When you are managing a grant, one of the decisions you may need to make is what type of contract to use for procurement of 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.
What is a Firm Fixed Price Contract?
The favored contract type for federal funding is a “firm fixed price” contract.
This 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, any underspending is retained by the contractor and the organization receiving the grant doesn’t receive the cost savings.
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 having to estimate the total cost for time and materials used by the contractor.
This stability of pricing makes the planning and grant management process simpler.
For contractors, a firm fixed price contract encourages efficiency to increase profits on the procurement contract.
What Could Go Wrong With a Firm Fixed Price Contract?
Because the risk of cost overruns is borne by the contractor, there could be a risk that firm fixed priced is inflated to cover unforeseen circumstances. (And may even an unreasonable 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.
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 an extreme.
(Change Orders are used when there are changes in the scope, and timing of a project amount other things.)
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 through 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 towards excessive use of Change Orders.
What is a Cost Reimbursement Contract?
The less favorite contract type used by grant recipient with federal funding
is a “cost reimbursement” contract.
This is a 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.
In some cases, a reasonable profit margin is included in the cost reimbursement contract.
In this type of contract, there is little incentive for the contractor to do
the work efficiently because one hundred percent of their costs are covered by the grant recipient.
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 is written into the contract.
Why Select a Cost Reimbursement Contract with a Grant?
The cost reimbursement contract is appropriate when there is a great deal of 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 period of time. In this case, you don’t know the length of time that 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 prior to the beginning of 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 difficult to manage and will require a higher level of oversight to make sure that 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 budget.
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 review (yes, put them on your calendar) to review the appropriateness of this contract type.
You should also keep close tabs on the spending on a cost-reimbursement to keep the project on track.
Finally, make sure you stay in compliance 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.
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Lucy Morgan CPA, MBA
CEO, Compliance Warrior