Contractual Means of Achieving High-level Performance in Transit Contracts (2013)

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4 contract, the criteria to consider when writing perform- ance standards, and the surveillance methods used by transit agencies to assure compliance with the stan- dards and delivery deadlines in contracts. Section V of the digest discusses the transit agen- cies’ best practices when using incentive-payment and liquidated-damages clauses in their contracts, the ex- tent to which agencies responding to the survey are paying incentives or collecting liquidated damages, and examples of incentive-payment and liquidated-damages clauses that transit agencies are using. Section VI of the digest discusses the transit agen- cies’ evaluation of performance-based contracting; the effect of the incentive-payment and liquidated-damages clauses on claims against transit agencies; and the po- tential for claims by contractors for a contractor’s addi- tional costs if a contractor accelerates performance of a contract to meet an incentive-payment or avoid a liqui- dated-damages deadline under the contract; and other issues such as the need for carefully drafted contractual provisions to reduce the risk of claims. Finally, it may be noted that the transit agencies’ responses to the survey are discussed throughout the digest. Appendix C contains examples of incentive- payment and liquidated-damages clauses and perform- ance standards now being used by transit agencies in their various contracts, such as for construction projects or for the procurement of capital equipment or services. II. THE USE OF INCENTIVE AND LIQUIDATED- DAMAGES CLAUSES IN CONTRACTS WITH FTA FUNDING A. Introduction Liquidated-damages and incentive clauses may be used by a grantee for any project receiving financial assistance from the FTA, including funding for fixed guideways and for equipment and other capital acquisi- tions. The payment of VE incentives also is authorized. B. FTA New Starts Program An important part of FTA’s funding of transit agen- cies is the New Starts program, which applies to a new fixed guideway system or to an extension of an existing fixed guideway system.10 A “fixed guide- way” is a public transportation facility using and occu- pying a separate right-of-way or rail for the exclusive use of public transportation and other high-occupancy vehicles or “using a fixed catenary system and a right- of-way usable by other forms of transportation.”11 A fixed guideway system includes a rapid rail, light rail, commuter rail, or automated guideway transit system; people movers; ferry boat service; and fixed guideway facilities for buses (such as for bus rapid transit) and other high-occupancy vehicles.12 Part 10 49 C.F.R. § 611.5. 11 49 U.S.C. § 5302(a)(4)(A) and (B). 12 49 C.F.R. § 611.5. 611(a) of Title 49 of the Code of Federal Regulations (C.F.R.) governs the process that applicants must follow for capital investment grants and loans for new fixed guideway systems or extensions of existing systems. However, Part 611 does not apply “if the total amount of funding from 49 United States Code (U.S.C.) 5309 will be less than $25 million, or if such projects are oth- erwise exempt from evaluation by statute.”13 It may be noted that there are incentives for grantees under the New Starts/Small Starts Program authorized by the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU).14 As explained in the FTA Contractor Performance Incentive Report (CPIR), “[f]or grantees, SAFETEA-LU authorizes the Secretary to allow for additional scope to be added to a Full Funding Grant Agreement (FFGA) project if the final cost comes in below the original FFGA project cost, 49 U.S.C. 5309(h)(2).”15 Furthermore, a grantee may receive a higher share of federal funding when the Secretary determines that “the net project cost of the project is not more than 10 percent higher than the net project cost estimated at the time the project was approved for advancement into preliminary engineering” and that “the ridership estimated for the project is not less than 90 percent of the ridership estimated for the project at the time the project was approved for ad- vancement into preliminary engineering….”16 C. Funding of Capital Projects In August 2008, FTA submitted a Report to Con- gress on Incentives in Federal Transit Formula Grant Programs.17 As the report notes, pursuant to 49 U.S.C. § 5307 and 49 U.S.C. § 5311, respectively, there are two incentives, one for urbanized areas (§ 5307) and one for rural and small urban areas (§ 5311). An ur- banized area is one with a population of not less than 50,000 people.18 D. Use of Value Engineering A Transportation Research Board Synthesis states that a VE incentive clause may be used in connection with a construction project.19 At the time of the Synthe- 13 Id. § 611.3(b). 