[Federal Register Volume 70, Number 105 (Thursday, June 2, 2005)]
[Notices]
[Pages 32306-32310]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-10910]


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DEPARTMENT OF DEFENSE


Contract Financing: Performance-Based Payments

AGENCY: Department of Defense (DoD).

ACTION: Response to public input.

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SUMMARY: The Director of Defense Procurement and Acquisition Policy 
(DPAP) recently completed an internal assessment regarding the use of 
performance-based payments as a method of financing for DoD contracts. 
This assessment has resulted in recommendations for revisions to 
policy, guidance, and training on the use of performance-based 
payments.

FOR FURTHER INFORMATION CONTACT: Mr. David Capitano, DPAP Policy 
Directorate, by telephone at (703) 847-7486, or by e-mail at 
[email protected].

SUPPLEMENTARY INFORMATION: As part of the internal assessment, DPAP 
published a Federal Register notice on September 9, 2004 (69 FR 54651), 
requesting the views of interested parties on what they believe are 
potential areas for improving DoD's use of performance-based payments. 
Seven sets of public comments were received in response to the DPAP 
request.
    The DoD internal assessment resulted in 47 recommendations for 
revisions to the Federal Acquisition Regulation (FAR), the Defense FAR 
Supplement (DFARS), the DoD User's Guide to Performance-Based Payments 
(User Guide), and DoD training programs. The anticipated completion 
dates for these actions are as follows:
     FAR Revisions--Final FAR Rule: July 2006
     DFARS Revisions--Final DFARS Rule--August 2006
     Revised User Guide--August 2006
     Revised DoD Training Programs--August 2006
    A summary of the public comments and the DPAP responses are as 
follows:

A. Training on Methods of Designing Performance-Based Payment 
Milestones

    Comment: One respondent states that the greatest needs are for 
training of contracting officers and requiring activity personnel on 
the methods of designing performance-based payment milestones that are 
(1) truly performance based and (2) tied effectively to incentives, 
where appropriate. The training should also emphasize the ``preferred 
method'' status of performance-based payments, and the collaborative 
effort (between contracting officers and the requiring activity/end 
user) that is necessary to design effective and meaningful performance-
based payment schemes.
    DPAP Response: DPAP plans to amend the current DoD training 
materials to address the design of milestones and to emphasize the 
preferred status of performance-based payments.

B. Performance-Based Payments as the Method of Preferred Financing

    Comment: One respondent believes that progress payments are 
preferable over performance-based payments. While progress payments are 
based on costs incurred, milestones for performance-based payments are 
highly influenced by the contractor and are skewed in their favor. The 
number of milestones on many programs may be greater than the line 
items on a contract, and the fact that the milestones are negotiated/
established at the beginning of the contract does not take into account 
the fact that the contract changes over the lifetime. This makes many 
milestones dubious and/or unnecessary as the contract matures. This 
respondent also states that the time necessary to establish these 
milestones requires a number of additional negotiations during the life 
of the contract, which adds time to administration rather than 
streamlining the effort. While establishing milestones is supposed to 
flag problem contracts when a milestone is missed or not billed, the 
respondent believes that the loss position in a progress payment 
catches many more people's attention, since a single milestone could be 
lost in a myriad of milestones established in the contract. As such, 
the respondent believes that the policy of utilizing performance-based 
payments as the financing vehicle of choice is a bad idea.

[[Page 32307]]

