FAR 31.205-42—Termination costs.
Plain-English Summary
FAR 31.205-42 explains which costs may be treated as allowable termination costs when a contract is ended before completion, and how those costs must be evaluated alongside the general cost principles in FAR subpart 31.2. It covers common items, costs that continue after termination, initial costs such as starting load and preparatory costs, loss of useful value of special tooling and special machinery/equipment, rental under unexpired leases, alterations of leased property, settlement expenses, and subcontractor claims. The section exists because termination creates unusual costs that would not normally arise in full-performance contracts, and the Government needs rules to separate legitimate termination-related costs from costs that should be absorbed elsewhere or disallowed. In practice, this section controls what a contractor can recover in a termination settlement proposal and what a contracting officer should scrutinize when evaluating whether claimed costs were necessary, unavoidable, properly allocated, and supported by records. It also requires attention to mitigation, segregation of costs, residual value, title protection, and the relationship between direct charges and overhead. For both parties, the practical significance is that termination settlements are evidence-driven and highly fact-specific, with recovery often turning on whether the contractor could reasonably reuse property, stop costs promptly, and document the connection between the claimed cost and the terminated effort.
Key Rules
Use with other cost principles
Termination costs are not a separate free-standing category; they must be evaluated together with the other cost principles in FAR subpart 31.2. A cost must still be reasonable, allocable, and otherwise allowable under the general rules unless this section specifically addresses it differently.
Common items must be reused or proven unusable
Costs of items reasonably usable on the contractor’s other work are not allowable unless the contractor shows the items could not be retained at cost without loss. The contracting officer should look at current and planned production, and contemporaneous purchases of the same items are evidence that they are usable elsewhere.
Post-termination costs are limited to unavoidable costs
Costs that continue after the effective date of termination are generally allowable only if they could not be stopped immediately despite reasonable efforts. Costs that continue because of the contractor’s negligent or willful failure to discontinue them are unallowable.
Initial costs may be recoverable
Starting load costs and preparatory costs can be allowable if they were incurred for the terminated contract and were not fully absorbed because of the termination. If claimed as direct costs, they cannot also be included in overhead, and costs attributable to only one contract cannot be shifted to other contracts.
Special tooling loss is conditionally allowable
Loss of useful value for special tooling and special machinery/equipment is generally allowable only if the items are not reasonably usable on other work, the Government’s interest is protected by title transfer or other means, and the claimed loss is limited to the terminated portion’s share of acquisition cost.
Lease costs require mitigation and reasonableness
Rental under unexpired leases may be allowable, less residual value, if the lease was reasonably necessary for performance and the claimed rental does not exceed reasonable use value. The contractor must make all reasonable efforts to terminate, assign, settle, or otherwise reduce the lease cost.
Alterations to leased property may be recovered
The cost of alterations and reasonable restorations required by the lease may be allowed when the alterations were necessary to perform the contract. The key issue is whether the lease-driven work was tied to contract performance and whether the restoration cost is reasonable.
Settlement expenses are generally allowable
Reasonable accounting, legal, clerical, storage, transportation, protection, and disposition costs needed to prepare the settlement proposal and settle subcontracts are generally allowable. Significant settlement expenses should be tracked in a separate cost account or work order, and related indirect costs are limited to items like payroll taxes, fringe benefits, occupancy, and immediate supervision.
Subcontractor claims can be passed through
Subcontractor claims, including allocable common portions, are generally allowable if they are properly tied to the terminated work. The contractor may allocate an appropriate share of indirect expense to subcontract settlements only if the allocation is proportionate to the benefits received and consistent with FAR 31.201-4 and 31.203(d).
Responsibilities
Contracting Officer
Evaluate whether claimed termination costs are necessary, reasonable, and properly allocable; examine the contractor’s plans and orders to determine whether common items can be used on other work; protect the Government’s interest in special tooling and equipment; determine whether lease-related costs and settlement expenses are reasonable; and ensure indirect expense allocations to subcontract settlements are proportionate and consistent with the cost principles.
Contractor
Mitigate termination costs, stop costs promptly after termination, document why common items cannot be reused without loss, segregate and support initial costs if claimed, protect and account for special tooling and equipment, reduce lease costs where possible, separately identify significant settlement expenses, and substantiate subcontractor claims and related indirect allocations.
Subcontractor
Submit and support any termination-related claims against the prime contractor with adequate documentation of costs, including allocable common costs where applicable, so the prime can evaluate and pass through allowable amounts in the settlement process.
Agency/Government
Review settlement proposals under the termination cost rules, ensure the Government does not pay for costs that should be absorbed elsewhere or that result from poor mitigation, and safeguard title or other interests in special tooling, machinery, and equipment when those assets are involved.
Practical Implications
Termination settlements are documentation-heavy: contractors should expect to prove reuse limitations, residual values, lease mitigation efforts, and the basis for every major cost element.
Common items are a frequent dispute area; if the contractor is still buying or planning to use the same items on other jobs, the Government may reject the termination allocation.