14 49 U.S.C. § 5309(d). 15 FED. TRANS. ADM., OFFICE OF BUDGET AND POLICY, CONTRACTOR PERFORMANCE INCENTIVE REPORT 2 (Nov. 20, 2006) (hereinafter “CPIR”), available at http://www.fta.dot.gov /documents/ContractorPerformanceIncentiveReport102006. pdf. 16 Id. (citations omitted). 17 SEC’Y OF TRANSP., REPORT TO THE UNITED STATES CONGRESS PURSUANT TO 49 U.S.C. § 5336(c) (Aug. 2008), avail- able at http://www.fta.dot.gov/documents/Incentives_Report_- _Final_As_Approved_8-14-08.pdf. 18 49 U.S.C. § 5302(a)(17). 19 JOEL T. CALLAHAN, MANAGING TRANSIT CONSTRUCTION CONTRACT CLAIMS 18 (Transit Cooperative Research Program Synthesis 28, 1998), available at http://onlinepubs.trb.org/

5 sis, 90 percent of the reporting agencies used VE dur- ing the design phase. According to the Construction Project Management Handbook (CPMH), a project manager should encourage contractors to raise VE ideas and the Agency to include incentives in con- struction contracts for contractors to propose VE changes to the work called for in the drawings and specifications. If the proposed changes are acceptable to the Agency the cost savings could be shared between the Agency and the contractor. 20 VE “reflects an effort by the government to reward the contractor for its initiative by permitting it to share in this reduced cost of the work.”21 The Federal Acqui- sition Regulations (FAR), which provide guidance on the use of VE for various types of contracts, includes specific VE clauses to be used.22 FAR Section 48.202 requires the insertion of a VE clause in construction solicitations and contracts exceeding a certain amount.23 According to FTA’s most recent circular on the subject, first, the Common Grant Rule for govern- mental recipients encourages them to use VE clauses in contracts for construction projects.24 Second, the FTA “generally will not approve a New Starts grant applica- tion for final design funding or a full funding grant agreement until value engineering is complete.”25 If a contract, such as a design-build contract, includes value engineering, “FTA does not require separate value engineering proposals, contract changes, or other onlinepubs/tcrp/tsyn28.pdf (stating that “[t]he objective of value engineering during the design stage of a project is to ensure that the completed facility is adequate for its function at the lowest life-cycle cost reasonable”). 20 Construction Project Management Handbook at 6-6, here- inafter cited as “CPMH,” available at http://www.fta.dot. gov/documents/FTA-CONSTRUCTION-PRJT-MGMT- HDBK2009.pdf, last accessed May 31, 2012. 21 SMITH, CURRIE & HANCOCK, FEDERAL GOVERNMENT CONSTRUCTION CONTRACTS, A PRACTICAL GUIDE FOR THE INDUSTRY PROFESSIONAL 309 (Thomas J. Kelleher, Jr., Thomas E. Abernathy IV, Hubert J. Bell, Jr., & Steven L. Reed, Eds., John Wiley & Sons, Inc., 2d ed. 2010) (hereinafter cited as “Smith, Currie & Hancock”). 22 Id. See FAR §§ 48.001 and 52.248-3. 23 Subpart 48.202. Clause for construction contracts, states, The contracting officer shall insert the clause at 52.248-3, Value Engineering—Construction, in construction solicitations and contracts when the contract amount is estimated to exceed the simplified acquisition threshold, unless an incentive contract is contemplated. The contracting officer may include the clause in contracts of lesser value if the contracting officer sees a po- tential for significant savings. The contracting officer shall not include the clause in incentive-type contraction contracts. If the head of the contracting activity determines that the cost of com- puting and tracking collateral savings for a contract will exceed the benefits to be derived, the contracting officer shall use the clause with its Alternate I. See also FAR § 52.248.3. 24 FTA Circular 4220.1F, at IV-28, http://www.fta.dot.gov /documents/FTA_Circular_4220.1F_-_Finalpub1.pdf. 25 Id. processes.”26 FTA states, moreover, that “[f]rom a pro- curement view, the concept of value engineering is more important than the form it takes.”27 Transit agencies reported on whether they have made incentive payments during the most recent 3-year period to contractors for submitting proposals that re- duced the cost of a project (Table 2). Nineteen agencies said that they had not, whereas four agencies reported that they had made such payments. The Southeastern Pennsylvania Transportation Authority (SEPTA) re- ported paying $234,000 for VE.28 26 Id. 27 Id. 28 Survey response of Southeastern Pennsylvania Transpor- tation Authority (SEPTA).

