Chapter 15: Contract Termination and Settlement
For Ordnance, termination of contracts began as a mere trickle in December 1941, continued at a steadily mounting rate during the next three years, and then reached flood proportions at the end of the war. After the basic policy decisions were made, the number of terminated contracts rose steadily until some thirteen thousand had been closed out by the end of 1944. Valuable experience was thus gained long before the war ended, and staffs were trained to deal with the problem. When the Japanese surrendered in August 1945, Ordnance was able to settle its outstanding contracts quickly, and generally with satisfaction to all concerned.1
This record stood in sharp contrast to the debacle after World War I when thousands of war contracts remained unsettled for many months after the Armistice, leaving a legacy of ill will and suspicion for the next twenty years.2 Conscious of its World War I history, the War Department during World War II resolved to avoid making the same mistake twice. “Let’s leave a better taste in their mouths after this war” was the attitude frequently expressed at contract termination conferences.3 Taking a broad look at the economy of the nation in the middle of the war, Army policymakers saw that about 60 percent of all business concerns were dependent, wholly or in part, on war production, and that most of these concerns needed prompt action on their contracts if they were to succeed in making the change back to peacetime production. Under Secretary Patterson testified before the House Military Affairs Committee on the magnitude and urgency of the problem, recalling that after 1918 the Ordnance Department alone had 10,000 employees working on terminations.4 In 1943
it was estimated that Ordnance had 148,000 contracts with industry totaling $47 billion in value, and giving employment to millions of workers.5 “If terminations are not completed and money paid to the contractors with utmost expedition,” wrote an Ordnance district official from Chicago, “we will inevitably have a wrecked and bankrupt business structure in the United States.”6 Ordnance was also keenly aware of the importance for future production of retaining the good will of industry by fair treatment at the time of contract termination.7
Ordnance had given little thought to contract termination during peacetime, for the problem seldom arose. Nor was much attention paid to the matter during the defense period when top priority was assigned to speedy placement of orders with industry. The contract forms standardized by the Army in 1939 contained termination clauses covering instances of default by contractors, but their use by the procuring services was optional.8 In September 1941 Ordnance broke new ground by issuing a standard clause for contract termination at the convenience of the government, and a few weeks later the Under Secretary’s office issued Supply Contract No. 1, including a clause for termination when the contractor was not in default, and settlement according to a formula. The essence of these clauses was their provision that the contractor be reimbursed for “all actual expenditures certified by the Contracting Officer as having been made. ...”9 The hitch to this arrangement was that the contracting officer could certify that expenditures had been made only after the auditors had gone over all the books and assured him that every penny was accounted for. This was a long and tedious process, and it was feared that firms without strong financial backing might go bankrupt while the auditors were at work; for employees the procedure might result in “unemployment by audit.”10 Further, cost accounting was not an exact science or a matter of simple arithmetic. It required exercise of good judgment in weighing a host of varied elements. As a leading industrialist testified, “If you take six cost accountants of equal competency and put them on the job to find out what one of our crankshafts cost you would get six different answers.”11 How Ordnance contributed
to solving this problem is illustrated by the following two case histories.
