Since Performance Based Payments (PBPs) are a form of contract financing it is important to understand the Federal Acquisition Regulations (FAR) requirements and guidance regarding contract financing.
A. What is Contract Financing?
Contract Financing is covered in FAR Part 32 and is defined as the Government authorized payment of funds to the contractor prior to acceptance of supplies or services by the Government. Contract financing does not include invoice payments, payments for partial acceptance or lease or rental payments. Payments of invoices on cost type contracts are not considered contract financing. Therefore, contract financing only applies to fixed price contracts.
B. Purpose and Scope of Contract Financing
The purpose of contract financing is to assist the contractor in paying costs incurred during the performance of the contract. FAR 32.104(a)(1) states that when contract financing is provided it should be provided only to the extent actually needed for prompt and efficient performance.
It should be noted that in the FAR 32.106 order of preference for contract financing below, the first preference is that no Government financing be provided and that the contractor obtain private contract financing without Government guarantee. It should also be noted that except for two certain situations involving non-profit educational or research institutions or the management and operation of Government-owned facilities, advance payments are the least preferred method. The order of preference for contract financing is as follows:
(a) Private financing without Government guarantee
(b) Customary contract financing other than loan guarantees and certain advance payments (see FAR 32.113)
(c) Loan guarantees
(d) Unusual contract financing (see FAR 32.114)
(e) Advance payments (see exceptions in FAR 32.402(b))
From a business perspective, the FAR order of preference is entirely logical. Any prudent buyer would prefer to pay the seller only upon delivery. Payment only upon delivery is less costly and less risky for the buyer and provides the maximum motivation for the seller to deliver the item or service as soon as possible. Likewise, the least preferred method is advance payments where the Government pays in advance of work being accomplished.
These basic business concepts are important to keep in mind in any discussions of financing in general and PBPs in particular.
Although the first preference is that no Government contract financing be provided, the Government provides contract financing on the vast majority of fixed price, non-commercial contracts when deliveries are scheduled to begin six months or more after contract award. FAR states that the need for contract financing is not to be considered a handicap for contract award. When financing is provided it is almost always in the form of customary contract financing.
D. Customary Contract Financing
FAR 32.113 describes what can be considered to be customary contract financing methods for various types of goods and services. The financing method most commonly used to date has been customary Progress Payments based on cost which is covered in FAR Part 32.5.
Performance-Based Payments (PBPs) are also a customary form of contract financing and are covered in FAR Part 32.10. FAR Part 32.1001 states that PBPs are the preferred Government financing method when:
- the contracting officer finds them practical and
- the contractor agrees to their use.
It is important to note that PBPs are only the preferred method when they are deemed practical by the contracting officer. FAR implicitly recognizes that PBPs will not be practical for all contracts.
E. A Contract Cannot Use Both Progress Payments and PBPs
A contract (or individual order under an indefinite-delivery contract) can use either progress payments or PBPs but not both. A contract or individual order cannot use progress payments for one line item and PBPs for another. However, a contract or individual order can be modified to change the contract financing method from progress payments to PBPs but both types cannot be used at the same time.
F. Changing Financing Methods
Remember that when a contract financing method is changed to a method that is more favorable to the contractor, adequate new consideration to the Government is required under FAR Part 32.005.