    Another respondent states that DPAP should issue policy stating 
that performance-based payments are the preferred method of financing 
on fixed-price contracts when the contractor concurs.
    A third respondent states that progress payments are easier for the 
contract specialist because all the contract specialist has to do is 
make sure the FAR and DFARS progress payment clauses are in the 
solicitation. Conversely, performance-based payments are a tremendous 
amount of extra work. General milestones are included in the 
solicitation, and once award is made, detailed performance-based 
payment milestones must be negotiated. The respondent asserts that, in 
most cases, the milestones cannot be finalized in a competitive 
procurement. Depending on who gets the award, manufacturing processes 
may be different and events occur at different times. The respondent 
believes that, having used performance-based payments on five 
contracts, the experience will make it easier to use such payments in 
the future.
    DPAP Response: Performance-based payments generally require more 
up-front work than progress payments. However, this is offset by the 
reduced administrative effort that results from the elimination of cost 
verifications. In addition, performance-based payments increase 
competition, since some commercial firms do not have accounting systems 
that are acceptable for progress payments. As such, performance-based 
payments should continue to be the preferred method of financing. To 
emphasize this preferred status, the FAR may need to provide a more 
assertive requirement for the use of performance-based payments. For 
example, when a contractor proposes performance-based payments but the 
contract includes progress payments, the FAR could require a 
contracting officer to document in the contract file why performance-
based payments were not used. DPAP has recommended that this issue be 
addressed as part of the FAR case to review/revise the current FAR 
coverage on performance-based payments.

C. Indefinite-Delivery/Indefinite-Quantity Contracts

    Comment: One respondent notes that establishing performance-based 
payments under indefinite-delivery/indefinite-quantity contracts at the 
``contract'' level rather than the ``order'' level results in an 
administrative quagmire for both the Defense Contract Management Agency 
and the Defense Finance and Accounting Service. The respondent 
recommends this issue be addressed as it has in the areas of progress 
payments. The respondent asserts that the similarity of each is 
highlighted at FAR 32.1001(c) and (d), Policy. These provisions state, 
in pertinent part, that ``Performance-based payments are fully 
recoverable, in the same manner as progress payments * * *.'' The 
provisions further state ``For Government accounting purposes, the 
Government should treat performance-based payments like progress 
payments based on costs under Subpart 32.5.'' The respondent recommends 
adding a paragraph to FAR 52.232-32, Performance-Based Payments, that 
is substantially the same as that at FAR 52.232-16(m), Progress 
Payments.
    DPAP Response: FAR coverage may be needed to address indefinite-
delivery/indefinite-quantity contracts, particularly with regard to if/
how performance-based payments are established (i.e., contract vs. 
order level). DPAP has recommended that this issue be addressed as part 
of the FAR case to review/revise the current FAR coverage on 
performance-based payments.

D. Lesser of Cost and Performance Payment

    Comment: One respondent states that FAR 32.1002 sets forth the 
basis or bases upon which performance-based payments might be made, 
none of which involve cost. There are instances where contract 
provisions have been included where performance-based payments are 
limited to the lesser of a specified performance-based payment schedule 
amount or incurred costs. The respondent asserts that this is 
inconsistent with the intent of performance-based payments.
    DPAP Response: The benefits of performance-based payments are 
significantly reduced when there is a requirement to use the lesser of 
cost or the value of the performance payment. DPAP has recommended that 
this issue be addressed as part of the FAR case to review/revise the 
current FAR coverage on performance-based payments.

E. Responsible Official for Reviewing/Approving Performance-Based 
Payments

    Comment: The respondent notes that, under FAR 32.1007(a), the 
contracting officer responsible for administration of the contract 
shall also be responsible for review and approval of performance-based 
payments. Where contracts are administered by other than the Procuring 
Contracting Officer (PCO), the contract administration function of 
reviewing and approving/disapproving contractors' requests for either 
performance-based payments or progress payments are normally not 
retained by the PCO, but delegated to the Administrative Contracting 
Officer (ACO). However, there have been instances where review and 
approval of performance-based payments are not delegated to ACOs, 
notwithstanding the delegation of all other contract administration 
functions. The respondent asserts that this is an inefficient practice, 
given the ACOs' presence in or proximity to contractor manufacturing 
facilities, and familiarity with contractors' business and other 
systems. The respondent recommends that FAR 42.302(a) (or alternatively 
DFARS 242.302) require that performance-based payments be delegated to 
the ACO, unless the PCO can demonstrate compelling circumstances as to 
why the function should not be delegated.
    DPAP Response: FAR 32.1007(a) requires that the contracting officer 
responsible for administering the contract also be the one responsible 
for reviewing and approving the performance-based payments. However, 
FAR 42.302(a)(12) is a function that may be retained by the PCO, i.e., 
not delegated to the ACO. Thus, the ACO could administer most of the 
contract, but the PCO could retain the review/approval function for 
performance-based payments. In such cases, the contracting officer 
responsible for administering the contract would not be the same as the 
contracting officer responsible for reviewing/approving performance-
based payments. DPAP has recommended that this possible inconsistency 
in the existing FAR provisions be addressed as part of the FAR case to 
review/revise the current FAR coverage on performance-based payments.

