ommend a more complete audit, in whole or in part, in respect to the items which seemed questionable. Then we might contemplate, after this group had made a negotiated settlement, that they would render a report which I understand is customary, probably to the Accounting Office, and their head contracting officer, which would outline the basis of settlement and would call attention to any unusual circumstances which might be subject to further investigation. Of course, prior to this negotiated settlement, it has been indicated the contractor is always required to submit his data with his claim, his supporting data, which gives an introduction and gives a starting point for the negotiation. We believe, then, that in order to aid the financial position of the contractor that the Government should be authorized immediately upon presentation of its claim and before any negotiation, advance payment in some equitable percentage. A percentage of 35 or 40 percent has been suggested. This is without any audit or any check whatever. After completion of the negotiated settlement we believe that then a complete 100-percent payment less any advance payment should be made to the contractor upon recommendation of the negotiating group. We believe that the condition of the settlement should be that that payment should be made in some reasonably prompt time, say 30 days. In other words, the contractor may say, as a result of negotiation, "I can afford to take $100,000 for the sake of settling it," but his answer would be different if it was a settlement of $100,000 which he might get a year from then. That is, of course, just a suggested outline which would require careful study, but we believe the two important features are finality and speed. Thank you. Senator MURRAY. Thank you very much. The hearing will now take a recess until Friday morning, October 15, at which time we have several other witnesses. (At 12:05 p. m. a recess was taken until the following day, Friday, October 15, 1943, at 10 a. m.) PROBLEMS OF CONTRACT TERMINATION FRIDAY, OCTOBER 15, 1943 UNITED STATES SENATE, SUBCOMMITTEE ON CONTRACT TERMINATION Washington, D. C. The subcommittee met at 10:15 a. m., pursuant to adjournment, in room 357, Senate Office Building, Senator James E. Murray (chairman of the subcommittee) presiding. Present: Senator Murray (chairman). Also present: Dr. Robert K. Lamb, staff director; A. G. Silverman, general counsel; and B. M. Gross, chief of hearings and research. Senator MURRAY. The hearing will come to order. The hearing this morning will continue with statements by witnesses who have been notified to be here for this purpose. At the close of the hearing today, I will have a statement to make which I think will be of interest to all those who are studying this problem. It happened yesterday that the three witnesses at our hearing on contract termination were representatives of smaller businesses. We have here today the representatives of the Baldwin Locomotive Works and the Aeronautical Chamber of Commerce of America. These gentlemen will probably typify the producers of the two leading lines of military end products-tanks and planes-in the termination problems they have encountered. We have not to date considered the largescale problems of the builders of merchant or naval vessels, but hope to do so before the close of this series of hearings. The subcommittee will probably reconvene on Thursday, October 21, to hear additional representatives of business, and we expect to begin the hearing of representatives of Government agencies on Tuesday, October 26. Further announcements will appear in the press as the schedule of these hearings is settled. Our first witness today is Mr. J. Tyson Stokes of the Baldwin Locomotive Works. Mr. Stokes will please take the stand. STATEMENT OF J. TYSON STOKES, A VICE PRESIDENT OF THE BALDWIN LOCOMOTIVE WORKS, PHILADELPHIA, PA. Senator MURRAY. Mr. Stokes, have you a prepared statement which you wish to put in the record and then discuss it? Mr. STOKES. Mr. Chairman, I think if I might paraphrase my prepared statement, it might be more effective, and then discuss any questions which may develop as a result of that introduction. Senator MURRAY. That will be satisfactory, and your statement will be included in the record. 39 (The statement referred to is as follows:) MEMORANDUM OF THE BALDWIN LOCOMOTIVE WORKS REGARDING TERMINATION OF GOVERNMENT CONTRACTS The purpose of this memorandum is to set forth in summarized form (1) the experience which the Baldwin Locomotive Works has had to date with the problems arising from the termination by the Government, for its convenience, of certain large prime contracts prior to the completion of performance thereof; (2) to express certain conclusions which have been reached in the light of this termination experience; and (3) to suggest the necessity of prompt remedial legislative action on the part of the Congress. I. EXPERIENCE Because Baldwin's manufacturing facilities were readily adaptable to the manufacture of military tanks, Baldwin has from time to time, commencing in the latter part of 1940, entered into several cost-plus-a-fixed-fee contracts with the United States, acting through the War Department, for the furnishing of a large quantity of military tanks of various types and sizes. The production schedule contemplated by these contracts would have carried tank production by Baldwin through the calendar year 1944. However, in the spring of 1943, a change in the country's military requirements made it necessary to curtail Baldwin's production of tanks so as to enable it to increase substantially its locomotive production. Accordingly, notices of termination were received in April and May of 1943 from the Government's contracting officer, which notices directed the company to terminate all work under two contracts, one for heavy tanks and the other for medium tanks, except as necessary to complete a specific number by the end of the calendar year 1943. Baldwin has therefore had about 6 months in which to accumulate much valuable and practical termination experience. The production of military tanks in assembly line quantities has involved many extremely difficult procurement and production problems. A tank is an assembly of thousands of separate parts and subassemblies, to a large extent manufactured in accordance with special and intricate designs. There has been a constant change in specifications in order to effect improvements in performance as experience was gained in the field. Baldwin has issued over 4.000 separate subcontracts under the two canceled contracts alone. The number of separate subcontracting entities approximates 475 and includes the largest corporations as well as many small "one man" machine shops