The Walter Scott Case
On 5 June 1940 Ordnance had placed an educational order with Walter Scott and Co. of Plainfield, N.J., for manufacture of fifteen recoil mechanisms for the 155-mm. gun, along with certain machine tools and manufacturing aids. Fifteen months later the company, not yet in production, had taken on a large Navy contract that threatened to leave no room for future Ordnance production orders. Under these circumstances Ordnance decided, two weeks before Pearl Harbor, to cancel the contract and move elsewhere the machine tools the company had purchased. This decision officially opened the contract termination phase of Ordnance World War II history.12
As there was no question of default on the part of the contractor this was clearly an example of contract termination “for the convenience of the government,” as the lawyers expressed it. The paragraph of the contract that covered such cases provided that the government should reimburse the contractor for all expenses incurred by him in good faith in performance of the contract plus 10 percent of the total of such expenses. To avoid making a complete audit of the contractor’s books, the Chief of Ordnance, on the day after Pearl Harbor, suggested that the company might be willing to terminate the contract by a supplemental agreement providing for payment of a lump sum determined by negotiation. Here was the origin of the negotiated settlement that did so much to speed reconversion at the end of the war. Satisfactory terms were soon worked out, and the contractor signed a termination agreement on 26 June 1942 releasing the government from all further obligation under the contract in return for payment of $18,155.89.13
The Guiberson Case
Before the Scott case was closed, another and much larger termination was in the works. In April 1942, when the Army decided to replace diesel tank engines with gasoline engines,14 steps were taken to cancel two contracts, totaling $8 million, with the Guiberson Diesel Engine Co., and to turn over the Guiberson plant in Garland, Texas, to Continental Motors Co. for production of gasoline engines. Although the earlier of the two Guiberson contracts had no clause covering termination for convenience of the government, the later contract did, and the company agreed to let this clause apply to both. But the clause in the later contract called for reimbursement of the contractor according to a formula based on a complete audit of all expenditures. The accounting and auditing work on such a contract, Ordnance reported, would reach “gigantic proportions,” requiring the full-time services of fifteen auditors for nine months, for the contract extended over a long period of time and involved large sums of money, complex inventories, work in process, and claims of many
subcontractors.15 When he had signed the contract, the contractor had had no idea he would some day be called upon to produce a written record of every expenditure. In addition, Ordnance pointed out that the results of the audit would be subject to review by “another governmental agency,” meaning the General Accounting Office, ‘and expressed some concern lest the GAO take exception to minor irregularities and thus do, in the long run, more harm than good. Ordnance felt that any such review would involve the exercise of new judgment on complex problems and would, in effect, amount to a new negotiation. Ordnance argued that terminations should be kept within the control of the agency responsible for the original contract, for only in that agency was there intimate knowledge of the kinds of property involved, the avenues for its disposition, and knowledge of its value. Further, Ordnance contended that a detailed audit of all large contracts would delay contractors from shifting to other war work and would thus hamper the war effort, while the war continued, and would hold up reconversion in the postwar era.
In view of these facts the Ordnance legal branch proposed that the contract be terminated with a negotiated lump-sum settlement; there would be no complete audit or review by another governmental agency, but only sufficient spot checking and accounting analysis to satisfy both parties. This proposal was based on the ancient common law principle that private contracting parties may agree to settle a contract in any way they choose, regardless of contract provisions for some other method of settlement. The Ordnance view was that contracting officers who were empowered to enter into contracts and agree upon prices to be paid for war goods in the first place were assumed to have equal authority to agree upon final compensation when the contracts were canceled.16 “The negotiated settlement in essence,” wrote Lt. Col. Harold Shepherd in formal legal language,
is the use of a contract device to convert unliquidated claims not susceptible of exact demonstration without too percent audit into a new liquidated obligation in the nature of an accord, merging and extinguishing all prior rights and claims not specifically reserved. It has all the sanctions and legal incidents of an original contract, and the contracting officer who negotiates it has all the discretion, authority, and responsibility that he has in making any original contract.17
Convinced of the wisdom of this approach, Ordnance laid the whole matter before the Judge Advocate General in August and asked for an opinion. Within three weeks that office and the U.S. Attorney General approved the Ordnance proposal on the basis of the First War Powers Act and Executive Order No. 9001, and Ordnance proceeded at once to settle the Guiberson case by negotiation. In the process it used the services of only five auditors for about four or five months. Thus another major step was taken toward developing a new Army policy on contract termination and settlement for
