The federal procurement process (i.e., the process whereby agencies obtain goods and services from the private sector) requires funding. Contractors are generally paid using appropriated funds, and agency personnel—who are generally also paid with appropriated funds—are responsible for entering and administering contracts on the agency's behalf. The use of appropriated funds to finance contract performance and/or administration means that federal contracts may be affected by actual or potential funding gaps or shortfalls, such as could arise from a failure to raise the debt limit, budget cuts, or sequestration, all of which have been topics of wide-spread congressional and public interest during recent years. While these occurrences are distinct in their causes and their effects upon federal procurement, as Table 1 illustrates, all prompt similar questions about what the government must or may do when confronted by a lack of funds, and how contractors could be affected by potential government actions. This report provides an overview of the various options that the government has, pursuant to contract law or otherwise, when confronted with actual or potential funding gaps, funding shortfalls, or budget cuts. It begins by considering the legal principles underlying the government's generally broad rights not to incur new obligations (e.g., by canceling solicitations or declining to exercise options). The report then addresses the contractual and other rights that the government may exercise under existing contracts (e.g., changing certain terms of the contract or altering the performance period). Overall, these rights are comparatively well established. However, as the report concludes, the effects of the exercise of these rights upon contractors and, particularly, upon federal spending on procurement contracts are less clear and generally would depend upon the facts and circumstances of individual cases. The report does not address changes in contract policy that could also occur in response to funding shortfalls, nor does it address the effects that exercising certain of the rights noted here might have upon agency programs. In thinking about the government's contractual and other legal rights in this area, it helps to keep in mind the ways in which government contracts are—and are not—like other contracts. In many ways, federal procurement contracts are like other contracts between private parties, notwithstanding the fact that certain terms of these contracts are required by law. Like other contracting parties, the government generally has a duty to perform largely as specified in the contract, absent modification, excuse, or discharge of its obligations. Also like other contracts, government contracts are construed in light of the parties' intent, and the parties' intent could potentially be found to be contrary to the literal meaning of the contract. For example, a contract that purports to be a fixed-price contract (i.e., a contract whereby the contractor agrees to supply certain goods or services to the government at a predetermined price) could be found to be a cost-reimbursement contract (i.e., a contract that provides for the government to pay the contractor, at a minimum, allowable costs incurred in performing the contract up to a total cost specified in the contract) because other terms of the contract indicate that this was the parties' intent. Similarly, as with other contracts, certain implied duties, such as the duty of good faith and fair dealing, will be read into federal procurement contracts even when they are not express terms of the contract. Such duties could potentially become important where changes to existing contractual obligations, like those discussed below, are involved because one of the implied duties that contracting parties generally have is mitigating the damages they incur due to the other party's conduct. In addition, like other contracting parties, the government and/or government contractors could potentially waive certain terms of the contract, or their failure to perform could be excused. Certain standard terms of federal procurement contracts, discussed below, do permit the government to take certain actions that could potentially give rise to liability for breach under the common law of contracts. For example, the various changes clauses—allowing the government to unilaterally change certain terms of the contract —run contrary to the general rule that modifications to a contract must be bilateral. However, to the degree that these rights arise from terms of the contract, private parties could, and sometimes do, enter contracts granting themselves such rights. Perhaps the best example of this is the clause allowing the government to terminate the contract for its convenience, which the Federal Acquisition Regulation (FAR) requires to be included in all federal procurement contracts. Termination for convenience clauses are also used in contracts between private parties to give the parties some flexibility as to the quantity of goods or services delivered under the contract, as well as limit the scope of potential liability under the contract. Such clauses are necessary, particularly in private contracts, to avoid the operation of the general rule that a buyer who informs a seller that he does not intend to purchase certain goods or services provided for in a contract has anticipatorily repudiated, or breached, the contract and is liable for damages, potentially including anticipatory profits and consequential damages. Anticipatory