case.  In this regard, see FAR 16.401(d).  There is no mention of a D&F in the decision.

Retreadfed said:

I think you are missing something.  The parties were in dispute as to the nature of the deductions added to the contract post award.  The contractor contended they were liquidated damages and the government contended they were incentives.  The Board did not say the deductions could not be incentives or that the contract could not contain incentives.  Instead, it merely held the government had not proved its case.  In this regard, see FAR 16.401(d).  There is no mention of a D&F in the decision.

Thanks, Retreadfed. Your interpretation assumes that a FFP contract with performance/delivery incentives is an "incentive contract" as the FAR uses that term, but I don't think the FAR is clear on this point at all. For example --

• FAR 16.202-1 states that such a contract "remains firm-fixed-priced."  
• FAR 16.401(a) states that "Incentive contracts as described in this subpart are appropriate when a FFP is not appropriate."  
• FAR 16.401(c) states that "the two basic categories of incentive contracts" are addressed in FAR 16.403, 16.404, and 16.405 (not 16.402).  
• FAR 12.207(d) explicitly permits the use of such incentives when purchasing commercial goods and services (likely since an "incentive contract" would be barred from use by 12.207(a)). (See also FAR Case 2000-013: "The changes made in this rule are intended to facilitate greater use of FAR Part 12 for commercial services acquisitions by providing the contract type flexibility embodied in statute." https://www.federalregister.gov/documents/2000/12/29/00-33153/federal-acquisition-regulation-contract-types-for-commercial-item-acquisitions)

Putting that aside, I personally don't think the Board made its decision based on the absence of a D&F, or it would have pointed that out. Instead, the Board in its opinion is stating that subpart 16.4 "does not apply" because it's a FFP contract. It doesn't see how the positive or negative incentives discussed at 16.402-2(b) could apply unless the contract were other than FFP.

But its reference to a "fixed-price incentive contract" completely misses the mark, since such contracts are defined at FAR 16.204, and this is clearly not what USTRANSCOM was doing. And its reference to "any type of incentive contract" is vague. Moreover, which clauses the Board would have wanted to see are unclear, as neither the FAR, DFARS, nor TRANSFARS prescribes a clause for FFP + performance/delivery incentives.

Bottom line for me, it's not clear what beyond a deduction schedule and agreement from the contractor USTRANSCOM needed to establish negative performance incentives. If the ASBCA was indeed tracking FAR 16.202-1, I would have liked to have seen it explain that instead of discussing an unrelated concept like fixed-price incentive contracts or expecting clauses that are not prescribed.

@FrankJon I am just diving into this case this week.  Do you think everything written after this statement at p. 3 in the decision is just poor justification for what the judge sensed to be a cardinal change?

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The initial contract did not contain a section on deductions for missions completed a day late, which is the issue in this appeal...

On 9/17/2024 at 8:28 AM, FrankJon said:

negative performance incentives

FAR uses that phrase twice, but does not explain it. How is an NPI supposed to work?

Would someone please provide an explanation and perhaps an illustration?

The ASBCA decision is very poorly written.

I just know from practical use and terminology, negative performance incentive is a credit or deduction from earned incentives.  For example an agency establishes a 95% performance objective.  If the contractor exceeds that level, they earn an incentive amount for each point above 95% - $100 for 96%, $200 for 97%,, and so on up to $500 for $100%.  If performance drops below 95%, the contractor loses $100 of the earned amount for each point less than 95%.

formerfed said:

If performance drops below 95%, the contractor loses $100 of the earned amount for each point less than 95%.

Why?

Would performance less than 95% render the performance unacceptable as per the inspection of services clause?

If not, why the reduction in payment? If so, is the loss of $100 per percentage point shortfall based on a calculation of the damages suffered by the government for each point of shortfall?

If not, why isn't it a prohibited penalty? If so, why isn't the negative incentive liquidated damages?

Vern Edwards said:

Why?

What is the rate of loss per point based on?

Is the loss of $100 per percentage point shortfall based on a calculation of the damages suffered by the government for each point of shortfall?

If not, why isn't it a prohibited penalty? If so, why isn't the negative incentive not liquidated damages?

All good points.  I asked in one case.  The response was “we are paying for excellence.  If the contractor slacked off, why should they keep the bonus?”  I always ask agencies if they did market research and was incentives discussed, make sense, and motivated performance.

The negative incentive is just the flip side of the bonus.  If excellence is worth $100, why should performance below the threshold not be nicked the same $100?  This all is above the contract minimum standard of acceptability.  This just is the rational many agencies use.  I doubt if anyone measures the effectiveness of the bonus or deductions.

On 9/17/2024 at 8:28 AM, FrankJon said:

Do others agree that the ASBCA in this case fundamentally misunderstands the use of performance/delivery incentives in a FFP contract, or am I missing something?

The court's judge's explanation for the board's decision is obscure:

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Because the government has failed to provide any support for its negative incentive, we grant RBT's appeal and find it nothing more than an unenforceable penalty.

I don't understand what the judge meant by "support". Maybe she wanted the government's lawyers to provide a better explanation of why their "negative performance incentive" wasn't a penalty. The couldn't, and so they lost.

As to the judge's interpretation of FAR concerning the use of incentives in an FFP contract, it was unclear. They did not seem to know what they were talking about. You can have an incentive in an FFP contract. The question is: How does it work?

"Negative performance incentive" is a vague concept, at best. The FAR does not explain the concept, and I found no reference to it in the DAU Contract Pricing Reference Guides.

I first wrote about the concept in 1997, and I felt then that it was a dubious idea. See Performance Based Contracting: Negative Incentives--Liquidated Damages or Penalties?  8 NashCibinic ¶ 40, August 1997. The only agency that has provided additional coverage in its FAR supplement is NASA, and even there the concept is fuzzy. The statement in FAR Part 11 that liquidated damages are not a negative incentive is ridiculous.

