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Contract Options: Know the Requirements.

Contracting officers must test the market before exercising an option. Failure to do so can have serious consequences.

The use of options is widespread in government contracting. [1] Options are frequently used to obtain additional quantities of supplies and to extend performance periods, particularly where funding limitations preclude agencies from entering into contracts for more than one fiscal year. It is not unusual for service contracts that are funded with annual funds to include a base year with as many as four option years. Such contracts potentially can freeze the losing competitors out of the market for as many as five years.

The Federal Acquisition Regulation (FAR) provides for a detailed procedure that contracting officers must follow before exercising an option. [2] The comptroller general has held that "the intent of the regulations concerning the exercise of options is not to afford a firm that offered high prices under an original solicitation a second chance to beat the contractor's option price." [3] Nonetheless, unsuccessful bidders and offerors have succeeded at times in overturning the attempted exercise of an option and forcing a recompetition. [4] This article addresses the option exercise issues that are faced by the contracting officer, the contractor, and the competitors who are seeking another chance for success.

The Regulatory Requirements

Regarding options, FAR 17.207(c) provides that

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 (see paragraphs (d) and (e) of this section) considered; and

(4) The option was synopsized in accordance with Part 5 unless exempted by 5.202(a)(11) or other appropriate exemptions in 5.202.

The contentious requirement is the determination that the option exercise is the most advantageous method of fulfilling the government's needs, price, and other factors considered. The regulations provide that this determination must be based on (1) a new solicitation that fails to produce a better price or more advantageous offer than the option, (2) an informal analysis of prices or an examination of the market that indicates the particular option is the better price or more advantageous offer, or (3) the fact that the time between award of the initial contract and the exercise of the option is so short, it indicates that the option price is the lowest price obtainable. [5] With respect to the consideration of "other factors," the regulations provide that the contracting officer's determination should take into account the government's need for continuity of operations and the potential cost of disrupting operations. [6]

The contracting officer's responsibility to perform the necessary test of the market before exercising an option is very serious. In at least one instance, a contracting officer has been held liable for failure to exercise this responsibility. In that situation, the contracting officer exercised an option for liquid chlorine for $355 per ton without testing the market. The producer price index for the product was $165 per ton, and the agency docked the contracting officer more than $80,000 in pay and retirement benefits for his failure to comply with the FAR requirements to conduct a market price study prior to exercising an option extending a contract. That assessment was upheld by the comptroller general. [7]

Issuance of a New Solicitation

Although the issuance of a new solicitation is the first method listed in the regulations for testing the market, it should not be used if the anticipation is that the best price available is the option price. [8] Generally, a new solicitation is issued after an informal analysis of prices or when the market indicates that better prices or offers may be obtained.

When a new solicitation is issued, however, the option prices are disclosed because the evaluation of bids or offers is based on whether they are better than the option. This disclosure of option prices places the contractor in the unenviable position of bidding against his own contract price or hoping that a competitor will not go lower than the option price bull's-eye that is prominently displayed in the new solicitation. Contractors have complained bitterly that such disclosure of option pricing is unfair. These complaints have been rejected uniformly by the comptroller general on the ground that option prices are not confidential or proprietary information. [9] Courts likewise have found that contract pricing information is releasable under the Freedom of Information Act. [10] The court decisions turn on the finding that option prices are not confidential business information the release of which would (1) impair the government's ability to obtain necessary information in the future or (2) cause substant ial harm to the competitive position of the person from whom the information was obtained. [11]

Contractors have also argued that new solicitations that expose option prices are tantamount to a prohibited auction. However, the comptroller general has rejected that argument on the grounds that it is proper to advise bidders that their bids would be compared to option prices because that comparison is decisive in determining whether awards will be made under the solicitation. [12] Thus, if a new solicitation is used as the basis to test the market prior to the exercise of an option, the contractor is at a severe disadvantage.

