Mitigating the Impact of Post-Covid Leasing Considerations for Government Contractors

Navigating Lease Assignments, Terminations, and Remote Work Arrangements

Overview 

One long-lasting impact companies have seen from the COVID-19 pandemic involves the decreased use of corporate office space. As a result of workforce mobility and technology that enable companies to collaborate remotely, many government contractors have transitioned to hybrid or fully remote workforce models. While the decreased utilization of corporate office space can offer cost savings, the recent downturn of the corporate real estate market has resulted in lengthy office leases and, often, limited options to reduce the burden of long-term lease obligations.  

Mitigating Lease Costs for Underutilized Space 

Contractors have three primary options to decrease costs of underutilized office space: 1) subleasing, 2) partial termination (downsizing), and 3) lease termination. Historically, companies have turned to subleasing underutilized space as a mechanism to offset lease expense; however, the downturn of the real estate market has decreased demand for office and retail space alike. Contractors must review their lease agreements and property management companies/lessors to evaluate whether downsizing or lease termination are viable options. Lease agreements may allow for partial or full termination at certain points in the lease term, subject to approval by the lessor and usually accompanied by termination fees. Property management companies also may not be willing to offer downsizing of leased space if that space will otherwise be vacant, unless concessions or additional downsizing fees are paid. 

Evaluation of Lease Termination Expense 

Contractors should evaluate partial- and full-lease termination fees, penalties, and/or associated costs to determine if these short-term expenses will provide long-term benefits. Contractors typically classify lease expenses as an indirect expense included as a component of Overhead, General & Administrative expenses or a Facilities Service Center. Therefore, evaluation of potential termination fees and associated costs must consider the requirements in FAR 31.201-2, Determining Allowability, and FAR 31.205-17, Idle Facilities and Idle Capacity Costs. These requirements and considerations include: 

• Reasonableness: Was the original lease appropriate when it was entered into? 

• Allocability and consistent recording: Is the lease expense recognized in accordance with Generally Accepted Accounting Principles (GAAP) under ASC 842 and allocated to final cost objectives in accordance with FAR Part 31, 2 CFR 200, or Cost Accounting Standards? 

• Limitations set forth in FAR Part 31.205-17/2 CFR 200.446: Does the lease expense consist of costs for idle facilities (i.e., the office space is completely unused) or idle capacity (i.e., the space is partially unused and results from normal fluctuations of usage). 

Contractors should analyze whether payment of a lease termination fee would result in an aggregate overall decrease in lease expense over the entire lease period. If an overall decrease in lease expense can be demonstrated with future year savings for the US government, a termination fee payment may be claimed as an allowable cost incurred pursuant to a prudent business decision. 

How Can BRG Help? 

BRG Government Contracts professionals have assisted contractors in evaluating options for mitigating the impact of excess space, including evaluating termination and subleasing options. We have helped clients mitigate excess facility costs, including assisting them to negotiate advance agreements with government customers incorporating reimbursement of sublease losses and termination fees. Our experts offer insights to navigate the complex federal regulatory landscape. Our team can perform compliance assessments, business system reviews, and mock audits; implement remediation activities; and guide contractors through the unique government contracting regulatory environment.