THE FEDERAL GOVERNMENT IS THE NATION'S SINGLE largest energy consumer. It buys billions of dollars of electricity and natural gas from utilities each year. Deregulation, and the competition it brings, will change how the government buys these services.

For utilities that signed contracts with the government in the past few years, the future may be here. Utilities must read their contracts carefully; they must know which rules apply to them, and try to comply. Noncompliance can lead to criminal and civil penalties for the utility and its employees.

There is time, however, to help establish rules for this new competitive federal market. Utilities should try to capture the benefits of recent United States government procurement reforms. If done correctly, both sides, the utilities and the government will come out ahead.

A Safe Haven No More

Utility services have long occupied a niche in federal procurement law, but that niche may soon give way to risk and uncertainty.

In the "normal" contracting situation, the presumption arises that the federal government will acquire goods and services using full and open competition. %n1%n With utility services, however, the statutes and regulations run in virtually the opposite direction. Here, the federal procurement officers must justify the use of competitive procedures. If it cannot make a case for competitive procedures, then the government will acquire utility services without competition. %n2%n As a result, the government buys utility services without full and open competition.

The Federal Acquisition Regulations explicitly acknowledge that this arrangement is highly unusual. The FAR states that agencies "shall acquire utility services by a bilateral written contract" [FAR 41.201(b)]. However, this contract must include only a handful of the myriad of typically required government contract clauses. %n3%n

There are two categories of "mandatory" written sole- source contracts: a separate contract between a utility and a particular federal facility or an "areawide" contract, which covers services provided within the utility's franchise territory or service area. When an areawide contract is in place "[a]ny federal agency having a requirement for utility service within an area covered by an areawide contract shall acquire services under that areawide contract unless¼ service is available from more than one supplier" [FAR 41.204(c)].

In reality, however, utilities often have operated outside even these minimum requirements. For example, some utilities have simply refused to enter either type of written contract, treating the government as just another ratepayer that had to follow the utility's rules. In fact, the government has been forced to recognize this reality. Thus, the federal regulations include procedures for contracting with utilities that refuse to enter a written contract. %n4%n After all, what's the government to do? It needs energy, and the utility has been the only game in town.

Nevertheless, we all know that this game cannot continue. Once competition arrives, it will force changes virtually overnight. Utilities or their marketing affiliates (defined here collectively as "utilities") arguably will be required to comply with many of the same rules applicable to regular government contractors. So long sole-source contracts; hello cost and risk. These changes will cover the entire spectrum from how utilities obtain a contract to post-contract performance obligations. In general, they promise more rights for the federal government (em and for utilities, added obligations.

What to Expect After Deregulation

Utilities, once worry-free about obtaining or retaining their government contracts, will soon find reason to worry about both.

To obtain a government contract, utilities will submit proposals, conduct negotiations and compete with others (em all subject to statutes, regulations and solicitation rules both complex and confusing. The better the competition and the more complex the procurement, the more the utility will lose.

And even if the utility wins the contract, the battle doesn't end there. A competing contractor may protest the award. Protests in a large-dollar competitive environment are frequent. If the protest is successful (usually because of some error by the government) the utility may be forced to compete again or the competitor may be given the contract. If the utility is successful and the protest is denied, the utility in most cases is still out the costs of defending itself in what is usually fast-paced, high-cost litigation. %n5%n

In general, the new rules that apply will vary, depending on the nature of the services provided and the degree of competition. Normally, the highest risks arise when there is no adequate price competition.

INADEQUATE COMPETITION. In this higher-risk environment, the utility may face onerous accounting, disclosure and audit obligations.

When prices are not set by tariffs, rates, rules or regulations, the utility will probably need an accounting system that segregates allowable versus unallowable costs as determined by government regulations and that have a look, feel and complexity akin to the federal tax laws. The utility in some instances may have to disclose "cost or pricing data" and certify that it is current, accurate and complete as of the date of agreement on price. %n6%n The definition of "cost or pricing data" is extremely broad, and the utility will need rigorous internal procedures to ensure that it satisfies this disclosure requirement.

The government, however, will not just take the utility's word for it. It will enjoy far-reaching rights to audit the utility's books. What the auditors find can and will be held against the utility. For example, if the government finds less than full disclosure of cost or pricing data, it can unilaterally reduce the price of the contract to what the government believes the price would have been if the data had been disclosed. If the utility disagrees with this reduction, it must proceed under the standard disputes clause in the contract, which often means litigation before a Board of Contract Appeals or the Court of Federal Claims.