Unsuccessful competitors may try to encourage contracting officers to issue a new solicitation by promising lower prices than the option. However, a contracting officer may properly disregard bare promises of lower prices without a tangible, enforceable guarantee. For example, the comptroller general has held that an unsuccessful competitor's "offer" of more advantageous pricing was not credible because no financial information to support a lower but unspecified price had been provided to the contracting officer. [13] Similarly, the comptroller general upheld a contracting officer's rejection of an unsuccessful competitor's offer to perform at a lower price than the option price where the offeror originally had been determined to be nonresponsible and no evidence had been found that those inadequacies had been eliminated. [14]

Although contracting officers are not required to consider unenforceable "offers" from previously unsuccessful bidders or offerors, it would be hard to ignore a firm offer at a price below the option price. Ignoring such an offer would be particularly difficult when the new offer included information that supported and justified any reduction from prior unsuccessful offers. In such a case, the new offer would reflect a change in the market and not simply an attempt by a previously unsuccessful offeror to get another "bite at the apple." Where a new, firm offer indicates that the option price is not the most advantageous price for the government, the proper course of action would appear to be for the contracting officer to formally issue a new solicitation to test the market. A sole-source award to the new offeror would not be justified. An interesting question is whether the firm offer and the option price should be disclosed in the new solicitation. Seemingly, a strong argument can be made that both prices should be disclosed, as those are the prices against which other offers would be evaluated. [15] In that instance, the unsuccessful competitor offering the new, "firm" offer is at the same disadvantage as the contractor. Each is placed in the unenviable position of bidding against oneself.

Informal Price Analysis

Apart from any new solicitation, a contracting officer may also test the market through an informal price analysis. The comptroller general has observed that "[t]he FAR grants contracting officers wide discretion in determining what constitutes a reasonable informal price analysis or examination of the market for available prices." [16] In this regard, the comptroller general has upheld the reasonableness of price analysis that compared the protester's unsolicited proposal with the option price and determined that the option was more advantageous. [17]

Likewise, the comptroller general has upheld a contracting officer's determination to exercise an option where the test of the market involved only a comparison of the option pricing with the prices offered in the original competition. [18] In that case, the comptroller general noted that the contracting officer had also considered both the desirability of maintaining program continuity and the administrative costs of conducting a new competition. The comptroller general further emphasized that "[t]he exercise of an option does not permit a firm seeking to compete with an opportunity to compel a new competition or a 'market test' merely by virtue of suggesting that it might provide a lower price." [19]

The comptroller general has also denied a protest against the exercise of an option where the contracting officer's determination under FAR 17.207(d) was based on a favorable comparison of the rate of increase in the option price with the base-year price and the Consumer Price Index increases. [20]

Informal Market Surveys

Under FAR 17.207(d), a contracting officer may also test the market through an informal market survey. Again, wide latitude is afforded the contracting officer in making such a survey. The comptroller general has stated that "[w]here an agency elects to conduct an informal market survey, the form the survey takes is largely within the discretion of the contracting officer, as long as it is reasonable." [21] Thus, in making a market survey to determine whether the exercise of an option is most advantageous to the government, a contracting officer is not required to contact all available sources. [22] Likewise, the comptroller general has upheld a contracting officer's determination to exercise an option where there had been only two offerors out of eleven solicited firms for the initial procurement, and there had been "no changes in the marketplace for the labor categories that would drive salaries and benefits down." [23] Moreover, even where the market survey shows a lower price had been obtained for the ite m, the contracting officer properly may conclude that the price for the option quantity is more advantageous based on the fact that it is for a much smaller quantity. [24] In that regard, the contracting officer concluded that the lower price on the more recent procurement was based substantially on the fact that a much larger quantity was involved (4 million versus 213,312 for the option quantity).

The Contracting Officer's Discretion Is Not Unfettered

Although a contracting officer has great latitude in making a determination, under FAR 17.207, that the use of an option is the most advantageous method of meeting the agency's requirements, the contracting officer's determination must nonetheless be supported and rational. In AAA Engineering & Drafting, Inc. , [25] the comptroller general upheld a protest against the exercise of an option where the contracting officer failed to take into account changes in the local marketplace and in the contract itself that likely would have resulted in lower prices under a new solicitation. The contract at issue called for the preparation, processing, and storage of technical orders. Included in the work scope was a requirement for climate-controlled storage. The original contract required only 3.6 percent of the total storage to be climate controlled, but during performance, this amount increased to approximately 50 percent of the total storage. Moreover, the market rate for climate-controlled storage in the contract loc ations was approximately $3 per square foot as compared with the option price of $8 per square foot. Considering these facts, the comptroller general found that the contracting officer's determination to exercise the option, based solely on a comparison of the option price with the option prices proposed by the unsuccessful offerors in the initial procurement, was unreasonable.

