Incentive Contracts

Q.  For an FTA funded construction contract, may we insert a clause in our contract provisions regarding a penalty for completing the project late and a reward for delivering the project early? For this particular project, time is of the essence. 

A. You may use both incentives for early delivery and liquidated damages for late delivery. We recommend you review the guidance in the FTA Best Practices Procurement Manual (BPPM), section 8.2.3 - Liquidated Damages. You will note that the rate of damages must be a reasonable estimate to compensate for possible damages and not be so large as to be considered a penalty. If it is construed as a penalty by a court the liquidated damages will be held unenforceable. There is also an Appendix B.3 - Liquidated Damages Checklist in the BPPM that will help you think through the areas of possible damages to the agency. In addition, FTA Circular 4220.1F, Ch. VII, Para. 4.b(2), requires that any damages collected be credited to the grant, thus becoming available to you for activities that are within the scope of the grant. (Revised: August 21, 2009

Q.  Can a cost type incentive contract have incentives which are fixed to an exact date of delivery or quality without a Fee adjustment formula? An example would be if the contractor finished the task one day late, no fee would be awarded at all! And can strings be put into multiple incentives such that if you don't meet one deadline you will lose all fees the string is tied to.

A. There is no legal prohibition to negotiating an incentive contract where all the delivery incentive fee would be lost if the product was delivered one day late. You must be very careful, however, not to motivate the contractor to spend any amount of money it takes in order to meet the delivery date and earn the fee. In other words, be sure you are willing to pay the additional costs for the delivery you want and structure the cost sharing and delivery incentives accordingly. We would not advise to use a cost type contract where the only incentive was delivery, as that would motivate the contractor to incur very high costs in order to earn the delivery incentive.  (Reviewed: August 21, 2009)

Q. I believe there is a procurement rule that states when an incentive is used in a procurement, there must also be a disincentive. Am I correct? If so, where would I find this definition in writing?

A.  Incentive contracts are covered in the Federal Acquisition Regulation (FAR) at Subpart 16.4 - Incentive Contracts. The FAR is not binding on grantees, but the FAR discussion of what is required on Federal contracts may be helpful.

Incentive contracts take many forms and we do not believe there is an absolute rule for all types of contracts. For example, a firm fixed price contract may be awarded with a reward-only provision for early delivery of the items or services. A Federal agency could use a fixed-price contract with an award fee provision (see FAR §16.404). This arrangement would involve no penalty or negative incentive provision, only a reward for improving the contract delivery schedule or other performance criteria specified in the contract. On the other end of the spectrum would be a fixed price contract with liquidated damages. This would entail only a penalty or negative incentive for late delivery, with no offsetting reward for on-time or early performance.

Perhaps what you may have in mind is a cost-reimbursement contract where performance incentives are being considered. See, FAR §16.402-4, Structuring Multiple-Incentive Contracts, requires all multiple-incentive contracts to include a cost incentive (or constraint) that operates to preclude rewarding a contractor for superior technical performance or delivery results when the cost of those results outweighs their value to the government. The FAR would preclude awarding a cost-type contract with only performance or delivery results when the cost of those results outweighs their value to the government. The FAR would preclude awarding a cost-type contract with only performance or delivery incentives because the contractor would be motivated to incur unlimited cost at the government's expense in order to meet the early delivery or otherwise improve the performance results of the contract, and thereby earn the reward stipulated in the contract incentive provision. And as already noted above, firm fixed price contracts may be negotiated with rewards or penalties only because the contractor is absorbing all the increased costs of performance. (Reviewed: August 21, 2009)