F. Valuation of Performance-Based Payment Events

    Comment: One respondent recommends that valuation of performance-
based payment events receive increased emphasis, because the respondent 
believes it continues to be a weakness of contracting officers.
    DPAP Response: The User Guide currently discusses the need for 
valuations to be commensurate with work performed, but does not include 
specific examples. DPAP plans to amend the User Guide and training to 
provide examples of inappropriate valuations (e.g., front or back-
loading of payments).

[[Page 32308]]

G. Increased Education and Emphasis on Use of Performance-Based 
Payments

    Comment: One respondent notes the reluctance of some PCOs to 
include performance-based payments, even when the contract is a good 
candidate for use of such payments. This respondent recommends more 
education and emphasis on the use of performance-based payments. 
Another respondent also recommends more education. This respondent 
asserts that ``contractors and DoD Buying Commands truly are unaware of 
the benefits of performance-based payments and especially how to 
structure a performance-based payment contract to achieve the mutual 
benefits performance-based payments provide. Progress payments are most 
acquisition personnel's (Government and private) comfort zone. They 
understand them and have used them for years.'' This respondent 
suggests increasing education via a ``Performance-Based Payment Road 
Show'' presented by the Office of the Secretary of Defense (OSD), with 
assistance from DoD personnel who have a wealth of performance-based 
payment experience and knowledge. This respondent suggests 
presentations by OSD personnel to contractors would also be beneficial.
    DPAP Response: Increased training will facilitate the use and 
effectiveness of performance-based payments. DPAP will review the 
current training plan and revise it as necessary to maximize the 
effectiveness of DoD's performance-based payment training.

H. Advantages/Disadvantages of Performance-Based Payments

    Comment: One respondent identifies the following advantages and 
disadvantages of performance-based payments:

Advantages of Performance-Based Payments

     Performance-based payments drive the Program Team to focus 
on performance events and consequently the related performance-based 
payments billing.
     Performance-based payments help maintain the program 
schedule. Progress payments do not provide an insight into schedule 
performance.
     Performance-based payments provide the contractor an 
opportunity for increased cash flow; if the billing event is completed 
ahead of schedule, then payment is received earlier.
     Performance-based payments reduce the cost of 
administration and streamlined oversight. Progress payments require a 
separate system approval by the Government. Material Management and 
Accounting Systems are not required for performance-based payment 
contracts.

Disadvantages of Performance-Based Payments

     Use of performance-based payments requires the agreement 
of both parties to the contract. This complicates the source selection 
process and can disadvantage the offeror seeking the use of 
performance-based payments.
     Additional effort is required to track each performance-
based payments event due date and monitor completion status of each 
event. This is particularly difficult in a production build 
environment. The performance-based payments billing schedule is often 
made more complicated than necessary.
     Despite the Government's policy that performance-based 
payments is the preferred method of financing, certain contracting 
officers have not fully adopted the practice. This puts the contractor 
offering performance-based payments at a disadvantage in a competitive 
source selection, and could even cause the offeror to be declared non-
responsive.
    DPAP Response: DPAP is in the process of updating the User Guide. 
As part of this update, each of these potential advantages and 
disadvantages will be reviewed and, as appropriate, included in the 
Guide.

