GAO: Major defense contracts cheaper to cancel than continue

Watchdog finds that even after termination costs are factored in, it’s generally less expensive to end an unneeded program than to keep paying for it.

For years, some Defense Department officials have griped that canceling certain weapons programs would cost more than completing them and making all obligated payments. After 18 months of research, the Government Accountability Office has quashed that notion.

In a report (GAO-08-379) released Monday, the congressional watchdog concluded that, as a general rule, it costs less to end a major weapons system contract prematurely than to complete it.

GAO found that since 1995, eight contracts for weapons systems valued at more than $100 million have been terminated. In none of these cases did the cost of halting the contract exceed the final settlement paid to the contractor.

For example, in 2002 the Army canceled a $1.87 billion contract with United Defense Industries (since purchased by the British-based BAE Systems) to build the Crusader, an automated self-propelled howitzer. Defense officials said soldiers no longer needed a 60-ton armored cannon, which was designed to fight Soviet forces on the battlefields of Europe.

According to data from the Defense Contract Management Association's Terminations Center, canceling the contract saved the Army more than $211 million.

GAO found only one instance -- involving the Air Force's C-130J cargo plane -- when the decision to terminate a contract was halted, in part, because of higher than anticipated costs to terminate the contract. And in that case, critics, including watchdog groups and the Defense Department inspector general have suggested the termination costs may have been overstated.

Federal acquisition regulations require that a "termination for convenience" clause be inserted in nearly all federal contracts, allowing the government to end a contract prior to its expected completion, even if the contractor is performing well. In 2006, the Terminations Center processed 600 terminations, more than half for contracts less than $100,000.

In the past, the government has used this clause when facing budgetary restraints or when the needs of the Defense Department changes, such as at the end of the first Gulf War, when the military no longer needed large stashes of prepackaged and shelf-stable meals. Theoretically, if the war in Iraq were to come to an abrupt halt, the clause could be invoked for other long-term service contracts.

In 2007, the Pentagon's planned investment in new weapons systems totaled $1.6 trillion; roughly half remains in outstanding commitments.

Acquisition regulations also place limits on the government's liability when terminating fixed-price and cost-reimbursable contracts.

The government must pay a termination settlement that includes the cost of work already performed, an agreed-upon fee for completing that work and expenses associated with terminating the contract -- such as preparing a settlement proposal, disposing of inventory and negotiating with subcontractors. Since the first two cost factors must be paid either way, GAO said it would only cost more to end a contract than to complete it if the termination costs were more than the costs of the remaining work under the contract. "Settlements tend to be lower if a contract is terminated sooner rather than later because incurred costs increase over time," the report noted.

GAO recommended that Defense officials review, and if needed, amend their guidelines to ensure that officials have the tools necessary to identify the conditions appropriate to terminate a contract. The Defense Department concurred with that recommendation.