Ordinarily, incentives apply only to ranges of contractually acceptable performance. Acceptable performance is that which conforms to contract requirements. See FAR 52.246-4, Inspection of Services. In an FFP contract with a performance incentive, acceptable performance might fall within a range that runs from minimally acceptable to best possible, with a target or goal usually somewhere between the two. Under a fixed-price formula-type incentive you might have an delivery incentive arrangement such as follows:

• Best Delivery: 1 day after shipment. Price: $50.00
• Target Delivery: 3 days after shipment. Price: $25.00
• Minimally Acceptable Delivery: 5 days after shipment. Price: $10.00

The incentive there is clear. It involves no "deductions". It's just a scale of firm-fixed pricing.

Anything other than acceptable would be breach of contract. At that point the inspection of services clause would kick in, paragraph (e):

Quote

(e) If any of the services do not conform with contract requirements, the Government may require the Contractor to perform the services again in conformity with contract requirements, at no increase in contract amount. When the defects in services cannot be corrected by reperformance, the Government may-

(1) Require the Contractor to take necessary action to ensure that future performance conforms to contract requirements; and

(2) Reduce the contract price to reflect the reduced value of the services performed.

That seems like an incentive not to fail.

So I don't know what people mean by "negative performance incentive" or how they work.

And I don't think the policymakers that introduced the concept to FAR in the early 1990s knew. It "sounded" like it made sense, but they never made sense of it. I doubt they thought it through.

The government lawyers (three of them!) in the Red Bobtail case were grasping at straws by calling the government's scheme a "negative performance incentive", thereby hoping to keep the scheme from being ruled a penalty. They lost.

The FAR coverage of "negative performance incentives" is a classic example of dunderheaded policymaking.

Vern Edwards said:

I first wrote about the concept in 1997, and I felt then that it was a dubious idea. See Performance Based Contracting: Negative Incentives--Liquidated Damages or Penalties?  8 NashCibinic ¶ 40, August 1997.

Thanks, Vern. I also came across Using Incentives on Commercial Item Contracts, 14 No. 9 Nash & Cibinic Rep. ¶ 44, in which you advocate for "award purchase" incentives in lieu of profit-based incentives for commercial goods and services. This sounds similar to the present-day "award term" contract.

Voyager said:

@FrankJon I am just diving into this case this week.  Do you think everything written after this statement at p. 3 in the decision is just poor justification for what the judge sensed to be a cardinal change?

Well, my thoughts in this post are specific to the quoted text. But overall I think that:

1. USTRANSCOM erred first by apparently failing to cite to FAR 16.202-1 or attempt to distinguish performance incentives from delivery incentives (the latter of which are not expressly addressed in part 37) in its argument.

2. ASBCA's finding that the NPIs were impermissible because they weren't tied to performance standards as required by FAR 37.601(b)(3) seems reasonable to me.

2. ASBCA erred by refusing to even consider FAR 16.402-2 or 16.402-3 based on the rationale that this was a FFP contract.

Here are my thoughts.

The contract is what counts, regardless of what the FAR may or may not say.  The Board decision is saying there was no clause/term and condition  to enforce the deduction.  "If the deduction was meant to have RBT perform at a level appropriate to the government’s needs, then the deduction should have correlated somehow to the performance requirements set forth in the contract (the 90/95/98 percent performance standards). Since the deduction does not, or at least the government does not explain how it does, we cannot buy into the government’s argument the deduction was part of its performance based acquisition plan."

With this thought and to the discussion in the thread,  I admit I have not attempted to formulate a monetary "negative performance incentive" but could there not be nonmonetary negative performance incentives?  Or in other words I am not too hung up on the lack of FAR discussion on negative performance incentive as it seems the guiding principles leave it to the contract drafters to determine what a "negative' might be, monetary or nonmonetary.

As to breach I have this question.   By having a contract clause/term and condition that defines and provides for a "negative performance incentive" is not breach of contract parameters narrowed?  By simple example what if I had a contract that included definitive clauses/terms and conditions for "liquidated damages" , "penalty" and "negative performance incentive" could they not all exist in a contract?  Another way on my part to say it is what is in the contract that counts. 

And I will add my "who cares" on what the FAR says as it seems to me that the Board erred in trying substantiate its position by bringing in the guiding principles of the FAR.  Again what counts is what the contract did or did not say.

FrankJon said:

Well, my thoughts in this post are specific to the quoted text. But overall I think that:

1. USTRANSCOM erred first by apparently failing to cite to FAR 16.202-1 or attempt to distinguish performance incentives from delivery incentives (the latter of which are not expressly addressed in part 37) in its argument.

2. ASBCA's finding that the NPIs were impermissible because they weren't tied to performance standards as required by FAR 37.601(b)(3) seems reasonable to me.

2. ASBCA erred by refusing to even consider FAR 16.402-2 or 16.402-3 based on the rationale that this was a FFP contract.

@FrankJon I think you have misread the decision. I think this is the language that is bothering you:

Quote

And so we look to the government's argument that the negative incentive used here is permissible...

***

Further, FAR subpart 16.4, Incentive Contracts, does state that positive and negative performance incentives shall be considered for certain service contracts. FAR 16.402-2(b). However, FAR subpart 16.4 applies when “a firm-fixed-price contract is not appropriate.” FAR 16.401(a). The government cites to no clauses in the contract or any modification identifying it as a fixed-priced incentive contract (or any type of incentive contract) nor could we find any based on the record presented. Therefore, this subpart does not apply.

Am I correct that this is what you find troubling?

Vern Edwards said:

Am I correct that this is what you find troubling?

