The high cost of savings

T hree years ago, the Pentagon began cancel-  ing the Army’s ambitious modernization program, which would have cost billions and created a sophisticated network of vehicles, drones and radios. ¶ This kind of cut might appeal to politicians calling for significant decreases in government spending. ¶ But turns out, it’s not that simple. Even years later, the Defense Department and the Army are still negotiating with the contractor and estimate they’ll pay a fee of almost $500 million — on top of the roughly $19 billion an Army study estimated the service already paid for the complex program that never came to fruition. ¶

With the Pentagon looking to trim its budget and politicians finding traction in urging government cuts, these cancellations could become all the more common and the government could face even more drawn out and expensive negotiations.

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(Jeffrey MacMillan/Capital Business) - WASHINGTON, DC. MAY 22, 2012: Beth Ferrell, attorney at McKenna, Long & Aldridge, where she specializes in termination fees for government contracts in Washington, DC on May 22, 2012

(Viktor Koen/The Washington Post)

“With all of the budget pressures that agencies are going to be faced with ... we are going to be seeing a lot more terminations, restructures and changes to contracts,” said Elizabeth A. Ferrell, chairwoman of McKenna Long & Aldridge’s terminations and contract restructures group, which was only established last year. Companies “believe that their programs are at risk.”

Contract termination is a complex legal process, but essentially the trouble starts when the government needs to terminate for convenience, rather than for cause.

If a termination is for cause or default — meaning something has gone wrong with the program — the government is off the hook. But if it’s for convenience — which is typically what happens — the government must pay the contractor the costs it will incur to shut down the contract.

Analysts and attorneys say the government is often in a position of weakness in these negotiations as contractors with expensive attorneys fight for large fees.

The Army confirmed this month that it expects to pay nearly $500 million — still $200 million shy of the level it anticipated — to close out with prime contractor Boeing the sprawling Future Combat Systems program, which began to shut down in 2009 when then-Defense Secretary Robert Gates cut its manned ground vehicle component.

The high-priority program was made up of multiple parts, including a family of vehicles, unmanned air and ground systems and high-tech radios, all connected by a network. While some pieces have been salvaged, the program as it was imagined was never built.

The vehicle cancellation fee alone is expected to hit about $164 million, according to the service.

In a statement, the Army said termination negotiations — being handled by the Defense Contract Management Agency — are still ongoing because the contractor has a year to present termination fee proposals. Most of those negotiations are expected to end in December; some are slated to continue until July 2013.

New contract language needed?

“I think contract termination costs are going to become an increasing consideration,” said Todd Harrison, a senior fellow at the Center for Strategic and Budgetary Assessments. The government has “got to do a better job, I think, from now on in writing contracts, thinking through what would happen if this contract were terminated at any given point.”