Incentive Contract Law and Legal Definition

Incentive contracts are entered into when there is some uncertainty in the cost of work, particularly when a product is being built to unique specifications. These contracts specify the amount of profit or fee payable under the contract for a contractor's performance. Incentive contracts establish a target price, target profit and a maximum cost. This is common in contracts involving test programs or new technology or processes. Incentive contracts are designed to motivate contractor efforts that might not otherwise be emphasized and discourage contractor inefficiency and waste.

The two basic categories of incentive contracts are:

1. Fixed-price incentive contracts; and

2. Cost-reimbursement incentive contracts.

According to 48 CFR 16.401, award-fee contracts are also a type of incentive contract. An award-fee contract is suitable for use when:

1. The work to be performed is such that it is neither feasible nor effective to devise predetermined objective incentive targets applicable to cost, schedule, and technical performance ;

2. The likelihood of meeting acquisition objectives will be enhanced by using a contract that effectively motivates a contractor toward exceptional performance and provides the government with the flexibility to evaluate both actual performance and the conditions under which it was achieved.

Incentive contracts specify a completion date that must be met in order for a contractor to receive his/her full fee, or profit. Positive incentives can be built in which the fee may be increased for early completion. On the other hand, a negative incentive can also be included to the fee through liquidated damages if the schedule date is not met.