Additional Resources in This Section
There are standard patterns into which Federal government contract claims fall. These patterns are very similar at the State and Local government levels, as well as commercially.
But, for purposes of the discussion that follows, each pattern claim is treated as if it occurs individually. Set out in this article are the elements that the contractor must prove, case law support for them, and areas in which contractors are generally weak in their claim submissions, as well as areas of defense open to the government or other contracting parties. In the seminar problems section, there are real life examples of how these patterns occur in combination, and in overlapping fashion.
The pattern claims covered are:
Interpretation disputes
Defective specifications
Impossibility of performance
Superior knowledge
Claims arising during the inspection and testing phase of work
Acceleration/Delays (compensable delays, Chapter III. F.)
Late or Withheld Payments
Breach of Contract
Government Claims
Default Termination
Convenience Terminations
Deductive Changes
Proprietary Data Related Claims
Defective Pricing
Fraud/Waste/Abuse
Other contractor and government claims also occasionally occur during performance. The foregoing claims are those that repeatedly occur. Both contracting parties should understand the proof and defenses to these repetitive disputes.
What are Common Interpretation Disputes in Federal Contracts?
Interpretation disputes in their most fundamental form involve a disagreement over the minimum contract standard that must be met for performance.
The contractor believes that the work that he is producing (or planning) in a particular area meets those minimum contract requirements. The government believes that a more expensive, different, perhaps better way of performance is required by the minimum contract standards. These disputes are often the product of how specifications are created, as explained below:
Interpretation Disputes Are Often Caused by Competition/Funding
The procurement process drives such disputes:
Compromises
Many government specifications are the result of compromises between the using activity (which is to receive the product) and the contracting/funding activity (which must initially pay for the product).
Lack of Funding
Because of a lack of funding, the user agency is often forced to accept the deletion of desired performance characteristics in favor of a more generic but a lower cost specification for the end item. This is the specification that finds its way into the agency’s request for proposals from competitors.
Forced Bidding Standards
The contractor in a competitive environment must bid to the minimum requirement to have a chance to win. The contractor thus reasonably interprets the agency’s compromise specification to permit less than the optimal performance the user desired in its original specification. As a result, the contractor's price for the specified product is lower and within available funding. He may win.
Performance Disconnect
The problem occurs after performance begins. The user activity, which is charged with reviewing the prime's design, strongly "suggests" to the prime that the design be revised in accordance with its original interpretation of the "intent" of the specification or it will not be approved. Not surprisingly, the user’s interpretation closely resembles the specification the user had to give up because of funding constraints.
While the user’s position can be grounded in very real agency needs, in effect, the user is attempting to recoup through "interpretation", the pre-award compromise it made with the procuring activity.
Vanishing Procurement People
More often, this situation results from the disappearance of the original agency participants in the "compromise" discussions. No one still working on the project, including the users and the procuring officials, remember the compromise reached. Indeed, the users cannot believe that their predecessors would have agreed to forgo such important “requirements”.
Disagreement—No Communication
Thus, both parties can actually believe in good faith that their positions are correct. Indeed, as a practical, engineering, management practice, or other matter, both parties may be correct in their views. However, under legal standards for contract interpretation as discussed in Section A – Introduction, above, only one party is legally correct. This is the essence of interpretation disputes.
Ripe for Claims
The foregoing scenarios do not always occur in the format described. But, the problem is the same – misunderstanding and miscommunication by both parties as to what they expect in contract performance. On top of this, competitive pressure forces contractors/bidders to reduce their views as to minimum acceptable interpretation/performance to lower and lower standards.
“The contractor’s own unwritten intent can sometimes be decisive in negotiating a resolution short of litigation. This is particularly true if the contractor is a good performer. The agency may decide it can forgo its technical, subjective rights.”
This is a situation ripe for claims regarding interpretation disputes. In a worst case scenario, it can produce a contract performance/contract disputes gridlock that ends in performance stoppages and perhaps a default termination.
Claim Preparation Issues – Contractor – Interpretation Issues
While interpretation disputes are analyzed as a separate claim basis, interpretation disputes are often portions of other claims or connected to other claims. Contractors are also often not particularly clear in articulating the basis for their claim. Do not assume that an “interpretation” claim will always be labeled as such, or the parties will debate them in those terms.
The issue is identifying the minimum contract requirement, and establishing whether the government directly or indirectly required the contractor to exceed it. This claim is remedied on a "constructive change" theory.
Establishing the Minimum Contract Requirements
The minimum contract requirements are often established, at least in litigation, by accepted contract interpretation rules. We have discussed those at a higher level in the introductory section. However, it must be remembered that these rules are not the only issues or approaches to claims negotiation/resolution for interpretation disagreements. Often, subjective and practical issues must be dealt with.
Significance of Subjective Interpretation
How many meetings have you attended in which parties spent a good deal of time arguing about what they subjectively intended a particular specification or drawing to mean? Or, what was the best interpretation of a particular drawing or specification, or how other contractors were interpreting this specification?
Think: How would you prove intent? Government or contractor?
From the contractor’s claim preparation perspective, all of these issues are legally irrelevant. They are not, however, practically irrelevant because the parties, particularly the agency user or the agency buyer, may believe that they are significant, important, support their position and right to increased performance under the contract, at no increased price.
The contractor’s own unwritten intent can sometimes be decisive in negotiating a resolution short of litigation. This is particularly true if the contractor is a good performer. The agency may decide it can forgo its technical, subjective rights.
Both subjective views can be extremely important in litigation and if the matter is referred for mediation or Alternative Dispute Resolution, since the mediator typically is looking for some basis to cause a compromise.
Other Criteria Used to Establish the Minimum
Some additional issues, which warrant consideration and discussion in terms of establishing the minimum contract requirements, are:
Trade practices of others in the industry.
Prior interpretations of the Agency and the government of this particular specification.
Statements that the contractor made in pre-bid documentation, including proposals and cost and pricing data, which are or are not, incorporated in the contract. Plano Bridge & Culvert, ASBCA No. 35,497, 90-3 BCA ¶ 23,2324 (agency failure to answer pre-bid inquiry); TRW, Inc., (GEODSS), ASBCA No. 27602, 87-3 BCA ¶ 19,964. (discussed earlier)
Demands that the using activity may have for the equipment in service.
Separate statutes, regulations, or specifications that may apply to the item in questions, i.e. EPA requirements, OSHA requirements, etc. (some separate clause in the contract may require that these requirements be taken into consideration).
Government Direction: The Interpretation Order Itself
An essential element of a REA or claim under the Changes clause is an “order.” This is true for interpretation disputes and most others.
The government’s interpretation, to a higher level of performance than the minimum contract requirement, can be in the form of a direct order or more subtle.
Here are examples of several types of interpretation orders:
The Government can reject the contractor’s work thereby imposing a higher standard of performance;
The Government may prioritize which effort is to be done;
The Government can insist on interim inspections, thereby imposing a higher performance level;
The Government can simply send a letter of direction to the contractor saying its interpretation is incorrect;
The Government can threaten default termination, unless its interpretation is complied with;
The Government can reject or imply that a design submission will be rejected unless a higher level interpretation is complied with;
The Government can express great displeasure with the contractor’s performance either orally or in writing and strongly suggest that the work is not going to be accepted if it continues in that fashion.
The point is that the direction or order to perform more than a “minimum interpretation” does not necessarily come in one written document. It may come orally or it may develop through a multitude of documents and position statements.
The question is whether, as a whole, the contractor was required to exceed the minimum contract requirements as a result of government action or inaction.
Often, the answer will be derived through a number of subtle actions that when considered together, create the “order”. This often occurs in contracts with performance-type specifications. Contrary to the belief of many agencies, performance specifications can actually increase the number of interpretation disputes, over “build to print” specifications. This is explained below.
Think: How would you do away with all of the foregoing disputes over direction? A letter to C.O.?
Abridgment of Interpretations in Performance-Type Contracts
In a contract with performance-type specifications, the contractor, in theory, has a right to perform in any reasonable fashion that it wants. But what happens if during the design approval process, the government rejects five design options that the contractor has open to it in a particular area, leaving only one?
What if proceeding with any of the remaining design options will increase the minimum compliance level of the specification? If, absent this agency intervention, the contractor would have chosen a less expensive interpretation, say of the five design routes presented, the agency is effectively directing the contractor’s interpretation.
That agency interpretation is almost always more expensive (or risky) than the contractor’s “minimum” performance level. Otherwise, the contractor could just do what the government agency wanted.
The Agency’s Conflict between Control and Responsibility
These interpretation claims are the result of the agency’s conflicting goals in a performance-type specification contract.
The agency chose performance-type specifications to avoid liability for making design choices that ultimately might not meet the performance requirements. The agency placed that responsibility on the contractor. This is a proper contract risk apportionment. It may be more expensive, or perhaps not, for the agency.
At the same time, the agency has a “mission” that is to be accomplished through the contract. That mission is defined by the performance specifications.
Thus, the agency has a need for control to make sure that performance – the mission – is successful. This control-orientation has a natural tendency to make the agency particularly cautious about letting a contractor make its own selections and in the agency's view, mistakes.
The result of actions to exercise control, however, is often an “abridgement” of the contractor’s design alternatives. Such “abridgement” is a classic interpretation claim basis. The contractor could not use the lower cost approaches to satisfy the performance specifications.
Interpretation Change "Orders”—they may be very subtle.
“Follow-on, first-time, “build-to-print” contractors often find themselves spending inordinate amounts of time performing in essentially a research and development mode, to try to achieve the specifications only to discover through Freedom of Information Act requests or from other sources that waivers had been granted that were never incorporated into the specifications/drawings.”
The abridgment “order” element under performance specifications can come in a number of subtle and not so subtle forms. A typical pattern is a continuous request for supporting documentation before approval will be given to a lower-priced part or design the contractor has selected, but which the agency considers less than optimal. See Toombs v. United States, 4 Ct. Cl. 535 (1984).
Another unfortunate pattern we have observed in a number of fixed price development programs, with performance specifications, occurs when an agency specifies requirements that, it knows, are unlikely to be met. The contractors are assured informally, or reasonably believe based on past experience, that after they make a reasonable effort to meet the nominal letter of the specifications, waivers will be granted. The hidden cost is that the government will often grant these waivers for “consideration”—for example, a more expensive design in another area.
The Past Performance Waiver—Foster Sportswear.
Further, if agency personnel who are unfamiliar with the past waivers take over, the agency no longer needs the product, or it becomes politically or personally inconvenient for agency officials due to new oversight of their activities, waivers may not be granted at all. (See L.W. Foster Sportswear v. United States, 405 F.2d 1285 (Ct.Cl. 1969) for this factual scenario, but in a “build to print” specification setting.)
In follow-on buy situations, these disputes often occur when the government either has not purchased or not required the submission of detailed drawings from the predecessor contractor.
Follow-on, first-time, "build-to-print" contractors often find themselves spending inordinate amounts of time performing in essentially a research and development mode, to try to achieve the specifications only to discover through Freedom of Information Act requests or from other sources that waivers had been granted that were never incorporated into the specifications/drawings.
Claim Defense – Agency Proactive Wash
Agencies need to approach interpretation disputes with awareness of the causes for many of these problems: it must be recognized and accepted that all contract specifications are subject to different interpretations of the minimum contract requirements. Agencies can anticipate and solve many of their problems.
Agencies should also be aware that in the competitive process for obtaining fixed price contracts, contractors are under substantial pressure to bid to the absolute minimum or they will lose the award. Contractors are not doing this because they want to—they must to survive
So how does an agency avoid or minimize interpretation claims?
The materials below are practical solutions.
Agency Pre-Bid Reviews
To deal with interpretation disputes in advance, many agencies perform pre-bid or pre-construction reviews of the specification, so that the solicitation effectively communicates what the government wants. In some agencies, a group of senior experienced contracting or program management personnel that are detached from the procurement are called in to review a specification or a set of drawings from the contractor’s perspective. They are asked to point out every different low cost interpretation a contractor could make of the specification.
Many agencies encourage the contractors to participate to some degree so that all views are represented. Often this occurs when contractors are given an opportunity to comment on the specifications/contract requirements.
Based on this input, the agency decides whether it wants to alter or rewrite the specifications before they are put out for bids or proposals. Often, it does so.
Site visits by contractors can have a similar effect. They provoke contractor questions that can be incorporated into the specifications.
Unfortunately, many agencies do not have this luxury. Moreover, the pressures on agencies from a lack of funding can undermine even these types of reviews when compromises have to be made to meet the available budget.
Forcing the Contractor to Define its Interpretation Pre-Award
If a senior agency group review, site visit, or contractor required “town meeting” on the specifications is not possible (probably due to funding), then the next REA/claims prevention approach requires care to be taken in soliciting and evaluating proposals.
Through the solicitation, and if necessary, through the discussion and clarification process, agencies can require contractors to disclose their interpretation of potentially problematic specifications and price their effect. Again, this requires serious effort, time, and precise drafting on the agency’s part.
This approach by agencies is intended to prevent the contractor from recovering its losses if the government later insists upon performance in accordance with the contractor's own interpretation.
For example, in TRW, Inc., ASBCA Nos. 27,299, 27,602, 87-3 BCA ¶ 19,964, the Board held that TRW had not complied with its contractual obligation to reasonably evaluate both tube vendors. TRW was required to evaluate and purchase tubes from both vendors at its cost even though TRW had pointed out that the price of one of the vendors was unreasonable and its approach was unlikely to succeed
The holding in TRW is analogous to illegal "bait and switch" cases in which an offeror proposes its best (and most expensive) personnel, obtains a higher technical score and the award and then, immediately after award, replaces these personnel with lower priced personnel to increase its profits. See Ann Riley & Associates, Ltd., Reconsideration, B- 271741.3, March 10, 1997, 97-1 CPD ¶122. In both cases, the contractor was essentially required to perform as it had proposed. Recall the GEODSS case discussion above also.
There are Practical Limits on Agencies Asking for Too Much
If the above preventative medicine is not feasible, agencies then must be cautious in this interpretation claims area of going too far in interpretation requirements.