convenience of the government. Soon thereafter Ordnance drew up termination instructions for its field representatives and gave wide publicity to the negotiated settlement among Army personnel, lawyers, and industrial contractors.18 Emphasis was placed on speeding war production by enabling contractors to shift quickly from one product to another, and assuring industry that, at war’s end, their claims would be settled fairly and quickly. The goal was to achieve the 3 F’s of contract termination, making them “fair, fast, and final.”19
The International Harvester Case
In December 1941 Ordnance approached the International Harvester Company about making a new type of tank that then existed only on the drawing board. It was to weigh twenty tons, carry a 57-mm. gun, and be both fast and maneuverable. International Harvester accepted the proposal, contracts totaling $217 million were signed, and Ordnance immediately purchased and remodeled for Harvester’s use an idle plant at Bettendorf, Iowa, naming it the Quad Cities Tank Arsenal.20 Soon thereafter the proposed tank was ‘redesigned in the light of British reports from North Africa of the need for more powerful guns and tougher armor to cope with German tank and antitank weapons. The 57-mm. gun became a 75-mm., and the weight of the tank went up to 28 tons. A steady flow of engineering change orders delayed the start of production until March 1943. Then on St. Patrick’s Day, just as the first tanks were rolling off the line, the contract was canceled. It was a stunning blow for the company and its employees and caused a certain measure of resentment. Assurance that cancellation was dictated by the fortunes of war, and that no blame attached to the plant, was received in silence by the employees assembled to hear the news from Col. John Slezak of the Chicago district.21 Explanation that the tank, originally meant to be light, had grown to be of medium weight and was thus too close to the existing Shermans did not prove very convincing.
Compared with the Harvester contract, the Scott and Guiberson cases had been small potatoes. Not only was there $217 million involved in the Harvester contract, but the company used 12 different plants located in as many cities. Its 438 subcontractors were to be found in 100 cities scattered over an area of 20 states, and there were, in addition, about 2,000 sub-subcontractors. The company had on hand a huge stock of all the countless parts that go into a tank—generators, tracks, periscope assemblies, and even a few tank hulls—as well as machine tools, jigs, and fixtures. When everything was piled into an impromptu warehouse so the company
could get on with a tractor order that was to replace the tank contract, the place looked like “an auditor’s nightmare and a junkman’s dream.”22 The whole stock, valued at over $ to million, had to be quickly inventoried and disposed of by public sale or transfer to other government agencies. Engines, tanks, and armor plate were promptly diverted to other tank manufacturers or to Field Service for use as spare parts.23 Hundreds of subcontractors had to be given help in submitting their claims, and for that purpose the company organized a staff of fifteen traveling termination specialists. The Chicago Ordnance district sent representatives to Bettendorf to work with the company’s termination team toward arranging advance payments for subcontractors and ironing out procedural details. Although the principle of the negotiated settlement was applied, so many aspects of the problem required careful checking that the whole process took about fifteen months. This was no speed record, to be sure, but the Chicago district felt that in the process it had gained experience that would enable it in the future to cut that time in half. The company settled for $25 million.24
Organization and Training
By mid-summer of 1943 Ordnance had completed about eight hundred negotiated settlements. The district offices reported that contract settlements could be reached by negotiation with a 75 percent saving of time and labor over settlements based on a complicated formula and complete audit. Immediate partial payments were made to both prime contractors and subcontractors to tide them over the conversion period. Contracting officers were permitted to use their own judgment in each case, and there was no need for review of the settlement by any other agency, except in case of suspected fraud. All this was to the good, but adequate preparation for the anticipated avalanche of terminations at the end of the war called also for creating and staffing strong termination units in all the district offices, and providing a firm statutory and regulatory base for the new procedures.25
Though keenly interested in speed, Ordnance did not intend that negotiated settlements would be reached haphazardly without scrutiny by lawyers, auditors, and production experts.26 A set of rules was, in fact, soon developed and published in April 1943 as a section of the Ordnance Procurement Instructions. Ordnance assigned termination work to its district offices where each terminated contract was passed through the hands of district specialists in procurement negotiation, inspection, engineering, and accounting, and was finally reviewed by the district’s
Settlement Review Board. It thus became “procurement in reverse.”27 In the Chicago district the basic philosophy was put into a memo by the chief of the termination policy unit, stressing speed rather than meticulous accuracy and “true negotiation vs. the rejection of each part of each claim that cannot be proven in detail by the contractor.”28
