The purpose of this policy is to reduce the government’s risk of financial exposure in the event a contractor fails to perform. Air Force supplemental guidance includes a standard contract clause allowing contracting officers to use their discretion in determining the amount to be withheld. At the Naval Sea Systems Command and the Naval Air System Command (NAVAIR) procurement and contracting officials agreed that amounts withheld should directly relate to the anticipated cost of work to be performed by a contractor after delivery. In July 1997, AFMC revised this clause and left the determination of the amount withheld to the contracting officer’s discretion. Inadequate Withholds Result in Contractors Being Paid for Work Not Completed

Our review of four selected acquisition programs indicated that each of the services conditionally accepted nonconforming items, with the expectation that the contractors would correct known deficiencies and complete unfinished work. When conditionally accepting nonconforming items, each of the services paid contractors the billing prices, assuming 100-percent completion, less some amount that was withheld for nonconforming or unfinished work. The services differed in how they determined the withhold amounts, but in each case, the amounts were less than the estimated costs to correct known deficiencies and complete unfinished work. However, the amount withheld was significantly less than the estimated cost to correct known deficiencies and finish other incomplete work. Program officials told us that the withhold policy implemented in the C-17 program was not intended to cover the estimated cost and profit of the work remaining to be done by the contractor after conditional acceptance. Our review indicated that the cost and profit to correct deficiencies and complete unfinished work for production lots III and IV exceeded the $47 million withheld by about $61 million, based on the contractor’s estimates of the cost of the aircraft at completion, or about $127 million, based on DCMC’s estimates of the cost of aircraft at completion. In July 1995, the program office modified the contract’s conditional acceptance clause to require an additional withhold amount on program year 1 and  2 vehicles. At the time of our review, the contractor had generally completed work and corrected deficiencies identified at the time of conditional acceptance. Although the contracting officer withheld payment for the above noted work, he did not withhold for other deficiencies. As a result, the services’ withholding practices are inconsistent and contractors are being paid for work not completed at the time of delivery. We also spoke with the DOD Director of Defense Procurement and with acquisition and contracting officials from the Departments of the Air Force, the Army, and the Navy and the Defense Logistics Agency located in Washington, D.C., to determine their policies and procedures for accepting temporarily nonconforming items.
Why GAO Did This Study

GAO reviewed the Air Force's procedures for payment to contractors for work not completed at the time of delivery, focusing on whether: (1) this situation occurred in other programs; and (2) additional guidance was needed to avoid paying contractors for work not done at the time of delivery.

What GAO Found

GAO noted that: (1) its review of four selected Air Force, Army, and Navy acquisition programs showed that each of the services accept items conditionally; (2) however, federal and Department of Defense (DOD) regulations do not provide guidance to contracting officers for determining amounts to be withheld from payments in these cases; (3) there is no consensus among Office of the Secretary of Defense and service officials as to what policy should govern payments at the time of conditional acceptance; (4) some officials agreed that the amount withheld should reflect the estimated cost and profit associated with the work to be done by a contractor after delivery while others indicated that contracting officers should have discretion to withhold whatever amount they determine appropriate; (5) the extent of service guidance ranged from the Army providing no guidance to standard Air Force and Navy contract clauses that leave determining the amount to be withheld to the contracting officer's discretion; (6) such guidance does not ensure that the amount withheld reflects the estimated cost and profit to correct known deficiencies and perform other incomplete work; (7) as a result, it lacks the safeguards necessary to reduce the government's risk of financial exposure and is inconsistent with the policy of paying only for completed work; (8) GAO's review of the four selected acquisition programs showed that when items were conditionally accepted, each of the services paid contractors the billing price, assuming 100-percent completion, less some amount for nonconforming or unfinished work; (9) in general, the amounts withheld were less than the costs to correct known deficiencies and complete unfinished work and resulted in contractors being paid for work that had not been performed at the time of conditional acceptance; (10) for example, the estimated price to correct known deficiencies and complete unfinished work on two C-17 production contracts exceeded the amounts withheld by about $61 million, based on the contractor's cost estimates, or $127 million based on the cost estimates used by the Defense Contract Management Command in administering the contract; (11) the Hunter Unmanned Aerial Vehicle program accepted five systems with six conditional waivers for which no money was withheld; (12) program officials told GAO that they believed the contractor would correct the deficiencies; and (13) the program office was not able to provide an estimate of the potential cost of this work.