Can the Government Just Defund a Contract? Not So Fast!

I’ve seen some misconceptions floating around about Government contracts—specifically, the idea that the Government can cancel or defund contracts whenever it feels like it for the sake of efficiency. Spoiler alert: It can’t. Not unless some laws get changed first.

I’m not writing so much to educate my Contracting colleagues as I am to enlighten small businesses and those in my network who think that contracts can be eliminated and defunded with the stroke of a pen in the name of efficiency. Contracting Officers know that trying to defund a contract is anything but easy and efficient. If you know all this already, feel free to skip to the end where I tell you how I did it legally, even though I hated it.

Contracts aren’t just handshake deals—they're legally binding agreements backed by a massive rulebook called the Federal Acquisition Regulation (FAR). If Uncle Sam doesn’t play by the rules, things can get very messy, very fast.

Let’s first break down the key dangers of taking money off a federal contract without following the right process—especially when it comes to the Anti-Deficiency Act (ADA). (Hint: This is the law that says the Government can’t spend money it doesn’t have or for purposes not intended by Congress.) Fear of violating the ADA and being subject to punishment for it is drilled into every Contracting Officer from the moment they learn to spell the word contract. I had it printed out and on my wall above my desk when I was a puny GS-5 intern with grand hopes of one day getting my Contracting Officer’s warrant. When Legal reviewed my contracts, they always double-checked me to make sure I didn’t screw up, and I lived for that LEGALLY SUFFICIENT stamp.

1. Breach of Contract = Big Legal Trouble

If the Government unilaterally cancels a contract without using one of the built-in “exit ramps” (like Termination for Convenience or Default), it’s in breach of contract. That means the contractor can sue for damages, including costs for work already done, close-out expenses, and even lost profits. Ouch.

2. Anti-Deficiency Act (ADA) Violations

The ADA is no joke—it’s what keeps agencies from spending money they don’t have. If a contract gets canceled and defunded and the Government still owes the contractor money—but doesn’t currently have funds for the Contractor to bill against—that’s an ADA violation. We’re talking personal liability for the officials involved, not just a slap on the wrist.

3. Personal Accountability

Did I mention personal liability? If someone in the Government messes this up, they could face:

• Administrative Penalties:

31 U.S.C. § 1349(a) – Adverse Personnel Actions “An officer or employee of the United States Government or of the District of Columbia government violating sections 1341(a) or 1342 shall be subject to appropriate administrative discipline, including, when circumstances warrant, suspension from duty without pay or removal from office.”

• Criminal Penalties:

31 U.S.C. § 1350 – Criminal Liability “An officer or employee of the United States Government or of the District of Columbia government knowingly and willfully violating sections 1341(a) or 1342 shall be fined not more than $5,000, imprisoned for not more than 2 years, or both.”

• Reporting and Accountability Requirements:

31 U.S.C. § 1517(b) – Agency Head Reporting Obligations If an agency exceeds its appropriations or budget apportionments, the head of the agency must report the violation to the President and Congress, as well as to the Comptroller General.

You do not want your name in that report.

4. Breaking Trust with Industry

Canceling contracts willy-nilly makes the Government look unreliable. Contractors might:

• Raise prices to account for future risk
• Stop bidding on projects altogether

Remember, vendors aren’t just names on paper—they’re companies with payrolls, supply chains, and stakeholders who expect the Government to stick to its word. Burn them now, and they’re not going to hang around to be burned again.

5. Mission Fallout

Canceling a contract without a backup plan means delays, service disruptions, and missed goals. For critical programs (think national security or public safety), this can get very serious, very fast.

6. Congressional Headaches

Congress loves holding hearings when things go wrong. If your agency breaks the ADA or needs emergency funding to clean up the mess, expect some awkward questions. Plus, it’s not a situation where the old adage that “any press is good press” is true.

Best Practices for Avoiding the Drama

Here’s the bottom line: Follow the rules.

• Use termination clauses like “Termination for Convenience” when needed.
• Get legal advice before pulling the trigger.
• Document everything. Trust me—you’ll thank yourself later.