In the summer of 1943 ASF helped to standardize procedures throughout the War Department by issuing a technical manual on termination accounting for fixed-price supply contracts, closely following the earlier Ordnance instructions.29 Soon thereafter a new section on contract termination was added to the Procurement Regulations as PR 15.30 This section described the main steps in termination procedure, beginning with the government’s telegram to the contractor advising him to stop work on a specific contract, followed by a confirming registered letter and a copy of the War Department Termination Accounting Manual. The contractor then notified his subcontractors, began to look for other business, and put men to work drawing up his claim for payment by the government. Surplus material and government-owned equipment was promptly moved out of the plant, and representatives of the company sat around a conference table with government officials to work out a negotiated settlement. When possible, a pre-termination conference was held with the contractor to iron out problems of timing and procedure.31 Reasonably explicit rules and regulations governed each major step in the process, and it was through these regulations, plus the detailed provisions of the termination accounting manual, that the interests of both contractor and government were protected and the whole process given a semblance of due process of law.32
A much simpler type of settlement was that in which the contractor made no claim for payment above what he had already received. In return for waiving any claim he might have against the government the contractor had the right to retain his termination inventory, which might include scarce raw materials or useful semifinished items, and dispose of it as he saw fit. He was immediately free to proceed with conversion to other work without need to take an inventory and prepare his claim against the government, thus saving time for himself and for the
government. This was especially attractive to contractors during the first two years of the war when they could easily shift to other war work. As it was the essence of administrative simplicity, its use was also attractive to the government and was given official encouragement. A further reason for the popularity of “no cost” settlements was the Renegotiation Act. When a contractor knew he had earned all allowable profit during a given period there was no point in trying to gain more in the final settlement.33 By the end of December 1945, “no claims” cases accounted for roughly one-fourth the money value of all Ordnance settlements, and well over half the number of cases settled.34
In November 1943, when ASF created a Readjustment Division, headed by an Ordnance officer, Col. David N. Hauseman, and the Office of War Mobilization established the Joint Termination Board, Ordnance set up a contract termination section in the Legal Branch and called in Col. Dean Witter from the San Francisco district office to head it. Meanwhile, Ordnance called regional conferences in Chicago, Detroit, New York, and St. Louis to inform district officials of plans and policies being formulated in Washington. The Ordnance districts created their own termination sections and prepared to put their procurement machinery into reverse.
Each Ordnance district opened termination training courses for members of its staff and drew up manuals to prescribe practical operating procedures. When this work was well under way the districts turned to the task of introducing contractors to the mysteries of contract termination and settlement, and stimulating their interest in advance preparation for submitting termination claims. Specialists from Colonel Witter’s staff and from district offices gave short talks on the subject to trade associations, chambers of commerce, and professional societies. In February and March 1944 the Boston district held a series of eight all-day conferences for contractors in the Boston area. The Springfield district conducted similar training conferences while the New York district arranged for New York University to give evening classes in contract termination. In the Philadelphia area, the Ordnance district cooperated with other. government procurement offices to prepare a course in contract termination to be given by the University of Pennsylvania. The purpose of these courses was to speed contract termination and settlement by instructing contractors how to submit their claims to the proper government agency. The staff of the Chicago district wrote a comedy skit called “Negotiation for Termination, or You Can’t Take It With You,” presented it as after-dinner entertainment for many businessmen’s groups, and gave one performance for a subcommittee of the House Military Affairs Committee.35
The Statutory Base
The principle of termination by negotiation was applied, on the basis of the
Judge Advocate General’s decision, to cases that came up in 1942-43, but procurement officials and contractors both saw the need for putting such important matters on a firm statutory base. The War Department drafted proposed legislation for this purpose in 1943, and committees of Congress opened hearings on the subject. At this point, Lindsay Warren, the Comptroller General, vigorously objected to the Army’s plan to put the negotiated settlement on a firm statutory base. Mr. Warren complained that the procedures proposed by the War Department contained no adequate means of safeguarding the public interest. They bypassed the General Accounting Office, and required no audit, no documentary evidence of the validity of contractors’ claims, and only a spot check that was “an insult to proper audit of a matter of this magnitude.” “When I read these regulations,” he testified,