In Banknote Corporation of America, Inc., [26] the comptroller general sustained another protest against the exercise of an option on the basis that the agency's determination under FAR 17.207 was unsupported and lacked a rational basis. In that case, involving a procurement for printing food stamps, the contracting officer determined that the option price was most advantageous based solely on a comparison of the option prices proposed in the original procurement. However, the original contract had been awarded to the only company that, at the time, offered to supply all contract line items. Moreover, that offer had been submitted on an "all or none" basis. The comptroller general found that, subsequent to the award of the initial contract, capacity for specialized printing was greatly increased in the industry and that fact had been communicated to the agency. In other words, the market had changed substantially, and greater competition could be expected, which would lower prices.

Although the previously unsuccessful offerors in AAA Engineering and Banknote Corporation were successful in protests against the exercise of options on the contracts they had lost, they were Pyrrhic victories because performance had continued during the pendency of the protests. The comptroller general sustained the protests but did not recommend termination of the contracts.

This continued performance is a problem for unsuccessful bidders and offerors. Apparently, a protest against the exercise of a option does not invoke the automatic stay provisions of FAR 33.104. In this regard, the stay provisions relate to the award of a contract or to performance after the award of a contract. The exercise of an option does not involve the award of a contract. For example, a decision not to exercise an option that is based on responsibility-type concerns does not require referral to the Small Business Administration because such a decision does not involve a responsibility determination. [27] The comptroller general has held that the concept of responsibility is applicable only in the contract formation process and not in the administration of contracts already awarded. [28] Moreover, even if the stay provision were applicable, it would likely be overridden in those cases where the option was for continuing services. In other words, a competitor who believes that a change in requirements o r in the market has occurred that would lead to lower prices should make that case to the contracting officer well in advance of the option exercise date. A contracting officer will need time to assess the ramifications of the information and make his or her own determination.

Price Is Not the Only Factor to Be Considered

The determination under FAR 17.207(c)(3) that the exercise of an option is the most advantageous method of fulfilling the government's needs takes into account both "other factors" and price. As previously mentioned, the regulation provides that "other factors" include the government's need for continuity of operations and the potential costs of disrupting operations. [29] However, those other factors may also take into account the factors that are considered in making a best-value selection, including technical considerations. [30]

Conclusion

The exercise of an option is not a ministerial act. A contracting officer must carefully follow the regulatory requirements of the FAR in determining that the exercise of the option is the most advantageous method of fulfilling the government's needs while also considering price and other factors. Although contracting officers have considerable discretion in how they test the market to make that determination, it nonetheless must be a rational, supported decision. Most important, a contracting officer must consider whether a change has occurred in either the contract or the market that might affect whether the option is most advantageous. In those situations when a contracting officer decides to test the market by issuing a new solicitation, the contractor is placed in a difficult position. Most likely, its option prices will be exposed as a target for competitors. In contrast, competitors who were unsuccessful in the original procurement cannot easily force a recompetition for the option. A mere offer to sub mit a lower price without more substantial information is insufficient. However, when a competitor can demonstrate that a change has occurred in the market or in other circumstances that would justify lower prices, that competitor may possibly get another bite at the apple.

About the Author

D. WHITNEY THORNTON II is a partner in the San Francisco office of Seyfarth Shaw, where he practices government contract law. He is a member of the Silicon Valley Chapter. The assistance of Peter S. Vincent, an associate with Seyfarth Shaw, in the research for this article is gratefully acknowledged.

Endnotes

(1.) The use of options is covered in FAR 17.201, Special Contracting Methods, Definition, which 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."

