Sequestration, the U.S. government’s across-the-board deficit reduction mandate, is programmed to go into effect on January 2, 2013, despite universal warnings about the consequences of this action. Under this policy, fiscal year 2013 domestic discretionary spending will see an 8.4 percent cut in appropriated funds, and non-exempt defense spending will suffer a decrease of 9.2 percent. Defense agency budget actions could range from decreasing output to reducing personnel costs, and cuts in the personnel budget would most likely be through furloughs because terminating staff costs money. While operational defense forces in the field would not be cut, their training, equipment, facilities and logistics support could be cut.
It is impossible to exaggerate how bad sequestration will be if it happens, warns John F. Cooney, a partner at Venable LLP, who specializes in economic regulatory, administrative and constitutional litigation involving federal agencies. Across-the-board cuts apply to each program, project or activity, “good or bad, effective or ineffective,” he emphasizes. These indiscriminate cuts are required by sequestration, which was a doomsday device intended to force the parties in Congress to reach agreement when all other approaches failed. It will go into effect because the Joint Select Committee on Deficit Reduction could not agree on $1.2 trillion in deficit reduction last year. All involved understood that it was a terrible policy, and now defense contractors are “hostages in a showdown between two parties over fundamental fiscal policy decisions on taxes and spending,” Cooney states. “The problem with a game of chicken is knowing when to quit,” he adds.
Should sequestration occur, agencies have until the end of the second quarter of the fiscal year to make their cuts. While nothing will happen on day one of sequestration, Cooney predicts, every day the agencies wait to make their moves, the size of the cuts will increase as will the abruptness of the actions. Agencies will likely defer many new contract awards, and the net flow of new contracts or options would drop. Contractors would not be able to plan even two months in advance in this scenario, he says. Productivity among employees who face furloughs would fall, and small and medium-size contractors would pay the price. Major parts of the financial markets would respond in adverse and unpredictable ways, Cooney explains. The Pentagon has stated that sequestration will not affect current contracts funded with FY 2012 dollars; however contracts signed on or after October 1, 2012, will be subject to the cuts.
Sequestration could still be avoided, Cooney offers. One possibility would be if the lame duck Congress makes the $1.2 trillion deficit reduction required. Another possibility is a law that extends both the expiration of the Bush tax cuts and the imposition of sequestration for several months into the normal period for adoption of the Reconciliation Act. This would only defer implementation, but in doing so, it would give lawmakers more time to work. A third option is a combination of the other two, with a down payment toward resolution of the structural fiscal deficit and a deferral of the tax increases and sequestration. The worst possible scenario is that sequestration kicks in and both parties have to negotiate fiscal policy during a period of uncertainty, Cooney warns.
There are steps contractors can take to mitigate the impact of sequestration, both at the macro and micro levels, explains Paul A. Debolt, also a partner at Venable LLP. Debolt, whose expertise is in helping companies do business with the federal government, suggests that, even if sequestration is avoided, defense contractors will still see fewer contracts for smaller amounts, so they will have to become more competitive.
At the macro level, Debolt has the following advice for contractors:
Be proactive and get involved.
Reach out to agency policy officials both directly and through trade associations. Communicate and stay in close touch with customers in the agencies. Emphasize the importance of the contract and obtain information about agency plans for it. Maintain favorable relationships with customer agencies within ethics guidelines, and keep abreast of developments affecting the contacts. But understand that agencies may not know sequestration’s impact on a contract until late in the process.
Look at accounting practices.
Review and update accounting and record-keeping procedures.
Figure out how to keep the best employees.
Pressure will occur to bid at a low rate, which could push salaries down, but at the same time, the market for employees with clearances is going up. Look at adjusting fringe benefits, and consider outsourcing tasks currently done in house.
Determine if your company is required to issue Worker Adjustment, Retraining and Notification (WARN) act notices.
The WARN act requires most employers with 100 or more employees to give 60 days’ notice of plant closing or mass layoffs. The administration has asked companies not to issue notices, and guidance from the Office of Management and Budget states that contractors would be compensated for legal costs if layoffs occur because of contract cancellations from sequestration. However, the layoff notices required by individual states or unions could be different from federal requirements and need to be understood.
Follow the money.
Explore areas such as cyber, intelligence, counter intelligence and healthcare as examples. If a company is not in these spaces, it should consider training or mentor-protégé programs. Develop or purchase capabilities in areas of government focus.
On the contract-to-contract micro level, Debolt has the following suggestions:
Conduct a vulnerability assessment.
Determine how much of the existing contract portfolio has been funded, as well as how do subcontracts or teaming arrangements address the impact of less work in calculating work share. Now is also the time to review contracts for potential cost growth or schedule slippage and determine if sequestration is an excusable delay. Also determine a company’s obligation to pay its subcontractors if it is not paid. Make sure employees know the terms of both prime contracts and subcontracts.
Take the initiative.
If it appears a contract will be eliminated or reduced, do not wait until government unilaterally makes a decision. Go to the customer to determine how to restructure the contract.
Closely monitor cost and schedule.
Identify the root cause and document the problems.
Review current contracts for any potential legitimate requests for equitable adjustments or claims.
Do not delay in filing these only to maintain good will. Document the claims as extensively as possible, and be sure to have supportive backup. Avoid using a lot of adjectives, and do not use the claim process as an opener for a negotiation position.
Do not unilaterally slow down work without having it in writing from the customer.
File invoices currently owed.
The AFCEA Small Business Committee hosted Cooney and Debolt at a recent meeting to give small businesses an opportunity to learn more about sequestration and how to prepare for it.