I became so amazed and astounded that I have wondered if those officers or civilian employees of the War Department who prepared them ever gave a passing thought that they were in fact servants of the Government, whose interest they were sworn to protect. These regulations have all the appearance of being put forward by special pleaders for industry in disregard of the Government and those other citizens who are paying the Government’s bills.36
Warren brought forth case after case to show that contractors in the past had claimed payment for goods or services in no way related to their government contracts, and had been stopped only by the GAO audit. He challenged the War Department’s assertion that all its contracting officers were efficient and capable men working within a well-established framework of regulations, and asserted that contract settlements without audit were open invitations to fraud. The War Department’s answer to these charges was that the General Accounting Office had so far disallowed less than to cents per $1,000 of expenditures under War Department contracts, and had approved 99.95 percent of all procurement vouchers submitted for audit during the four months ending with August 1943.37 Industry spokesmen termed Warren’s proposal impractical.38
The House Committee on Military Affairs later reported out a bill to place the Comptroller General in charge of termination settlements, but the bill was defeated in favor of a modified version of the War Department’s proposal. Strong support for the negotiated settlement came from industry representatives who testified before the House Committee in October 1943, and further support appeared in February 1944 when the Baruch-Hancock report on postwar adjustment policies was released. It recommended “quick, fair, and final settlement of terminated war contracts through negotiations by the contractors and the procurement agencies.” The Comptroller General’s insistence on detailed audit before payment would, the
report contended, “quibble the nation into a panic.”39 The Contract Settlement Act of 1944, signed by the President on July, created the Office of Contract Settlement headed by a director responsible for prescribing policies and procedures and enforcing their observance.40 The act followed existing procedures in providing for quick negotiated settlements, prompt removal of inventories from contractors’ plants, and interim financing to enable contractors to proceed with conversion to peacetime business.41 Joint Termination Regulations (JTR) issued by the War and Navy Departments in November 1944 set forth detailed procedures to guide government officials in applying the law. JTR and the Contract Settlement Act laid a firm statutory and regulatory base for the procedures Ordnance had first tried out in the Scott and Guiberson cases more than two years earlier.
By the end of December 1944, Ordnance had authorized termination of nearly fourteen thousand contracts, and of that total some 93 percent had been finally settled. The time required to settle cases was steadily reduced during the year, dropping from ten months for settling a large claim in April to less than six months by the end of the year. The backlog of pending cases had dropped from its February peak of 2,265 involving over $4 billion to less than one thousand totaling about $1½ billion.42 In February 1945 the Office of Contract Settlement commended the War Department on its contract settlement performance during the preceding six months and observed that the progress made during this period was “largely due to the continued good performance of the Ordnance Department and to the great improvement made by Army Air Forces.”43
Action on V-J Day
During the second week in August 1945, ASF gave Ordnance detailed instructions for terminating contracts upon Japan’s surrender. A standard telegram to be sent to prime contractors was enclosed, along with one for the contractor to send to his subcontractors.44 These forms were to be filed with Western Union, accompanied by a list of contractors, contract numbers, and other essential data, pending the signal for Western Union to send them out. Ordnance forwarded these plans to its district offices and arsenals with instructions to be ready for prompt action as soon as Japan surrendered. Shortly after 7 p.m. on 14 August the Japanese surrender was announced and the Chief of Ordnance received a letter from ASF to get out the termination telegrams at once. In this process some eleven thousand contracts were terminated and the district
Table 24: Dollar value of Ordnance contract terminations as of 31 December 1945
| Initiated | $16,067,601,000 |
| Completed (settled) | 9,970,894,000 |
| – (with claims) | 7,302,799,000 |
| – (without claims) | 2,668,095,000 |
| In process | 6,096,707,000 |
Source: Graphic Analysis, Progress of Ord Program, sec. 4, 23 Jan 46, p. 2, OHF.
offices were deluged with settlement work. By the end of the year, the job was well under way, as the table shows. (Table 24) By the end of the following year Ordnance could sum up its contract settlement record in terms of some thirty-five thousand fixed-price contracts settled—most on a no-claim basis—for a total canceled commitment value of over $13 billion. Settled cost-plus-fixed-fee contracts were fewer in number—only 184 all told —but accounted for an additional $3 billion.