Initial costs can be recoverable, but only if they are properly separated and not double-counted in overhead or shifted to unrelated contracts.
Lease and tooling claims often turn on mitigation and title protection, so contractors should preserve evidence of efforts to terminate leases, assign property, or otherwise reduce losses.
Subcontractor settlements can be recoverable, but the prime must show the amounts are tied to the terminated work and that any added indirect burden is proportionate and consistent with the cost principles.
Official Regulatory Text
Contract terminations generally give rise to the incurrence of costs or the need for special treatment of costs that would not have arisen had the contract not been terminated. The following cost principles peculiar to termination situations are to be used in conjunction with the other cost principles in subpart 31.2 : (a) Common items. The costs of items reasonably usable on the contractor’s other work shall not be allowable unless the contractor submits evidence that the items could not be retained at cost without sustaining a loss. The contracting officer should consider the contractor’s plans and orders for current and planned production when determining if items can reasonably be used on other work of the contractor. Contemporaneous purchases of common items by the contractor shall be regarded as evidence that such items are reasonably usable on the contractor’s other work. Any acceptance of common items as allocable to the terminated portion of the contract should be limited to the extent that the quantities of such items on hand, in transit, and on order are in excess of the reasonable quantitative requirements of other work. (b) Costs continuing after termination. Despite all reasonable efforts by the contractor, costs which cannot be discontinued immediately after the effective date of termination are generally allowable. However, any costs continuing after the effective date of the termination due to the negligent or willful failure of the contractor to discontinue the costs shall be unallowable. (c) Initial costs. Initial costs, including starting load and preparatory costs, are allowable as follows: (1) Starting load costs not fully absorbed because of termination are nonrecurring labor, material, and related overhead costs incurred in the early part of production and result from factors such as- (i) Excessive spoilage due to inexperienced labor; (ii) Idle time and subnormal production due to testing and changing production methods; (iii) Training; and (iv) Lack of familiarity or experience with the product, materials, or manufacturing processes. (2) Preparatory costs incurred in preparing to perform the terminated contract include such costs as those incurred for initial plant rearrangement and alterations, management and personnel organization, and production planning. They do not include special machinery and equipment and starting load costs. (3) When initial costs are included in the settlement proposal as a direct charge, such costs shall not also be included in overhead. Initial costs attributable to only one contract shall not be allocated to other contracts. (4) If initial costs are claimed and have not been segregated on the contractor’s books, they shall be segregated for settlement purposes from cost reports and schedules reflecting that high unit cost incurred during the early stages of the contract. (5) If the settlement proposal is on the inventory basis, initial costs should normally be allocated on the basis of total end items called for by the contract immediately before termination; however, if the contract includes end items of a diverse nature, some other equitable basis may be used, such as machine or labor hours. (d) Loss of useful value. Loss of useful value of special tooling, and special machinery and equipment is generally allowable, provided- (1) The special tooling, or special machinery and equipment is not reasonably capable of use in the other work of the contractor; (2) The Government’s interest is protected by transfer of title or by other means deemed appropriate by the contracting officer; and (3) The loss of useful value for any one terminated contract is limited to that portion of the acquisition cost which bears the same ratio to the total acquisition cost as the terminated portion of the contract bears to the entire terminated contract and other Government contracts for which the special tooling, or special machinery and equipment was acquired. (e) Rental under unexpired leases. Rental costs under unexpired leases, less the residual value of such leases, are generally allowable when shown to have been reasonably necessary for the performance of the terminated contract, if- (1) The amount of rental claimed does not exceed the reasonable use value of the property leased for the period of the contract and such further period as may be reasonable; and (2) The contractor makes all reasonable efforts to terminate, assign, settle, or otherwise reduce the cost of such lease. (f) Alterations of leased property. The cost of alterations and reasonable restorations required by the lease may be allowed when the alterations were necessary for performing the contract. (g) Settlement expenses. (1) Settlement expenses, including the following, are generally allowable: (i) Accounting, legal, clerical, and similar costs reasonably necessary for- (A) The preparation and presentation, including supporting data, of settlement claims to the contracting officer; and (B) The termination and settlement of subcontracts. (ii) Reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract. (iii) Indirect costs related to salary and wages incurred as settlement expenses in (i) and (ii); normally, such indirect costs shall be limited to payroll taxes, fringe benefits, occupancy costs, and immediate supervision costs. (2) If settlement expenses are significant, a cost account or work order shall be established to separately identify and accumulate them. (h) Subcontractor claims. Subcontractor claims, including the allocable portion of the claims common to the contract and to other work of the contractor, are generally allowable. An appropriate share of the contractor’s indirect expense may be allocated to the amount of settlements with subcontractors; provided, that the amount allocated is reasonably proportionate to the relative benefits received and is otherwise consistent with 31.201-4 and 31.203 (d). The indirect expense so allocated shall exclude the same and similar costs claimed directly or indirectly as settlement expenses.