That’s right. That specific paragraph strikes me as unsound. The board appears to be seeking something formal—such as a clause or assigned contract type—to show it’s an incentive contract before considering subpart 16.4. If true, this contradicts FAR 16.202-1, which allows for the contract to remain FFP while incorporating certain incentives addressed under subpart 16.4.  

That’s my view anyway. Which part have I misunderstood?

C Culham said:

And I will add my "who cares" on what the FAR says as it seems to me that the Board erred in trying substantiate its position by bringing in the guiding principles of the FAR.  Again what counts is what the contract did or did not say.

Judge Eyester did not write very clearly, and that's obviously caused some confusion. Read what follows.

@FrankJon The important part of the judges decision begins on page 8, with the paragraph that begins, "And now we finally reach the merits." From that point on she seeks to determine whether the deduction provisions in the contract were, in fact, (a) part of an incentive, as envisioned by the FAR, or (b) an impermissible penalty provision. In the latter regard, Amercan law is that contracts may not include penalty provisions.

See Restatement (Second) of Contracts § 355 (1981):

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Punitive damages are not recoverable for a breach of contract unless the conduct constituting the breach is also a tort for which punitive damages are recoverable.

See 24 Williston on Contracts § 65:1 (4th ed.):

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Compensation not punishment. The purposes of awarding contract damages is to compensate the injured party. See Introductory Note to this Chapter. For this reason, courts in contract cases do not award damages to punish the party in breach or to serve as an example to others unless the conduct constituting the breach is also a tort for which punitive damages are recoverable. Courts are sometimes urged to award punitive damages when, after a particularly aggravated breach, the injured party has difficulty in proving all of the loss that he has suffered. In such cases the willfulness of the breach may be taken into account in applying the requirement that damages be proved with reasonable certainty (Comment a to § 352); but the purpose of awarding damages is still compensation and not punishment, and punitive damages are not appropriate. In exceptional instances, departures have been made from this general policy. A number of states have enacted statutes that vary the rule stated in this Section, notably in situations involving consumer transactions or arising under insurance policies.

So the judge looked for evidence that the deductions were part of an incentive rather than a penalty. She considered (1) what the government lawyers said about the deductions, (2) the FAR provisions it cited, and (3) the contract itself, and concluded (1) FAR does not require the inclusion of incentives in service contracts, (2) the terms of the deduction provision were not consistent with FAR requires of contract incentives, and (3) the government cites no clause in the contract that identifies it as an incentive contract. Thus, if it does not look like a duck, walk like a duck, or quack like a duck, it must not be a duck. And thus, the deduction provision in the contract was an impermissible penalty.

The judge did not rule that incentives are impermissible in FFP service contracts. She only ruled that the deduction provision in the contract in question was not an incentive, it was an impermissible penalty.

Now, you may disagree with the judge's analysis. But I have obtained the original RFP and the statement of work, and I think that if the government had actually thought of the deduction provisions as part of an incentive, as described in FAR Parts 16.4 and 37, then they did a crappy job of it. I think they came up with that argument as part of their defense at the ASBCA, but just could not sell it.

BTW, the judge had been a Navy procurement lawyer. I will say, however, that her decision is not well written, somewhat confusing, and that she was careless with her use of certain phrases. But see Footnote 3, in which I think she was trying to say that negative incentives are permissible if they meet the requirements of FART Parts 16 and 37.

But it's an interesting case. Professor Nash has written it up, and I'm going to do so as well. What's important to me is the lack of clarity about the concept of "negative performance incentives" and lack of guidance about their proper construction so as to avoid claims that they are penalties.

The Question: How do you have a "negative incentive" that is neither damages for breach nor punitive?

Vern, using my prior example, if the negative incentives only apply against to what the contractor earned, is that considered punitive or damages?  I’ll add that the overall amount can’t go below zero.   

Quote

For example an agency establishes a 95% performance objective.  If the contractor exceeds that level, they earn an incentive amount for each pointabove 95% - $100 for 96%, $200 for 97%,, and so on up to $500 for $100%.  If performance drops below 95%, the contractor loses $100 of the earned amount for each point less than 95%.

Vern Edwards said:

Read what follows.

Thanks Vern.  I was wrapped up on other matters yesterday.  My final thoughts for whatever they are worth.

Vern Edwards said:

Amercan law is that contracts may not include penalty provisions

I struggle with this as I believe it depends.  After all in some cases American law might provide for penalties.  By example while not specific to this case and this thread, how about 10 USC 4328?

Vern Edwards said:

She only ruled that the deduction provision in the contract in question was not an incentive, it was an impermissible penalty.

I agree.  Once again what was in the contract counts.  The discussion about what the FAR allows or does not allow was to counter what the government was alleging.  Bolstered I might add by Footnote 3 at the end of the decision.   

Here I would add that @FrankJon concerns should be alleviated to some extent by the footnote as it is a "non-precedential case".

Vern Edwards said:

The Question: How do you have a "negative incentive" that is neither damages for breach nor punitive?

In my view and as I stated before, clearly provide for a "negative incentive" by a definitive clause/term and condition.  This will be thought of as a crazy statement on my part but especially in a negotiated procurment anything is negotiatable including the specifics of a monetary negative incentive.

C Culham said:

I struggle with this as I believe it depends.

Carl, why on Earth are you struggling with the idea that in our legal system a party cannot recover punitive damages for non-tortious breach of contract? For pities sake, I cited and quoted the Restatement of the Law, Contracts, and the Corbin treatise. Have you read something authoritative that suggests otherwise? Here is Farnsworth, 3d ed., §12.18, Liquidated Damages, Penalties, and Other Agreed Remedies:

Quote

To what degree is the law of remedies for breach of contract amenable to contrary agreements by the parties? Compared with the extensive power that contracting parties have to bargain over their substantive contract rights and duties, their power to bargain over their remedial rights is surprisingly limited. The most important restriction is the one denying them the power to stipulate in the contract a sum of money payable as damages that is so large as to be characterized as a "penalty"... If a provision is condemned as a penalty, it is unenforceable.