Example:
If the contractor has a $3 million contract, and the agency imposes an interpretation that is going to cost $6 million, unless the contractor is large, the likelihood of a cardinal change argument is significant. See Section H.3 below. As discussed there, this means that there is going to be a work stoppage by the contractor.
Even if work proceeds, other severe performance problems are likely. This may threaten the agency’s mission—the primary reason for having a contract in the first place.
The point is that there must be a reasonable relationship between what the contractor is being asked to do under the government’s interpretation in terms of the bids submitted.
Example:
If all bids were clustered around a certain price, this tends to show that an interpretation greatly increasing that price was not shared by the contractor or its competitors. The same can be true of government estimates, which reflect a significantly lower amount of work than that being called for. Contractors should get this bid/proposed information from the government and put it in their file at the start of performance.
The competitive process can be a practical check on what the government can do in terms of imposing its interpretation upon the contractor.
See, MJW Enterprises, Inc., ENGBCA No. 5813, 93-1 BCA ¶ 25,405; William A. Hullet, AGBCA No. 91-230-3 et. seq., 93-1 BCA ¶ 25,389.
What Are Grounds for Defective Specification Claim Bases?
The claim of defective specifications is common in all types of contracting (government at all levels, and commercial). The essence of a defective specification claim is a government warranty - if a contractor follows the details in drawings, specifications or other contract requirements, and the product does not work, or produces excessive scrap or rework, the agency is strictly liable for the extra cost.
Detailed Design
This type of claim arises most often from detailed design specifications where all elements of the contractor’s performance are spelled out (or at least the ones affecting the failure) in detail. The leading case in this area is Spearin v. United States, 248 U.S. 132 (1918).
The Engineering Work—Bid Low
The fairness behind the Spearin implied warranty claim is the concept that once the agency spells out all the details of how performance is to be done, the agency is, in effect, telling the contractor that the government, or a prior contractor, has already done the necessary engineering and planning work. The agency expects a lower price because it does not expect to get charged a second time for the design work.
Agencies Prior Work Responsible
Thus, if the agency’s (or the prior contractor’s) engineering or planning work that led to the detail design is incorrect, the agency is responsible for the cost consequences to the contractor.
The Rule
The classic definition is set forth in the Consolidated Diesel Electric Corporation case, ASBCA No. 10486, 67-2 BCA ¶6669 at 30, 951:
Where one of the parties to a contract undertakes to prepare the specifications, that party is responsible for the correctness, adequacy and feasibility of the specifications, and the other party is under no obligation to check and verify the work product of the party who assumed the responsibility for the preparation of the specification, even though he may be as much or more of an expert than the party who prepared the specifications. Courts have held many times that a bidder need not verify the correctness and adequacy of government specifications prior to bidding. Ithaca Gun Co. v. United States, [11 CCF ¶ 80,493], 176 Ct.Cl. 477 (1976); Harvey Whipple Inc. v. United States, [10 CCF ¶ 72, 944], 169 Ct.Cl.689 (1965). This is still the law today. White v. Edsall Construction Co., Inc., 297 F.3d 1081 (Fed. Cir. 2002); Blount Brothers Corporation v. United States, 872 F.2d 1003 (Fed. Cir. 1989); and Northrop Grumman Corporation v. United States, 47 Fed. Cl. 20 (2000).
This is a fair result too. The government is paying only for manufacturing, etc. of the item – not paying again and again for the non- recurring engineering costs for the specifications and drawings.
Prior Work by Same Contractors?
What about situations where the government takes the contractor’s own detailed design from a prior contract and uses it for the purposes of soliciting bids?
Even though the government did not write the specifications itself, the government may still be responsible to all new contracting parties, including the original contractor, for defective specifications. Hickman Sea Sled Company, Inc., ASBCA No. 3008, 57-1 BCA ¶1177. By adopting those specifications as its own, it warrants to all contractors that bid the work that the performance will be met based on that detailed design, already in existence.
This may seem unfair to the government at first reading, but it probably makes sense. Again, the government is not paying multiple times for the same engineering work.
Defective Specifications Claim Preparation Issues for the Contractor.
A defective specification claim in a "build-to-print" type contract is fairly straightforward to prove. The contractor must essentially show:
That it had a detailed set of plans and specifications, or at least detailed direction as to how to perform a particular element of the work.
That it followed all the details and set up its production line, performed construction work, undertook service activities, etc. in a reasonable fashion. (Extraordinary carefulness, or attention to detail, etc. are probably not required; see White v. Edsall Construction Co., Inc., 297 F.3d 1081 (Fed. Cir. 2002).)
That it had problems that cost additional monies that were not anticipated in preparing the bid.
As noted above, the contractor reasonably assumes that no engineering work will be required so it can simply pick up the plans and specifications, and perform without any significant amount of advance planning or engineering checking, and achieve a product meeting the agency’s requirements.
Design Versus Performance Specifications
The line between performance and design specifications is not always clear. If what appear to be performance specifications are particularly detailed and directive and leave only certain limited design opportunities open, that also may result in a type of defective specification claim.
See Ryan Aeronautical Corporation, ASBCA No. 13366, 70-1 BCA ¶ 8287 and the closely related case of Kinn Electronics Corp., ASBCA No. 13526, 69-2 BCA ¶ 8061.
“Pure Performance” Specification Issues—Can There Be Claims?
Further, even with “pure” performance specifications, at a certain point, government direction and monitoring of a performance specification that abridges design alternatives to one design approach can also create a warranty if that design fails. Toombs v. United States, 4 Cl. Ct. 535 (1984).
From a contractor’s perspective, there are issues that need to be investigated before making any such claim such as:
Was there a pre-production engineering clause in the contract in question?
(If so, then it will be more difficult to argue that one could reasonably expect to perform without incurring development cost.)
Are there trade practices that have to be followed or violated?
(Often, not every detail of how to perform is given. Therefore, the contractor must be certain that it has filled in these details in a manner that will meet the “reasonable” contractor standard in its field.)
What did the contractor know about the particular problems before the contract was awarded?
(As discussed below, this may or may not affect the warranty).Should the contractor have been able to determine from the specifications that the government had made a design error?
Actual knowledge of a design defect will affect any warranty even if the contractor advised the government of the defect. See: Robins Maintenance, Inc. v. United States, 265 F.3d 1254 (Fed. Cir. 2002) (Where contractor had knowledge of a defective specification in the RFP (acreage), it could not later recover for additional costs even where it advised the CO about the defect and the CO refused to correct it. The rationale was that the contractor was not “misled”.)
Defective Specification Claims Defense Issues – Agency
Notice Failures.
“If the contractor can show that the production line was set up in an ordinary fashion, the existence of unusual scrap or other costs produced may itself, without pointing to a particular problem in the specifications, be adequate proof of a defective specification.”
Lack of notice is generally not a good defense to a defective specification claim. See Powers Regulator, GSBCA Nos. 4668 et. al. 80-2 BCA, ¶14, 463 at p. 71, 319. It is generally assumed that the contractor does not discover a defective specification until after the 20 or 30-day notice period has expired.
But what of long contractor delays in giving notice of a potential defective specification when the government did not have an opportunity to redirect the work?
What of difficulties when unusual scrap or rework occurs during the course of production? The Ithaca Gun Company v. The United States, 176 Ct. Cl., 437 (1966). Scrap/rework above the normal expected rate using a set of specifications is likely indicative of a defective specification.
Should the contractor be required to give notice of this potential defective specification within the time period in the Changes clause? Is this reasonable? Probably not.
Performance Failures.
Some agencies reflexively consider any performance failure to be the contractor’s responsibility. This often is not a good defense to a defective specification claim.
The agency needs to determine whether the unusual increase in cost raised by the contractor resulted from problems with the specifications. It is often wise for the agency to investigate the product’s history before taking a position.
But even if no history is available or there was no indication to the Agency of any prior problem, that does not end the inquiry in a contract containing detailed design specifications.
If the contractor can show that the production line was set up in an ordinary fashion, the existence of unusual scrap or other costs produced may itself, without pointing to a particular problem in the specifications, be adequate proof of a defective specification. The Ithaca Gun Co., supra.
Contractor Expertise.
Agencies often contend that the contractor’s greater expertise in the technical field should have caused the contractor to recognize that the specification was defective. This defense should fail. Blount Brothers Construction Co., v. United States, 872 F.2d 1003 (Fed. Cir. 1989).
The agency, not the contractor, has warranted that the result of following its design specifications will be successful. The agency is getting the benefit of a lower cost, because no non-recurring engineering is paid for.
Patent Ambiguity
Notwithstanding any defect in the specifications, if the defect was the product of a “patent” ambiguity, i.e. a glaring or obvious discrepancy, the claim of defective specifications will fail. See White, supra citing Blount Brothers Construction Co., Inc. v. United States, 346 F.2d 962, 972-73 (Ct. Cl. 1965).
However, this rule will not assist the government in imposing an additional duty on the contractor to ascertain whether the design specifications will work.
“Defective specification claims against agencies are straightforward to prove for contractors and difficult for the agency to defend. ”
But, what if the agency can prove that the contractor was actually aware that the specifications were latently defective? This will be the basis for a successful government defense. See Robins Maintenance, Inc. v. United States, 265 F.3d 1254 (Fed. Cir. 2002); T. Brown Contractors, Inc. v. Pena, 132 F.3d 724 (Fed. Cir. 1997).
What if the government shows, from an examination of the contractor’s bid sheets, that the contractor did not rely upon the defective drawings or specifications. Instead, the contractor chose to use its own approach and such approach failed to meet the specifications.
A lack of reliance on the government’s design could potentially be a significant factor in rebutting a defective specification claim.
See California Reforestation, AGBCA No. 88-254-1, 91-3 BCA ¶ 24,306. That is because a defective specification claim is founded on actual harm to the contractor from being misled by the specifications. Turner Construction Co., Inc. v. United States, 367 F.3d 1319 (Fed. Cir. 2004); Robins, supra.
Mixed Design/Performance Specifications
Many contracts contain a mixture of design and performance specifications. The courts only apply the Spearin warranty where the contractor can prove that following the design specifications has or will result in a failure to meet one or more of the performance specifications.
See R.E.D.M. Corporation v. United States, 428 F.2d 1304, 1310 (Ct. Cl. 1970 (performance specification that required testing of fuze assembly at a specified centrifugal force did not affect government warranty that if the detailed design instructions were followed, fuze assembly would pass the performance test); P.R. Burke Corp. v. United States, 277 F.3d 1346 (Fed. Cir. 2002) (Stating the law of design versus performance specifications.)
The government should be prepared to show that the performance failure is not related to the design specifications. See Dynalectron Corp. v. United States, 518 F.2d 594 (Ct. Cl. 1975); and Defense Systems, Co., ASBCA No. 50918, 2002 BCA ¶ 30,991(Where the Board found the contract contained “mixed” design and performance specifications, warranty only applied to the design specifications and the contractor had the burden of showing that its damages were generated by those defective specifications.)
Summary
Defective specification claims against agencies are straightforward to prove for contractors and difficult for the agency to defend. This claim basis should be distinguished from impossibility of performance and superior knowledge claims, discussed below, which are generally far more difficult to prove for the contractor.
What is Required for an Impossibility of Performance Claim?
Impossibility of performance claims most often arise in contracts where there are performance-type specifications, i.e. the contractor has been given broad general guidance as to a result to be accomplished, but not detailed design direction. The contract contemplates that the contractor will expend its own non-recurring engineering effort and money to meet the general contract requirements.
In this type of contract, the contractor theoretically has the flexibility to accomplish the result in any fashion that it wants. When things go wrong, and the required performance cannot be accomplished, the contractor must spend additional funds to accomplish the result.
What is the contractor to do if, at some point, it becomes clear that the specifications cannot be met or the job becomes so expensive that the contractor will become bankrupt if it attempts to perform?
Most contractors begin looking for ways to exit the job or to somehow recover some of the cost overruns through a claim. If the contractor could point to a defective design specification, a Spearin warranty remedy is at hand as the claims basis. But in a contract with performance specifications, a claim based on defective specifications generally is not available.
What claim approach is left? The answer is an impossibility of performance claim.
Two Types of Impossibility
Actual Impossibility.
Impossibility claims fall into two basic types. The first, called "actual impossibility", requires the specifications to be absolutely impossible with current technology. "Actual impossibility" is not proven just because the contractor cannot meet the specifications.
The contractor must show that it made all reasonable attempts to meet the specifications. It must also show that no one else could have met them. These are difficult burdens to meet.
Commercial Impracticability.
The second type, called "commercial impracticability", occurs where performance is so unexpectedly expensive that the law requires the contractor to be excused from performance. Seaboard Lumber Co. v. United States, 308 F.3d 1283 (Fed. Cir. 2002) (defense denied even where contractor alleged performance would bankrupt the company because market fluctuation was a basis assumption of the contract); Numax Electronics, Inc., ASBCA No. 29080, 90-1 BCA ¶ 22,280; Johnson Electronics, Inc., ASBCA No. 9366, 65-1 BCA ¶ 4628.
Examples.
At what point do the costs become unexpectedly too high so as to excuse further performance? Is it permissible for the contractor to show it would have to spend twice the contract price, i.e. $10 million on a $5 million job? Or must a contractor show it would spend five times the amount of the contract price, i.e. $25 million on a $5 million job?
The case law is unclear on this point. Recall that a contractor may often recognize the impossibility of performance claim potential before it has expended the entire value of the contract, i.e. the $5 million, and the cost projections are simply that, forward looking cost projections to complete the job.
As a practical matter, many contractors do not have financial resources to spend much more than the original contract price. They are forced by circumstances to claim impossibility even if it will likely be difficult to prove.
There are issues affecting both the government and the contractor—we will review the various possible scenarios in the materials that follow.
Consequences of a Successful Impossibility Claim.
At the federal level, the contractor can potentially recover all or a portion of the costs that were expended in attempting to perform the impossible specifications.
This claim is based on an implied warranty that the performance specifications issued by the government are possible to meet and/or commercially practicable. See Laka Tool and Stamping Co., Inc. v. United States, 650 F.2d 270 (Ct. Cl. 1981).