I. Performance-Based Payments ``Required'' Rather Than ``Preferred''

    Comment: One respondent notes that the FAR language stating 
``performance-based payments are the preferred Government financing 
method when the contracting officer finds them practical'' provides 
considerable discretion for the Contracting Officer to include progress 
payments, which are much easier to include in the solicitation. The 
respondent recommends revising FAR 32.1001(a) to require performance-
based payments. The respondent asserts that there should be very few 
circumstances where progress payments are used. This respondent states 
that the OSD(AT&L) policy letter of November 13, 2000, requested that 
performance-based payments be the sole financing method by fiscal year 
2005. The respondent recommends that OSD(AT&L) issue an update to the 
November 13, 2004, policy letter. The letter should emphasize 
performance-based payments as the ``mandatory'' form of contract 
financing.
    DPAP Response: It is not advisable to mandate a particular form of 
contract financing. However, the FAR could provide a more assertive 
requirement for the use of performance-based payments. In particular, 
the FAR should be reviewed to determine whether more emphasis should be 
added to the ``preferred'' use of performance-based payments. For 
example, when a contractor proposes performance-based payments, but the 
contract includes progress payments, the FAR could require a 
contracting officer to document in the contract file why performance-
based payments were not used. DPAP has recommended that this issue be 
addressed as part of the FAR case to review/revise the current FAR 
coverage on performance-based payments.

J. FAR 52.232-28, Invitation To Propose Performance-Based Payments

    Comment: One respondent states that FAR 52.232-28, Invitation to 
Propose Performance-Based Payments, requires the contracting officer to 
include evaluation criteria in competitive solicitations. The 
respondent believes this not only increases the complexity of the 
evaluation, but also discourages offerors from proposing performance-
based payments due to the potential downgrading of the proposal. The 
respondent recommends revising FAR 52.232-28 to delete Alternate I, 
thereby eliminating the penalty for offering performance-based 
payments.
    DPAP Response: The regulations should not penalize or discourage 
contractors that propose performance-based payments. DPAP has 
recommended that this issue be addressed as part of the FAR case to 
review/revise the current FAR coverage on performance-based payments.

K. Facilitating Implementation of Performance-Based Payments

    Comment: One respondent states that use of performance-based 
payments can be facilitated if performance-based payments discussions 
between the PCO and the contractor begin immediately after a proposal 
is submitted. A PCO may require additional detail (expenditure profile 
by contract line item) or may want to talk to the ACO. By the time pre-
award negotiations begin, the PCO should be well aware of the 
performance-based payments financing request with no opportunity for 
``delay pending availability of supplemental data or outstanding 
questions.'' In certain situations, it may be feasible to delegate 
responsibilities for establishing the performance-based payments 
criteria to the ACO. This respondent states that performance-based 
payments can be further facilitated by requiring a detailed 
performance-based payments plan and

[[Page 32309]]

supporting expenditure profile to be submitted with the proposal.
    DPAP Response: DPAP plans to amend the User Guide and training to 
emphasize the need to address performance-based payments as early in 
the acquisition process as practical, including during pre-award 
negotiations.

L. Developing Performance-Based Payment Billing Events

    Comment: One respondent recommends updating the DoD Guide on 
Performance-Based Payments to provide additional examples on how to 
develop billing events. Emphasis should be on milestones relative to 
the expenditure profile, and not individual contract line item prices 
and schedules. A second respondent recommends mandatory training on how 
to establish payment criteria.
    A third respondent recommends issuing guidance stating that, as 
part of the acquisition planning and contract formation process, each 
performance-based payments event shall be formulated so that it is 
objective, quantifiable, and as easy to measure as possible. For 
example, tying performance-based payments events to already defined 
program reviews, tests, or manufacturing plan milestones or other 
events on the integrated program schedule for manufacturing activities 
is often the best course. For services, tying performance-based 
payments events to program reviews, key performance milestones, or 
other suitable events is good business practice. This respondent also 
notes that defining a performance-based payments event as ``100% 
completion'' of tasks should be avoided, since there are frequently 
minor action items left open even when a major milestone is otherwise 
considered accomplished. This respondent recommends revising FAR 
32.1007(d), which prohibits payment of performance-based payments for 
incomplete performances to address cases where the milestones are 
materially met, but not by a 100 percent standard. This respondent 
recommends that FAR be revised to ``allow for Contracting Officer (CO) 
discretion for payment of partial amounts of performance-based payments 
when a specified milestone is not met.'' This respondent states that 
this change would address those instances when a milestone is not 
achieved by a very small margin.
    DPAP Response: DPAP plans to amend the User Guide and training to 
address the development of the performance metrics, including the 
targeting of milestone requirements that are integral and necessary to 
completion of the contract. However, it is not advisable to provide for 
partial payments of performance-based payments milestones. The solution 
to this issue is in the development of the milestone metrics. If there 
are minor tasks that are not an integral part of the milestone 
completion, the metric for the milestone could list these minor tasks 
and state that they are not part of the milestone completion 
requirements. This would ensure that the parties agree up-front on what 
the metrics are, rather than arguing later about ``partial payment.'' 
In addition, partial payment raises an issue of how to make such a 
payment (how do the parties determine how much of the payment is made) 
and significantly reduces the effectiveness of performance-based 
payments, which are predicated on satisfactory performance of the 
milestone requirement.