Struggle with something else, like how a "negative incentive" should be properly structured!

Vern Edwards said:

Carl,

Sematics!  I appreciate your thoughts.   I guess I will leave it to the boards and courts to parse what something really is!  And why they might do so.  Rule of law that sets precedent or whatever!

10 USC 4328 - " The Secretary shall encourage the use of incentive fees and penalties as appropriate and authorized in paragraph (2) in all covered contracts for weapons systems"....From paragraph (2)...."or the imposition of penalties to be paid by the contractor to the Government for failure to achieve such design specification requirements. Information about such fees or penalties shall be included in the solicitation for any covered contract that includes such fees or penalties."

As refelcted in the instant case discussed in this thread the struggle is real, yet I suspect there are those that have created, agreed to and have applied, proper or not in the eyes of the rule of law,  negative incentives through the wonders of a contract, agreed to by the parties that is not argued after the fact where the arguement is left to the boards and courts to decide.  Perfectly agreed to in the imperfect world of contracting!

Thanks again for the exchange of thoughts.

C Culham said:

I struggle with this as I believe it depends.  After all in some cases American law might provide for penalties.  By example while not specific to this case and this thread, how about 10 USC 4328?

Carl, there are several sources of "American law."  One is the common law.  Another is statutory law.  Under the former, a penalty cannot be imposed by contract.  However, under statutory law, it appears that penalties can be imposed by contracts if authorized by statute overruling the common law prohibition.  In this regard, compare 10 U.S.C. 4328 with 15 U.S.C. 637(d).

Just now, Retreadfed said:

Carl, there are several sources of "American law."  One is the common law.  Another is statutory law.  Under the former, a penalty cannot be imposed by contract.  However, under statutory law, it appears that penalties can be imposed by contracts if authorized by statute overruling the common law prohibition.  In this regard, compare 10 U.S.C. 4328 with 15 U.S.C. 637(d).

True, but such penalties are usually for breaking a some law that the contract requires you to comply with and provides for criminal or civil penalties in cases of violations. The penalties are not imposed by the contract, but by the law itself. Such violations may also be breaches of contract for which damages may also be sought. But such damages cannot be punitive.

Vern Edwards said:

True, but such penalties are usually for breaking a some law that the contract requires you to comply with and provides for criminal or civil penalties in cases of violations.

We are in agreement.  As regards the Red Bobtail case, I am unaware of any law that imposes a penalty under the circumstances described there.  Thus, the common law prohibition on penalties would apply.

Just now, Retreadfed said:

As regards the Red Bobtail case, I am unaware of any law that imposes a penalty under the circumstances described there.  Thus, the common law prohibition on penalties would apply.

But I keep finding myself coming back to a basic question: What the heck is a "negative incentive" in the context of contracting if it's not liquidated damages or a penalty, and how does such an incentive work so that it is not interpreted as a kind of liquidated damages or penalty?

On 9/18/2024 at 4:18 PM, Vern Edwards said:

FAR uses that phrase twice, but does not explain it. How is an NPI supposed to work?

Would someone please provide an explanation and perhaps an illustration?

A good answer to this question by Vern can be found in the Cibinic, Nash, and Nagle discussion on withholds in Administration of Government Contracts_._  Their use of the term "withholding" refers to an intra-contractual right that allows the government to refuse payment to which the contractor is not entitled.  See Chapter 12, PAYMENT AND DISCHARGE, II. PAYMENT PROCEDURES, F. Withholding (pp. 1166-70 in my 4th Ed.).

To me, a negative incentive is no afterthought to be arranged post-award.  It should be the crux of the contract, upon which all offerors decided to offer and upon which there was then a mutual agreement of the parties, via negotiation.  You can throw into your RFP the standard payment clauses like FAR 52.232-5 with its construction retainage terms and conditions, but without an additional, nonstandard clause assented to by the parties together setting up the negative incentive as a withhold amount and, if necessary, a sliding scale of reductions to that amount, you will likely find you only have an illegal penalty in a judge's eyes.

Retreadfed said:

Carl, there are several sources of "American law."  One is the common law.  Another is statutory law.  Under the former, a penalty cannot be imposed by contract.  However, under statutory law, it appears that penalties can be imposed by contracts if authorized by statute overruling the common law prohibition.  In this regard, compare 10 U.S.C. 4328 with 15 U.S.C. 637(d).

Okay.

Vern Edwards said:

True, but such penalties are usually for breaking a some law that the contract requires you to comply with and provides for criminal or civil penalties in cases of violations. The penalties are not imposed by the contract, but by the law itself. Such violations may also be breaches of contract for which damages may also be sought. But such damages cannot be punitive.

Are all 164 "penalty" references in the FAR for the "usually" or are some specific to the FAR?  No research on my part to figure out but intriging to me is the use of penalty at FAR 16.402-3. 

Retreadfed said:

We are in agreement.  As regards the Red Bobtail case, I am unaware of any law that imposes a penalty under the circumstances described there.  Thus, the common law prohibition on penalties would apply.

Why "common law"?  Afterall the discussion is regarding a contract written pursuant to the FAR for a negative performance incentive.  

Vern Edwards said:

But I keep finding myself coming back to a basic question: What the heck is a "negative incentive" in the context of contracting if it's not liquidated damages or a penalty, and how does such an incentive work so that it is not interpreted as a kind of liquidated damages or penalty?

So the point I am trying to get to is that in the context of a contract structured and written pursuant to the FAR a "negative performance incentive" is just that if structured correctly.   While the term is not defined specifically, its use in context of the FAR it is not a liquidated damage nor a penalty.  Reference FAR 11.501(b) "Liquidated damages are not punitive and are not negative performance incentives (see 16.402-2)."

