Debt Limit Default

Concerns about the federal debt limit have simmered since the Government reached the limit in January, but things are coming to a boil with the Treasury Department confirming that, as early as June 1, “extraordinary measures” may be insufficient to prevent the U.S. from defaulting on its obligations. A default would be unprecedented, creating uncertainty about how the Administration will proceed. It is important, therefore, that contractors understand the circumstances and be prepared to respond effectively to a range of scenarios.

What is the Federal Debt Limit?

The federal debt limit is the maximum amount of money that Congress, by statute, permits the Treasury to borrow.  When Treasury reached this borrowing limit in January 2023, it began taking “extraordinary measures” to keep paying the federal government’s bills, but those extraordinary measures can only temporarily stave off default.  Once the federal government’s cash on hand is no longer sufficient to pay its bills despite those extraordinary measures, the U.S. could begin defaulting on its payment obligations. 

If the U.S. Reaches Default, Will the Federal Government Shut Down?

Contractors have become familiar with federal government shutdowns when Congress fails to pass appropriations needed for the fiscal year, but a debt limit default could be different.  For most federal agencies, Congress has already appropriated funds for the current fiscal year, which does not end until September 30, 2023.  Because of this, the Administration should have the appropriations necessary to continue operations even if the government does not have enough cash on hand to actually pay for those operations.  Contractors should, however, remain vigilant about shutdown preparedness given uncertainties about how the administration will proceed. 

Fundamentally, Congress’ power of the purse means that Congress decides whether (or not) to appropriate funds for a particular program or activity, and Congress decides the amount of that funding.  These appropriations (and related authorization bills, if applicable) grant the Administration a finite authority to make new obligations—in other words, appropriations from Congress permit the Administration to make promises to pay in the future (i.e. “incur obligations”) consistent with the amounts and restrictions Congress has provided in annual appropriations. 

Shutdowns typically occur when Congress has not passed appropriations for a fiscal year.  The Anti-Deficiency Act (31 U.S.C. §1341) generally bars agencies from incurring new obligations (to federal employees, contractors, and others) without congressional appropriations for the period, amount, and nature of the obligation.  As a result, if Congress does not pass an appropriations bill then federal employees must often be sent home and the federal government “shuts down.” 

Here, however, Congress has already appropriated funds for fiscal year (FY) 2023, and a debt limit breach would not revoke or alter those appropriations.  Thus, under likely interpretations of the Anti-Deficiency Act, the Administration would not lose its authority to incur obligations to operate the government, allowing the Administration to avoid a shutdown even if the Treasury could not pay all of its bills. 

As noted above, however, this circumstance is unprecedented and the federal government’s response cannot be fully known at this time.  The government could decide that it should or must diminish draws on cash by suspending some federal operations and thereby reducing its obligation to pay federal wages.  Federal contractors thus should be mindful that government operations could be disrupted.

If Government Operations Could Shut Down, What Should Contractors Do?

If relevant government operations are shut down, existing contracts and funding already committed to them are not automatically altered, even though the government may be unable to make timely contractual payments.  Contractors could, however, experience lapses in funding on incrementally funded contracts, delays resulting from contracting officer directions to stop work, and other delays and disruptions caused by an inability to obtain necessary government direction or inability to access federal sites.

Because of these possibilities, contractors should consider actions to, for example:

• Ensure personnel are aware of their obligations if stop work orders are issued, including their obligation to immediately comply with the terms of the order and to take all reasonable steps to minimize the continued incurrence of costs related to the stopped work.
• Advise relevant personnel to document and track in real time any schedule or cost impacts, and to timely advise the government contracting officer of such impacts.
• For any incrementally funded contracts at risk of exhausting funds, contact the contracting officer to determine whether additional funding can be added prior to a potential debt limit default.  Also ensure personnel are aware of FAR clause 52.232-22, Limitation of Funds, providing that the government is not obligated to reimburse a contractor for costs incurred in excess of the amount allotted to the contract, and that the contractor is not obligated to incur higher costs unless funds are added to the contract.
• For cost-reimbursement contracts that are were fully funded at award but nevertheless may be approaching the estimated cost specified in the contract Schedule, contact the contracting officer to determine whether additional funding can be added prior to a potential debt limit default.  Also ensure personnel are aware of FAR clause 52.232-20, Limitation of Cost, providing that the government is not obligated to reimburse a contractor for costs incurred in excess of the estimated cost stated in the Schedule and that the contractor is not obligated to incur higher costs unless the contracting officer increases the estimated cost.
• Where contract performance requires access to federal sites or may require critical government direction in order to proceed, contact government representatives to determine whether any plans are in place or direction is provided if government operations are disrupted due to a debt ceiling default.
• Where invoices have been submitted but are not yet approved for payment, contact the government to determine whether approvals can be completed promptly to increase the chance of payment prior to a debt ceiling default.

What Payments Stop? 

Regardless of whether government operations are shut down, contractors should expect delays in payment if there is a debt limit default.  Some have suggested that the Treasury could choose to prioritize certain types payments while delaying others, but that has never been done and implementation could be challenging.  Others have suggested that Treasury must, or should choose to, treat all obligations equally, paying each in order as cash becomes available.  At this time, the Treasury has not issued public guidance about how it will proceed.  Under either scenario, however, contractors would see delays in payments—perhaps even more so if the Treasury chooses to prioritize bond payments and/or mandatory spending programs like Social Security.  Contractors should consider whether they have adequate resources in place or access to funding to sustain operations in the event of a prolonged delay in payments. 

What if I Do Not Get Paid for My Work?  Can I Stop Performance?

In extreme circumstances, contractors may face questions of whether to continue performance in the face of potentially material government failures to pay.  A unilateral cessation of work involves considerable risk for a contractor, particularly considering the duty to proceed imposed by the FAR “Disputes” clause.  FAR 52.233-1 requires that “[t]he Contractor shall proceed diligently with performance of this contract, pending final resolution of any request for relief, claim, appeal, or action arising under the contract.”  The “Alt. I” version of the Disputes clause extends that duty further to issues “relating to” the contract, which is generally understood to include government breach.  Failure to comply with the duty to proceed can be an independent basis for the government to terminate a contractor for default.  Thus, it is important that contractors considering any unilateral cessation of performance first seek legal guidance based upon a detailed analysis of the relevant facts and law. 

Key Takeaways

• A debt limit default may not occur, and if it does, it may not last long. But contractors should be aware of the potential consequences and be prepared for a range of potential impacts. 
• A debt limit default may not force a government shutdown, but the administration could impose a full or partial shutdown of government operations for which contractors should be prepared.
• The Treasury’s ability and willingness to prioritize certain types of payments is uncertain at this time, but contractors should expect payment delays under any scenario following a debt limit default.
• Contractors should not assume that payment delays will automatically allow them to cease performance.

Our team is closely monitoring events and standing by to help you work through any issues that may arise.