FAR 49.202 Settlement Profit: Common Mistakes on Terminated Work
When the government ends a contract for convenience, contractors frequently struggle to determine what profit they are permitted to recover. Under FAR 49.202, the termination contracting officer (TCO) is directed to allow profit on preparations made and work done for the terminated portion of the contract. However, many trade contractors and estimators misunderstand how settlement profit is evaluated, leading to disputed settlement proposals and unallowable claims. Avoiding key misconceptions regarding allowable profit helps ensure your firm recovers fair compensation without unnecessary audit friction.
Mistake 1: Claiming Anticipatory Profits and Consequential Damages
One of the most widespread errors is assuming a termination settlement should include the entire margin originally planned for the whole project. Under FAR 49.202(a), anticipatory profits and consequential damages shall not be allowed (with a cross-reference to 49.108-5). Profit is strictly restricted to preparations made and work performed on the terminated portion. The contractor cannot demand the profit that would have been earned on work that was never started or executed prior to the termination action. Understanding this distinction is vital when adjusting expectations from initial job estimates, much like reviewing your baseline numbers in markup vs margin analyses.
Mistake 2: Adding Profit to Settlement Expenses
Preparing a settlement proposal requires substantial time, accounting reviews, legal guidance, and clerical effort. While settlement expenses themselves can be submitted as part of the overall cost settlement, FAR 49.202 explicitly bars charging profit on those settlement expenses. The TCO shall allow profit on the actual preparations and physical work done for the terminated scope, but settlement expenses must remain strictly at cost. Adding a markup percentage to your administrative proposal preparation expenses is an immediate compliance red flag during federal settlement negotiations.
Mistake 3: Marking Up Undelivered Subcontractor Supplies and Offsite Stored Materials
For prime contractors and upper-tier subcontractors, managing lower-tier suppliers is central to the settlement process. Two specific restrictions apply here under federal regulations:
- Undelivered items: Profit shall not be allowed to the contractor for material or services that, as of the effective date of termination, have not been delivered by a subcontractor, regardless of the percentage of completion.
- Materials on hand vs. work in place: When computing profit on the terminated portion of a construction contract, the contracting officer must allow profit on settlements with construction subcontractors for actual work in place at the job site, but must exclude profit on settlements with construction subcontractors for materials on hand and for preparations made to complete the work.
Failing to segregate subcontractor costs between actual work in place at the site and materials on hand offsite or in storage leads to disallowed profit calculations.
Mistake 4: Basing Subcontract Settlement Effort Solely on Settlement Dollar Totals
A prime contractor invests genuine administrative effort into handling lower-tier claims and negotiating terminated subcontracts. However, under FAR 49.202(a), profit for the contractor's efforts in settling subcontractor proposals shall not be based on the dollar amount of the subcontract settlement agreements. Instead, the regulation states that the contractor's efforts will be considered in determining the overall rate of profit allowed the contractor. If you simply apply a percentage markup over lower-tier settlement amounts, the TCO will reject the calculation method.
Mistake 5: Overlooking the TCO Profit Factors During Negotiations
FAR 49.202 establishes that the TCO may use any reasonable method to arrive at a fair profit. Contractors often fail to supply the narrative documentation that justifies a higher rate. In negotiating or determining profit, the contracting officer considers specific factors, including:
- The extent and difficulty of the work done as compared with the total work required by the contract, considering engineering estimates of completion percentages if available (though ordinarily they should not be required).
- Engineering work, production scheduling, planning, technical study, supervision, and other necessary services.
- Contractor efficiency regarding quantity and quality production, cost reduction, economic use of materials, facilities, and manpower, and disposition of termination inventory.
- Amount and source of capital, extent of risk assumed, and inventive or developmental contributions.
- Character of the business, nature of materials, complexity of techniques, and difficulty of managing subcontracts and settlements.
- The rate of profit the contractor would have earned had the contract been completed, as well as the rate contemplated when the contract was negotiated.
Providing clear records supporting your performance on these factors strengthens your position, similar to documenting field conditions when pricing change orders.
Sources
FAR 49.202 Profit. | Acquisition.GOV
Published October 30, 2026. No affiliate links on this page. Facts come from the sources linked above; check them for updates.