A. “Value” of a PBP Event
B. Special Considerations with Severable Events
After the parties have agreed on the events that will be used to trigger financing payments and have settled upon how their accomplishment will be measured or determined, the next critical step in the process is setting dollar or percentage values for the events themselves.
It is important to remember that the fundamental purpose of all contract financing is to assist the contractor, in the paying the cost it incurs in the performance of the contract and per FAR 32.1004(b)(2)(i), to do so “only to the extent actually needed for prompt and efficient performance”. Clearly the contractor can never have a “need” for more than its actual cost incurred at any point in time.
FAR 32.1004(b)(3)(ii) states that the contracting officer must ensure that PBPs “are not expected to result in an unreasonably low or negative level of contractor investment in the contract.” FAR does not define “unreasonably low” level of contractor investment but it is clear that PBPs are not intended to result in the Government funding all contract costs as they are incurred throughout the contract. The prohibition against “negative level” of contractor investment means that PBPs must not be structured in such a way as to become equivalent to advance payments.
DFARS 232.1001, 232.1005, and the associated contract clauses, 252.232-7012 and 2013, include mandatory language to ensure that cumulative PBPs will never exceed cumulative cost incurred on the contract or delivery item, whichever is applicable, at any point during contract performance. This language, while ensuring the PBPs will not result in a negative contractor investment, does not negate the need for the Government to evaluate the expenditure profile for reasonableness but does permit more Government flexibility in resolving expenditure profile issues.
The starting point for the valuation of PBP events should be a comparison of the evaluated expenditure profile to the schedule of PBP events by month. For instance, if the expenditure profile indicates that through month 3 of the contract, cost incurred is predicted to be $7 million, and the first PBP event is scheduled to be completed in month 3, the starting point for that event's value would be no more than $7 million based on the expected financing need at that point in time. Although the cost limitation language in DFARS 232.10 will prevent an advance payment scenario from occurring, a PBP schedule that is front-loaded when compared to the expenditure profile should not be established.
Although the expenditure profile itself does not have to be agreed upon and the cost limitation language provides for some flexibility, significant disagreement could make it impossible to agree on event values. For example, if the Government considers the expenditure profile to be front-loaded, it will want to assign lesser amounts to early PBP events than the contractor proposes. If the contractor believes the proposed expenditure profile is correct, it will view any significant reduction in the amounts for early PBP events to be unwarranted.
A. "Value" of a PBP Event
In addition to the financing-need perspective, the amounts must be commensurate with the value of the performance event or performance criterion. FAR does not define “value” in this context but in order to comply with both FAR requirements on the “value” of the event it should be assumed that the amount can be less but not greater than the anticipated cost incurred at that point.
However, it is important to understand that the value of the event is not limited to the cost of performing that specific event or task. Otherwise, in order for the contractor to be paid all his expected cost incurred, it would be necessary to establish a PBP event for every discrete task on a contract.
Therefore, PBP events are established as representative milestones that may reflect the total effort needed to accomplish not only that particular milestone but other activities through that timeframe. For instance, while the cost of performing the specific PBP event in month 3 might only be $200,000, it may be appropriate to value that event at the $7 million of cost expected to be incurred by that point in time because the event is considered to fairly represent the progress achieved in the first 3 months of the contract.
The $7 million would be the starting point for setting the amount for the event but the relative value of the event versus other events should also be considered. For instance, assume the next PBP event is scheduled to occur in month 5 and the total cost expected to be incurred at that point is $13 million. If the first event was assigned a value of $7 million, the maximum amount available for the second event would be $6 million ($13M less $7M). What if the event in month 5 was considered to be much more significant in terms of measuring progress on the contract? In order for the amount to be commensurate with its value, it should be valued greater than the event in month 3? Since the total financing-need as of month 5 is $13 million, the event in month 3 might be reduced to $5 million so the event in month 5 could then be set at $8 million. This would mean that the payment in month 3 would only provide $5 million of the $7 million of cost incurred. The contractor would have to accomplish the more significant event in month 5 to receive financing equal to expected total cost incurred at that time. While the contractor will certainly want to accomplish both events in a timely manner, the greater focus will appropriately be on the event with the greater programmatic significance and dollar value. In this situation the financing provided through the first event would be less than would have been provided via 80% progress payments ($5M ÷ $7M = 71%). However, the financial benefit provided by PBP cash flow must be assessed over the life of the contract which is what the PBP Analysis Tool does. Keep in mind that every event does not need to be precisely valued relative to all other events but care should be taken to ensure that there is reasonable consistency in event valuation so that the contractor’s financial focus is in basic alignment with programmatic priorities.
B. Special Considerations with Severable Events
Severable events are payable whenever accomplished, and those events are usually subject to the most variability as to when they will actually occur both in time and the expected sequence of events. Because the amount assigned to each event is more than the cost of performing the specific event and is based on when it was expected to occur, early performance of the event can result in payments that, absent the cost limitation language, could result in front-loaded payments. While it is generally in the Government’s best interest for the contractor to complete all tasks and deliver the end item or service ahead of schedule, PBPs are not to be used as an incentive for exceeding the contract requirements. Furthermore, accomplishing a severable event ahead of schedule may have no beneficial impact on the delivery date. For example, a PBP event may be established for the “ordering of parts” in month three of the contract based on the need for the parts later in the production process. Ordering the parts early may not expedite the production process at all. Furthermore, if the event is valued based on an expenditures expected to occur through month three, early performance of the event may only result in paying the contractor for the cost of other activities that have not been performed yet.
If there is significant concern about the timing of specific, severable events, it may be advisable for the contract PBP schedule to identify "not earlier than" payment dates for those items.
