Common Contracting Options and Considerations

By: John Ford, Senior Consultant

Most of us have seen contracts that contain options. However, many of us have probably not given much thought to what they are and exactly how they are to operate. This article is intended to provide some information on these topics.

Federal Acquisition Regulation (“FAR”) 2.101 defines an “option” as “a unilateral right in a contract by which, for a specified time, the government may elect to purchase additional supplies or services called for by the contract, or may elect to extend the term of the contract.” There are some significant points contained in this definition. First, that an option is a unilateral right vested in the government. This means that the government is not contractually bound to exercise the option. Instead, the government can choose not to exercise the option. If the government chooses not to exercise an option, the contractor generally has no recourse because the failure to exercise an option is not a termination of the contract. On the other hand, if the government does decide to exercise an option, the contractor is bound to perform; otherwise, the contractor can be held to be in default with all the ramifications that entail (e.g., a poor CPARS, potential excess re-procurement costs, negative reps and certs, etc.)

Next, options can be included in any type of contract without regard to how the contract is priced. Thus, an option can be included in contracts for supplies, services and construction. If the contract contains an option for additional supplies, usually the option states an additional quantity of supplies that can be obtained through exercise of the option. In this regard, there does not appear to be any minimum or maximum limitation on the amount of supplies that can be obtained through the exercise of an option. If the contract is for services, the option can be stated as a quantity of services (e.g., number of applications to be processed or a period in which services are to be performed). Regardless of whether the option is for additional supplies or services, it must have been priced and evaluated at the time of the original contract award in order to ensure compliance with the Competition in Contracting Act (“CICA”) and to ensure that the contract has been awarded to the offeror providing the best value to the government. In this regard, an option is not a separate contract. If it is exercised, the contract containing the option is modified to include the new work. Thus, the option is governed by the terms and conditions of the contract.

As we will discuss in greater detail below, options must be exercised in strict accordance with their terms. This means that, as a general rule, options must be exercised at the price included in the contract. However, there is an exception to this rule concerning contracts that are subject to the Service Contract Act (“SCA”) and that contain the clause at FAR 52.222-44.

When the government intends to exercise an option on a contract subject to the SCA, the government is required to obtain a new wage determination and include it in the contract per FAR 52.222-41. When the new wage determination is included in the contract, FAR 52.222-44 provides that the contract price will be adjusted to reflect increases or decreases by the contractor in wages and fringe benefits to the extent that these increases or decreases are made to comply with the new wage determination. However, the price adjustment will be limited to the accompanying increases or decreases in social security, unemployment taxes and workers’ compensation insurance. The adjustment is not to include any amount for general and administrative costs, overhead or profit. Thus, the adjustment is not an equitable adjustment, but merely a price adjustment.

As stated in the definition, an option is required to be exercised within a specified period of time. Thus, it is not open ended. FAR 17.207 provides guidance to contracting officers concerning the exercise of options and states in part:

The contracting officer may exercise options only after determining that —

(1) Funds are available;

(2) The requirement covered by the option fulfills an existing Government need;

(3) The exercise of the option is the most advantageous method of fulfilling the Government’s need, price and other factors considered;

                                  *                       *                       *

(6) The contractor’s past performance evaluations on other contract actions have been considered and;

(7) The contractor’s performance on this contract has been acceptable, e.g., received satisfactory ratings.

If all of these factors cannot be answered in the affirmative, the contracting officer may not exercise the option.

There are several clauses in FAR Part 52 that deal with the exercise of options. For purposes of this article, we will only address the two that deal with contracts for services, FAR 52.217-8, Option to Extend Services, and FAR 52. 217-9, Option to Extend the Term of the Contract. Under the -9 clause, the government is required to give the contractor written notice of its intent to exercise the option a specified number of days before the contract is to expire. This has been interpreted to mean that the contractor must receive the preliminary notice within the contractually specified time period. If the contractor does not receive the notice timely, any attempted exercise of the option will be invalid.

In addition to the preliminary notice, the government must give the contractor written notice of the exercise of the option within the time period specified in the contract. If the notice of the exercise of the option is received late, this attempted exercise of the option will be considered invalid.

The failure to exercise an option in strict accordance with its terms presents some interesting issues for the government and contractor. From the government’s perspective, the defective exercise of an option may be considered an invalid sole source procurement that is subject to being protested by a third party. From the contractor’s perspective, a contractor is not required to perform an option that has been defectively exercised. Thus, if this happens, the contractor is faced with the question of whether it should perform the option, and if so, should it request an equitable adjustment to the option price. A defective exercise of an option is considered a breach of contract that excuses further performance by the contractor. However, the contractor can waive the breach by performing, and if it does so without protest, the contractor may have waived its right to breach damages. However, if the contractor performs under protest, it may be able to recover breach damages.

Turning to the -8 clause, the government does not have to give the contractor preliminary notice of its intent to exercise the option under that clause. Instead, the government is only required to give the contractor written notice of the exercise of the option within the period specified in the clause. Under this clause, the government can exercise the option more than once, but the total extension of the contract under this clause cannot exceed six months. If the -9 and -8 clauses are included in the same contract, there is no requirement that options covered by the -9 clause must be exercised before any options under the -8 clause can be exercised. On the contrary, one or more options under the -8 clause can be exercised before any option under the -9 clause is exercised.

As this brief discussion illustrates, the question of whether an option has been properly exercised can be complex. If you have any questions or concerns regarding the exercise of options on your contracts, do not hesitate to reach out to us for advice and assistance.