FAR 42.709-7—Contract clause.
Plain-English Summary
FAR 42.709-7 tells contracting officers when to include the clause at 52.242-3, Penalties for Unallowable Costs, in solicitations and contracts. The section focuses on the scope of the clause, the dollar threshold, and the main exceptions, including fixed-price contracts without cost incentives and firm-fixed-price contracts for commercial products or commercial services. It also explains, in practical terms, which contracts are generally considered covered—typically those containing cost-reimbursement or similar cost-based billing clauses such as 52.216-7, 52.216-16, or 52.216-17, or comparable agency supplement clauses. The purpose is to ensure the Government can assess penalties when contractors include expressly unallowable costs in claims for reimbursement or other cost submissions. In practice, this section helps contracting officers identify when the penalty clause must be flowed into the contract and alerts contractors to the heightened risk of submitting unallowable costs under covered arrangements.
Key Rules
Use the penalty clause
Include 52.242-3, Penalties for Unallowable Costs, in all solicitations and contracts over $1 million unless an exception applies. This is a mandatory clause requirement, not a discretionary one, when the contract falls within the covered category.
Dollar threshold applies
The clause requirement applies only to solicitations and contracts exceeding $1 million. Contracts at or below that threshold are outside the scope of this section.
Fixed-price exception
Do not use the clause in fixed-price contracts without cost incentives. These contracts are excluded because they do not generally involve the same cost-submission risk that the penalty clause is designed to address.
Commercial FFP exception
Do not use the clause in any firm-fixed-price contract for the purchase of commercial products or commercial services. The FAR specifically carves out these commercial fixed-price acquisitions from the penalty clause requirement.
Covered contracts are usually cost-based
Covered contracts are generally those containing 52.216-7, 52.216-16, or 52.216-17, or a similar clause in an agency supplement. These clauses typically signal cost-reimbursement, cost-sharing, or incentive arrangements where unallowable cost penalties are relevant.
Agency supplements may qualify
A similar clause from an executive agency’s FAR supplement can also make a contract covered. Contracting officers must look beyond the FAR text and consider agency-specific clauses that function like the listed cost-based clauses.
Responsibilities
Contracting Officer
Determine whether the solicitation or contract exceeds $1 million and whether any exception applies. Insert 52.242-3 when required, and verify whether the contract contains one of the listed cost-based clauses or a similar agency supplement clause that makes the contract covered.
Contractor
Recognize that covered contracts may expose the contractor to penalties for expressly unallowable costs. Ensure cost submissions, invoices, and claims exclude unallowable costs and that accounting and compliance controls are strong enough to prevent penalty exposure.
Agency
Maintain acquisition policies and clause prescriptions consistent with FAR 42.709-7 and any applicable supplement clauses. Ensure contracting personnel understand which contract types are covered and when the penalty clause must be included.
Practical Implications
This section matters most in cost-reimbursement and other cost-based contracts, where the Government reimburses allowable costs and can penalize expressly unallowable ones.
A common mistake is assuming the clause applies to every contract over $1 million; the fixed-price and commercial FFP exceptions are important and must be checked first.
Another pitfall is overlooking agency supplement clauses that function like 52.216-7, 52.216-16, or 52.216-17 and therefore bring the contract within the covered category.
Contractors should treat the presence of 52.242-3 as a compliance warning sign: cost allowability reviews, billing controls, and proposal/invoice screening become especially important.
Contracting officers should confirm clause applicability at award and not rely solely on contract type labels, because the actual billing and adjustment clauses determine whether the penalty clause is required.
Official Regulatory Text
Use the clause at 52.242-3 , Penalties for Unallowable Costs, in all solicitations and contracts over $1 million except fixed-price contracts without cost incentives or any firm-fixed-price contract for the purchase of commercial products or commercial services. Generally, covered contracts are those which contain one of the clauses at 52.216-7 , 52.216-16 , or 52.216-17 , or a similar clause from an executive agency’s supplement to the FAR.