Be aware, however, if you are a subcontractor, under state law (UCC § 2-615) an impossibility claim only results in giving the subcontractor an excuse for nonperformance. That is, there is no monetary recovery from the prime.
Commercial law allows the subcontractor to stop further work and discontinue the expenditure of funds. In some circumstances, this can also be the result in a government contract case. See Ocean Salvage, Inc., ENGBCA No. 3485, 76-1 BCA ¶11,905.
Commercial law may in fact be a much easier burden to meet to just stop work, and therefore stop spending money.
REA and Claim Preparation Issues for Contractors
Contractors must first understand that the government has many more potential defenses to this claim, than to a claim for defective specifications.
The contractor's burden of proof is difficult. It must prove that:
The work was actually or practicably impossible and not the result of its own mistake in bid;
The contractor did not assume the risk;
The increased costs are a specific result of an impossibility of performance.
Impossibility Claims Defenses by Government Agency
Impossibility claims are often submitted as a defense to a default termination. The product delivered does not meet the specifications and is unacceptable to the using activity. In another scenario, faced with an overly expensive and an uncertain correction process, the contractor refuses to proceed and is terminated for default.
Failure to Try All Reasonable Means to Perform
The government often asserts that the contractor has not attempted all possible means of determining whether the specifications could be met. See Blount Brothers, supra (court held that Blount had not proven that it looked for conforming aggregate rock in reasonably accessible areas).
Contractors must be prepared to document their attempts at all reasonable means that could have a chance of success.
Bid Mistake
The government typically asserts that the contractor's overruns are the product of a mistake in bid. Before asserting this defense, the government should examine its own internal estimate of the cost of performance.
If the government’s estimate approximated that of the contractor, the government will have to explain why it also was mistaken. If the government’s estimate is substantially higher than the contractor’s bid and the government should have known that this represented a mistake, but failed to inform the contractor, the government may be liable for the increased cost and/or the contractor may rescind the contract.
See: Giesler v. United States, 232 F.3d 864 (Fed. Cir. 2000); United States v. Hamilton Enterprises, 711 F.2d 1038 Fed. Cir. 1983); FAR §14.407- 2(g) and -3(a).
Competent Contractor
Another frequent Government defense is that the specifications would not be impossible for a “competent” contractor. The Government is often able to present the contractor's competitors, or other experts in the area as witnesses on its behalf.
With the advantage of perfect 20/20 hindsight, the contractor's competitors and experts claim that the work can be performed as specified without a drastic increase in contract price.
Indeed, so long as the Government reissues the contract with the same or substantially similar specifications, the case law shows that the fact that another contractor was willing to attempt the task is strong evidence that the specifications were possible of performance.
Unless the Government relaxes the specifications at issue, (or was found to have relaxed them in the past) the burden of showing that the specifications are possible of performance is not that difficult for the Government.
See: Foster Wheeler Corp. v. United States, 513 F.2d at 594, 598 (Ct. Cl. 1975) (prior waivers proved impossibility); Marshall Associated Contractors, Inc. and Columbia Excavating, IBCA No. 1901, 01-1 BCA ¶ 31,248 (subsequent waivers of specifications proved that specifications were defective).
Assumption of the Risk
Even if the contractor demonstrates that the specifications are impossible, the Government may still succeed in defending against this claim if it can show that the contractor “assumed the risk” of impossibility.
A Federal Circuit decision held that where the solicitation did not expressly address a foreseeable risk, it was presumed that the contractor assumed the risk. Seaboard Lumber Company, Inc. v. United States, 308 F.3d 1283 (Fed. Cir. 2002).
Greater Expertise Than Government
If the contractor had the greater expertise, substantially participated in the drafting or review of the specifications prior to award, it may have "assumed the risk". J. A. Maurer v. United States, 485 F.2d 588 (Ct. Cl. 1973) (with knowledge that the requirement had never been met, contractor’s proposal assured agency that its own technique would succeed based on its expertise and agency changed contract type in reliance on these representations); Austin Co. v. United States, 314 F.2d 518 (Ct. Cl. 1963) (contractor replaced government’s specifications with its own); Bethlehem Steel Corporation v. United States, 462 F.2d 1400 (Ct. Cl. 1972) (contractor with greater expertise in the field reviewed and drafted the specifications).
Compare to Defect Specification Basis—Have you Picked the Right Basis?
Note how different the proof requirements for impossibility of performance are from defective specification claims. The assumption of risk defense is generally not present in defective specification claims.
Contractors should thus always thoroughly explore whether they have a defective specification claim basis, before taking up the task of proving an impossibility of performance claim.
In one case, the Government was given the opportunity to establish this assumption of risk defense by showing that the contractor had substantially participated in a review of the feasibility of the specifications before solicitation was issued and then submitted a proposal. Oak Adec Inc. v. United States, 24 Ct. Cl. 502 (1991).
This review was somehow equated to a meaningful participation in the drafting of the specifications.
How Should Superior Knowledge Claims be Addressed?
The theory of this claim is that prior to bidding, the Government had but did not disclose information that, if provided to the contractor, would have caused the contractor to increase its bid price substantially. For its failure to provide this information, the Government must pay the increased price.
Intent to Deceive is Unnecessary
Superior knowledge is a type of civil misrepresentation claim. The Government sometimes takes offense when a contractor files a claim based on superior knowledge thinking that it is being accused of intentionally deceiving the contractor, i.e. fraud. However, there is a major difference between a claim of superior knowledge and fraud
Unlike a fraud case, the contractor need not prove that the Government intentionally or actually misrepresented the work requirements to the contractor, but only that the agency did so innocently or mistakenly. This can occur when the contracting officials are unaware of actions of government officials in prior contract.
For example, in the leading case of Hardeman-Monier-Hutcherson v. United States, 458 F.2d 1364 (Ct.Cl. 1972), the Government, due to personnel turnover, lost a report dealing with weather conditions (typhoon like conditions) that were expected to be experienced at a particular job site. As a result, it failed to disclose this information to the bidders and the winning contractor experienced major losses due to extremely severe weather.
Although what happened was regrettable, the Government’s failure to disclose this information was innocent. Nevertheless, the Government was held responsible on a breach of contract basis for the failure to disclose these extremely adverse weather conditions of which the contractor was unaware. This is really a superior knowledge case.
Note that under the Changes clause, damages caused by unforeseen weather conditions (assuming that adverse weather in the South Pacific are unforeseen) would most often be an excusable cause of delay, not a compensable cause of delay. It is the superior knowledge element that converts an otherwise excusable delay issue only into a compensable claim item.
Claim Preparation Issues for the Contractor
The contractor needs to prove at least the following basic facts to support a superior knowledge claim
Agency Knowledge
Two types of agency knowledge are required. The contractor must prove that the agency knew or should have known of (1) vital information, and (2) that the contractor would be highly likely to have used this vital information in preparing its bid at the time the contract was awarded.
Helene Curtis Industries Inc. v. United States, 312 F.2d 774 (Ct. Cl. 1963) is the leading case in the area and reflects the classic superior knowledge fact pattern. The government had past difficulties with a particular item that was specified in the contract and how it was to be manufactured. This information was unavailable to bidders. The agency did not disclose that fact to prospective bidders. Had the bidders known of it, they would have increased their bid price.
The Court held that the government was responsible for the increased costs incurred by the winning bidder resulting from those undisclosed difficulties.
If the agency becomes aware of superior knowledge, it must disclose it effectively. Petrochem Services, Inc. v. United States, 837 F.2d 1076 (Fed.Cir.1988) (offhand remarks by agency held to be ineffective notice).
Which Agency's Knowledge Counts
The government is a large institution. Not all of its institutional “knowledge” counts for purposes of a superior knowledge claim—--only the knowledge possessed by the procuring agency. However, there are exceptions to this rule.
Not the procuring agency has the knowledge.
In J. A. Jones Construction Co. v. United States, 183 Ct. Cl. 615, 390 F.2d 886 (1968), one agency knew of another agency’s planned work in a geographic area relatively isolated from population centers. It did not disclose to the contractor that the other agency's planned contract would compete for the available skilled labor pool in the area.
After award, the contractor was unable to hire sufficient labor locally and incurred substantial increased labor costs in bringing workers in from elsewhere. The court found this to be a superior knowledge situation even though it concerned access to labor, which is generally a contractor responsibility, and even though two agencies, not just the procurement agency, were involved.
Another scenario in which the government's superior knowledge can be extended beyond the procuring activity occurs when several agencies are developing similar items. Although in reality, the agencies may not actually be sharing information because of inter-agency competition for funding, there may be ways sharing can be legally presumed to occur.
For example, the Defense Department may impose joint agency conferences to discuss the technical problems and solutions to a weapons system a number of military departments are implementing. The departments, which are often "competing" with each other to develop the better or least expensive system first, often attend these conferences without truly working with each other.
Classified Programs; Think Tanks
Yet, the appearance may be enough to overcome later arguments that each agency's knowledge may not be imputed to the other since they were supposed to be sharing it.
See for example one of the decision in the Trial Court decision in Northop Grumman, Military Aircraft Division v. United States, 63 Fed.Cl. 12 (2004) in which the Court refused to grant the government’s superior knowledge defense based on the Agency’s argument “that a contract formed in an environment of deliberately compartmented programs negated any implied duty to share information from other programs.”
The Court further refused to grant the government’s defense that the information at issue was classified, and therefore was not subject to a superior knowledge claim:
The defendant has not demonstrated any basis for this court to create or recognize a compartmented programs or classified information exception to the government’s duty to disclose under the superior knowledge doctrine, nor has any court so held. The result was later undone on appeal.
Another variation on this theme is where each agency hires the same “think tank” contractor to assist in technically evaluating their separate programs. The knowledge of the "think tank" contractor may be constructively considered the “knowledge” of all of the procuring agencies. We have argued this in several cases.
2. The Government’s Knowledge Must be Superior
If the information claimed to be “superior” is publicly available or is known in the industry generally, then the Government does not have superior knowledge. Granite Construction v. United States, 24 Cl. Ct. 735 (1991).
3. Contractors Must Actually Take Action Based Upon the Lack of the Vital Information
A contractor must show that it actually was misled and harmed by not having the significant information. AT&T Communications v. Perry, 296 F.3d 1307 (Fed. Cir. 2002) (AT&T could not demonstrate that it would have acted differently or was harmed by alleged superior knowledge).
This means that the contractor must show how the absence of the knowledge caused it to bid in a different manner to its detriment.
Claims Defense Issues – Agency
In addition to factual defenses relating to the knowledge actually possessed by the agency, the government often has good defenses and points to defend against contractors’ superior knowledge claims:
A major point of attack is what the contractor actually knows before contract award because of its experience and presence in a particular industry. This is often a knock out blow to a contractor’s superior knowledge claims.
A defense sometimes overlooked is whether the vital information could have been derived from a Freedom of Information Act ("FOIA") request.
Further, there are various databases that agencies maintain, many of which can now be searched over the Internet. These public sources of information can be a powerful rebuttal tool. Classified data to which the contractor has access may well also defeat a contractor’s claim.
How Should I address a Claim Arising from Inspection and Testing (aka "Over-Inspection)?
This area of contractor claims is perhaps one of the most confusing because there are general rules and then a multitude of factual circumstances in which such inspection-related claims can arise
The general claim basis is a standard constructive change. The contractor is essentially asserting that it has complied with the minimum contract requirements.
The agency is saying the contractor has not complied with the minimum requirements as the agency defines the requirements through the inspection criteria and directs the contractor to meet a higher inspection standard and expend more costs doing so. It is unlikely that a formal change order will be issued in this situation.
Claim Preparation Issues for Contractors
There are a number of claim preparation issues resulting from the inspection and testing phases.
Be Alert for Defective Specifications Exposed by Testing/Inspection Criteria
The inspection process can expose conflicts and defects that may exist in the specifications or test criteria. If detailed design specifications are involved, the use of test specification itself can be the event that discloses a defective specification. Dayton Wright v. United States, 64 Ct.Cl.544 (1928); see also Zundel Brothers, AGBCA No.83-212-1 AB, 85-3 BCA ¶18,451.
Interpretation of Inspection Standards; A Second Claim Basis?
The testing/inspection process can also lead to differing interpretations of what performance specifications require. A specification that appears to be achievable can be interpreted in a way to become impossible or much more expensive.
Recall that with a detailed design specification, there are design details containing previously prepared engineering work that the contractor follows without the right to redesign the unit. The contractor produces a particular product to those government detailed plans and specifications. The contractor then submits that item to the government for testing.
It is the testing that may show that the detailed design is defective. The testing itself is a type of performance specification – the contractor’s reasonable interpretation of it should control – not the government’s “best” or “higher cost interpretation”.
Development of the Test/Inspection
A key issue is often what tests are to be performed. In many contracts, the government expects the contractor to develop the test specifications. Does the item comply with a set of performance standards chosen by the agency?
A contract with performance specifications often requires the contractor to submit inspection procedures for approval after award.
What if the government then rejects the contractor’s proposed test specifications or procedures and will only approve test criteria that effectively increase the performance requirements? This government action can be a constructive change through the vehicle of establishing the test criteria.
See United Technologies Corp. v. United States, 27 Fed. Cl. 393 (1992)(government cannot retroactively correct test procedures that fail to adequately demonstrate compliance with specifications); accord SMS Data Products v. United States, 17 Ct. Cl. 1 (1989); E.W. Eldridge, ENGBCA No. 5269, 89-3 BCA ¶ 21,899.
Beyond Testing Issues: Detailed Specifications Control The General Specifications as with Other Interpretation Disputes
Conflicts between detailed requirements, and overall performance requirements are resolved in favor of the detailed requirements. Thus, if the contractor performs in accordance with the detailed design requirement, and the item does not pass government-imposed performance or test standards, the performance specification or detailed specification and/or the inspection criteria, is/are defective. This is the Spearin doctrine in operation.