M. Increasing Use of Performance-Based Payments

    Comment: One respondent states that current policy and regulatory 
implementation of performance-based payments are generally adequate. 
DoD policy clearly states that performance-based payments are the 
preferred form of contract financing employed by the Government. 
However, the initial effort involved in identifying objective payable 
events may cause some contracting officers to remain reluctant to adopt 
the use of performance-based payments. The respondent recommends 
adopting a policy stipulating that, for all major fixed-price 
production programs in which the end item delivery cycle exceeds 12 
months, the contracting officer must obtain a waiver from the head of 
the contracting activity in order to use progress payments rather than 
performance-based payments.
    DPAP Response: It is not advisable to require a waiver to use 
performance-based payments or progress payments. This decision should 
be made by the contracting officer.

N. Revising Milestones

    Comment: One respondent notes that sometimes new leadership 
(program manager or PCO) wishes to revise the initially established 
events, which tends to negate the benefits of performance-based 
payments by adding administrative effort. The respondent recommends 
issuing a policy stating that previously established milestones or 
criteria should remain stable unless payments are in violation of the 
general restrictions on financing payments in FAR Part 32.
    DPAP Response: It is not advisable to preclude the contracting 
officer's ability to modify performance-based payments events. Note 
that in the absence of a change in contract performance requirements, 
modifying the performance-based payments events generally requires 
mutual agreement of the parties.

O. Verification of Incurred Cost for Performance-Based Payments

    Comment: One respondent recommends prohibiting verification of 
incurred costs as part of performance-based payments. The respondent 
states that one important advantage of performance-based payments is 
the elimination of Government auditing of incurred costs. In addition, 
it is not clear what the Government intends to do with the incurred 
cost information. Regardless of the costs incurred to achieve a 
performance milestone, the payment terms in the contract will prevail. 
If there is a need to limit payments to a percentage of incurred costs, 
the original contract terms should establish progress payments as the 
correct contract payment mechanism. The respondent is concerned that 
the language at FAR 32.1004(a)(3)(ii) may be causing contracting 
officers to request incurred cost data for each milestone. The 
respondent notes that the second sentence of this paragraph states that 
``the contracting officer may request expenditure profile information 
to confirm that the contractor's investment is sufficient.'' The 
respondent recommends that the FAR be revised and/or guidance be issued 
to make it clear that the expenditure profiles may only be requested 
during the contract pre-award stage.
    DPAP Response: Including verification of costs incurred as a 
requirement for payment significantly diminishes the value of 
performance-based payments. DPAP has recommended that this issue be 
addressed as part of the FAR case to review/revise the current FAR 
coverage on performance-based payments.

P. Single Financing and Liquidation Rate

    Comment: One respondent recommends establishing one financing and 
liquidation rate. The respondent believes that one rate will make it 
much simpler for DoD and the contractor to administer, pay, and close 
out contracts.
    DPAP Response: It is important for the contracting officer to have 
the flexibility in the negotiation of the contract financing and 
liquidation rates, rather than forcing a single financing and 
liquidation rate for all contracts.