located in all parts of the United States. The termination of these subcontracts in the most economical and efficient manner so as to make effective use of excess material by using such material for spare parts or disposing of it to other prime contractors who may have occasion to use it, or scrapping it in order to get the material back promptly into production, requires the greatest skill and hard and time-consuming work on the part of nearly every department of the company. The first step in the termination procedure, therefore, is to determine what subcontracts to terminate and when and at what point to cut them off. This process of selection having been accomplished, much detailed information must be obtained from each subcontractor so that when it is assembled it may be reviewed and the cancelation charges, if asserted, analyzed before payment of these charges can be made to the subcontractor by the prime contractor. With one or two exceptions, all subcontracts entered into under our cost-plus-a-fixed-fee contracts have been fixed-price subcontracts. In order to expedite and coordinate the handling of these problems, the company established a contract cancelation department in charge of a competent senior executive. All matters related to termination have been discussed with and procedures have been approved by the Ordnance Department officials, which Department since the inception of the contracts has maintained a large suboffice staff on Baldwin's premises. Much of the groundwork has therefore been laid and much data are now in hand. The time to make payment to subcontractors in settlement of their cancelation charges has arrived and some payments should, in all fairness, be made at once. The fact is that payments of subcontractors' cancelation charges arising out of the partial termination of the prime contract have not been made for reasons which will later appear. The matter of the settlement of subcontractors' claims would not on the surface, and to one not familiar with governmental contracting and accounting procedure, appear to present a serious problem, particularly under a costplus-a-fixed-fee contract containing the termination clause generally in use in that type of contract. With respect to the settlement of subcontractors' claims the termination clause in the prime contract reads: 3. Upon the termination of this contract, as hereinbefore provided, full and complete settlement of all claims of the contractor arising out of this contract other than those provided for elsewhere, shall be made as follows: "(a) The Government shall assume and become liable for all obligations, commitments, and claims that the contractor may have therefore in good faith undertaken or incurred in connection with said work and in accordance with the provisions of this contract; and the contractor shall, as a condition of receiving the payment mentioned in this article, execute and deliver all such papers and take all such steps as the contracting officer may require for the purpose of fully vesting in the Government the rights of the contractor under such obligations or commitments." The clause above quoted, as properly interpreted by the War Department in Procurement Regulation 15 recently issued, imposes the duty of disposing of these claims on the Government and relieves the prime contractor of that obligation. This assumption of liability by the Government was made clear to subcontractors when the orders were placed with them and was doubtless relied on as an assurance of settlement payments. However, there are both legal and practical reasons why the prime contractor with his specialized knowledge and customer contacts is, perhaps, in a better position to settle the claims of a subcontractor than is the governmental contracting oflicer. Procurement authorities have stated it to be their policy to turn this matter over to the prime contractor whenever possible as tending to lead to a more prompt settlement of cancelation claims. In the case of Baldwin, in order to carry out the stated policy of the War Department above referred to, Baldwin was requested to supplement its cost-free contracts, after notice of termination had been received, so as to incorporate therein a revised form of cost-free termination clause which in substance gives the prime contractor the right and imposes on him the obligation, to settle with his subcontractors on the basis of negotiated settlements, A settlement so negotiated is, under the new clause, of course, subject to the approval of the contracting officer and, if that approval is obtained, the claim is placed in line for payment by the prime contractor and the expenditure by the prime contractor thus made becomes, at least in theory, an item of disbursement for which the Government has, in turn, agreed to reimburse the prime contractor under the cost-fee contract. After the most careful consideration, Baldwin decided not to accept the revised termination clause and formally advised the Government to that effect on September 15, not because Baldwin was unwilling or not equipped to do the work and to give it its best efforts, but because at that time it was felt that the General Accounting Office might well, at a later date and long after the settlement had been made and closed, invalidate or refuse to ap prove these negotiated settlements either in whole or in part, in which event the prime contractor would be obliged to absorb the loss. In Baldwin's case this possibility had a potential running into millions of dollars, and in a costfee contract there is no "cushion" to absorb losses. The decision reached by the company has since been more than amply justified by the conclusions and comments of the Comptroller General as stated in his letter dated September 20 addressed to the Honorable James E. Murray, chairman of the Senate Small Business Committee. At this point it may be helpful to explain briefly the procedure whereby a cost-fee contractor is reimbursed for expenditures incurred by him and the procedure whereby such expenditures are audited. Before any commitment is entered into by the prime contractor, the proposed arrangments are submitted to the contracting officer for approval in all cases where more than $590 is involved. When the approval of the contracting officer has been obtained, the commitment with a subcontractor is entered into by appropriate document and when the subcontractor has delivered the material, he presents his invoice to the prime contractor. The accounting department of the prime contractor compares the invoice with the purchase order to see that the amount stated in the invoice corresponds to the purchase order or subcontract. A report is then received from the prime contractor's inspection department and receiving de |