You know how I have a reputation for being a renegade and finding ways of doing things that might be a little risky? Well, this one, I’m a stickler on, but there are legit ways to do it, just not usually unilaterally. “Unilaterally,” for those who don’t speak Contracting, means that you, the Contracting Officer do something without the Contractor’s agreement for that specific action. Getting the Contractor’s agreement makes it “bilateral.”

So here’s the better way to do it, and yes, I’ve done them all in certain situations.

• Is the Contractor at fault for the needed cancellation? Then it may be a Termination for Default. It might also be something less severe, depending on a number of factors, but the starting question for a termination is always going to be “Whose fault is it?”The second question is going to be whether I have all the information I need to make that decision—because I once nearly T-for-D’d a small business that diverted resources for a DX-rated contract I didn’t know about, and they didn’t know it was important to tell me.
• Termination for Convenience. Imagine the rest of that phrase: “for convenience of the Government." That means the Contractor hasn’t done anything wrong. Maybe it’s a mission change. Maybe the Government decided not to pursue that technology in favor of a different one. Maybe a budget cut means this contract shouldn’t continue. The biggest issue I was aware of on the Government side was that T for C’ing a contract could mean paying out more money to settle it, especially if the Contractor expected to make up current losses toward the end of the contract.
• And then there’s the other way I used most, and almost always in lieu of a T for C: descoping or downscoping to the level of work already done, plus a final report or any outstanding reports that showed what work had been done. I recall a flurry of these around any wartime situation, usually if we needed to try a prototype of some low-TRL effort on the battlefield and it didn’t work, or if real-world needs changed and we no longer needed that particular supply or service.

How did I stay as efficient as possible for everyone and stay legal?

I would give the Contractor a phone call as a heads up because it could sometimes be very disappointing and needed a gentle and compassionate hand to explain whatever had happened. I would assure them they were not at fault in this decision, something I would later put in writing to them and, on a few occasions, in the purpose section of the modification we negotiated, so that it would be clear on their past performance in the future that they were cut short through no fault of their own.

Then I would send them an updated Statement of Work or equivalent with the yet-to-be-performed work deleted or ask them to cross out the work on their SOW they hadn’t done yet, except for the final report that we wanted. Sometimes all this was obvious in their original proposal and costs were easy to decipher.Sometimes things weren’t obvious at all and we needed a downscope proposal, and sometimes we had to pay for that.

Note that I did NOT do this unilaterally, nor did I send them a contract mod cutting them off without extensive discussion. We had a regular negotiation to downscope the contract, which created problems with managers who told us to cancel the ongoing contract and then immediately eliminated the positions of the people who needed to spend the next 2-6 months downscoping the contract the legal way.

Why so long? Because we didn’t want to violate the ADA by taking too much money off the contract. Sometimes Contractors could point to their own documentation, and we could agree on an exact amount that could be de-obligated from the contract, either as a large chunk now with the rest after more documentation or the full amount, to the penny. Other times, especially for large contracts that were far more complex, I had to have an audit so that the Government could discern what work had been done and not done and the price associated with both. It was, in those cases, a team effort with DCAA, my ACO, Program Manager, and more. All so I could make sure I wasn’t violating the law by taking too much money from the Contractor and no longer having funds for the work they had already done, or we needed them to wrap up for us.

My point here, if you’ve missed it, is that defunding a contract legally was not an easy thing; no two were exactly alike for a variety of reasons, and it was never ever ever a quick thing to do. I’m positive people who’ve not been there have no idea what’s required to take money off a Government contract, but I promise I did it the most efficient and legally sufficient way I could each time.

Federal contracts are complicated, but one thing is simple: taking funds off unilaterally is a legal and financial disaster waiting to happen. So next time you hear someone say, “The Government can just cancel contracts whenever it wants,” you’ll know better.

Any of my former Government attorneys want to weigh in?

Find my books at RapidLorna.com and my articles at AgileAcquisition.com.

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