Termination of cost-plus-fixed-fee contracts posed special problems. Under such contracts the government was obliged to reimburse contractors for expenses incurred in performance of their contracts. But what expenses were to be considered reasonable and proper? Each contract presented a host of puzzling questions. Seemingly small matters, such as a few cents increase in the hourly rate of pay for employees, could mount up to a million dollars on a large contract. Contractors were slow to settle their CPFF contracts because they feared that agreements reached with Ordnance or one of the other military procurement agencies would be upset later by the General Accounting Office. They declined to dispose of their inventories or close their accounts with subcontractors until the government settled their claims. The situation became so serious that Under Secretary of War Patterson appealed to the Attorney General for help. In October 1944 the Attorney General expressed the opinion that contracting agencies had the authority to make settlements of all claims and that the Office of Contract Settlement had authority to issue appropriate regulations on the subject. The Office of Contract Settlement soon published, as part of the Joint Termination Regulations, a procedure that required contracting officers to answer objections raised by the General Accounting Office during a 60-day period after the termination agreement was reached.45
Insofar as speed was concerned, the overall Ordnance record on terminations was good, but by January 1946 the original forecast of accomplishment had not been met. In explanation, the contract termination section reported that delays stemmed from a variety of causes. Some contractors had not submitted their claims promptly while others, having received partial payment, were content to postpone final
settlement until more urgent reconversion work was completed. Other contractors showed a tendency to insist upon getting the last dollar on each claim even though that meant prolonging the negotiation. Ordnance was at fault in some instances. The districts had underestimated the personnel they would require after V—J Day, while mandatory cuts in personnel undermined morale and disrupted normal routine. The letdown that came with the end of the war combined with the desire of civilians to get back to peacetime pursuits to create a really serious personnel problem.46
The conclusion that Ordnance contract settlements were, on the whole, fast and final, appears sound,47 but it is impossible to determine precisely how “fair” they were. The settlement process left much to the discretion of the contractor and the contracting officer, and placed less emphasis on following the rule book than on following the practices of private business in drawing up an agreement acceptable to both parties. It may be assumed that contracting officers, modestly paid guardians of the public interest, must at times have grown weary of the struggle when pitted against representatives of firms with a heavy financial stake in the settlement. Pressure to settle contracts with utmost speed must at times have led them to take short cuts and to accept rule of thumb estimates that may have been overly generous. But a field survey by accountants from the Office of Contract Settlement in December 1944, including a check of twelve Ordnance district offices, concluded that contract settlement agencies were doing a good job and that many contractors were so eager to convert to peacetime business that they did not insist on all the profits they were entitled to. Later surveys sponsored by the Office of Contract Settlement came to the same conclusion.48 The years that followed World War II brought to light no substantial evidence of unjust enrichment of Ordnance contractors. Neither did these years bring the economic paralysis and widespread unemployment feared by many. Instead, they brought speedy demobilization of the armed forces and rapid conversion of the nation’s economy from war to peace production, and a relatively high level of prosperity. Friendly relations of Ordnance and its contractors, the indispensable basis for wartime cooperation, were not disturbed. Several factors contributed to this result, chief of them being the high wartime tax rates and the recapture of excess profits under the Renegotiation Act. The Internal Revenue Bureau’s decision that termination payments were to be considered as income received on the day of termination, rather than on the date of final settlement, kept contractors from dragging out negotiations to take advantage of lower postwar tax rates.49 Industry’s natural desire to beat swords into ploughshares, aided by the government’s enlightened contract termination and settlement policy worked something akin to an industrial miracle in postwar reconversion.