profits are profits that the non-breaching contractor would reasonably have realized had the contract been performed. Consequential damages are damages that, while not a direct result of the breach, are a consequence of it. There are, however, several ways in which government contracts differ from other contracts precisely because the government is the sovereign. One way is that certain standard contract terms, such as the clause allowing the government to terminate the contract for its convenience, will be read into contracts from which they are lacking. The grounds upon which this is done, and potentially also the types of clauses that will be read in, have arguably shifted over time. The most recently articulated grounds for doing so are that (1) the clause represents a "deeply ingrained strand of public procurement policy," and (2) federal regulations can "fairly be read" as permitting the clause to be read into the contract because they require agencies to incorporate the clause in their contracts. However, courts had previously held that termination for convenience clauses, in particular, should be read into government contracts because the government should be given broad latitude to act in the "public interest. " Another way in which government contracts differ from other contracts is that, in certain cases, the government could avoid liability for conduct that would otherwise give rise to liability for breach because it acted in its sovereign capacity when it took the action. For example, in one recent case, the U.S. Court of Appeals for the Federal Circuit found that the government was not liable for damages incurred by a contractor after the government blocked the contractor's access to a construction site on a military base for 41 days following the terrorist attacks of September 11, 2001. According to the court, the government took this action in its capacity as a sovereign, and the action was not "specifically targeted at appropriating the benefits of a government contract." The government's rights are broadest where prospective contracts, or prospective obligations (i.e., definite commitments to spend appropriated funds) under existing contracts, are concerned. The Supreme Court has held that, "[l]ike private individuals and businesses, the Government enjoys the unrestricted power to produce its own supplies, to determine those with whom it will deal, and to fix the terms and conditions upon which it will make needed purchases." This generally means that the government may cancel a solicitation, decline to exercise an option under a contract, and not allot additional funding to cost-reimbursement contracts, even if the contractor has expended costs in preparing a bid or offer in response to the solicitation, or otherwise relied upon the expectation that the government would exercise the option, or allot additional funding. The contractor's ability to recover when the government opts not to incur new obligations is generally limited, although it is broader when the government does not allot additional funds to incrementally funded cost-reimbursement contracts than in other cases. The Anti-Deficiency Act generally bars agencies from incurring new obligations during funding gaps by prohibiting the obligation of funds in excess or advance of appropriations. Agencies would generally not be similarly barred from incurring new obligations when the debt limit is not increased, or spending is cut, but they may voluntarily limit such obligations in order to reduce spending. Even if the government has already issued a solicitation (i.e., a request for interested persons to submit bids or offers to the government ), it generally has broad discretion to cancel the solicitation at any stage in the procurement process prior to award of the contract. The Federal Acquisition Regulation (FAR) expressly authorizes cancellation of solicitations in certain circumstances, although these circumstances differ depending upon the method of source selection (i.e., sealed bidding, negotiated procurement ) and the timing of cancellation, in the case of procurements conducted using sealed bidding. Pursuant to the FAR, agencies arguably have the broadest discretion in canceling solicitations in negotiated procurements, where cancellation will generally be upheld so long as there was a "reasonable basis" for it. However, even in the case of cancellations after bid opening in sealed-bidding procurements, where agencies have the least discretion, they arguably retain considerable discretion. While a "cogent and compelling reason" is required for cancellation after bid opening, judicial and other tribunals have found that the determination of whether a sufficiently compelling reason for cancellation exists is "primarily within the discretion of the administrative agency and will not be disturbed absent proof that the decision was clearly arbitrary, capricious, or not supported by substantial evidence." In practice, this means that agencies will generally prevail so long as they can articulate reasonable, supportable grounds for the cancellation. Such grounds can include changes in agency mission or operations, lack of funds, or deciding to perform the work in-house, any or all of which could occur in response to funding shortfalls or budget cuts. In contrast, a showing of bad faith or fraud on the part of the agency (e.g., canceling a solicitation to avoid an award to a specific offeror ) could result in a cancellation determination being found unreasonable and, thus, improper.