United States: The U.S. Military & Caveats Of Long-Term Charters

Previously published in the Maritime Reporter, March 2011

The U.S. Government, acting through the Military Sealift Command (MSC), enters into time charters for ocean transportation services. MSC treats these time charters as commercial type contracts and incorporates into them the U.S. Government's standard commercial type contract terms and conditions. A 2009 decision by the Armed Services Board of Contract Appeals (ASBCA) demonstrates the risks contractors run when entering into charters containing these commercial terms. Specifically, the ASBCA narrowly limited the monetary recovery to which a contractor is entitled in the event the Government terminates for its convenience a charter. With the expected reduction in military budgets, contractors need to consider the impact of the ASBCA decision when entering into charters and alternative forums for monetary recovery should a charter be terminated. While this article focuses on long term charters, contractors are at financial risk even for short term or voyage charters. Contractors competing for long term charters typically have to arrange to acquire and re-flag the vessel being offered. The successful contractor must obtain financing and make a significant initial investment in upgrading the vessel to meet U. S. flag standards. These costs are then amortized in whole or in part over the life of the charter. At the same time, every U.S. Government contract contains a termination for convenience clause, which permits the government to terminate the contract for any reason provided it pays the contractor compensation pursuant to the terms of the termination clause and governing regulations. The standard termination for convenience clause found in the Federal Acquisition Regulations (FAR) permits the contractor to recover, among other things, unamortized startup costs as well as costs continuing after termination that cannot be avoided. The clause, FAR § 52.249-2, Termination for the Convenience of the Government, provides that the contractor is entitled to recover the "costs incurred in the performance of the work terminated, including initial costs and preparatory expense allocable thereto. . . ." The FAR cost principle applicable to terminations provides for the recovery of unamortized start-up costs and further provides for the recovery of costs continuing after termination which cannot be discontinued upon termination. FAR § 31.205- 32(b) and (c). The standard termination clause also provides for recovery of settlement expenses, such as the cost of settling with suppliers whose subcontracts must be terminated and submitting a termination proposal to the Government. Thus, under the standard termination clause the contractor may recover the unamortized costs of reflagging the vessel as well as ownership costs continuing for a reasonable period after termination allowing the contractor to sell or find an alternate use for the vessel.

The commercial-type contract termination clause, however, is worded differently and provides only that "the Contractor shall be paid a percentage of the contract price reflecting the percentage of the work performed prior to the notice of termination, plus reasonable charges the Contractor can demonstrate to the satisfaction of the Government using its standard record keeping system, have resulted from the termination." FAR § 52.212-4(l). The percentage portion of the clause poses little difficulty. MSC time charters typically have per diem hire rates, so determining the percentage complete is rarely disputed. Even for lump sum voyage charters, MSC typically will determine percent complete in terms of hours or days. The difficulty arises from the second part of the clause, namely in addition to being paid a percentage of the contract price, the contractor is entitled to "reasonable charges the Contractor can demonstrate . . . have resulted from the termination." The ASBCA concluded that the terminology means only costs in the nature of the settlement expenses that are provided for under the standard termination clause, discussed above. Thus, the ASBCA concluded that the contractor was not entitled to recover any unamortized start-up costs incurred to reflag the vessel or any costs of ownership following termination. While the ASBCA decision concerned a long term charter that was terminated in its final months, the ruling applies irrespective of when the charter is terminated. Also, the commercial type termination clause in question is used in all MSC charters, be they long term or voyage charters.

Assuming for the moment that the appeal was correctly decided, MSC needs to consider whether the use of the clause in long term voyage charters is reasonable. Commercial contracts in general rarely have termination clauses allowing the buyer to terminate at will and without cause. While the Government's right to terminate for convenience has long been recognized, the governing regulations and case law have always required that the contractor be compensated fairly and not left at a financial loss solely as a result of the decision to terminate. The termination of a long term charter almost guarantees that the contractor will suffer a financial loss unless it is compensated for unamortized start-up costs and costs unavoidably continuing following termination. Commercial-type contracting principles and procedures arose from the Federal Acquisition Streamlining Act of 1994, and were intended in part to ease the regulatory burden on contractors selling commercial supplies and services to the Federal Government. But commercial supplies are typically items that companies maintain in inventory or that can readily be resold in the commercial marketplace. Similarly, a commercial service is one which the contractor regularly provides to commercial customers. In either case, the consequences of a termination rarely involve more than a restocking charge or redeployment of service workers. A long term time charter is not analogous to either situation. Since Federal Government contracts essentially are contracts of adhesion with respect to standard terms and condition – i.e., government agencies cannot simply negotiate the language of standard contract clauses – MSC should consider reverting to the standard FAR termination clause when entering into long term charters. If not, then contractors must either assume the financial risk of termination or be able to include that risk in pricing the initial term of the contract without being prejudiced in MSC's price evaluation.

The ASBCA decision in question, Appeal of Red River Holdings, LLC, is now on appeal in the District Court of Maryland, but even if the decision is reversed, it is not clear that the ASBCA would be required to follow the District Court's ruling. Moreover, in view of the ASBCA's decision, as long as MSC continues to use the commercial-type contract termination clause, it is not clear that MSC could agree to pay unamortized start-up costs and continuing ownership costs in settling termination claims. Therefore, contractors must consider forums other than the ASBCA. Under the Suits in Admiralty Act, disputes concerning maritime contracts can be brought in the federal district court in which the contractor is located. Those courts are not required to follow the ASBCA decision and while district courts may be inclined to show certain deference to the ASBCA given its expertise with Government contracts, when enacting the Contract Disputes Act of 1984, Congress intentionally left the district courts with jurisdiction over maritime contracts in recognition of the district courts' historical role and experience with maritime and admiralty issues. There also are several legal reasons why a district court could decide not to follow the ASBCA decision. For example, while the commercial type termination clause provides in part that the "Contractor shall not be required to comply with the [FAR] cost principles . . ." it does not render those principles inapplicable if the contractor wishes to rely on them. As stated, the Termination cost principle expressly provides for recovery of both unamortized start-up costs and costs continuing after termination that cannot be avoided. The authors of the FAR's commercial-type termination clause presumably knew of the Termination cost principle and what it provides for. Had they intended that the provision not apply to commercial contracts, presumably they would have drafted the clause to exclude or modify the Termination cost principle. Also, while the termination clause provides that the contractor may recover "reasonable charges [that] have resulted from the termination," it also provides that the "Contractor shall not be paid for any work performed or costs incurred which reasonably could have been avoided." (Emphasis added.) The ASBCA limited those costs to settlement type expenses, but the language of the clause tracks very closely with the Termination cost principle that provides for recovery of costs "continuing after termination [which] [d]espite all reasonable efforts by the contractor . . . cannot be discontinued immediately after the effective date of termination." A court could reasonably conclude that drafters of the commercial type termination clause knowingly chose language that tracks with Termination cost principle because the drafters believed those continuing costs to be allowable. Finally, allowing additional compensation for "work performed . . . which reasonably could not be avoided" seems at odds with the ASBCA's narrow interpretation of additional costs being limited to settlement type expenses, which do not involve additional work.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.