I would like to know the grounds for legitimate withholding payment such as FAR, DFAR, or any reference materals i can referr to for justifying the government's determnation.
There is authority for withholding payment in the funding clauses themselves, and in the different sections of FAR part 32. I don't know what type of payments clauses are in your contract- so you need to look there first. But here's an example:
Notice of Progress Payments (Apr 1984)
The need for customary progress payments conforming to the regulations in Subpart 32.5 <https://www.acquisition.gov/far/html/Subpart 32_5.html#wp1047463> of the Federal Acquisition Regulation (FAR) will not be considered as a handicap or adverse factor in the award of the contract. The Progress Payments clause included in this solicitation will be included in any resulting contract, modified or altered if necessary in accordance with subsection 52.232-16 <https://www.acquisition.gov/far/html/52_232.html#wp1152807> and its Alternate I of the FAR. Even though the clause is included in the contract, the clause shall be inoperative during any time the contractor’s accounting system and controls are determined by the Government to be inadequate for segregation and accumulation of contract costs.
Also take a look at FAR 32.503-6,Suspension or reduction of payments as another example.
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