Or stated more simply the attempt to apply American Law, Common Law or even Statutory Law is misplaced.  I think  "FAR Law" applies and is the very reason the Board decision is written as is.  Application of FAR as opposed to reaching to the concepts of American Law, etc.  Reference Footnote 3 in decision  "To be clear, we are not holding that the challenged provisions of the PWS would be unallowable in all circumstances; merely that the arguments presented by the government here, in this non-precedential case, did not persuade us that the negative incentive was permissible."

I conclude that the effort to apply American Law etc. is misplaced, just apply the FAR and the FAR allows for "negative performance incentives"!

PS - My conclusion is based in part on research of tree planting contracts.   In FAR tree planting contracts there is a deduct for trees not planted correctly.  One might call it a negative performance incentive.   However in looking at non-FAR based contracts issued non-Federal public entities not subject to the FAR, the use of the term "liquidated damages" is common for effecting a deduction for trees not planted correctly.  Ergo, as contracts subject to American Law the negative performance incentive is framed as a liquidated damage and not a penalty or negiative performance incentive.

Examples -

https://www.hoodrivercounty.gov/vertical/Sites/{4BB5BFDA-3709-449E-9B16-B62A0A0DD6E4}/uploads/Conifer_Tree_Planting_2024_RFP.pdf

Go to SAM.gov "Contract Opportunities" and "search" for solicitation number 127EAV24R0004.  Uncheck the "Active Only" box.

On 9/19/2024 at 1:24 PM, Vern Edwards said:

The judge did not rule that incentives are impermissible in FFP service contracts. She only ruled that the deduction provision in the contract in question was not an incentive, it was an impermissible penalty.

I don't assert that the Board ruled it, but that the Board erred in stating that subpart 16.4 "does not apply" without further analysis. In my view, the paragraph I quoted in the OP evidences a misunderstanding of what it means to combine FFP contract type with incentives. I say this because:

1. The judge cites only to FAR 16.401(a) when considering the question, conspicuously omitting FAR 16.202-1; and  
2. The judge mentions "fixed-price incentive contracts," but these are defined at FAR 16.403, and have no bearing on the facts of this case or the Government's argument. This tells me she is seeking evidence that the contract type is other than FFP simply because she hasn't considered the language at FAR 16.202-1.

I've thought about this paragraph quite a bit over the past week. Unless the judge is using "fixed-price incentive contracts" in some widely accepted generic sense that I'm unaware of, I still don't see how this paragraph can be interpreted any other way.

On 9/19/2024 at 1:24 PM, Vern Edwards said:

But see Footnote 3, in which I think she was trying to say that negative incentives are permissible if they meet the requirements of FART Parts 16 and 37.

Or, as Professor Nash points out, perhaps they would have been permissible if the Board had been willing to consider them as delivery incentives. But that would have required applying subpart 16.4.

Appreciate the robust discussion, all, and looking forward to the article, Vern.

FrankJon said:

I don't assert that the Board ruled it, but that the Board erred in stating that subpart 16.4 "does not apply" without further analysis. In my view, the paragraph I quoted in the OP evidences a misunderstanding of what it means to combine FFP contract type with incentives. I say this because:

1. The judge cites only to FAR 16.401(a) when considering the question, conspicuously omitting FAR 16.202-1; and  
2. The judge mentions "fixed-price incentive contracts," but these are defined at FAR 16.403, and have no bearing on the facts of this case or the Government's argument. This tells me she is seeking evidence that the contract type is other than FFP simply because she hasn't considered the language at FAR 16.202-1.

I've thought about this paragraph quite a bit over the past week. Unless the judge is using "fixed-price incentive contracts" in some widely accepted generic sense that I'm unaware of, I still don't see how this paragraph can be interpreted any other way.

@FrankJon I think you're wa-a-a-y too focused on what that judge said about FAR 16.4. Forget about it. The decision cannot be cited as precedent.

Here are the interesting questions:

• What is a "negative" performance incentive?
• What does it (should it) look like on paper?
• How does it (should it) work?

A fixed-price cost incentive is designed to discourage the incurrence of cost by offering a payoff in return for cost avoidance. It's just a cost incentive, not a "negative cost incentive". The lower the cost, the higher the profit. So why are we talking about "negative" performance incentives and price deductions? It's the word "negative" that's causing confusion.

Why not just a fixed-price "performance incentive"? Why not set an optimal target level of performance and an acceptable level of performance below target, with a range of cash bonuses running upward from acceptable to optimal? Anything below minimally acceptable is breach, which means that the contractor is not entitled to any payment for rejected work, and may be liable for damages, if any. That's a deterrent, not an incentive.

To me, "negative performance incentive" sounds like a contradiction in terms. It is a phrase that some unknown bureaucrat thought up without explaining what they meant. Why not just "performance incentive"?

I think that any "negative performance incentive" that deducts from a firm-fixed-price will be vulnerable to challenge as a penalty. It's not an incentive. It's a threat.

Vern Edwards said:

To me, "negative performance incentive" sounds like a contradiction in terms. It is a phrase that some unknown bureaucrat thought up without explaining what they meant. Why not just "performance incentive"?

Based on my limited research I would agree.  I would further propose that the term be removed from the FAR as it seems the references that led to its creation are now rescinded.

It seems that the term appeared in the FAR 16.402-2 in 1997.  Reference 62 FR 44815 , Aug. 22, 1997.

Its genesis was most likely from OFPP Policy Letter 91-2, Service Contracting.  Reference - Federal Register Vol. 56 No. 72 Published April 15, 1991, page 15110.   Of note the OFPP Letter did not include the term "negative performance incentive" but did use "deduction schedule" and its variation.  The policy letter has since been rescinded.