The government agency often will not see it that way; however, the case law supports the contractor. See, Dayton Wright v. United States, 64 Ct.Cl.544 in which the court stated
When the government specifies in detail the design and construction to be followed by the contractor in the manufacture of the equipment and also specifies performance requirements for such equipment and the contractor manufactures the equipment in a workmanship manner in accordance with the government design but the equipment does not meet the performance requirements of the specification the contractor will not be denied compensation for the reason that it finally develops that the work done in accordance with the government plans does not produce the intended results.
So-Called “Over-Inspection” Claims
Contractors can occasionally prove that the agency inspectors were overzealous and overreaching. Or, the inspection process has been shut down in order to force the contractor to do things that exceed the minimum contract requirements.
A leading over-inspection case is G.W. Galloway Company, ASBCA Nos. 17436, 17723, 17836, 17911 and 18324, 77-2 BCA ¶ 12,640. In that case, the government’s inspection processes were completely out of control. The government was found to be “nit-picking” and otherwise pressing the contractor so excessively as to amount to overreaching and unconscionable activity.
See also Caddell Construction Co., VABCA No. 5608, 03-2 BCA ¶ 32,257 (shutting down construction on a second floor after problems were discovered on a different floor was held to be overzealous).
This kind of a case is rare. At least it is rare for a contractor to be able to successfully prove it. Think about the situation and you will see why.
The government has inspection procedures that are incorporated in the contract by reference which often give the agency a great deal of discretion as to how it conducts its inspection process. Many of the determinations in that process are subjective.
Often, the point at which the inspection is unreasonable is in the aggregate rather than a single instance. For a contractor to prove that the government was enforcing greater than the minimum requirements in the inspection process, it must first establish what is reasonable, (subjective itself) and then produce evidence to show that in the aggregate reasonableness was exceeded.
See, Atlantic Dry Dock Corp., ASBCA Nos. 42,609- 42,613, 42,679, 42,685 - 42,686, 44,472, 98-2 BCA ¶ 30,025 (agency-directed change to planned and approved method of performance was a constructive change).
If you are trying to run a plant or a construction operation at the same time that you are trying to amass this evidence, the difficulty is readily apparent.
Sample or Lot-size Variations
Another inspection-related claim occurs when the agency changes the sample or lot sizes. This is because in a very real sense, the use of a lot size represents an agency decision to take the chance that a certain number of items will be defective.
Assume that a production contract calls for a sample of 10 units to be drawn from a lot of 1,000 units, and that the government can reject that lot if more than one deficient unit is found in the sample. The government cannot simply increase the sample size to 20 units or decrease the lot size to 500, and permissibly reject that lot if one defect is found. Statistically, the contractor’s chance of having a rejection is now at least doubled.
That means that the performance requirements have increased. Associate – Aircraft - Tool & Mfg., Inc., ASBCA No. 7255, 1963 BCA ¶ 3739.
It may be a difficult concept for the government to accept, but when the contract specifies a particular type of sampling inspection, the government is in effect agreeing that it will accept a specific level of units that do not comply with the performance requirements. Why is the agency willing to do this? Because it is economically prudent to do so.
Zero Defects Are Expensive.
If the Government wants a 100 percent inspection of every item, it can call for that in the solicitation. What will happen? The prices the Government pays may be much higher because the contractor must add the cost of any potential defective items in its production run, and the increased costs of inspection.
Accordingly the government often determines, based on this cost/benefit analysis, some modest level of defects will be acceptable. That is what a sampling specification represents.
The lot size variation claim in effect enforces the agency’s economic decisions. Southwest Welding & Mfg. Co. v. United States, 413 F.2d 1167 (Ct. Cl. 1969) (imposition of 100% inspection for welding inspections exceeded contractual sampling standard).
Read the Contract Requirements Regarding Set-Ups in Inspection Standards
Be aware that the government can include a provision in the contract (and often does) that permits the agency to vary the lot or sample size. For example, it is common in Defense Department inspection provisions to have an increased level of inspection after a certain number of defects are discovered in a lot or sample.
“A failing of many federal solicitations is that they do not provide clear testing requirements. From the contractor’s perspective, this gives the agency too much discretion in establishing “reasonable” inspection standards. The problem occurs where the agency defines the test requirements in a manner that can cause the contractor substantial increased cost.”
So long as the government specified this procedure prior to contract award, so the contractor can increase its bid price to anticipate any additional cost of this agency right, this inspection increase mechanism is permissible and will be enforced without further compensation to the contractor.
A compensable claim only exists if, after the contract is signed, the Government varies the lot or sample size without a contract provision, permitting it to do so.
Additional Inspection Forces
What about a situation in which the government requires that the contractor provide its own inspectors after the contract is awarded?
What of government direction to provide training for the government inspectors coming to the job site as to how the work is being performed?
* * *
These are both extra contractual work requirements and can be the basis for a claim. The government is required to provide its own inspection forces and its own training for them. See Kimmins Constructing Corp., ASBCA No. 46340, 94-2 BCA ¶ 26,915 (requirement for an additional inspector was a compensable claim).
However, contractors should consider whether this opportunity to participate in the inspection process is worth the additional cost. It may want to do (a) and (b) at no cost to the government.
Undue Delays/Continuous Inspection
Under the standard Inspection Clause, FAR §52.246, a federal agency has an obligation to inspect in a manner that does not “unduly delay” the work. All inspections cause some minor delay in the work. The government is not liable for “normal” delays on a constructive change basis. It is “undue delay” that causes liability.
What about situations in which the Government can only provide inspectors every other day at the contractor's plant?
What about situations where inspectors can only be present during the afternoon?
What about a situation in which the contractor told the Government in its proposal that it was going to run a twenty-four hour a day operation, three shifts, and then after award, the Government says it can only provide inspectors one shift a day?
* * *
All of the above are technical violations of the Government’s duty to provide a continuous inspection once the work starts, and to not unduly delay or hinder the work. While the contractor may be able to work with the Government and stockpile items for inspections during afternoons or during one shift, if that is not the case and it causes the contractor increased costs, the contractor needs to bring the matter promptly to the Government’s attention.
If the Government insists on its approach, the contractor can submit a claim for his increased costs. See PNM Construction Inc. ASBCA No. 33350, 90-1 BCA ¶ 22,312; Maintenance Engineers, ASBCA No. 17474, 74-2 BCA ¶10,760; Russell R. Gannon Co. Inc. v. United States, 417 F.2d 1356 (Ct. Cl. 1969); Herman Adams v. United States, 358 F.2d 986 (Ct. Cl. 1966).
Non-Specific Testing Requirements
If there is no inspection standard prescribed, the Government may apply any test which reasonably shows that the contractor’s item complies with the specifications in the contract. Ball, Ball, and Brosamer Inc., IBCA No. 2103-N 93-1 BCA ¶ 25,287.
The Uniform Commercial Code in § 2-513 provides a similar rule for state law (and commercial transactions). The buyer may establish any reasonable inspection approach that establishes compliance with contract requirements.
A failing of many federal solicitations is that they do not provide clear testing requirements. From the contractor’s perspective, this gives the agency too much discretion in establishing “reasonable” inspection standards. The problem occurs where the agency defines the test requirements in a manner that can cause the contractor substantial increased cost.
Testing Standards and Approaches
In general, tests must be performed in a manner that is repetitive, the results can be duplicated; records are kept of the tests, and there are specific objectives and measurements in the testing process. See Puma Chemical Co., GSBCA No. 5254, 81-1 BCA ¶ 14844; M.B. Associates, ASBCA No. 19924, 77-2 BCA ¶ 12,797.
If the tests are simply a wild, free-for-all in which the agency inspection officials are attempting to break the contractor’s product, that is not a valid test. These tests are improperly requiring an indestructible product that was not called for in the specifications and are a valid basis for a claim.
Industry Standards
There may be trade practices, documents or manuals accepted by recognized testing associations and authorities that establish how a valid test is performed. Trident Industrial Products, DOTCAB No. 2807, 98-1 BCA ¶ 29,619 Nomura Enterprises, ASBCA No. 50959, 2001 BCA ¶31,168 (agency’s version of the industry standard exceeded the contractually specified load).
If there is no testing standard in the contract, the government cannot impose a test that exceeds that industry standard. D.E.W., Inc., ASBCA No. 37,232, 93-1 BCA ¶ 25,444 (claim granted for agency imposition of inspection criteria for blistering in excess of industry standards).
Agency Defenses
Lack of Authority
A common agency defense to claims based on changes from the inspection process is a by-product of the process itself:
Only the Contracting Officer authorized to bind the agency can make changes to the specifications.
Ordinarily, the government official most closely tied to the inspection process is a representative of the Contracting Officer who technically lacks this authority.
Contractors are deemed to know that these inspectors lack authority.
Yet, these inspectors are the persons who can determine whether the product is acceptable, particularly on the kind of time frames necessary to avoid disruption.
Given the above, the Government seems initially insulated from constructive changes caused by its inspectors. Any change to the test or inspection criteria that is suggested or even directed by a person other than the authorized Contracting Officer cannot technically be the basis for a claim.
This may be true even if the Contracting Officer is present when the direction is given. Cf. Harbert-Lummus Agrifuels Projects v. United States, 142 F.3d 1429, 1434 (Fed.Cir.1998), cert. denied 525 U.S. 1177; Hawkins and Powers Aviation, Inc. v. United States, 46 Fed. Cl. 238 (2000) (Government official lacked authority to exchange government property for services).
Contractors must therefore be careful to involve the Contracting Officer in any inspection disputes. The C.O. must be kept informed, and this must be done in writing.
Involving the Contracting Officer; Reverse Contracting
How then, can a contractor protect itself in this inspection process? Is it practical to stop the production line each time an inspector’s suggestion may result in a change or increase costs? Obviously, no.
If the inspector's direction will substantially increase the contractor’s cost, the inspector should be questioned orally as to whether the Contracting Officer has approved his or her direction.
If the inspector indicates that the Contracting Officer approved the direction given, but no written change order is forthcoming, the contractor should send a confirmatory letter to the Contracting Officer.
The letter should state that the contractor intends to proceed in accordance with the inspector’s direction, that the inspector indicated that the Contracting Officer had approved, and there will be an increased cost.
If the inspector indicates that the Contracting Officer will approve their “suggested” approach, the contractor should engage in "reverse contracting". After advising the inspector that a letter to the Contracting Officer will be written, send a written notice of the change order that should have been issued to the Contracting Officer.
The notice should state that the contractor considers the inspector’s direction to be a change to the contract, and that there are increased costs. This gives the Contracting Officer the opportunity to tell the contractor not to proceed.
While reverse contracting may create some irritation, the agency inspector should recognize that for a contractor to proceed with knowledge that an expensive suggestion or direction may be unauthorized is an unfair risk for the contractor
Once the letter is sent, the contractor must carefully document the additional costs being incurred.
If no response from the Contracting Officer is received, the contractor is not free to charge away and expect recovery. Nor, is it prudent business wise to do so. A meeting is in order with the Contracting Officer.
In most cases, the Contracting Officer will respond. However, if no response is received and pressure is exerted on the contractor to proceed with the altered inspection approach, the contractor should write another letter to the Contracting Officer advising that it is reserving its rights to a constructive change, and proceeding. While this is not foolproof, it is the best that can be done.
If the meeting is refused, the contractor now must seek technical direction as to how to proceed. A refusal to provide technical direction can be an excuse to stop work. A contractor that is facing financial impairment or bankruptcy from proceeding may well have to stop and claim that the Government breached the contract.
Agency Delegations to Other Agencies
Government procurement agencies need to be cautious when delegating inspection authority to other agencies.
For example, Department of Defense agencies such as the Air Force routinely delegate authority to the Defense Contract Management Agency (“DCMA”) inspectors. Those inspectors have their own procedures, rules, and concepts. If they follow them, as opposed to the strict contract requirements, claims are going to be generated.
However, the Contracting Officer is ultimately responsible for the cost impact of incorrect inspection. Grumman Aerospace Corp., ASBCA No. 50090, 01-1 BCA ¶ 31,316 (Where inspection was transferred from a DCAS office that had emphasized hardware inspection to an office that emphasized documentation inspection, the Board found a constructive change.)
Preventive Measures to Avoid Inspection Disputes; Contractor Presence at Inspections
Often inspection disputes arise because the contractor is not present at an inspection. The Government inspector does not have an opportunity to discuss with the contractor how the test should be set up, why something is failing, etc.
From an agency’s perspective of achieving its mission, if an item has been rejected, it is also wise to consider a retest of the item with the contractor's and Government’s inspectors are both present. We have seen numerous instances where claims were avoided by retesting and working the problems out constructively between the parties.
Fraud, Waste, and Abuse Issues: Miscommunication.
Communication between responsible officials of both parties during inspections can avoid more serious charges of product substitution or tampering. Often such charges stem from a lack of understanding of each other’s processes, and a failure of communication about the testing at issue.
Do not ignore these issues – the parties need to engage each other, and explain to each other their differences and problems.
How Should an Acceleration/Deceleration Claim be Filed?
Acceleration claims are a relatively straightforward concept. A contract required delivery in two years. The contractor encountered a delay that was excusable at some point during performance for one month. Therefore, it should be entitled to additional time to deliver to reflect the impact of that excusable delay.
If, in spite of the excusable delay, the Government still requires the contractor to deliver in two years, the original schedule, as though no delay had occurred, the contract has been constructively accelerated.
Directed Acceleration
Some government contract clauses contemplate payment for a directed acceleration of the work (or slow down). The Changes Clause in many construction contracts so provides. They may provide a mechanism for payment.
If the contract is silent, there are instances where the Government will state in writing that they desire the contractor to deliver ahead of schedule.
The standard Supply Changes clause does not permit unilateral changes to the delivery schedule. Therefore, such direction presents an opportunity to enter an advance agreement to be paid for all costs and a reasonable profit, a fixed price, or, if no agreement can be reached and circumstances require, to declare a breach and refuse to proceed.
More often, the contractor treats the direction to accelerate as a constructive change.
Constructive Acceleration
Although the Government has no right to demand a change to delivery schedule under the standard supply Changes clause, courts and boards have developed a mechanism for the Government to achieve the same result. It is called a “constructive” acceleration.
