FAR 49.108-3—Settlement procedure.
Plain-English Summary
FAR 49.108-3 explains how subcontract termination settlements are handled when a prime contract is terminated or changed. It covers the contractor’s duty to settle with subcontractors in line with the termination principles used for prime contracts, the requirement that subcontract settlement proposals be acceptable in form and basis to the prime contractor or next higher-tier subcontractor, and the need for supporting accounting data and other information sufficient for Government review. It also addresses the prohibition on Government payment for a prime contractor’s loss of anticipatory profits or consequential damages arising from a subcontract termination, except as otherwise allowed by FAR 49.108-5. On the Government side, it requires the TCO to ensure subcontract termination inventory is disposed of and accounted for under the Government property clause, and to require submission of subcontract settlements for approval or ratification unless an exception applies. Finally, it sets out the TCO’s review duties: confirm the subcontract termination was caused by the prime termination or change order, assess good faith, reasonableness, and allocability, apply the broader termination principles and related accounting review requirements, and then provide written approval/ratification or a written explanation for disapproval. In practice, this section is about controlling downstream termination costs, ensuring subcontract settlements are supportable, and preventing the Government from paying unsupported or nonallowable amounts through the prime contractor.
Key Rules
Subcontract settlements follow prime principles
Contractors must settle with subcontractors in general conformity with the termination policies and principles that apply to prime contracts under this subpart and subparts 49.2 or 49.3. The subcontract settlement process is not free-form; it must track the same basic termination concepts used at the prime level.
Prime contractor controls settlement form
The basis and form of the subcontractor’s settlement proposal must be acceptable to the prime contractor or the next higher-tier subcontractor. This gives the upper-tier contractor control over how the claim is presented and ensures the proposal is usable for review and negotiation.
Support with accounting data
Each settlement must be backed by accounting data and other information sufficient for adequate Government review. Unsupported or poorly documented settlements are vulnerable to disapproval because the TCO must be able to verify the amount and allocability of the claim.
No anticipatory profits or consequential damages
The Government will not pay the prime contractor for loss of anticipatory profits or consequential damages resulting from termination of a subcontract. The only exception is where FAR 49.108-5 applies, so contractors cannot pass through these types of losses as termination costs by default.
Subcontract inventory must be properly disposed of
Except where FAR 49.108-4 applies, the TCO must require that all subcontractor termination inventory be disposed of and accounted for under paragraph (j) of the Government Property clause at 52.245-1. Inventory handling is part of the termination settlement process and must be traceable.
Prime contractor must submit settlements for review
The prime contractor must submit all subcontract termination settlements to the TCO for approval or ratification unless an exception applies. The Government retains oversight over subcontract settlements because they can affect the amount reimbursable under the prime contract.
TCO must review for causation, good faith, reasonableness, and allocability
The TCO must promptly determine whether the subcontract termination was made necessary by the prime contract termination or a change order, and whether the settlement was made in good faith, is reasonable, and is allocable to the terminated portion of the contract. If only partly allocable, the allocation method must itself be reasonable.
Written decision required
After review, the TCO must notify the contractor in writing either approving/ratifying the settlement or stating the reasons for disapproval. This written record is the formal Government action on the subcontract settlement.
Responsibilities
Contractor
Settle with subcontractors using termination principles consistent with prime contract settlements; ensure the subcontractor’s proposal form and basis are acceptable to the prime contractor or higher-tier subcontractor; provide accounting data and other supporting information; submit subcontract settlements to the TCO for approval or ratification; and ensure subcontract termination inventory is properly disposed of and accounted for when required.
Prime Contractor
Review and accept the basis and form of subcontractor settlement proposals; submit all subcontract termination settlements to the TCO for approval or ratification unless an exception applies; and ensure subcontract settlements are supportable, reasonable, and properly allocated to the terminated work.
Next Higher-Tier Subcontractor
Where applicable, accept the basis and form of lower-tier subcontractor settlement proposals and participate in the settlement chain so that proposals can be reviewed and passed up for approval or ratification.
Termination Contracting Officer (TCO)
Require proper disposition and accounting of subcontract termination inventory; review subcontract settlements promptly; determine whether the subcontract termination was caused by the prime termination or change order; assess good faith, reasonableness, and allocability; apply relevant termination and accounting review principles; and issue written approval/ratification or disapproval with reasons.
Government
Review subcontract settlements through the TCO process and ensure the Government does not pay for anticipatory profits or consequential damages from subcontract terminations, except as specifically allowed by FAR 49.108-5.
Practical Implications
Contractors should expect subcontract termination settlements to be scrutinized just like prime termination claims, so documentation quality matters as much as the dollar amount. Poor cost support, weak allocation logic, or informal settlement packages often lead to delays or disapproval.
The prime contractor cannot simply pass through every subcontractor demand. It must be able to show that the settlement is acceptable in form, supported by records, and tied to the terminated portion of the work.
Inventory disposition is not an afterthought. If subcontract termination inventory is not properly identified, disposed of, and accounted for under the property clause, the settlement can become noncompliant and harder to approve.
Claims for lost profits or downstream business impacts are a common pitfall. This section makes clear that anticipatory profits and consequential damages from subcontract terminations are not payable by the Government through the prime contractor, absent a specific exception.
TCOs should document the causation analysis carefully. A subcontract settlement is only reviewable under this section if the termination was actually necessitated by the prime termination or a change order, and the written approval/disapproval should clearly explain the basis for the decision.
Official Regulatory Text
(a) Contractors shall settle with subcontractors in general conformity with the policies and principles relating to settlement of prime contracts in this subpart and subparts 49.2 or 49.3 . However, the basis and form of the subcontractor’s settlement proposal must be acceptable to the prime contractor or the next higher tier subcontractor. Each settlement must be supported by accounting data and other information sufficient for adequate review by the Government. In no event will the Government pay the prime contractor any amount for loss of anticipatory profits or consequential damages resulting from the termination of any subcontract (but see 49.108-5 ). (b) Except as provided in 49.108-4 , the TCO shall require that- (1) All subcontractor termination inventory be disposed of and accounted for in accordance with the procedures contained in paragraph (j) of the clause at 52.245-1 , Government Property; and (2) The prime contractor submit, for approval or ratification, all termination settlements with subcontractors. (c) The TCO shall promptly examine each subcontract settlement received to determine that the subcontract termination was made necessary by the termination of the prime contract (or by issuance of a change order-see 49.002 (b)). The TCO will also determine if the settlement was arrived at in good faith, is reasonable in amount, and is allocable to the terminated portion of the contract (or, if allocable only in part, that the proposed allocation is reasonable). In considering the reasonableness of any subcontract settlement, the TCO shall generally be guided by the provisions of this part relating to the settlement of prime contracts, and shall comply with any applicable requirements of 49.107 and 49.111 relating to accounting and other reviews. After the examination, the TCO shall notify the contractor in writing of- (1) Approval or ratification, or (2) The reasons for disapproval.