There was also a guide published by OFPP, Final Edition was October of 1998 entitled "A Guide to Best Practices for Performance-Based Service Contracting".  Also now rescinded it used "negative performance incentive" and provided basic examples of same at Chapter 3.  

An archive copy of the guide can be found at the following link.  Of note copies that I did find on the web in my search carried this note at the end.  

1. Reprinted from the Nash & Cibinic Report, April 1995 by permission of Ralph C. Nash.

https://georgewbush-whitehouse.archives.gov/omb/procurement/pbsa/guide_pbsc.html

@FrankJon, It's a very common mistake to assume that a contract with an incentive is an incentive contract. I've made the same mistake. Judges make mistakes. It was this judge's turn to make that mistake. Fortunately, that mistake was not consequential in this case.

Don Mansfield said:

@FrankJon, It's a very common mistake to assume that a contract with an incentive is an incentive contract. I've made the same mistake. Judges make mistakes. It was this judge's turn to make that mistake. Fortunately, that mistake was not consequential in this case.

So, what's an "incentive contract"?

Vern Edwards said:

So, what's an "incentive contract"?

A compensation arrangement described in FAR part 16 that contains a cost incentive (or in the case of a contract with multiple incentives--a cost incentive or constraint).

Vern Edwards said:

How does it (should it) work?

I sense a lot of confusion about this concept's terminology within the halls of government.  If that is the case, how do you think the commercial marketplace sees these negative performance incentives terms?

Based on @C Culham's research, if these negative incentives are a governmental concept stemming from PBSA policy, then we should not rely on that in court.  We therefore should not negatively incentivize or deduct our FFP contracts' prices.  Instead, we can use the longstanding contractual practice of withholds.  Sure, withholds are small sums and are usually clawed back, but not until the government has extracted some stipulated performance improvement.  They do work as a matter of principle, and they also may be addressed in CPARS, making them doubly effective.  They may also work practically, because they strike at the heart of a contractor's business.

What do I mean by the heart of a contractor's business?  In America, contractors strategize their profit margin on obtaining invoiced sums as early as possible, because we live under Capitalism and those sums can be invested wisely to obtain dividends on your negotiated profit.  Consider this scenario:

• FFP proposal arrives in May 2024 including multiple subcontract quotes, each with 4% escalation in year 2 and 3s' performances 
• Prime contract awarded in September 2024; subcontracts subsequently awarded FFP
• Prime contract says any invoice for periods where X performance measure is not met will include a withhold
• Invoice for August 2025 performance received, withhold decreases contractor's accounts receivable that would have made 7% returns on investment in stock market
• Meanwhile, accounts payable goes up in October 2025 to cover 4% cost of subcontract escalation

As you can see, withholds have a ripple effect and, while your boss won't understand you fighting policy reviews for a nonstandard clause stipulating $15K off each invoice, your contractor counterpart sure will.  There is a host of case law on withholds to help guide your contract crafting.  See my prior post in this thread.  If T&M, see the FAR 52.232-7 payment clause's terms allowing withholds too.

Too often on the government side we don't see this time value of money (some may say we don't see the value of money at all, given our national debt!).

C Culham said:

It seems that the term appeared in the FAR 16.402-2 in 1997.  Reference 62 FR 44815 , Aug. 22, 1997.

The phrase "negative incentive" appeared in the DOD/NASA Incentive Contracting Guide in October 1969, without detailed explanation, but with an illustration, on pages 110 and 182. 

The phrase "negative incentive" made its first appearance in the FAR System in 1992, when NASA added it to its FAR Supplement. 7 Fed. Reg. 53681-01, Nov. 12, 1992, in connection with award fee incentives.

The phrase "negative performance incentive" was added to the FAR in 1997.

The first appearance of the phrase "negative incentive" in the Federal Register in any context was in 1965, but not in relation to procurement (acquisition, contracting).

C Culham said:

Of note the OFPP Letter did not include the term "negative performance incentive" but did use "deduction schedule" and its variation.

The concept of a "deduction schedule" first appeared in Air Force Regulation 400-28, Base Level Service Contracts (26 September 1979), which OFPP adopted as its A-76 Supplement, Pamphlet No. 4. However, the concept there was based on the Inspection of Services clause. The OFPP Pamphlet, which is available at Wifcon, provided as follows:

Quote

Deductions For Non - Performance . Through the Inspection

of Services clause , the government can deduct from a

contractor ' s payment an amount equal to the services not

provided .

a . To do this , the contract administrator must know the

major cost categories in the contract and the percentage of

cost each service output represents . The percentage cost of

each service is found in deduct analysis ; see chapter 2 ,

paragraph 2 - 9 . An example of how the deduct formula works is

shown in figure 5 - 3 .

b . Suppose the bid schedule showed the monthly contract

price for vehicle operations , maintenance , and analysis as

shown . The percentage cost of the service output is then

found by looking at the Performance Requirements Summary

Technical Exhibit in the contract statement of work . In the

example , the percentage cost of quality of completed work is

10 percent . This is then multiplied by $ 100 , 000 to obtain

the maximum amount to deduct .

c . If completed work was unsatisfactory during the

month ( that is , did not meet performance values ) and the

percent of the sample found bad was 20 percent , $ 2000 would

be deducted from the payment normally due the contractor .

Deduct Formula (Example)

If : Quality of completed work is unsatisfactory

(AQL of 6 . 5% exceeded )

Contract price and : is $ 100,000 per month

and : Quality of completed work deduct percentage is 10 %

and :

and :

Sample size is 50

Number of defects in the sample is 10 (Reject number is 8 )

Then : Deduction from the current month ' s invoice is :

= $ 100 , 000 Contract price

x Deduct percentage

. 10

$ 10 , 000

X Percent of sample defective

Deduction $ 2 ,000

Figure 5 - 3 . Deducting for Non - Performance .

d . This amount for quality of completed work is deducted

because the contractor failed to provide reliable , uniform

services within the assigned performance values . Although

some completed work may have met the standard during the

month , the acceptable quality level was not met and at least

20 percent of the observations were defective . Hence , the

total quality performance requirement has not been achieved .