Under a constructive acceleration theory, a contractor can recover an equitable adjustment under the Changes clause if the Government has, by its actions, effectively required the contractor to accelerate its performance to meet the existing schedule (or a schedule extension to which the contractor is already entitled) in less time.
The Elements to prove
There are essentially four elements that a contractor must prove to succeed:
The contractor must prove that there has been an excusable delay or a series of them.
The contractor must give notice to the Government that the contractor is entitled to an extension of time.
There must be an order by the Government requiring the contractor to accelerate (or a refusal to grant a time extension which has the effect of constructively accelerating the work);
The contractor must prove damages - its costs have actually increased as a result of the order to accelerate.
See Fru-Con Construction Co. v. United States, 44 Fed. Cl. 298 (1999).
Excusable/Compensable Delays
The contractor must have experienced a delay for which it is entitled to a time extension. Whether that delay is excusable or compensable does not make any difference for a constructive acceleration claim. James P. Purvis v. United States, 216 Ct. Cl. 398 (1978).
The Time Extension Request Requirement
To best preserve an acceleration claim, the contractor must actually submit a written request for an extension of time for excusable or compensable delay.
For example, a time extension of so many days for a strike at a vendor’s plant might be requested. The reason for this requirement is so that the Contracting Officer has an opportunity to grant a time extension, and thereby prevent a constructive acceleration claim. The CO grants time, not money.
See: Gastovo Associates, Inc., PSBCA (2001) (failure to request time extension led to denial of constructive acceleration claim), Emlyn T. Linkous, GSBCA No. 3832, 74-1 BCA ¶10,743, and Schouten Construction Co., DOT BCA 68-14, 68-2 BCA ¶ 7155.
This rule reflects a kind of presumption that the Government is prejudiced unless it is expressly advised that its order will cause the contractor to accelerate.
An oral request for a time extension can be sufficient. See Todd Pacific Shipyards, ASBCA No. 53674, 04-1 BCA ¶32,560. However, we recommend that Contractors should formally request a time extension of a specificof specific number of days in writing. If the contractor does not make a request for a time extension, it has limited its ability to recover.
Exceptions—Useless Acts
If no request for a time extension is made, the contractor will only be able to recover on a constructive acceleration theory if the agency already has made it clear that any request for an extension would be denied. Such a statement would effectively make any time extension request a useless act.
For example, if the Commanding General of a military department wrote a letter to a contractor after award that states “no requests for time extensions will be tolerated”, that direction would probably be enough to be a standing constructive acceleration order.
“....as a practical matter, the contractor should usually attempt to force the agency to either grant the extensions or deny them as quickly as possible. The reason is that the contractor should know the facts before it begins to spend money.”
The same rule would apply where the bidding documents, plans, or specifications made it clear that time extensions should not be requested. See: MSI Corp. GSBCA 2429, 68-2 BCA ¶7377 (GSA “policy” was to consider all causes of delay at the completion of the work); Humphrey Contracting Corp. IBCA 555-4-66, 68-1 BCA ¶6820 (contract provision).
The basis for these exceptions is similar to those that apply to other federal contract notice requirements. If the agency has not been prejudiced, and a benefit has been received from the contractor, the government cannot avoid paying for the benefit. No prejudice can arise from the performance of useless acts.
The Acceleration Order
Agency Failure to Act
The agency by its actions, or failure to take actions, can make it imperative that the contractor complete the work earlier than a contractor would otherwise be contractually required.
The most common situation that contractors are presented with is the most difficult — where the Government fails to take action on one or a series of time extension requests. What is the contractor to do? When can the contractor begin to accelerate its performance, incur the additional cost and preserve its ability to recover that cost?
The case law is not crystal clear on this issue. A case held that the contractor was not entitled to “immediate” action on a time extension request but only to respond in a “reasonable time.” Fraser Construction Co. v. United States, 384 F.3d 1354 (Fed. Cir. 2004) (upholding the trial court’s finding that ongoing negotiations and partial granting of time extensions for a period of weeks were reasonable).
But, as a practical matter, the contractor should usually attempt to force the agency to either grant the extensions or deny them as quickly as possible. The reason is that the contractor should know the facts before it begins to spend money.
Write to the CO with Explicit Information.
A “drop dead date” letter should be written to the Contracting Officer stating that if no action is taken on time extension requests by a date certain, the contractor will be required to add additional workers and otherwise incur additional costs to complete the contract according to the original schedule.
This will put the Contracting Officer on notice that a failure to act amounts to a constructive acceleration order.
“Requests”/ “Pressure” to Accelerate
Another difficult situation arises when the government “pressures” the contractor to complete the contract by the original schedule after you have submitted and while the Government is considering a request for a time extension.
Consider the following scenario:
The government states: “We know that you are behind schedule and do not understand why you are not applying additional resources to complete the contract”, or “We think you should add additional workers in order to be done by the original contract completion schedule”. Assume there is no mention of the time extension request in these communications.
If the contractor hires new workers and runs additional shifts based solely on these communications, it runs the risk of having the acceleration claim denied. The government will contend it is doing nothing more than asking a contractor to comply with the contract - noting that the contractor is behind the existing schedule.
The contractor must speak up before accelerating and request action on the time extension or it may lose its acceleration claim. See Norair Engineering Corp., GSBCA No. 2975, 74-1 BCA ¶10,645; Olin Mathieson Chemical Corp. v. United States, 179 Ct.Cl. 368 (1967).
Default Termination Threats
What if an agency threatens a default termination if you do not meet the original delivery date? Is this an “order” to accelerate? If the contractor is entitled to the time extension, in our view, this is a constructive order to accelerate due to the coercive effect of a default threat— the most serious civil threat to a contractor.
Compare Tri Industries, Inc., ASBCA Nos. 47880, 48,140, 48,491 99-2 BCA ¶ 30,529 (default threat would have been constructive acceleration order if excusable delay present) with Fraser Construction, supra, (trial court interpreted letters threatening default as a constructive acceleration order where claim for excusable delay had not yet been submitted and there were other reasons for threatening default) and R. J. Lanthier Co., ASBCA No. 51636, 2004 BCA ¶32,481 (holding the Government entitled to ask the contractor to comply with the contract schedule where Government did not state that time extensions would be denied).
In any event, the contractor must still respond to any default threat (“cure” letter) and repeat the basis for the time extension request.
Proving Acceleration Damages
In order to recover damages for acceleration, the contractor must prove that it has actually performed the work in a more rapid fashion and as a result, incurred extra costs. Montgomery-Marci Co., IBCA No. 59, 1963 BCA ¶3819. This can be difficult because there are times when contractors save money by accelerating the work!
Completion by the Delivery Date is not Required
It is not necessary that the contractor successfully complete the work by the original delivery schedule. It is only necessary to actually accelerate the work and expend additional funds. Even if the contractor misses the original date by a wide margin, as long as the contractor makes the attempt, meets the above elements of the claim, and incurred additional cost, it can still recover.
Conversely, just because the contractor completes the project on time in spite of an acceleration order does not prevent the recovery of additional costs. Norair Engineering Corp. v. United States, 666 F.2d 566 (Ct. Cl. 1981).
Documentation of Damages
As with all claims, contractors should attempt to document the additional funds spent in accelerating the work through the establishment of separate charge numbers. This account should include the costs for additional employees, hours, and material costs expended.
Someone who understands the claim must check to see that employees are billing to that account to make certain that the costs are accurately collected. Internal schedules should be checked and reworked. The contractor may be able to chart its loss (or gain) of efficiency over the original contract plan.
In addition to extra labor costs, contractors should consider the costs of any extra training or loss of efficiency caused by being required to perform in an accelerated manner.
Excusable Delay Becomes Compensable; Agency Safe Position
Denials.
Agencies are constantly confronted with a problem of unwarranted time extension requests. They should be denied unless the agency needs the item. But denials of potentially valid requests can have adverse consequences.
Granting Requests.
Indeed, it is often in the agency’s best interest to grant a time extension. If the agency does not absolutely need the item by the original delivery date, a time extension will avoid the claims and the dispute potential. This is particularly true in the case of excusable delays where the contractor ordinarily will bear all of the costs.
If an excusable delay causes an acceleration of performance, and a time extension is not granted, an excusable delay will in effect become a compensable delay. In addition, the agency may also lose its default termination rights.
Must Hold Original Delivery Date.
We recommend that all the time extension requests that are based on potentially valid excusable delays should be granted promptly, unless the delivery is absolutely necessary by the original contract delivery date. If that is the case, the agency should pay the acceleration costs because it will pay either way and by agreeing to pay the contractor, it better assures that the items will be received on time.
For a collection of many cases relating to the history of constructive acceleration, See Fermont Division, Dynamics Corp. of America, ASBCA No. 15806, 75-1 BCA ¶11,139, affirmed 216 Ct. Cl. 448 (1978).
How Should Interest Claims Arising from Late or Withheld Payments be Addressed?
Two principal statutes deal with the contractor’s rights to interest in this particular area. The Prompt Payment Act (41 USC § 3901) (“PPA”) generally provides for interest payments to contractors on routine invoices after 30 days, i.e. so long as the invoice involved is undisputed. PPA interest will accrue for 1 year.
As stated before, the CDA, 41 USC §611, provides for interest in disputed or non-routine situations. To initiate the recovery of interest, the contractor should provide (i) a narrative statement, (ii) a sum certain or accounting statement, (iii) a certification if the amount exceeds $100,000, and (iv) a demand for a Contracting Officer’s final decision.
Claim Preparation Issues for Contractors—Disputed Payments?
The critical issue for contractors is being sure that they know when an otherwise routine invoice or request for payment has become disputed or non-routine. See Reflectone, Inc. v. Dalton, 60 F. 3d 1572 (Fed. Cir. 1995); Raven Industries, Inc. v. Kelso, 62 F. 3d 1433 (Fed. Cir. 1995) (non- routine requests for payment are claims whether in dispute or not).
While the Prompt Payment Act is self-executing, i.e. the Government automatically is liable for interest after 30 days on routine invoices, the CDA is not automatically self-executing when routine requests and some non-routine requests (such as termination for convenience settlement proposals) for payment are involved.
To preserve its right to interest, the contractor must still take action if a routine invoice or payment is disputed and it is not otherwise apparent that the invoice is no longer “routine”. For all amounts in excess of $100,000, a certification is required.
Once the invoice is disputed or non-routine, the provisions of the Prompt Payment Act will not apply. See Durette, GMBH, 91-2 BCA ¶ 23,756 and a detailed discussion in Ranier, Prompt Payment Act, for an interesting remedy for government late payment, 21 Public Contract Journal 177, 261 (1992). The CDA will apply.
The apparently automatic nature of the Prompt Payment Act can be a trap for unwary contractors which allow seemingly routine invoices to go unpaid for extended periods. The trap is avoided if the agency is given some basis to consider the invoiced amount in dispute or non-routine, and a certified claim is submitted.
Problem 1: Losing Interest by Inaction
The contractor has a twelve-month contract to maintain a testing laboratory for which it receives one million dollars a month or twelve million for the year. The contractor submits its first monthly invoice but is not paid.
However, the invoices for all eleven other months are paid. There is ongoing discussion about why the first month’s invoice was not paid, and the Contracting Officer frankly does not know. It turns out that there has been an allegation that the contractor did not perform all of the work requirements in the first month.
If the contractor waits until the end of contract performance, to finally certify the invoice as a claim, does it lose one year’s interest on the million dollars? Answer: Yes.
What should the contractor do to preserve its right to interest? Answer: When CO says it is unsure of why payment is being withheld, file letter stating that invoice should now be considered a claim under the CDA.
Problem 2: Set-Off Following Deductive Change
A deductive change claim is issued. The Government asserts that the contractor owes it a refund of $2 million for work the contractor did not perform. The contractor contends that it does not owe $2 million, but only $500,000.
Thus, the parties are in dispute as to $1.5 million. As a set-off, the Government withholds the $1.5 million from the contractor’s ongoing progress payments. Later, the contractor and the CO agree the $500,000 is the correct figure without a claim.
If the contractor did not certify each progress payment invoice (over $100,000) that the Government set off against the payments it would otherwise have received as a CDA claim and seek partial payment from the Government as a claim, does the contractor have any chance of recovering interest on the $1.5 million withholding? The answer seems to be no.
The Durrette case, cited above, shows that the Government’s failure to tell a contractor that its invoices are disputed, to return an invoice, or to take action on an invoice within thirty days, will not excuse the contractor from its obligation to convert late payments into disputes under the CDA.
In other words, from a contractor’s perspective, every time an invoice has underlying disputes about it, is not paid in full or in part, that invoice (if over $100,000) must be certified or otherwise designated as a CDA claim if the contractor wishes to recover interest.
In addition, the contractor needs to be alert to all situations in which other payments for other contract performance requirements, i.e. progress payments, are being affected by an underlying dispute. Those payment requests may also require certification.
Practical Approach—CDA Form Letter
A contractor that is performing substantial work, for which payment vouchers or invoices may be disputed, or otherwise are no longer routine, should prepare and use a simple form letter.
It should advise the agency that an invoice submitted on a date has not been paid and that the contractor presumes that there is some dispute as to the underlying work.
For claims over $100,000, a CDA certification and a request for a Contracting Officer’s final decision should be attached. That will satisfy the requirements of the CDA for making a claim out of the disputed invoice and entitle the contractor to recover interest
What Constitutes a Breach of Contract Claim and How Should a Contractor Respond?
At the Federal level there is an unusual breach of contract doctrine that has resulted from a combination of the unique nature of government contracting.
Historically, where the government failed to perform a major aspect of the contract, that conduct has been held to be a “breach” of contract. See Brooklyn and Queens Screen Manufacturing Company v. United States, 97 Ct. Cl. 532 (1942) (Failure to pay).
Superior knowledge cases that involve drastic increases in the cost of performance have been treated as a breach of contract cases. See Hardeman-Monier-Hutcherson v. United States, 458 F.2d 1364 (Ct. Cl. 1972). Likewise, gross misadministration of a government contract in any respect could probably also be treated on a breach of contract basis.