[[Page 32310]]

Q. Financing Rates Should Provide Financing Incentives for Performance-
Based Payment Use

    Comment: One respondent recommends that the financing rates for 
performance-based payments offer incentives above that which could be 
achieved with the no-risk, administratively burdensome 80 percent 
progress payment option. The FAR currently states that performance-
based financing must be prudent and must not exceed 90 percent of the 
contract price. The respondent asserts that there have been numerous 
situations where the actual performance-based payments rates awarded 
provide lower effective financing than the 80 percent progress payment 
option. This trend is a disincentive for contractors to accept the 
risks associated with meeting performance-based financing events. The 
respondent recommends that DPAP issue guidance to the field advising 
PCOs to use performance-based payments rates that offer true financial 
incentives. The guidance should state that the 90 percent rate will be 
used on an ordinary basis and that lower rates should be used only when 
significant justification exists.
    DPAP Response: Providing performance-based payments financing at or 
below the effective rate for progress payments inhibits the use of 
performance-based payments. DPAP has recommended that this issue be 
addressed as part of the FAR case to review/revise the current FAR 
coverage on performance-based payments.

R. Use of Production Lead Times In Lieu of Performance Events

    Comment: One respondent recommends permitting performance-based 
payments based on production lead times for mature programs with 
reliable production processes, rather than using performance events. 
The respondent states that this is a common commercial practice and is 
appropriate in situations when the lead times and production processes 
are well known. The respondent asserts that this would result in a 
contract that is both simple to award and simple to administer, since 
the effort to validate and approve events would be eliminated.
    DPAP Response: The passage of time is not an acceptable 
performance-based event, even when the lead times and production 
processes are well known. When the production processes are well known, 
it should not be difficult to establish objective performance 
milestones in a manner that requires minimal validation effort.

S. Eliminate Requirement To Bill at Contract Line and Accounting 
Classification Reference Number (ACRN) Level

    Comment: One respondent recommends simplifying the contract 
administration and payment process by eliminating the requirement for 
contractors to bill and for the Defense Finance and Accounting Service 
(or other payment offices) to pay performance-based payments financing 
requests by contract line and ACRN. The respondent asserts that 
performance-based payments financing should be treated the same as 
progress payment financing by having the DoD payment systems allocate 
the billing amount to all ACRNs on the contract. The respondent asserts 
that adoption of this recommendation would eliminate the need for 
preparation of complex billings and the maintenance of manual 
spreadsheets by the contractor and DoD.
    DPAP Response: The current DFARS case, Payment and Billing 
Instructions (DFARS Case 2003-D009), addresses the respondent's concern 
(proposed rule published at 69 FR 35564 on June 25, 2004). This case 
will revise the DFARS to provide the contracting officer with twelve 
options, including the ability to have the payment office allocate the 
costs at the contract line item/ACRN level.

T. Segregation of Billings Into Multiple Invoices

    Comment: One respondent recommends permitting billings to be 
segregated into multiple invoices where a problem with a funding 
source, accounting station, or foreign military sales customer is 
expected to delay payment. The respondent believes that this option 
provides contractors with the ability to receive payment on time for a 
portion of the billing when problems arise with a particular funding 
source, accounting station, or foreign military sales customer, while 
also minimizing reconciliation efforts and the risk of expiring funds.
    DPAP Response: DPAP has established a DFARS case to address 
instances in which a portion of the invoice is payable but other 
portions are not due to problems with a funding source, accounting 
station, or foreign military sales customer.

U. Corrected or Delayed Billings of Prior Month Do Not Preclude New 
Billings

    Comment: One respondent recommends that guidance be issued stating 
that a corrected or delayed billing from a prior month does not 
preclude a contractor from issuing a new billing for performance-based 
payment events achieved in a subsequent month.
    DPAP Responsee: DPAP plans to amend the User Guide and training to 
address the processing of current invoices when there are corrected 
and/or delayed billings from a prior period.

Michele P. Peterson,
Editor, Defense Acquisition Regulations System.
[FR Doc. 05-10910 Filed 6-1-05; 8:45 am]
BILLING CODE 5001-08-P