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A legal look at sequestration

Planned cuts could reduce defense spending by $487 billion

One thing is for sure: Either Mitt Romney or Barack Obama will be inaugurated as president in Washington, D.C. on Jan. 21. It’s still unclear, however, how sequestration will play out if it kicks in as planned on Jan. 2.

Defense contractors aren’t waiting to find out. They already are internally scrambling to figure out how a $500 billion defense cut over the next 10 years might impact their operations.

"You will probably not get any company to disclose to you what, if any, layoffs they have planned. What will happen on Jan. 2 is still very much in the air,” said Beth Ferrell, a partner at law firm McKenna Long & Aldridge LLP in Washington, D.C.

Planned federal cuts are set to reduce overall defense spending by $487 billion, or at least 9 percent, starting next year.

By law, certain employers need to tell the Department of Labor when layoffs are coming. The Worker Adjustment and Retraining Notification Act (WARN) requires most companies with 100 or more employees to give a 60-day notice of plant closings or “mass layoffs,” affecting 50 or more workers, or at least 33 percent of the work force for companies under 500 employees.

That means the flurry of sequestration-related notices would have hit the public domain on Nov. 2.

The White House Office of Management and Budget (OMB) told companies in September not to bother reporting impending cuts tied to sequestration, promising to protect the companies by essentially picking up the tab for any costs, penalties or damages associated with violating the act.

Lockheed Martin Corp. (NYSE: LMT) took the government up on its offer and said it won’t warn employees if their jobs are at stake because of the possibility of sequestration.

From a lawyer’s perspective, however, the government’s plan to take on WARN Act-related liability doesn’t ensure that contractors are home free.

“One of these problems with funding is lack of funding,” Ferrell said. “Telling them they will cover it doesn't answer whether costs incurred are reasonable or not.”

Costs associated with the WARN Act, including employee compensation costs, may be allowable as determined by a court, according to the OMB notice.

“What if you settle with the employee short of litigation and you don't get to court? There are a lot of costs contractors could incur that would not be covered by the OMB,” Ferrell said.

If Obama or Romney issues direction to implement sequestration Jan. 2, that in and of itself doesn't trigger any requirement to issue a WARN Act notice.

“There has to be a specific contract action, such as the termination of a contract, that has an impact on a company to force them to consider a mass layoff or plant closing,” said Jim Schweiter, a partner at the law firm who focuses on government contracts and government affairs.

Sequestration means contractors may have to do things differently, but it doesn't mean the government will automatically terminate or modify a contract. The government may find money elsewhere to keep a desired contract afloat, for example.

Defense firms, however, shouldn’t bank on a contract just because the services are currently in demand.

"Two months ago, a particular defense contractor might have thought whatever they were providing satisfied a critical need for the government. Two months later maybe the government's priority has changed dramatically,” Ferrell said.

At that point, the contractor will be thinking about whether they will need to trim people.

“There's no way for contractors to anticipate what specific contract action the government will take,” Schweiter said.

Those specific actions are being formulated right now. The OMB is responsible for the implementation of sequestration and will issue guidance to executive branch agencies.

The Department of Defense will receive information from OMB about how to implement sequestration at the program, project and activity (PPA) level.

“Federal agencies don't know now what the OMB guidance will say because it has not yet been issued,” Schweiter said.

Agencies aren’t sitting idle, however, and are doing contingency planning and reassessing agency needs and priorities behind closed doors.

“At a minimum, if sequestration occurs there's going to be less money available to spend, and agencies will have to decide what is critical and what may be sacrificed,” Schweiter said.

OMB estimates that new obligations for DoD procurements are going to take a 9.4-percent cut.

“So if you have a program that is ongoing and needs funding for fiscal year 2013, you have to take a 9.4-percent cut to that,” Ferrell said. “It doesn't mean you have to terminate the program. It may mean you restructure what you have and change what is being purchased and reprogram funds.”

Sequestration does not claw back money already obligated to a contract. Only new money for fiscal year 2013 and unobligated funds may be sequestered.

“If [General Dynamics] NASSCO in San Diego has a contract to build a ship, the money has already been obligated on the contract for that purpose,” Schweiter said. “That money is not subject to sequestration.”

There are certain defense contractors with reported backlogs that simply haven't filled orders.

“You may have a certain number of months where you can fully perform with current funding,” Ferrell said. “You won't feel the impact of sequestration until later. There may be others dependent on new money on Jan. 2 that will be impacted immediately."

Contractors will have to make their own decisions and may have other business circumstances or contract situations that may cause them to issue a WARN Act notice in advance of January.

“We are entering into an era of declining budgets for defense contractors, which will impact those in the San Diego area. Companies may need to trim resources simply because of that," Ferrell said.

There’s no one-size-fits-all approach. Each contractor will have to assess its situation and decide whether it's reasonable and foreseeable that the company will have to lay off people.

"Everyone thinks sequestration would be a disaster,” Schweiter said. “Everyone would like to avoid it. Unfortunately, so far no concrete steps have been taken to avoid it."

The defense industry stands to lose the money as a result of the across-the-board cuts, but other important federal dollars are at risk as a result of the $1.2 trillion that would be slashed from planned federal spending over the next decade.

The National Institutes of Health budget, for example, would see a $2.5 billion cut next year, resulting in more than 2,000 fewer funded medical research grants.

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