Whether the action on the government’s part was a breach of contract or a constructive change once had significance in terms of where the case could be brought. Prior to the CDA, breach of contract cases could only be brought in the Court of Claims, while cases “under the contract” were heard by the agency Boards of Contract Appeals.
Therefore, if the contractor had a situation where it planned to stop work, sue for anticipated profits, (or wanted to be before the court rather than the board), it had to assert a breach of contract and proceed to the Court of Claims.
The CDA essentially did away with the distinction between the Boards’ and the Courts’ jurisdiction on breach cases.
However, the distinction between a breach and a change arising under the contract retains significance in the available remedy, see Ace- Federal Reporters, Inc. v. Barram, 226 F.3d 1329 (Fed. Cir. 2000) (Federal Circuit, in reversing the GSBCA, held that where agencies that were required to purchase services from GSA Multiple Award Schedule purchased from other sources, contractors could recover breach damages, including lost profits), and in the actions available to the contractor.
The Ability to Stop Work for a Material Breach
Ordinarily, under the standard Disputes and Changes clauses, a federal contractor cannot stop work. Alliant Techsystems, Inc. V. United States, 186 F.3d 1379 (Fed. Cir. 1999) (dispute over effective exercise of an option did not justify a contractor in stopping work even though contractor was right).
The contractor is required to continue to perform and resolve the dispute through the claims process. A major distinction between calling a dispute a breach and a constructive change is the fact that when a true "material" breach occurs, the contractor can stop work.
The reason that a stop work right under a breach theory is so important is that it may prevent the contractor from spending itself into bankruptcy.
Example:
Consider the contractor who has a $5 million contract. The government issues a new series of change orders. The estimated cost of completing the basic and changed work is now $10 million. Before this new series of changes were issued, the government failed to settle any of the other 24 outstanding change orders on the contract.
If the contractor is of small or modest size, it probably cannot afford to spend $5 million of its own money on a $5 million contract and expect to get that money back from the Government in a time frame that will prevent it from going into bankruptcy.
Also, consider whether a small or modest size contractor with a $5 million contract could even borrow an additional $5 million to complete the contract at $10 million in this situation. The contractor has an obligation to tell the bank that it may be several years or more before it will recover and that the government has resisted paying its other outstanding change orders. What bank will make that loan? It is unlikely.
The foregoing situations are infrequent but are not unheard of. Indeed, as we will discuss below, many Contracting Officers should be able to predict that breach allegations entitling the contractor to stop work will be raised when a contractor is losing very substantial amounts of money on the job. Below are legal rules of breaches considered sufficient to enable a contractor to stop work.
Cardinal Changes
In recent years, the so-called "cardinal" change is becoming a more frequently utilized claim theory. A cardinal change is simply a breach of contract – a breach of the Changes clause. By definition, a cardinal change arises when an agency directed or constructive change is "outside the scope" of the Changes clause (the limitation on change in the written standard Changes Clause language).
As discussed below, it is often not easy to tell whether a change is “outside the scope” of the original contract work. The matter is complicated further by the fact that cases involving “cardinal changes” in the bid protest context may impact the degree of change necessary to establish a cardinal change.
See for example, Northrop Grumman Corp. v. United States, 50 Fed. Cl. 443 (2001) (Modification to develop aspects of NDI radar system that did not add new products or efforts was within scope even though the modification was inconsistent with a strict reading of the contract’s NDI requirements because the parties, including the Government and protesters, had not interpreted the NDI requirements strictly).
The Narrow Federal Definition
Government contracts have a public rather than a private commercial purpose. This public purpose has resulted in expansive judicial interpretations of what is "within the scope" of the Changes clause and largely prevents a contractor from stopping work and suing for "breach of contract" or "cardinal change".
The circumstances when a contractor may more safely declare action by the Government to be a cardinal change, has been limited to two situations:
The Government has issued so many changes that the performance bears little or no relationship to the original contract, or
The dollar amount of the changes has increased by such a significant amount that it is considered a cardinal change.
Type One—the Air-a-Plane Case
In Air-a-Plane Corp. v. United States, 408 F.2d 1030 (Ct. Cl. 1969), the agency made over 1500 changes to a contract for smoke generators. Each of the individual changes was small and "within the scope" of the Changes clause. Many had been fully negotiated and resolved through bilateral modifications. Nevertheless, the contractor found itself in a major loss situation and sued for breach of contract.
The agency argued that the contractor had waived its rights to any damages by agreeing to the individual change orders that included releases. The Court of Claims disagreed and held that notwithstanding the releases, the cumulative effect of the 1500 changes was "outside the scope" of the original contract.
The court stated that what had been a fixed price supply: contract took on the aspects of a design or development contract …. the frequency and nature of the changes were disruptive of [the contractor’s reasonably contemplated] production [Id. at p. 1032] (bracketed material added).
At what number of changes will the court find this transformation from a fixed price contract to a research and development contract to have occurred? 100, 200, 500? Will the number change depending on the custom and practice of the industry? This is a very subjective test.
Type Two—the Marden Case
In Edward R. Marden v. United States, 442 F.2d 164 (Ct. Cl. 1971), the contractor was in the process of building an airplane hangar when the hangar collapsed and workers were killed.
Even though the parties were in dispute over whether the cause of the disaster was defective specifications or poor workmanship, the agency directed the contractor to rebuild the hangar using the same specifications. The prime refused and was terminated for default.
The agency argued that its direction to proceed to rebuild the hangar, to the extent it was a change, was clearly "within the scope" of the Changes clause since the performance required was identical to that originally specified.
The Court rejected this contention holding that there is a presumption that a change resulting in a 100% increase in price is "outside the scope" of the contract.
But what about a 50% increase, a 40% increase? Once again, this can be a very subjective test.
Interplay Between CICA and Cardinal Changes
Under the Competition in Contracting Act (“CICA”), most federal contracts must be competed. In the past, to avoid the cost and delays inherent in competition some agencies attempted to "modify" an existing contract rather than conduct a new competition.
Competitors that become aware of this activity have sometimes been successful in protesting to the General Accounting Office ("GAO").
They contend that the modification is "outside the scope" of the contract as to be effectively a sole source award. Neil Gross Reporting, Comp. Gen. B-237434, 90-1 CPD ¶212, 69 C.G. 247 (1990).
Because of sensitivity to such protests, agencies have exercised their right to cancel awarded contracts in which changes made shortly after award could be considered "outside the scope" of the contract.
Because procurement officials are given substantial discretion in contract award, cancellation and termination for convenience matters, the definition of what is "outside the scope" of the contract (and thus, a cardinal change) has been confused by these decisions.
The Krygoski Case
In Krygoski Construction Co. v. United States, 94 F.3d 1537 (Fed. Cir. 1996), Krygoski was the low offeror on a fixed price contract for the removal of asbestos. After beginning work at one of the sites, the contractor determined that additional asbestos removal work was required.
The agency considered this added work to be a "cardinal change" because it would have increased the total cost of the contract by 25% to 33%.
After the cancellation and termination for convenience of Krygoski's award, a new competition was conducted. Krygoski lost the new competition and was the sixth lowest bidder.
Obviously, the disclosure of its original winning price had "educated" its opponents and cost the contractor the award and the contractor argued that the termination was improper.
The Federal Circuit rejected this contention, effectively condoning the Government's 25-33% total contract cost standard as a cardinal change. The court noted that the specific asbestos removal work had gone from 10% to almost 50% of the work as a result of the change.
Krygoski does not purport to change the law of cardinal changes in the claims area. However, whether a change is "cardinal", i.e. within the scope of the Changes clause, should not mean one thing to the contractor and another to the Government.
Thus, a contractor which seeks to avoid a change order exceeding 25% of the total contract price, or which doubles or triples one type of work, can cite Krygoski as authority to stop work, as discussed below.
Agency Responses to Cardinal Changes
Default Termination
As discussed above, the case law almost uniformly recites that when a material breach or cardinal change occurs, the contractor has the option of stopping work. As the Marden and Air-A-Plane cases show, there is one more step if you stop work- default termination.
While a cardinal change in those cases excused the contractor's default, as discussed later in the course, the default is the Government's most feared and potent weapon. Business is lost by the fact of a default, even if it is later overturned.
But agencies should not rest on this threat to prevent a work stoppage because a default termination is not a victory. It does not resolve the agency's mission in issuing the contract - to obtain the product or service on the delivery date. Thus, agencies have to look harder at why a contractor would take the risk of stopping work.
Recognizing The Cardinal Change “Profile”
The first question an agency should ask is: why would a contractor not want a change order, when it is, in effect, a sole source, cost reimbursement contract entitling the contractor to its reasonable costs and profit? Indeed, this is the reason that contractors rarely object to cardinal changes.
Obviously something else is going on. We have already explained in the Introduction that a contractor may stop work if it knows that it will spend itself into bankruptcy.
But bankruptcy is not the only reason. Contractors are also opportunistic. If the contractor has made errors and mistakes in bidding the basic contract work and decides that it is a bad business bargain that it would like to exit, the agency's issuance of a series of changes will be the basis for the contractor to declare a cardinal change and stop work.
Pre-Award Avoidance Actions
In some circumstances, the government is aware that significant changes to the current specifications are likely to be issued during contract performance. For example, they may be aware that technology is changing or that changes to the specific requirements listed in the contract are being considered.
The last thing the agency wants is to go through an entire procurement process, make an award to a low offeror, and shortly afterward, receive requests for exorbitant amounts for such changes by the awardee, or bid protests from competitors.
While an agency cannot make a broad blanket statement to expand the changes clause to cover all conceivable changes, relatively specific clauses that disclose the likelihood of significant changes can protect the agency from protests and cardinal change claims.
In AT&T Communications v. Wiltel, 1 F.3d 1201 (Fed. Cir. 1993), shortly after award of a contract following a very expensive competitive procurement, the agency made massive dollar changes in the hundreds of millions of dollars. The competing contractor protested that these changes, by their sheer magnitude, were outside the reasonable scope of the contract and thus, cardinal changes.
The Federal Circuit did not agree. Recognizing this danger before the solicitation was issued, the agency had included a "Service Improvements Clause" designed to cover anticipated change orders to deal with rapidly changing technology expected in a long-term contract. Based on this clause, the court held that these types of changes were “within the scope” of the contract.
The Wiltel case does not absolutely insulate agencies from cardinal change claims or protests by inclusion of overly broad performance requirements. However, where large dollar changes of a specific type are expected, an agency would be wise to consider a special clause dealing with them. Indeed, by doing so, the agency can sometimes gain the advantages of competition in reducing the cost of those changes.
See also Phoenix Air Group, Inc. v. United States, 46 Fed. Cl. 90 (2000)(where original solicitation contemplated “world-wide” flight training services, addition of new flight districts by modification was not a cardinal change).
Post-Award Avoidance
The easiest way for the Government to diffuse a cardinal change situation after award is to be aware of the above cardinal change guideposts in terms of number of changes and dollar volume, and to avoid issuing changes in that range.
Most often the issuance of changes in large amounts is an inefficient situation costing the Government more money than it would otherwise pay if it let the extra work out for separate competitive bids.
At the first hint that the contractor thinks that there are too many changes or the dollar volume amount is high, or that the contractor is generally disgruntled over other issues, the Contracting Officer would do well to develop contingency plans for a separate procurement for the changed work. Except under the most extraordinary schedule pressure, the Contracting Officer should be able to find someone else to do the changed work through competition.
Bilateral Change Orders
The entire discussion of cardinal changes deals with unilateral change orders, i.e., directed by the agency without the contractor’s consent. Only unilateral changes can be cardinal changes. Bilateral agreements destroy the cardinal change claim basis.
See: Amertex Enterprises, Ltd. v. United States, 1995 WL 925961, 41 CCF (CCH) ¶77,047 (Fed. Cl., Dec 15, 1995) affirmed 108 F.3d 1392 (table)
(Fed. Cir. 1997) cert. denied 522 U.S. 1075 (2001); William F. Klingensmith, ASBCA No. 52,028, 03-1 BCA ¶32,072; see Cities Service Helex, Inc. v. United States, 543 F.2d 1306, 1313 (Ct. Cl. 1976).
A standard Government technique for eliminating a potential cardinal change situation is to negotiate settlements to all the changes that are outstanding as a group. Once the contractor has signed this bilateral agreement, absent an Air-A-Plane scenario, the contractor probably has forfeited its right to declare the changes "cardinal" and stop work.
Another technique is for the Government to go to the contractor, probably the contractor’s president or chief executive officer, and agree bilaterally that the contractor will perform a series of changes.
Once a contractor has agreed to perform certain groups of changes by bilateral agreement, even though there has been no agreement on the exact scope of work or the price for the change, the contractor has in effect, entered into a bilateral agreement, which probably will avoid the “counting up” of unilateral change orders discussed above.
The above scenario can also occur when the contractor proceeds with the work after advising the Government that it considers the direction to be a cardinal change. Information & Network Systems Corp., ASBCA No. 46,119, 02-2 BCA ¶31,952 (waiver of material breach by continuing to perform); Becho Inc., v. United States, 47 Fed. Cl. 595 (2000) (can proceed while reserving right to cardinal change as a defense to a default termination).
Other Types of Cardinal Changes
Contracting Officers should also be aware that the cardinal changes might occur in other than conventional ways. Inventive (or desperate) contractors will argue that a series of changes, which has a drastic impact upon the schedule, could also be a cardinal change.
Likewise, late Government furnished property that significantly disrupts the contractor’s performance may be held beyond the scope of the changes clause remedy.
Damages for Cardinal Change/Breach
Anticipatory Profits
Contractors that claim to have experienced cardinal changes are most often looking at financial reasons to exit contracts—they are losing money. Thus, it is unlikely that they will be able to show that the Government’s breach deprived them of anticipated profits.
While under breach theory, the contractor may recover its total costs to the point in time when the cardinal change breach occurred, it is an open issue whether that recovery would then be diminished by the percentage of these losses under the "loss formula" provisions of the Termination for Convenience clause. (This assumes that the Government’s default termination was converted to a T for C based on the cardinal change).