As a consequence , the service output is unsatisfactory .

See today's inspection of services clause, 52.246-4, paragraph (e). That procedure is not an incentive, and it is not the procedure used in the ASBCA case. The deductions reflect damages suffered by the government. And they are subject to challenge as punitive rather than reasonably compensatory.

I wrote about all this long ago. SEE:

Edwards, NONCONFORMING SERVICES: What Are The Government's Rights Under Fixed-Price Service Contracts? 22 NO. 4 Nash & Cibinic Rep. ¶ 22. (April 2008)

Edwards, SERVICE CONTRACT QUALITY: We''ve Got More Thinking to Do. 22 NO. 3 Nash & Cibinic Rep. ¶ 20. (March 2008)

Edwards, CALCULATING PRICE REDUCTIONS WHEN SERVICES ARE DEFECTIVE, 20 NO. 5 Nash & Cibinic Rep. ¶ 23 (May 2006)

Just now, Don Mansfield said:

A compensation arrangement described in FAR part 16 that contains a cost incentive (or in the case of a contract with multiple incentives--a cost incentive or constraint).

That's not an official definition. FAR Parts 2 and 16 do not define "incentive contract. Why can't we call a contract that has any kind of an incentive an "incentive contract"?

Voyager said:

We therefore should not negatively incentivize or deduct our FFP contracts' prices.

Why not? See, e.g., FAR 52.246-4(e):

Quote

(e) If any of the services do not conform with contract requirements, the Government may require the Contractor to perform the services again in conformity with contract requirements, at no increase in contract amount. When the defects in services cannot be corrected by reperformance, the Government may-

(1) Require the Contractor to take necessary action to ensure that future performance conforms to contract requirements; and

(2) Reduce the contract price to reflect the reduced value of the services performed.

That would be a right of any party that is the victim of a breach. You simply have to know what you're doing when you calculate your damages ("reduced value"). See, e.g., 

APPEAL OF -- FAMILY ENTERTAINMENT SERVICES, INC., 17-1 BCA P 36876 (A.S.B.C.A.), ASBCA No. 61157, 2017 WL 5194983, October 24, 2017.

But youy gotta know what you're doing.

Quote

Based on all of the discrepancies, all of which were provided to FES, the government determined that FES was responsible for maintaining 3,897 acres in Cycle 1 but only completed 3,088.6 acres, which resulted in 79.3% of the work being accomplished. For Cycle 2, the government determined that FES was responsible to maintain 3,897 acres but only accomplished 2,792 acres, for a total of 71.7% accomplished. For Cycle 3, the government determined that FES was responsible to maintain 3,897 acres but only accomplished 2,636.1 acres for a total of 67.6% accomplished. For each area and cycle, the government provided a more detailed breakdown to properly charge the deductions, based on the number of acres not performed in each cycle, each schedule, each service, and each level to be performed, which matched the way the pricing was set forth in the contract. (Finding 24)

The government was actually very generous to FES by limiting the amount of deductions. The government did not deduct money for FES's failure to submit daily reports and other written deliverables required by the contract (gov't br., attach, at 12). The government did not deduct the amount associated with additional hours it spent to administer the contract based on meeting multiple times for the same discrepancies or the time government employees spent performing grounds maintenance. The government allowed multiple extensions and changed the period of performance based on when Mr. Johnson asserted that FES could complete performance (finding 14). And the government provided multiple deficiency reports that clearly notified FES of what aspects of the contract were not being met (finding 19). Yet, FES still failed to meet the requirements of the contract. Accordingly, we hold that at no time did the government abuse its right, pursuant to the contract, to inspect the work performed and deduct an appropriate amount for the work that was not performed.

 The deduct was about $82,000.

Vern Edwards said:

Why can't we call a contract that has any kind of an incentive an "incentive contract"?

That wouldn't be consistent with the FAR's use of "incentive contract".

FAR 16.401(a) distinguishes incentive contracts from FFP contracts:

Quote

Incentive contracts as described in this subpart are appropriate when a firm-fixed-price contract is not appropriate...

FAR 16.202-1 permits the use of incentives based on factors other than cost:

Quote

The contracting officer may use a firm-fixed-price contract in conjunction with an award-fee incentive (see 16.404) and performance or delivery incentives (see 16.402-2 and 16.402-3) when the award fee or incentive is based solely on factors other than cost. The contract type remains firm-fixed-price when used with these incentives.

Given FAR 16.401(a), such contracts are not incentive contracts. So, you can have contracts with incentives that are not "incentive contracts" as that term is used in the FAR.

Also, see FAR 16.402-1(a):

Quote

No incentive contract may provide for other incentives without also providing a cost incentive (or constraint).

On 9/21/2024 at 8:39 AM, C Culham said:

Why "common law"?  Afterall the discussion is regarding a contract written pursuant to the FAR for a negative performance incentive.

When an appeal is presented to a contract appeals board, the board is engaged in contract interpretation to resolve the dispute.  As has been held many times by  the appeals boards and courts, contract interpretation is a question of law.  In the Red Bobtail appeal, because there is no statute that authorized the deductions/penalty at issue, the ASBCA applied the common law rule against penalties imposed by contract to help resolve the issue.

Just now, Retreadfed said:

When an appeal is presented to a contract appeals board, the board is engaged in contract interpretation to resolve the dispute.  As has been held many times by  the appeals boards and courts, contract interpretation is a question of law.  In the Red Bobtail appeal, because there is no statute that authorized the deductions/penalty at issue, the ASBCA applied the common law rule against penalties imposed by contract to help resolve the issue.

