Chain Management

The Case for a Cost Limitation Clause

A monthly expenditure profile is a critical element in establishing PBP event values. Unfortunately, accurately predicting expenditures can be more difficult than accurately estimating the total cost of a contract. Unless the item being procured has been bought in the same quantity and the same delivery schedule, and the monthly expenditures (actual) for those prior buys shows a consistent expenditure pattern, it can be difficult predicting the monthly cash flow requirements for a given contract. In a contract financed with progress payments, accurately predicting cash flows is not necessary because actual cost, not projected costs, will determine the finance payments. PBPs, which rely on predicted cash flow requirements, have the potential for being significantly front-loaded in comparison to actual expenditures. In fact, on several major Air Force contracts, although the contractor’s expenditure profile was consistent with the contractor’s cost proposal by year, the expenditure profile and resulting contract PBP schedule turned out to be so front-loaded that the contractor would have been paid in excess of $100M more than his cost incurred well before contract completion had it not been for “cost limitation” language in the PBP clause on the contract.

When the Government does not have a reasonably high degree of confidence in a contractor’s expenditure profile upon which the event values are established, the contracting officer should consider including “Cost Limitation” language into the PBP clause in the contract. Below is an example of cost-limitation language:

“Under no circumstances will cumulative performance-based payments made to the contractor exceed cumulative cost incurred on the contract. Payment amounts earned for successfully completed events but withheld due to this cost limitation may be paid in the following month, without completing another event, as long as cumulative cost incurred...