In any event, the contractor was certainly making no profit. Therefore the contractor's ability to recover anticipated profits in a cardinal change situation is usually theoretical. See United States v. Penn Foundry & Mfg. Co., Inc., 337 U.S. 198 (1949) (anticipated profit recovery rejected where contractor was unable to demonstrate that it was capable of completing contracts and making a profit).
What Sorts of Claims Can the Government Make?
Contractors who are considering filing claims should recognize that the Government may have claims of its own, many of which are based on standard clauses.
Default Termination
Problematic contracts are targets for a Government decision to terminate for default.
Grounds
The standard Government fixed price Default clause permits the Government the discretion ("may") to terminate the contract for default in 3 basic situations:
failure to deliver in accordance with the contract schedule,;
failure to make progress thus, “endangering performance”; and
failure to comply with clauses that are considered “material”.
Government’s Monetary Damages
For a valid default termination in a fixed price contract, the Government can claim (less the value of any “manufacturing materials” to which it takes title):
an “automatic” refund of any progress payments,
excess reprocurement costs, or “cover”, i.e. the additional cost of buying a similar item,
liquidated damages, and
other “common law” damages resulting from the default.
In addition, if the default is valid, most contractor claims are forfeited. However, pre-existing claims that are unrelated to the default may survive. Laka Tool and Stamping v. United States, 650 F.2d 270 (Ct. Cl. 1981) (claim based on impossibility survived valid default termination based on failure to comply with relaxed specifications); see also, Peter Gross GMBH & Co. KG, ASBCA No. 50326, 98-1 BCA ¶ 29,489.
Non-Monetary Damages to Contractor
In addition to money damages, there are often more significant future effects to a contractor from a default termination. The contractor may be:
debarred or suspended, usually for a persistent or egregious failure to perform,
found non-responsible in future competitive procurements, or
adversely affected in future evaluations of its past performance.
Because the consequences of a default termination are so harsh, the authors believe that an agency should issue a default termination only in extreme cases. Indeed, most contractors fear default terminations so much that to prevent their issuance, they will be willing to negotiate a resolution favorable to the government.
Agencies must remember that they also are damaged by a default termination. The mission of the contract is usually delayed. Recovery of money from the contractor is often illusory.
Moreover, because of the onerous consequences to the contractor, a default termination often compels the contractor to initiate litigation where any mistakes in the procurement by the government will be subject to public scrutiny.
Further, it is possible that the contractor (or other businesses) will no longer participate in government procurement, a bad result if the contractor has successfully performed contracts other than the one at issue.
Government’s Burden of Proof
The legal burden of establishing a basis for a default termination is on the Government. Danzig v. AEC Corp., 224 F.3d 1333 (Fed. Cir. 2000); McDonnell Douglas Corp. et. al v. United States, 182 F.3d 1319 (Fed. Cir. 1999); Lisbon Contractors, Inc. v. United States, 828 F.2d 759, 764 (Fed.Cir.1987).
Failure to Deliver as Preferred Basis
Because a failure to meet the delivery schedule is typically the easiest default to prove, it is the favored basis for the government in issuing a default termination. In contrast, showing that a contractor has “failed to make progress” sufficient to deliver on time or that performance was otherwise “endangered” presents a much more onerous burden for the government.
Ordinarily, the government must show that there was "no reasonable likelihood that the [contractor] could perform the entire contract effort within the time remaining for contract performance." AEC Corp., supra; Lisbon, supra.
Because the proof of the contractor’s actual progress and its ability to take extreme steps with the future to perform is subjective, this is often a very difficult standard for the government to meet.
But see Morganti National, Inc. v. United States, 49 Fed. Cl. 110 (2001) (requiring only “a demonstrated lack of diligence indicates that [the government] could not be assured of timely completion”).
Although the Morganti “lack of diligence” formulation is a quote from Lisbon, it could be construed as a lesser standard of proof.
Relationship of Contractor Delay Claims
Delivery Schedule
Since both of these most common default grounds are usually based on an enforceable and definite delivery schedule, a contractor facing a default termination threat must seek to extend the delivery date.
Upon receipt of a show cause or cure notice (or before) contractors need to consider whether they have any possible claims for excusable or compensable delay that have not been already submitted as time extension requests.
Overcoming Delay Claims
Conversely, agencies that intend to proceed with a default must carefully consider any delay claims that could extend the delivery date. The presence of excusable delay does not necessarily mean an agency has lost its ability to default terminate the contractor. However, the agency must treat this situation with care.
See: Ryste & Ricas Inc., ASBCA No. 51841, May 29, 2002, 02-2 BCA ¶ 31, 883, in which the Board overturned a default termination because the Contractingbecause Contracting Officer had failed to analyze the contractor’s delay claims.
Anticipatory Repudiation
If the contractor has taken actions constituting an “anticipatory repudiation”, the agency can terminate the contract for default regardless of the contractor’s entitlement to schedule extensions. Cascade Pacific International v. United States, 773 F.2d 287 (Ct. Cl. 1985); Action Support Services Corp., ASBCA No. 46,524, 2000 BCA ¶30,701 (contractor stopped work with condition precedent for continued performance).
However, an anticipatory repudiation requires an unequivocal statement or actions showing that the contractor will no longer perform. AEC Corp., ASBCA No. 42920, 98-2 BCA ¶29,952 (statements that work force was being reduced and statement that contractor could not predict when contract would be completed were considered equivocal). But see Danzig v. AEC Corp., 224 F.3d 1333 (Fed. Cir. 2000) (holding that unequivocal repudiation is not required where a contractor fails to adequately respond to a cure notice).
Consider the following:
Scenario — The Lemming
The contractor has been attempting to be paid on a major claim for more than a year. To avoid taking action, the contracting officer has put off the contractor with additional and largely useless requests for information and asserts that the government cannot issue a final decision without it.
The contractor knows it can appeal to the Board of Contract Appeals or the Court of Federal Claims on a “deemed denied” basis after 60 days without a government response, but also recognizes that because of the delays involved in that process, this remedy will not solve the cash flow problem that has been created by the claims issues.
The Board of Directors of the company monitor the status of this claim at every meeting and the president of the company can think of nothing to show them that progress is being made. Exasperated, he sends the contracting officer a letter stating that unless the company is paid within 7 days, the contractor will stop work.
What is the result? Answer: Possible anticipatory repudiation. And, successful default termination by the government.
What if the contractor writes a letter the next day stating that it will continue to perform? Answer: If no termination action was taken, the repudiation would no longer be unequivocal.
Failure to Make Progress
Even if excusable or compensable delays are present, if there are objective facts indicating that the contractor cannot ever succeed in performing the contract in a remotely reasonable time, a default for failure to make progress can be upheld.
This can occur when a contractor has gone bankrupt, or it has lost its work force and/or otherwise lacks the capability to hire a workforce.
Often this inability to perform is equated to an anticipatory repudiation. Universal Fiberglass Corp. v. United States, 537 F.2d 393 (Ct. Cl. 1976) (after delivery date was waived, default was upheld where contractor failed to submit a delivery schedule or take corrective action).
Other Contractor Default Defenses
Even if delay claims are unavailable, the agency needs to understand the other defenses contractors may assert to a default termination.
Abuse of Discretion
Courts have focused on whether the Contracting Officer's discretion to terminate has been properly exercised. FAR § 49.402-3(e)(4) contains a number of factors to be considered in exercising such discretion:
the agency's need for the item;
the contractor's reasons for its failure to perform;
the effect of a default termination on the contractor's other government contracts;
the contractor's effort in attempting to perform;
the cost and schedule impact of re-procuring the item from another source; and
other relevant factors.
Although the Government is not required to consider each of these factors in every case, the courts and boards look to whether these or other appropriate factors were considered. In general, a court or board will defer to an agency's consideration of these factors except in situations where the principal motivation for the default was other than the contractor's performance.
The leading case involving the proper exercise of discretion is Darwin Construction Co. v. United States, 811 F. 2d 593 (Fed. Cir. 1987). In Darwin, three construction contractors were equally late in completing buildings on the same construction project but only one was terminated for default.
The court held that the default termination was an abuse of discretion since the default was motivated by the agency's desire to "rid itself" of a particular contractor, not the alleged performance shortcoming.
In Sol O. Schlesinger v. United States, 390 F.2d 702 (Ct. Cl. 1969), a contractor was being investigated for wrongdoing in connection with certain contracts. As a result of the investigation, the contractor was defaulted for supposed actions on an unrelated contract.
The court found that the default action was motivated for reasons other than the contractor's performance and overturned the default. But see McDonnell Douglas Corp. et. al v. United States, 182 F.3d 1319 (Fed. Cir. 1999) (Federal Circuit reversed trial court and found that politically sensitive contract was terminated for reasons sufficiently related to performance to avoid this defense).
The practical effects, the cases and the regulations strongly suggest that default terminations should only be issued by the Government after careful consideration and documentation of all relevant FAR factors and a serious consideration of the motivations behind their issuance.
See: Marshall Associated Contractors, Inc. and Columbia Excavating, IBCA No. 1901, 2001-1 BCA ¶ 31,248 (failure to adequately consider claims held an abuse of discretion); ABS Baumaschinenverttrieb GMBH, ASBCA No. 48,207, 00-2 BCA ¶ 31,090 (contracting officer abused her discretion in failing to review test results that would have showed that default was improper); The Ryan Company, ASBCA No. 48,151, 00-2 BCA ¶ 31,094(discretion abused where Contracting Officer relied on materially erroneous information relating to culpability for a delay).
From the contractor's perspective, if a default has been threatened, the FAR factors that most favor continuation of the contract, and any claims, should be brought to the Contracting Officer's immediate attention in writing. Indeed, a failure to bring these matters forward, or any settlement of them, can result in a waiver. Rex Systems, Inc. v. Cohen, 224 F.3d 1367 (Fed. Cir. 2000).
Failure of the Government to Provide Technical Direction
The Government's cure or “show cause” notice should identify the general problems perceived to indicate the potential for a default termination. If the Government needs to provide the contractor with technical direction in any of these areas to enable the contractor to proceed and meet the delivery schedule, this is the time for the contractor to seek such direction.
A failure to provide technical direction is a breach of contract and at least excuses a default termination. Malone v. United States, 849 F.2d. 1441, 1446 (Fed. Cir. 1988).
Agencies must be somewhat wary of such requests. As shown below, agency participation in providing information at this juncture could be deemed to be an action inconsistent with exercising default rights, particularly if the delivery date has passed. If such direction is necessary, the agency should consider whether any time extensions are owed.
Waiver of the Delivery Date
Like any other contract right, the agency's right to issue a default termination can be lost if the agency’s actions are inconsistent with enforcement of the right.
Scenario 1—Providing Direction after the Date Has Passed
Assume that a delivery date has passed without delivery and without a default termination. Assume further that after the delivery date passes, the Government provides the contractor with technical direction that was requested in the contractor's response to the show cause letter.
Is this action directly or indirectly inducing the contractor to continue performing?
What if the agency should know that its direction will cause the contractor to incur significant cost?
If the contractor can establish that it reasonably relied on the agency’s provision of technical direction in deciding to incur those costs, a default termination based on the failure to meet the delivery date will be converted to a termination for convenience.
See: Joseph DeVito v. United States, 413 F.2d 1147 (Ct Cl. 1969); Bernardi Brothers v. United States, 47 Fed. Cl. 708 (2000).
Scenario 2— Acquiescing in Defective Designs
The contractor is developing a revolutionary electronics communications device for the Air Force. Assume that through design reviews, the Air Force learns very early in performance that the contractor's design will not succeed in meeting the performance specifications.
Because the Air Force has heard this excuse before, and because of the effort involved in re-procuring the item, and the high visibility of the program, the Air Force accepts the contractor’s vague promises of likely progress to some undefined level of performance that will meet the overall goals for the device.
After several years of work, it becomes apparent that the contractor’s design will not meet a number of key performance specifications. However, the Air Force has expended considerable political capital on retaining funds for this item based on the contractor’s promises and flight tests are approaching.
The parties meet to decide how to run the flight tests, knowing that certain tests will disclose the need for a major redesign. The Air Force decides to schedule only flight tests that can be met and appear to achieve success. When “success” is achieved, the Air Force program manager is promoted.
Instead of abandoning the old design, the contractor starts a new generic design effort under IR&D funds in parallel with the contractual effort that may assist in enabling the item to meet specifications. The Air Force is informed of and orally approves this idea.
One year later, a new Air Force manager is assigned to oversee the project. She is unaware of the full extent of the problems until she sees the contractor’s recent test results. She issues a cure notice and again receives promises from the contractor that potential designs that are being developed will improve performance in production.
A new president is appointed for the contractor. He observes that the contractor is losing millions of dollars every month.
Further, when he demands a solution from his engineers, he is told that none of these solutions will be ready to even test before the delivery date arrives the next year. The contractor realizes that it must scrap its old design and put all efforts into the new one. The contractor asks for additional monies to fund the development of new designs.
By this time, the new Air Force manager is unwilling to expend more money without proof that the proposed design changes will work.
Facing bankruptcy, the contractor temporarily stops production effort and begins to “study” how to resolve these problems. The “study” evokes a harsh response from the new Air Force project manager. She believes the study is a ruse and shortly afterwards, the agency terminates for default for failure to make progress.
Will the default termination be upheld? Cf. Maxwell Dynamometer Co. v. United States, 181 Ct. Cl. 607, 386 F.2d 855, 868-70 (1967). Answer: Likely, No. The Agency has participated too fully in the ultimate performance facility.
Scenario 3— Agency Reservation of Rights
Assume that the delivery date has passed on a construction contract. The government notifies the contractor in a show cause notice that while it is considering whether to terminate for default, it is reserving its right to terminate and that any assistance or forbearance it gave to the contractor should not signal a waiver of the delivery date.
After sending this letter, the government initially assessed liquidated damages but later released those funds to the contractor and encouraged the contractor to continue performance. However, the government refused to grant time extensions or otherwise change the delivery date.
During the next six months, the contractor continued to work and was paid. However, the government ultimately rejected its extra work claims, withheld liquidated damages and terminated the contract for default.