ADEQUATE COMPETITION. Even if competition is deemed adequate, the utility will still operate in an unfamiliar contracting environment in which the government may impose changes in the contract.

Under the typical "changes" clause, the government has a unilateral right to direct changes within the general scope of the contract. The utility must do what the government says. The price will be resolved later by negotiation or, if the parties cannot agree, the matter will be resolved under the "disputes" clause. Even if adequate price competition existed during the award of the basic contract, the utility will still need a good accounting system. Without such a system, it may do all of the additional work but only get paid part of its allowable and properly allocable costs.

In addition, if the price of the contract modification incorporating the change is expected to equal $500,000 or more and the modification does not qualify for an exception to the requirement for cost or pricing data, the government may argue that the utility must disclose cost or pricing data in connection with the negotiation of the modification and certify that the data provided is current, accurate, and complete. %n7%n

What if the utility refuses to perform this new work unilaterally imposed by its government customer? The utility will have breached the contract. The government's remedy is nearly all-encompassing. It includes, for example, recovering the excess costs the government incurs in procuring the services from another contractor. When there was no competitor, this just could not happen.

Even if the utility is not in breach, under the standard "termination" clause, the government has an absolute right to terminate the utility's contract for the government's convenience without cause. Subject to complex regulations and case law, the utility in this situation gets its actual allowable and allocable costs, including settlement expenses, that it can prove, plus profit on only the incurred costs. The utility will not recover anticipatory profit. Again, the utility will need that accounting system. But because the utility recovers only its allowable and allocable costs, the utility may not recover all of its costs, and the utility no longer has a contract.

Fines and Penalties?

A competitive environment also heightens the risk that a utility could violate the conflict-of-interest statutes, regulations and contract clauses. The standard conflict-of-interest provisions are complex, vague and confusing. They are often contrary to typical commercial practices. In general, they prohibit: (1) conflicts of interest between a government decisionmaker's responsibilities and his or her outside financial or business interests; (2) certain employment discussions with current government personnel; and (3) employing or assigning certain tasks to former government personnel.

Failure to comply with these provisions can lead to severe criminal and civil penalties for both individuals and the utility. Prison terms of up to five years and fines in the million-dollar range are provided for in the statutes.

There are many more rules, regulations, clauses and certifications that can add to the utility's risks and costs in a competitive federal energy market. Utilities will come to learn that whenever there is a requirement to certify facts (like the requirement to certify that cost or pricing data is current, accurate and complete), the utility and its employees will run the risk of incurring criminal and civil penalties for false statements and false claims. The government does not like to be misled, especially by those upon which it has bestowed the privilege of being a government contractor.

Moreover, utilities may not need to wait for some far-off future to encounter some of these added risks and costs. As explained next, they may have opened the door by signing areawide contracts.

Hidden Risks in Today's Contracts

Today's areawide contracts typically contain standard and nonstandard clauses that may already impose responsibilities and risks on utilities far greater than the minimum requirements for a bilateral, written government contract. One such nonstandard provision is a type of "most favored customer" clause, which also may give rise to audit rights for the government. Among the standard provisions in areawide contracts, two of the highest-risk clauses relate to gratuities and kickbacks.

MOST FAVORED CUSTOMER CLAUSE. Under the typical most-favored-customer clause, the utility warrants that neither the service rates made available nor the charges billed to a government agency will exceed those available or charged to any other customer served under the same service classification for the same or comparable services under like conditions of use or under similar circumstances. If the charges for any of these services are not established in tariffs, rates, rules or regulations, the ordering agency has the right to audit before payment.

Compliance with these requirements could prove difficult, time consuming and expensive. Procedures would have to be adopted to carefully compare the services, conditions, circumstances, charges, rates and prices applicable to the federal government with those applicable to all other customers. When there is an overlap, the government must be charged no more than the other customer.

These provisions could impose certain risks. First, the government could allege that the warrants represent false statements (em if, for example, through an audit or through other means (e.g., an action filed under the False Claims Act) the charges, rates or prices for a particular service are challenged. Second, if there are false statement allegations, there may also be allegations that any requests for payment made under the contract are false claims. These allegations could subject the utility and individuals to protracted investigations and civil and criminal penalties. %n8%n

GRATUITIES AND KICKBACKS. In areawide contracts, the standard gratuity provisions make it illegal to provide gratuities to government personnel. The penalties and sanctions associated with providing illegal gratuities include denial of the contract award, cancellation of the contract, criminal prosecution and debarment from federal government contracting.

