US Debt Ceiling Crisis Already Cutting Pay to Government Vendors

The debt ceiling crisis is presenting immediate concerns for federal contractors, even before the government reaches the X-date of running out of funds to pay its obligations.

Those issues, if left unresolved, will snowball into major problems for the Pentagon’s attempts to keep up with China—a major research goal—and the country’s broader tech industrial base.

“You could see companies, especially companies offering innovative solutions, walking away,” Eric S. Crusius, a Holland & Knight partner, said in an interview.

Congress has pushed for expanded use of procurement that allows agencies to buy certain goods and services more quickly than would otherwise be possible under standard federal acquisition rules. There has also been momentum for years to introduce nontraditional vendors into the government’s contractor base.

“All these efforts will take a step back,” Crusius said.

Contractors are already reporting government delays in payment for authorized amounts for work.

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PilieroMazza partner Cy Alba said he’s seeing claims from lenders against contractors that are still waiting on the government to release payments for completed work.

“They’re being withheld a long time,” Alba said. “I’ve had three, four claims recently that the lender sent to us because the contractor isn’t being paid and so the lender isn’t getting paid.”

The Treasury Department has been employing “extraordinary measures” to extend the timeline on when tax receipts will cover the government’s obligations.

There is no precedent for a default on the US government’s debts—which include obligations allocated to private-sector vendors fulfilling contracts with federal agencies.

Short-Term Work Stoppage

Contractors and their lawyers are confident of one thing: Paying contractors will not be a priority when competing with needs like funding Social Security, Medicare, Medicaid, veterans’ care, and salaries for military personnel, among others.

“When you think of contractors in that context, the violin strings aren’t playing quite as loudly,” Robert Tompkins, a Holland & Knight partner, said in an interview.

That means the contractors won’t have money to pay any of their lenders, even though work has been done.

Vendors may be contractually obligated to continue working if the government customer doesn’t issue a work stoppage order, even if no payment is forthcoming.

For smaller contractors, that situation may be too much for the business to survive.

Alba said he’s heard from health-care vendors working with the Department of Veterans Affairs and contractors doing other essential work who don’t know what will happen if they are unable to continue work—either because of stop work order or because a lack of funds shuts the whole business down.

Some companies will be able to float for some time without pay, but many would struggle if a default were to happen and may be unable to continue operations, no matter how essential their services are.

“How long can you take that heat?” he said.

Companies waiting to see if there is a default have limited options to prepare beyond ratcheting up documentation procedures and staying in close contact with contracting officers.

“Make sure you’re recording costs. Stay close to your government counterparts, contracting officers. Try to get payments as soon as possible on what you’ve done so far,” Dismas Locaria, a Venable LLP partner, said in an interview. “If the government is short-paying, or not paying the full amount, maybe have conversations with the contracting officer on if there’s anything you can do to cut costs.”

Government: Unreliable Customers

Lenders serving contractors—largely regional banks and factoring companies—have relied on the near-sure thing of a government contract payment if the work was completed. This gives smaller contractors that can’t rely on public markets or massive institutional investors easier access to capital.

“In the past, it’s gold,” Locaria said.

A default would turn that upside-down.

“When a contractor goes to a bank, they can show we have all these contracts, and they make excellent collateral,” Crusius said. “This can disrupt that. Even the prospect of a default can wake these institutions up.”

Putting the government’s debt in question will have forced a pivot in the thinking of investors and banks. Regional lenders, especially, have been key in providing smaller contractors needed financing to chase and execute on contracts. If the government becomes an unreliable customer, many of these lenders will either get out of the business of backing contractors or require steeper cuts of profit or higher interest rates to balance the risk.

“If government starts to create a credit risk problem they need get out of the space or take a deeper cut and make it harder for the littler companies who do all the stuff you don’t know are done by contractors,” Alba said. “I don’t think we’ve gotten to that yet.”

The biggest federal contractors won’t have to worry about this. Lockheed, Raytheon, General Dynamics, and other major defense vendors will have other problems with a default as rising risk sends stocks tumbling and threatens timeline contract payments, but the mid-size and small contractors could find themselves completely busted.

Companies that previously might have considered turning to the government has a client, despite the regulatory compliance lift and the need to amass capital ahead of projects, will look at agencies as too risky a play for steady revenue.

The potential impacts on small contractors and nontraditional businesses run counter to the administration’s stated goals to do more business with these types of companies.

To contact the reporter on this story: Caleb Harshberger at charshberger@bloombergindustry.com

To contact the editors responsible for this story: Amanda H. Allen at aallen@bloombergindustry.com; Fawn Johnson at fjohnson@bloombergindustry.com