(2.) FAR 17.207, Special Contracting Methods, Exercise of option. In addition, options must be exercised in strict accordance with the terms of the contract's option provision. See, e.g., Aydin Corp., ASBCA No. 43273, 93-2 BCA 25575.

(3.) Alice Roofing & Sheet Metal Works, Inc., B-283, 153, 99-2 CPD 70 (October 13, 1999).

(4.) It should be noted that the comptroller general will not consider protests against a contracting officer's refusal to exercise an option because the decision is a matter of contract administration outside the scope of the General Accounting Office's bid protest function. Digital Systems Group, Inc.-- Reconsideration, B-252,080, B-252080.2, 93-1 CPD 228 (March 12, 1993).

(5.) FAR 17.207(d), Special Contracting Methods, Exercise of Option.

(6.) FAR 17.207(e), Special Contracting Methods, Exercise of Option.

(7.) John Martino, B-262, 168, 96-1 CPD 256 (May 24, 1996).

(8.) FAR 17.207(d)(1), Special Contracting Methods, Exercise of Option.

(9.) See, e.g., Grant's Janitorial and Food Service, Inc., B-244,170, 91-1 CPD 512 (May 28, 1991); JL Associates, Inc., B-239, 790, 90-2 CPD 261 (October 1, 1990).

(10.) See Pacific Architects and Engineers, Inc. v. Department of State, 906 F.2d 1345 (1990); Acumenics Research & Technology v. Department of Justice, 843 F.2d 800 (1988); Racal-Milgo Government Systems v. Small Business Admin., 559 F.Supp.4 (1981). But see McDonnell Douglas Corp. v. NASA, 180 F.3d 303 (1999).

(11.) This test is set out in National Park and Conservation Ass'n. v. Morton, 498 F.2d 765, 770 (D.C. Cir. 1970), which is the leading case on this issue.

(12.) California Shorthand Reporting, B-236,680, 89-2 CPD 584 (December 22, 1989).

(13.) Sippican, Inc., B-257, 047, 95-2 CPD 220 (November 13, 1995).

(14.) Multi Services Assistance, Inc., B-248, 519, 93-1 CPD 296 (April 6, 1993).

(15.) See California Shorthand Reporting (1998).

(16.) Tycho Technology, Inc., B-222, 413, 90-1 CPD 500 (May 25, 1990).

(17.) Ibid.

(18.) Washington Consulting and Management Associates, Inc., B-243, 116, 91-2 CPD (July 19, 1991).

(19.) Ibid., 2.

(20.) See Alice Roofing & Sheet Metal Works, Inc., (1999).

(21.) National Customer Engineering, B-251, 034, 93-1 CPD 129 (February 11, 1993).

(22.) National Customer Engineering, (1999) p. 2, "While it may be appropriate in certain circumstances to contact all available sources to determine whether an option price is most advantageous, such a procedure is not mandated by regulation."

(23.) Person-System Integration, Ltd., B-246, 142, 92-1 CPD 204 (February 19, 1992). In that case, the comptroller general also noted that the contracting officer considered other factors including the desirability of maintaining program continuity and the superiority of contractor's proposal in the original competition.

(24.) Valentec Wells, Inc., B-239, 498, 90-2 CPD 176 (August 29, 1990).

(25.) AAA Engineering and Drafting, Inc., B-236, 034, B-236, 034.2, 92-1 CDP 307 (March 26, 1992).

(26.) Banknote Corporation of America, Inc., B-250, 151, 92-2 CPD 413 (December 14, 1992).

(27.) E. Huttenbauer & Son, Inc., B-258, 018, B-258018.3, 95-1 CPD 148 (March 20, 1995).

(28.) Ibid.

(29.) FAR 17.207(e), Special Contracting Methods, Exercise of Option.

(30.) Person-System Integration, Ltd. (1992), "[T]he contracting officer's determination here was not dependent on price alone. Rather the determination was based on price and other factors, such as the desirability of maintaining program continuity and the superiority of ISI's original proposal" (emphasis added).
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Author:THORNTON II, D. WHITNEY
Publication:Contract Management
Geographic Code:1USA
Date:Oct 1, 2000
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