FAR 49.108-5—Recognition of judgments and arbitration awards.
Plain-English Summary
FAR 49.108-5 explains when a termination contracting officer (TCO) must, or may, recognize a subcontractor’s final judgment or arbitration award as an allowable cost in settling a terminated prime contract. It covers three related topics: final court judgments against the prime contractor, the conditions that must be met for the TCO to treat that judgment as part of the prime contractor’s termination settlement costs, the fallback rule when not all conditions are satisfied, and the treatment of arbitration awards arising from subcontract settlement disputes. The section is designed to protect the Government from paying for subcontract disputes that could have been avoided or better managed, while still allowing fair reimbursement where the prime contractor acted reasonably and in good faith. In practice, it ties subcontract dispute handling to the termination settlement process and requires the prime contractor to show diligence in subcontract drafting, settlement efforts, notice to the Government, and defense of the claim. It also gives the TCO discretion to allow a fair portion of a judgment or award when strict conditions are not fully met, but only to the extent consistent with termination settlement policies. For contractors, this section is a strong reminder that subcontract terms, litigation management, and timely communication with the Government can directly affect what costs are recoverable after termination.
Key Rules
Final judgments may be recognized
If a subcontractor obtains a final judgment against the prime contractor, the TCO shall treat that amount as a cost of settling the prime contract, but only to the extent the judgment is properly allocable to the terminated portion of the prime contract.
Five conditions must be met
Full recognition of the judgment depends on five requirements: reasonable efforts to include an appropriate termination clause, fair subcontract termination rights, reasonable efforts to settle the subcontractor’s proposal, prompt notice to the contracting officer and no refusal to let the Government control the defense, and diligent defense of the suit or reasonable assistance if the Government took over the defense.
Subcontract clauses matter
The prime contractor must have tried to include a termination clause that excludes anticipatory profits and consequential damages, or a similar clause. The subcontract’s termination provisions must also be fair and not expand the subcontractor’s common-law rights unreasonably.
Settlement efforts are required
The contractor must show it made reasonable efforts to resolve the subcontractor’s settlement proposal before the dispute became a judgment. This rule encourages early resolution and prevents avoidable litigation costs from being shifted to the Government.
Government notice and defense control
The contractor must promptly notify the contracting officer when the proceeding begins and must not refuse to let the Government control the defense. This allows the Government to protect its interests in the underlying dispute.
Diligent defense or cooperation is required
The contractor must either diligently defend the suit itself or, if the Government assumes the defense, provide reasonable assistance as requested. Failure to do so can reduce or eliminate the amount recognized in the termination settlement.
Partial allowance is possible
If all five conditions are not met, the TCO may still allow the portion of the judgment that is fair for settling the subcontractor’s proposal, taking into account the policies governing termination settlements.
Arbitration awards are treated similarly
When the contractor and subcontractor submit the settlement proposal to arbitration under applicable law or contract terms, the TCO must recognize the arbitration award under the same standards that apply to judgments.
Responsibilities
Termination Contracting Officer (TCO)
Determine whether a subcontractor judgment or arbitration award is properly allocable to the terminated portion of the prime contract and, if the required conditions are met, recognize it as a cost of settling the prime contract. If the conditions are not fully met, decide whether a fair portion should still be allowed consistent with termination settlement policy.
Prime Contractor
Use reasonable efforts to include appropriate termination clauses in subcontracts, ensure subcontract termination rights are fair and reasonable, attempt to settle subcontractor settlement proposals, promptly notify the contracting officer of litigation, avoid blocking Government control of the defense, and diligently defend the suit or assist the Government if it takes over the defense.
Subcontractor
Pursue its settlement proposal or claim through the available subcontract dispute process, including litigation or arbitration where applicable, and obtain a final judgment or award that may later be considered in the prime contract termination settlement.
Government/Agency
When notified, decide whether to assume control of the defense and, if it does, request reasonable assistance from the contractor as needed to protect the Government’s interests in the dispute and termination settlement.
Practical Implications
Contractors should build termination clauses into subcontracts up front; failing to do so can reduce the amount the Government will recognize later.
Prompt notice to the contracting officer is critical. Late notice or refusing Government control of the defense can jeopardize recovery of the judgment amount in the termination settlement.
The TCO will not automatically pay every judgment dollar. Only amounts properly tied to the terminated work are potentially recoverable, and the TCO may trim amounts that are not fair or consistent with termination policies.
Good-faith settlement efforts matter. Contractors that ignore or mishandle subcontractor settlement proposals risk having the Government disallow part of the resulting judgment or award.
Arbitration is not a workaround. Awards from arbitration are treated under the same standards as court judgments, so the same documentation, notice, and defense-cooperation expectations apply.
Official Regulatory Text
(a) When a subcontractor obtains a final judgment against a prime contractor, the TCO shall, for the purposes of settling the prime contract, treat the amount of the judgment as a cost of settling with the contractor, to the extent the judgment is properly allocable to the terminated portion of the prime contract, if- (1) The prime contractor has made reasonable efforts to include in the subcontract a termination clause described in 49.502 (e), 49.503 (c), or a similar clause excluding payment of anticipatory profits or consequential damages; (2) The provisions of the subcontract relating to the rights of the parties upon its termination are fair and reasonable and do not unreasonably increase the common law rights of the subcontractor; (3) The contractor made reasonable efforts to settle the settlement proposal of the subcontractor; (4) The contractor gave prompt notice to the contracting officer of the initiation of the proceedings in which the judgment was rendered and did not refuse to give the Government control of the defense of the proceedings; and (5) The contractor diligently defended the suit or, if the Government assumed control of the defense of the proceedings, rendered reasonable assistance requested by the Government. (b) If the conditions in paragraphs (a)(1) through (5) of this section are not all met, the TCO may allow the contractor the part of the judgment considered fair for settling the subcontract settlement proposal, giving due regard to the policies in this part for settlement of proposals. (c) When a contractor and a subcontractor submit the subcontractor’s settlement proposal to arbitration under any applicable law or contract provision, the TCO shall recognize the arbitration award as the cost of settling the proposal of the contractor to the same extent and under the same conditions as in paragraphs (a) and (b) of this section.