When managing a federal grant, one of the decisions you may need to make is what type of contract to use for procuring goods and services.

And when that grant is a federal award, it becomes even more critical as the federal funding comes with rules and preferences about what types of contract you can use and which ones are prohibited from choosing.

Types of Contracts

There are two main types of contracts used for buying goods and services for your federal grant:

• Firm Fixed Price
• Cost Reimbursement

Though each type of contract has a definite place in the world of procurement, the federal government has a preference when it comes to grants management.

Types of Contracts: What is a Firm Fixed Price Contract?

The favored contract type for federal funding is a “firm fixed price” contract.

A firm fixed price is a type of contract where the total amount of the contract is agreed to in advance between the grant recipient and the contractor.

If the contractor spends more than the firm fixed price amount, that spending must be covered by the contractor and NOT the organization receiving the grant.

Likewise, if the contractor is more efficient than planned, the contractor retains any underspending, and the organization receiving the grant doesn’t receive the cost savings.

Types of Contracts: Why Select a Firm Fixed Price Contract for a Grant?

The firm-fixed-price contract is preferred for many reasons, but the main one is the certainty of costs for a project or program.

And that certainty allows organizations receiving grants to “lock-in” costs at the time of contracting without estimating the total cost for time and materials used by the contractor.

This stability of pricing makes the planning and grant management process more straightforward.

For contractors, a firm-fixed-price contract encourages efficiency to increase profits on the procurement contract.

Types of Contracts: What Could Go Wrong With a Firm Fixed Price Contract?

Because the contractor bears the risk of cost overruns, there could be a risk that the firm fixed price is inflated to cover unforeseen circumstances. (And maybe even an excessive number of worst-case scenarios.)

So even though the cost is fixed, the cost could run higher than the actual cost of the time, materials, and reasonable profit for the contract.

The other thing that can go wrong with a firm-fixed-price contract is when a contractor low-balls the proposal to win the contract and then carries the use of Change Orders to the extreme with the contract.

(Change Orders are used when there are changes in the scope, the timing, the amount, or other things related to the project.)

When a contractor adds Change Orders for things that are arguably assumed to be in the scope of work, the total cost of even a firm-fixed-price contract can spiral out of control rapidly.

How to Reduce Risk on Your Grant with a Firm Fixed Price Contract

There are two main ways to avoid the risk of cost overruns on your grant when using a firm-fixed-price contract:

• Ensure adequate competition among responsible contractors
• Take the time to develop a thorough scope of work, specifying what work is to be done in sufficient detail to reduce misunderstandings.

The number of bids required and how extensively the organization seeks out a variety of contractors can mitigate the risk of over-charging.

And a well-laid-out scope of work will go a long way toward the excessive use of Change Orders.

What is a Cost Reimbursement Contract?

The less favorite contract type used by grant recipients with federal funding is a “cost reimbursement” contract.

Cost reimbursement is the type of contract where the contractor bills the organization for every dollar spent on labor to do the work and materials to complete the job.

This type of contract is also called a “time and materials” contract.

Sometimes, a reasonable profit margin is included in the cost-reimbursement contract.

In this contract type, the contractor has little incentive to do the work efficiently because the grant recipient covers one hundred percent of their costs.

When it comes to federal grants, a cost-reimbursement contract can ONLY be used after a determination that no other contract is suitable for the work and if the contract includes a ceiling price that the contractor exceeds at its own risk.

In other words, federal grant recipients must ensure that cost-reimbursement contracts have a “not to exceed” amount written into the contract.

Why Select a Cost Reimbursement Contract with a Grant?

The cost-reimbursement contract is appropriate when there is significant uncertainty about how to accomplish the project or the time frame involved.

Here are a couple of examples:

• You need to contract with a temporary agency to cover for an administrative employee who has gone out on sick leave for an undetermined time period. In this case, you don’t know the length of time the employee will be gone, so it would be nearly impossible for the staffing firm to provide a firm-fixed-price contract. However, the hourly rate could, and should, be set before beginning the work.
• You need to hire legal counsel to defend the organization in a wrongful termination lawsuit. It would be extremely unlikely that a legal firm would agree to a firm-fixed-price contract because of the uncertainty of how much work the case will entail.

As you can see, a cost-reimbursement contract can be more challenging to manage and will require a higher level of oversight to ensure the costs remain reasonable.

What Could Go Wrong with a Cost Reimbursement Contract?

A cost-reimbursement contract is inherently a riskier type of contracting instrument.

And as a result, a cost-reimbursement contract requires much more vigilance by the responsible procurement officer or program manager to keep the project within the budget for the grant.

So, one of the main risks is that everyone will get busy, and the costs will escalate without anyone monitoring them.

Another risk to federal grant recipients is that the total cost will approach the unreasonable level, where it may have been time to look at hiring an employee to do the work rather than continuing to pay a consultant.

How to Reduce Risk on a Cost Reimbursement Contract

Even though a cost-reimbursement contract may make sense at the start, close monitoring is required to ensure that this contract type remains the best way to procure the goods or services needed for the federal award.

When you use this type of contract, you should plan periodic reviews (yes, put them on your calendar) to continue assessing its appropriateness.

You should also keep close tabs on the spending on a cost-reimbursement to keep the project on track.

Finally, ensure you comply with the Uniform Guidance by documenting that ANY cost-reimbursement contract paid for with federal funds includes the required “not to exceed” amount in the contract.