Nonprofits receiving contract awards from New York City or the state should carefully monitor President Donald Trump’s budget policies for potential retroactive effects on pre-existing contracts.
New York City Comptroller Scott Stringer recently reported that while just 9 percent of the city’s budget is federally funded, city agencies that provide social services depend heavily on federal grants. The New York City Department of Housing Preservation and Development receives 48 percent of its budget from the federal government, the city Administration for Children’s Services receives 43 percent and the city Department of Homeless Services gets 34 percent of its budget from the feds.
While it’s obvious that federal funding cuts could affect the availability of future state and city contracts, the new federal policies could also affect prior contracts. The problem stems, in part, from two features of New York City procurement: retroactive contracting and future funding clauses.
Nonprofits often provide social services before securing registered city contracts, so the city benefits from their services before it has any contractual obligation to pay. The city comptroller reported that 69 percent of city contracts in 2015 were retroactive. The five agencies with the most retroactive contracts – all in the human services sector – registered 4,259 contracts worth $4.3 billion. Nonprofits that may be working for up to a year without pay often bridge funding gaps by deferring payrolls, borrowing from commercial banks or the city’s Returnable Grant Fund.
Retroactive contracting is generally risky for nonprofits because they have to cover contract costs for an indefinite length of time and have no legal right of ever being repaid by the city. It does not usually matter that a commissioner urged the nonprofit to begin working, issued an award letter or even signed a contract. If no contract has been registered, the nonprofit may only have an “illegal but equitable” claim for a payment from the city comptroller. An appeal to the comptroller’s equitable discretion may not be successful when federal funds are scarce.
An unexpected change in federal policies could increase the potentially devastating risk of not being able to recoup costs from the city.
The risks don’t even end at contract registration. Multi-year contracts generally contain “future funding” clauses that make payment for each year “subject to the appropriation of funds” for that year. Thus, if a registered contract includes future funding for 2018 or 2019, for example, a loss of federal funds could gut the contract.
There are steps a nonprofit can take to mitigate some risks.
First, where possible, don’t perform or continue performing without a registered contract. If your mission requires performance, work with the government – possibly through associations – to accelerate contract registration, while complying with lobbying laws.
Second, keep records of all costs and the proof of benefits bestowed on the public.
Third, identify obligations posing special risks, such as wages and taxes. The state attorney general warns that board members may be personally liable for failing to pay employees’ wages and benefits, and for failing to pay state and federal taxes on employees’ wages. Work with counsel to ensure that these obligations are addressed.
Fourth, investigate “pay when paid” arrangements with subcontractors, suppliers and other partners to spread the risks of performing work without a registered contract. Work with lawyers to select contract structures that are most likely to protect such agreements, such as choosing the law of a favorable jurisdiction.
Fifth, avoid giving personal guarantees to secure the organization’s debts and explore whether existing guarantees can be released.
Sixth, consider disclosing risks to board members, auditors, creditors, major funders and other stakeholders. While these risks should not surprise diligent stakeholders, written disclosures discourage disputes.
Perhaps local government will seize this moment to end retroactive contracting. Such a long-awaited reform would be most welcome now.
Claude M. Millman, a partner at Kostelanetz & Fink LLP, is a former director of the Mayor’s Office of Contract Services.