Everyone should know that the Red Bobtail decision cannot be cited as precedent. From page 1:

Quote

RBT elected to pursue this appeal pursuant to the Board’s Rule 12.2, Small Claims (Expedited) procedure. Accordingly, this decision shall have no precedential value, and in the absence of fraud shall be final and conclusive and may not be appealed or set aside. 41 U.S.C. § 7106(b)(4)-(5).

Vern Edwards said:

Why not?

A big reason is because you are now discussing deductive changes, and per FAR 1.602-2(d), a Contracting Officer's Representative: "(5) Has no authority to make any commitments or changes that affect price, quality, quantity, delivery, or other terms and conditions of the contract nor in any way direct the contractor or its subcontractors to operate in conflict with the contract terms and conditions."

In the case of the withholds, the duty may be delegated to a COR for swiftness of action, which, if I am right about the time value of money, really matters to this concept.

A deductive change, on the other hand, would require CO time and expertise and negotiations "to reflect the reduced value of the services performed" as you quoted from the clause above.  Pricing the deleted work has its own host of case law and its own subheading in Administration of Government Contracts.  It usually occurs toward the end of the contract after forbearance and extensions, unless the two parties plan for it.  That's a tall order for this acquisition workforce.

I guess given contract law and these standard FAR clauses, every contractor signs up for a deductive change and/or a withhold in theory, but the smart CO will solicit a nonstandard clause anticipating and describing one or both of these action in practice.

Don Mansfield said:

Vern Edwards said:

Why can't we call a contract that has any kind of an incentive an "incentive contract"?

That wouldn't be consistent with the FAR's use of "incentive contract".

So what? It is not an officially defined term. However, I understand your argument and acknowledge the inconsistency.

Voyager said:

A deductive change, on the other hand, would require CO time and expertise and negotiations "to reflect the reduced value of the services performed" as you quoted from the clause above.  Pricing the deleted work has its own host of case law and its own subheading in Administration of Government Contracts.  It usually occurs toward the end of the contract after forbearance and extensions, unless the two parties plan for it.  That's a tall order for this acquisition workforce.

I am very familiar with Administration of Government Contracts. I don't recognize the procedure you have described. If a contractor delivers unacceptable work, or fails to deliver, and if the contractor cannot cure, then the CO does not process a deductive change. He or she should reject the work, refuse to pay, and either unilaterally sets or negotiates a price reduction, depending on the how the CLINs are set up. The government is also entitled to damages if it can prove them. The contractor can file a claim if it doesn't agree with the CO.

Anyway, none of that has anything to do with negative incentives, which is what interests me.

Vern Edwards said:

The phrase

Thank you

Some extended research into negative incentives has turned up several references that include descriptions of negative performance incentives used by NASA and the Air Force in certain spacecraft hardware contracts dating back to the 1980s.

See, for example: GAO, Satellite Acquisitions: Agencies May Recover a Limited Portion of Contract Value When Satellites Fail - GAO-17-490 (June 2017), which discusses the use of negative performance incentives.

See also:Space and Missile Systems Center (SMC) Incentive Guide, March 2007. Note this:

Performance Incentives 

Quote

[T]he most desired outcome to the Government in the technology development area is usually going to be enhanced performance. It is conceivable that when looking at the utility of the technology, if we want contractors to take risks to increase performance, a performance incentive where the incentive is paid for increased performance might be appropriate. Essentially, the fee is paid for performance above a negotiated level of performance, and the fee may be reduced for performance below a negotiated level of performance. The use of a performance incentive would be a good way to motivate a contractor if competition did not exist. The problem with this approach is the danger that the contractors might be incentivized to over promise the benefits of a technology in the technology development stage. The performance must be verifiable so that the incentive does not create an unintended consequence of encouraging unwarranted optimism during performance.

Emphasis added.

https://www.dau.edu/tools/space-and-missile-systems-center-smc-incentives-guide

It contains a lot of information about the use of negative incentives in spacecraft contracts.

See also: NASA FAR Supplement NFS 1816.402-2, Performance Incentives.

Quote

(b) When a performance incentive is used, it shall be structured to be both positive and negative based on performance after acceptance, unless the contract type requires complete contractor liability for product performance (e.g., fixed price). In this latter case, a negative incentive is not required. In structuring the incentives, the contract shall establish a standard level of performance based on the salient performance requirement. This standard performance level is normally the contract's target level of performance. No performance incentive amount is earned at this standard performance level. Discrete units of measurement based on the same performance parameter shall be identified for performance above and, when a negative incentive is used, below the standard. Specific incentive amounts shall be associated with each performance level from maximum beneficial performance (maximum positive incentive) to, when a negative incentive is included, minimal beneficial performance or total failure (maximum negative incentive). The relationship between any given incentive, either positive or negative, and its associated unit of measurement should reflect the value to the Government of that level of performance. The contractor should not be rewarded for above-standard performance levels that are of no benefit to the Government.

(c) The final calculation of the performance incentive shall be done when performance, as defined in the contract, ceases or when the maximum positive incentive is reached. When performance ceases below the standard established in the contract and a negative incentive is included, the Government shall calculate the amount due and the contractor shall pay the Government that amount. Once performance exceeds the standard, the contractor may request payment of the incentive amount associated with a given level of performance, provided that such payments shall not be more frequent than monthly. When performance ceases above the standard level of performance, or when the maximum positive incentive is reached, the Government shall calculate the final performance incentive earned and unpaid and promptly remit it to the contractor.

Emphasis added. See the contract clause at 1852.216-88 Performance incentive.

It is kind of funny that the literal read of "negative performance incentive" sounds like "an incentive to perform negatively".  🤨