Surge in canceled deals offers preview of sequester’s effects

August 19, 2012

A surge in canceled U.S. contracts as war funding winds down may be a preview of the damage ahead for government vendors under looming automatic budget cuts.

The federal government terminated 13,579 contracts in the fiscal year ended Sept. 30, more than double the 5,692 it ended in fiscal 2006, according to procurement data. The value of canceled deals was $2.15 billion last year, compared with $416 million five years earlier.

The terminations, which included a $144 million deal with Oshkosh Corp. for battlefield ambulances last year, reflect the discontinuation of war funding that fueled a boom in contract spending in the past decade. Government agencies led by the Defense Department may back out of more deals if automatic cuts known as sequestration take effect Jan. 2.

“It’s like any business; if you’ve got major uncertainty in the marketplace, then you’ve got to tighten the reins and plan for the worst,’’ said Dan Jacobs, chief executive of the Federal Market Group, a Warrenton-based consulting company.

National security and domestic programs face $1.2 trillion in across-the-board reductions over a decade if Congress and the White House don’t reach a deficit-reduction agreement.

Democrats are insisting that Republicans accept some tax increases in exchange for altering the defense cuts. No proposal to avoid the reductions has gained support, raising the possibility that agencies may drop out of deals so they have more flexibility to budget for priorities, Jacobs said.

Spike in cancellations

The surge in cancellations since 2006 outpaced that of total U.S. contract spending, which rose 23 percent to $531 billion last fiscal year from five years earlier.

The terminations were probably due to a decline in war funding, said Rob Guerra, a partner at Guerra Kiviat, a federal sales consulting firm based in Potomac, Md.

Cancellations for work performed in Iraq rose to $214 million last year from $805,000 in 2006, according to procurement data. They jumped to $493 million for Afghanistan work last year from $5.2 million five years earlier.

Most federal awards include a “termination for convenience’’ clause that gives the government broad latitude to back out of agreements. Cancellations because a contractor hasn’t complied with its obligations are less common, accounting for $162 million in terminations last fiscal year, or 7.5 percent of the $2.15 billion total.

Managers of Pentagon programs may be more likely to end contracts if the automatic cuts occur, according to a survey of 50 Pentagon officials by Myles Walton, a Boston-based analyst at Deutsche Bank Securities.

More than a quarter of the respondents said they believed there was as high as a 50 percent chance that they would terminate programs because of the automatic cuts, he wrote in a May 7 note to clients.

Cancellations occur for a variety of reasons. The largest termination this year was a $300 million military contract for aircraft awarded to Sparks, Nev.-based Sierra Nevada Corp., which planned to subcontract some of the work to Embraer SA of Brazil.

The service canceled the award and re-started the competition after losing bidder Hawker Beechcraft claimed in a lawsuit it was unfairly excluded.

For the government, cancellations are “expensive, slow and labor-intensive,’’ said Dan Gordon, a former administrator of the U.S. Office of Federal Procurement Policy and now associate dean for government procurement law at George Washington University Law School.

Uncertainty about future funding levels is more likely to lead to a slowdown in new contract awards than to a rash of cancellations, he said in a phone interview.

“I would expect there to be massive reluctance to enter into new contracts,’’ Gordan said.

— Bloomberg Government

Brendan McGarry in Washington contributed to this report.

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