The standard anti-kickback provisions make it illegal for a vendor or supplier to provide anything of value to a contractor or subcontractor for or because of favorable consideration. The phrase "anything of value" is construed broadly. It can include, for example, cash, gifts, entertainment, work on a home or employment of friends or relatives. The standard provisions impose an affirmative obligation on the government contractor or supplier to establish and enforce measures to preclude kickbacks within its organization. Stiff monetary penalties arise for violations of these provisions.

Adapting to the New Environment

All is not lost, however. To prosper, utilities simply must learn to live by the rules applicable to their government contracts. In fact, all the rules have not yet been set, giving utilities a little time to help fashion some of them.

The best news for utilities is that the government isn't their only customer. The services that utilities furnish to the government they also supply to many private, nongovernmental customers. Government procurement regulations call similar services "commercial items."

For valid public policy reasons, championed by Vice President Al Gore as part of the Reinvention of Government Initiative, government procurement of "commercial items" is not subject to the full panoply of government contracting rules and regulations. For example, procurements of commercial items qualify for an exemption from the requirement to provide cost or pricing data. Even so, commercial item procurements are not risk-free. The government is still the sovereign and requires some things that no commercial customer could demand from a supplier. Nevertheless, when appropriate, commercial item procurements are better for both the government and the contractor. In fact, the new rules for commercial item procurements mark one of the major accomplishments of the recent administrative reform.

Should utility services qualify under the new rules?

For valid historical reasons, the services provided by utilities heretofore have not been explicitly characterized in the regulations as commercial items (em they had their own set of rules for their own noncompetitive environment. But when competition is added to the utility industry, applying the old procurement rules to a competitive environment would be ironic (and nonsensical). Some court might eventually find that under the existing regulations, the services provided are commercial items. But, by then, numerous procurements may have been conducted (em possibly under the inefficient and inappropriate rules for noncommercial items.

There is a solution. All that is needed is a little advance planning and teamwork. In whatever time that remains before competition becomes a reality, utilities should work with the government to amend the procurement rules or at least clarify government-wide practices so that the services provided by utilities are procured using competitive commercial item procedures. Neither the government nor the utilities should move backwards. While the government gets the benefit of competition, both parties should get the benefit of recent procurement reforms. Indeed, there have been some procurements using commercial item procedures. This is an encouraging first step.

Meanwhile, utilities should read their government contracts. There may be a devil in those details. F

Frederick Moring and Raymond F. Monroe are partners in Crowell & Moring LLP, a law firm in Washington, D.C. Moring has specialized in the natural gas law field since 1961 and is a former president of the Federal Energy Bar Association. Monroe specializes in the practice of law relating to government, complex commercial, and energy-related contracts. Monroe received his law degree with distinction from Duke University School of Law in 1980 where he served as executive editor of

the Duke Law Journal.

1 The Competition in Contracting Act of 1984 (CICA), Pub. L. No. 98-369 § 2701-2753, 98 Stat. 1175-1203 (1984).

2 See, e.g., Federal Acquisition Regulations (FAR) 41.204(c). The government has relied on two other statutes for authority to acquire a broad range of energy management services from utilities without competition. See 10 U.S.C. § 2865(d) (military contracts); 42 U.S.C. § 8256(c) (civilian agency contracts); Raymond F. Monroe, "New Opportunities for Gas Sales to the Federal Government," Natural Gas, July 1997. The impact, if any, of deregulation and competition on this market is still to be determined. See generally, Hearings on the Federal Agency Energy Management Provisions of the Energy Policy Act of 1992, Senate Committee on Energy and Natural Resources, 105th Congress (Sept. 25, 1997).

3 The contracting officer has some discretion even with respect to these required clauses and must insert clauses "substantially the same as" the listed clauses [FAR 41.501(c)]. In addition, the contracting officer shall insert other standard clauses "[d]epending on the conditions that are appropriate for each acquisition" [FAR 41.501(e)].

4 FAR 41.202(c). Even without a written contract, the government is likely to argue that certain mandatory requirements are read into these oral contracts by operation of law.

5 FAR 31.205-47(f)(8) (costs unallowable unless incurred "pursuant to a written request from the cognizant contracting officer").

6 This may occur if the contract is for $500,000 or more of goods or services and the prices are not set by tariffs, rates, rules or regulations or the procurement does not qualify for another exception to the requirement for cost or pricing data. See The Truth In Negotiations Act, 10 U.S.C. 2306a; FAR 15.4.

7 See FAR 15.403-4(a)(1)(iii).

8 See, e.g., 31 U.S.C. § 3729-3731; 18 U.S.C. § 1001.

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