6 Table 2. Incentive Payments to Contractors for Proposals Reducing Project Cost for the Most Recent 3-Year Period. No. of Agencies Agencies that had paid incentives 4 (15%) Agencies that had not paid incentives 19 (70%) Agencies for which information was not available or that did not respond 4 (15%) In contrast, according to the Washington State DOT, the department has used an early completion incentive to reward contractors for the early completion of a pro- ject or a phase of a project, thereby reducing the impact of construction projects on the public.29 On some pro- jects, contracts permitted contractors to bid the amount of time needed to perform the work for which the department paid a premium for early completion.30 The department also pays performance contract- ing rewards to contractors for submitting ideas that lower the cost of a project, referred to as Cost Reduction Incentive Proposals or CRIPs.31 Thus, the department uses performance contracting to reward contractors throughout a project for providing consistent, on-time, high-quality performance.32 Since 2000, Washington State DOT has used performance contracting to pay more than $4.5 million in schedule-related incentives on 61 completed contracts.33 The department paid more than $836,000 in incentives, averaging almost $70,000 per contract, on 12 contracts completed in 2009.34 E. Value Engineering Clauses The Massachusetts Bay Transportation Authority’s (MBTA) General Conditions include a provision author- izing payments for VE. In brief, the provision permits a contractor to submit a proposal for a cost reduction that is based on a “sound study” conducted by the contractor that will result in a net saving to the agency. The proposal must be one that does not impair the project or require an “unacceptable extension” of the contract. The submission must describe the pro- 29 Washington State Dep’t of Transp., Performance Con- tracting at the Washington State Department of Transportation (undated), available at http://www.ofm.wa.gov/contracts/ resources/performance_based/performance_contracting_ wsdot.pdf. 30 Id. 31 Id. 32 Id. 33 Id. 34 Id. posed change and the difference it will make in the ex- isting contract and estimate the reduction in the cost of the contract. The decision of the agency whether to accept the proposal is final, and, if accepted, there is an equitable adjustment in the contract price by reducing the price by the amount of the “estimated decrease in the cost of performance minus 50 percent of the difference….” Thus, the agency and the contrac- tor share equally in the saving of the cost of perform- ance because of the contractor’s proposal. The aforesaid MBTA contractual provision states in full as follows: 1.1 CONTRACTOR COST REDUCTION PROPOSALS VALUE ENGINEERING (APPLICABLE TO CONTRACTS IN EXCESS OF $200,000) A. The Contractor may submit cost reduction Proposals for changing the Contract requirements. The Proposals shall be based upon a sound study made by the Contractor indi- cating that the Proposal: 1. Will result in a net reduction in the total Contract cost to the Authority; 2. Will not impair any essential form, fit, function, or characteristic of the Work, such as safety, service life, re- liability, economy of operation, ease of maintenance, and necessary standardized features; 3. Will not require an unacceptable extension of the Con- tract completion time; and 4. Will require a Change Order to the Contract. B. Cost reduction or Value Engineering Proposals shall be processed in the same manner as prescribed for any Contract initiated Proposal which would necessitate issu- ance of a Change Order. The Contractor shall submit the following information as a minimum, with each Cost reduc- tion Proposal: 1. A description of the difference between the existing Contract requirements and the proposed change, and the comparative advantages and disadvantages of each; 2. An itemization of the requirements of the Contract which must be changed if the Proposal is adopted and a recommendation as how to make such change (e.g., sug- gested revision);