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By Steve Kelman

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Share-in-savings contracting coming back?

My colleague Matthew Weigelt recently wrote an article about share-in-savings contracting. Tom Davis, the former Northern Virginia Congressman and moderate Republican leader in the House, had noted in a speech that government needs to look for innovative contracting methods to get work done in lean times.

The basic idea of share-in-savings contracting is that the government pays a contractor fully, or partly, in the form of giving the contractor a share of the savings the contracted effort generates. No savings means no (or limited) payment, while big savings means big payments. This ultimate form of results-based contracting should be part of the government's arsenal even in good times, but, as Davis noted, in these times it is particularly appropriate.

Government is doing some share-in-savings contracting now. One example is doing a phone inventory to identify unused phone lines, with the contractor getting a share of the money saved by canceling those lines. Another example is contracting debt collection on government loans, with the contractor receiving a proportion of loan repayments. One could imagine this in fraud detection efforts as well.

The catch is an obscure provision in appropriations law called "upfront funding of termination liabilities." In a share-in-savings contract, the contractor often makes investments upfront and then gets paid in the out-years by a stream of savings. However, government can always terminate a contract. If government does so in a share-in-savings situation, the contractor will have made the investment but not reaped any benefits. As a result, contractors typically demand that these contracts include "termination liabilities," a mutually agreed sum of money if the contract is prematurely canceled.

The problem is that under normal appropriations law, the entire sum of these termination liabilities – which is a hypothetical expenditure, unlikely ever actually to need to be paid out because there would seldom be reason to cancel the contract (see below) – must be funded in the first year of the contract. This often creates a huge sticker shock for agencies, making it difficult to fund, especially in this budget environment (ironically, when the idea is needed most). The examples of share-in-savings type arrangements discussed above can take place because they don't require major contractor investments and can normally be paid back over each fiscal year the contract is running.

Actually, it is highly unlikely that an agency would need to cover these termination liabilities if the contractor protects itself by owning the software and business processes developed under the contract. If the contractor owns the means to achieve the government savings, why would the government want to cancel just when the investment is yielding results for the government as well as the contractor?

If the contract is not saving money, then it’s not costing the government much money either, so there is still no need to cancel the contract and pay the termination liabilities. The parties also could renegotiate far lower termination liabilities, since the contractor wouldn't have an interest in keeping the contract going either. So this provision of appropriations law is creating a problem for a valuable contracting tool, for no real reason.

When he was in Congress, Davis got a bill passed that allowed temporary exemption from these provisions of appropriations law for a number of share-in-savings contracts. The opportunity languished, however, in the wake of a lack of interest inside the Bush administration. And renewal of the Davis provision was opposed by some self-styled "watchdog" groups, especially ironic given that one of the oldest examples of a share-in-savings approach is the qui tam provisions of the False Claims Act, these groups' most-beloved statute, which allows "whistle-blowers" to receive a percentage of the money the government recovers from contractor fraud they have disclosed.

To be sure, negotiating these contracts can be complex – a government organization should get advice from the best contracting experts – but the opposition seemed to be based on the perverse view that it is better to have a contract fail than for the contractor to make too much money. Savings from a share-in-savings contract might not materialize, so it is obvious that no contractor will sign up to such an arrangement unless their profit is greater than normal in the (hopeful) event that their efforts succeed.

By the way, there are other forms of results-only contracting that should be used more, especially in these times. That includes using contests as a procurement technique, with the government offering a fixed prize for being the first to achieve some government-mission related goal. Again, no results, no payment. There are no real statutory barriers to this method, and the administration has been promoting this idea, though not as aggressively in the contracting arena as I'd like to see.

Maybe Tom Davis can get some key Republicans on the Hill interested in statutory language to revive the ability to do share-in-savings contracting without the big termination liability hit upfront, and maybe Dan Gordon and the administration will step up too?  Maybe, just maybe, we could have an example of bipartisanship in the public interest? That would be nice for a change.

Posted on Mar 29, 2011 at 12:09 PM


Reader comments

Mon, Apr 4, 2011 Steve Kelman

Mike, have you become the mayor of a town in West Virginia??? If so, is this a fulltime job?

Sun, Apr 3, 2011 SP Mayor Summit Point, WV

An interesting idea. To eliminate the cost/price variability the Government might want to consider some form of risk pooling where the associated cost for coverge would be pre-determined and provided to offerors by the Government. There is also the possibility of framing the performance period/savings period to match the funding shelf-life so that savings would be available within the fiscal year of the funds. One of the proverbial problems with SiS is assuring the availability of the savings for payment to contractors. If done within the fiscal year there are few risks - otherwise savings are all to often withdrawn from the program. Mike Del-Colle

Thu, Mar 31, 2011 Steve Kelman

I wonder whether any industry folks have a comment on Stanley's suggestion.

Wed, Mar 30, 2011 Stanley

The simple solution to "upfront funding of termination liabilities" is to just buy a bond, like locksmiths have. The outside bond-provider is a insurance agency that charges a steady stream to the Govt based on the risk incurred by having to pay the charge. Or maybe more like a bail-bondsman that charge a small amount upfront. Sound like a great business opprtunity.

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