Did the agency’s “reservation” protect it from waiver? Answer: No.
The delivery date was 6 months ago. It is waived.
Did the contractor knowingly proceed with knowledge that it still might be default terminated and voluntarily take the risk?
Answer: Time for consideration of whether to default after a delivery date has passed grows shorter when the Government knows the contractor is incurring costs. Perhaps thirty days is permissible without a waiver.
Is there a difference if the above contract is a supply or construction contract? Possibly not. Cf. Abcon Associates, Inc. v. United States, 44 Fed. Cl. 625 (1999) (construction contract where reservation upheld) with Patten Co., ASBCA No. 35319, 89-3 BCA ¶21,957 and Flinkote Co., GSBCA No. 4223, 76-2 BCA ¶12,031 (rejecting non-waiver clauses in supply contract).
The burden is on the contractor to establish a DeVito type of waiver. Olson Plumbing and Heating Co. v. United States, 221 Ct Cl. 197, 204 (1979).
To avoid a DeVito waiver, the agency should include a non-waiver type clause or language to that effect in its cure or show cause notice.
However, as shown above, notwithstanding the clause or reservation, once the delivery date passes (15-20 days), the agency should act promptly once it has knowledge sufficient to form the basis for a default termination.
During that investigation period, the agency should take no actions that could be reasonably construed as an indication that a default termination will not be issued. Action Support Services, ASBCA Nos. 46524, 46800, 2000-1 BCA ¶ 30,701 (making of progress payment, repeated show cause notices, and offer of settlement inconsistent with reservation of default right).
Other types of inconsistent actions would include the provision of technical direction leading to contractor expenditures.
The agency must make a decision within a short time after the investigation is completed on whether to terminate for default or negotiate a new schedule or specifications that will enable the contractor to perform.
Re-establishing a Delivery Date
If a waiver has occurred, the agency must re-establish its default claim rights. A new delivery date must be established.
However, the new delivery date must be reasonable for that particular contractor. DeVito, supra. The best way for an agency to establish a reasonable schedule is:
Determine what a reasonable schedule would be for the particular contractor;
Seek the contractor's proposed, revised delivery schedule;
Negotiate a bilateral agreement re establishing a new schedule.
Contractors must be aware of their rights when a new delivery date is being established. The contractor needs to make a realistic and fair assessment of how long it will take to complete the work. Absent unusual circumstances, a contractor's own assessment will be enforced if it later fails to meet that delivery date.
Consider the following scenario:
The Imposed Schedule
The contract at issue was for the design and development of simulation software to train Navy captains on how to operate destroyers. The contract got off to an inauspicious start because the Navy was unable to supply sufficient data to enable the contractor to program the movements of the ships.
Further, there were disputes about how much realism was required in the simulation. The relationship gradually deteriorated; however, when the delivery date passed, the agency prepared a default termination letter.
Before the default letter could be sent, someone at the agency realized that the Navy had failed to provide adequate data and/or technical direction and that a default termination would be easily overturned.
That would be an embarrassment to the Admiral awaiting the simulator being built, particularly since funds were short and more would have to be used to pay the contractor’s termination costs.
The agency then devised a plan. The Navy requested that the contractor provide a new delivery date. However, the Navy insisted that the new delivery date had to be within 100 days of the current date. One hundred days represented the number of days the government had delayed the contractor in providing certain data.
The contractor, although fearing that it could not perform in 100 days, feared a default termination more. The contractor provided a schedule to perform the work within 100 days. However, it was unable to do so.
Who wins?
Answer: Probably the Navy.
Would it make a difference if, after receiving the contractor’s proposed schedule, the Navy drafted an internal memorandum indicating its belief that the contractor would be unable to perform in that time?
Answer: Yes. The default would probably be overturned.
What if the contractor also recognized that it would be unable to meet the schedule but agreed anyway to temporarily avoid the default termination?
Answer: Navy wins. Contractors can also waive their rights.
Practical Limitations on Issuing Defaults
Mission-Orientation
As noted earlier, agencies are not in the business of making money through claims. The mission, not the money, is usually the key agency motivator.
Further, because of this orientation towards accomplishing the mission, agencies often are not well prepared to prove affirmative claims against the contractor. Government cost and estimating accounting typically looks at costs in a framework unsuited to filing claims against the contractor.
Potential for Recovery
Probably the most significant practical limitation is that the agency’s default "recovery" in many cases will prove illusory. Many contractors have already spent their progress payments and if they are defaulted, proceed to bankruptcy. Thus, the return of progress payments, and the recovery of excess reprocurement costs and/or common law damages also is unlikely.
Judicial Scrutiny
The relationship between the agency and a defaulted contractor usually has been acrimonious. People do not always act their best in this type of relationship, including government employees.
Because of the judicial sensitivity to the harshness of a default termination on a contractor, the Government will necessarily be subject to great scrutiny in the above acrimonious situation.
Given this scrutiny, and the unlikely prospect of a meaningful recovery, and the effort necessary to obtain it, in many cases, the agency will be willing to work out a solution that can achieve its ends without effectively destroying the contractor. Such solutions exist.
For example, no cost terminations often can be negotiated. Default terminations can be withdrawn and converted to negotiated terminations for convenience or agreements to secure whatever valuable work can be performed, sometimes at a bargain for the agency.
Many contractors recognize that a satisfactory or no-fault performance evaluation following such a termination can avoid some of the negative effects of the termination in terms of its future participation in Government contracting.
Claims Based on Convenience Terminations
The Right to Terminate for Convenience (“T for C”)
“In our experience, federal district and state courts are less likely to automatically approve the application of a T for C by a prime, particularly if it appears that the motivation was simply to obtain a better deal elsewhere.”
An agency has a right to terminate a contract for its convenience under FAR § 52.249-6 even if (by error or otherwise) a termination for convenience clause is not listed in a fixed price contract for goods and services. General Engineering & Machinery Works v. O'Keefe, 991 F.2d 775, 779 (Fed.Cir.1993); G.L. Christian & Assocs. v. United States, 160 Ct. Cl. 1, 312 F.2d 418, rehearing denied, 160 Ct. Cl. 58, 320 F.2d 345, cert. denied, 375 U.S. 954 (1963).
This clause has even been held to be an implied term in federal government leases. Aerolease Long Beach v. United States, 31 Fed. Cl. 342 (1994), affirmed 39 F.3d 1198 (Fed. Cir. 1994) (table).
The government has the right to T for C in order to protect the public. Ordinarily, in exchange for this T for C right, the agency must pay the contractor's costs of performance plus a reasonable profit on work done, subject to several exceptions.
In a sense, with several exceptions described below, a fixed price contract is converted to a cost-reimbursement contract in which the contractor is entitled to a reasonable profit for the work done\costs expended.
A T for C situation sometimes results in an inadequate recovery or even a loss for a contractor. For purposes of this course, claims can have a role in maximizing a fair T for C recovery.
Breach of the T for C Clause
Case law through 1999 held that a T for C could be a breach of contract if it was an "abuse of discretion" or it was issued in “bad faith”. This is an extremely difficult burden for a contractor to meet in federal procurement law.
Abuse of Discretion.
Abuses of discretion have been found only where the government knew, before award, that it intended to dishonor a contractual obligation. In Torncello v. United States, 681 F.2d 756 (Ct. Cl 1982), the agency issued a requirements contract for pest control services covering a number of different pests. Contractors submitted different fixed prices for the various types.
The evidence showed that the agency knew when it issued the contract that it intended to retain the contractor's low prices for some services but to terminate its higher priced items for convenience and purchase them from another contractor. The court held that this T for C was a breach of contract.
Another type of “abuse of discretion” T for C breach occurred in Municipal Leasing Corporation v. United States, 7 Cl. Ct. 43 (1984), in which the government entered a contract to lease computer equipment for a number of years. One clause stated that it would make "good faith" efforts to obtain funding to exercise those options.
The evidence showed that the agency intentionally refused to make this effort because it wanted newer equipment models.
The court held that the government's failure to exercise the option could not be considered a "constructive" T for C and was a breach of contract. The court reasoned that for a T for C to be proper there must have been "changed circumstances" from those that existed when the award was made.
Bad Faith
The other ground for turning a T for C into a breach is even more difficult—“bad faith”. government officials, unlike contractors in a commercial setting, are legally presumed to have acted in good faith.
Rebutting this presumption literally requires overwhelming evidence of a specific intent to injure a contractor. Kalvar Corp. v. United States, 435 F.2d 1298 (Ct. Cl. 1976) cert. denied 434 U.S. 830 (1977).
In rare cases, contractors have succeeded in meeting this burden. Bill Hubbard v. United States, 52 Fed. Cl. 192 (2001) (agency direction to move concession stand to another area which deprived contractor of revenue held to be in bad faith); Libertatia Associates, Inc. v. United States, 46 Fed. Cl. 702 (2000) (intent to harm contractor for financial gain of government official proven).
In Krygoski Construction Co. v. United States, 94 F.3d 1537 (Fed. Cir. 1996), the Federal Circuit, while nominally retaining the Torncello and Municipal Leasing “abuse of discretion” line of cases, has appeared to merge these cases into a “bad faith” standard, effectively requiring “bad faith” to prove that a T for C was a breach.
Subcontractor Claims
While breach resulting from a T for C is a difficult claim to establish for a contractor against the Government, prime contractors should not feel quite as confident when dealing with their subcontractors. In a commercial setting, there is no legal presumption upholding the prime’s actions as being in “good faith”.
Their right to T for C does not directly involve the public interest. But see Linan-Faye Construction Co. v. Housing Authority of the City of Camden, 49 F.3d 915 (3rd Cir. 1995) (court treated the prime as though it was the Government).
In our experience, federal district and state courts are less likely to automatically approve the application of a T for C by a prime, particularly if it appears that the motivation was simply to obtain a better deal elsewhere.
Relationship of Claims to T for C
Assuming a proper T for C, the contractor's maximum recovery is limited by the clause to the total contract price.
The other major limitation on recovery is the “loss” formula. Under FAR § 49.203, if a contractor is breaking even or would have made a profit on the contract, it is entitled to recover its reasonable costs and a reasonable profit.
However, if the contractor would have lost money on the contract if it had been completed, the Government can reduce its total costs incurred by the percentage of loss and refuse to pay the contractor a reasonable profit.
Both of these limitations can be affected by the existence of claims. A valid claim will increase the total contract price. This enables the contractor to recover more of its costs and more profit.
Further, if a loss contract appears to be present, the increase to the contract price will reduce or eliminate that prospective loss. Moreover, if a contractor is close to breaking even, a claim may enable it to recover a reasonable profit on those costs.
Finally, certain types of claims, such as defective specifications or impossibility of performance can, if proven, eliminate the application of the loss formula altogether on the premise that it would be impractical to determine the contractor’s prospective contract performance costs absent the defect or impossibility.
See: Defense Systems Corp., ASBCA Nos. 44131R, 50563, 50562, 50997, 50998, 44835R, 00-1 BCA ¶ 30, 851; and The Swanson Group, Inc., ASBCA No. 52109, 02-1 BCA ¶ 31,836 (Where Government was responsible for cost overrun that could not be reasonably quantified, termination for convenience loss formula was inapplicable.)
"Non-conforming" Work
Another government defense that is being routinely asserted by agencies to reduce T for C recoveries is that the product or services were "defective" or did not conform to the contract requirements. Agencies, somewhat understandably, argue that the government should not have to pay for goods that do not meet the specifications and thus, provide no benefit.
This would be a valid argument if the contract had been permitted to continue. However, in a T for C setting, this defense has been rejected on the basis that:
the Government chose to terminate the contract for convenience, not default, knowing it could not later change its mind, See John Reiner & Co. v. United States, 325 F.2d 438 (1963) cert. denied 377 U.S. 931 (1964); and
by terminating the right to perform, the Government has itself prevented the contractor from correcting any defective or non-conforming work. New York Shipbuilding Company, a Division of Merritt-Chapman & Scott Corp., ASBCA No. 15443, 73-1 BCA ¶ 9852.
However, in Lisbon Contractors v. United States, 828 F.2d 759 (Fed. Cir. 1987), the Federal Circuit rejected a contractor's argument based on the New York Shipbuilding rationale, that it was automatically entitled to all of its costs regardless of its performance.
Lisbon has since become the basis for the Government’s argument that it does not have to pay for such costs.
Decisions since Lisbon appear to have returned to the New York Shipbuilding rationale, holding that only where the costs are "unreasonable", i.e. the work was "grossly" defective, can recovery of such performance costs be rejected. D.E.W. & D.E. Wurzbach, A Joint Venture, ASBCA No. 50796, 98-1 BCA ¶ 29, 385.
Since defining what is a "gross" non-conformity is subjective, agencies can be expected to continue to assert "gross" non-compliance with the specifications.
Contractors must be prepared to assert any claims regarding the proper interpretation, or defective and/or impossible nature, of the specifications to combat this defense. There is another reason to develop these claims—as discussed below, the agency can be required to pay for this effort.
T for C Proposal Preparation Costs
Ordinarily, FAR §31.205-47 prohibits contractors from recovering the cost of preparing claims. However, FAR § 52.249-2 specifically permits the recovery of the costs of preparing a T for C settlement proposal.
That means that if a claim is necessary to increase the contract price or to otherwise overcome the application of a “loss formula”, the cost of preparation of those claims, including legal fees, is likely a necessary part of a contractor's cost of preparing a termination settlement proposal.
The Government must pay these costs as a settlement expense. Systems & Computer Information, Inc., ASBCA No. 18458, 78-1 BCA ¶ 12,946; Baifield Industries, Division of ATO, ASBCA No. 20006, 76-2 BCA ¶ 12,096 at p. 58,104, aff'd on reconsideration, 76-2 BCA ¶12,203.
Deductive Changes
The Changes clause is not a one-way street. Agencies should be aware that some changes also reduce a contractor's costs. If so, the agency is entitled to a downward equitable adjustment in price. S.N. Nielsen Co. v. United States, 141 Ct. Cl. 793 (1958).
The reduction is based on the cost to the contractor. For example, in B&H Supply Inc. v. United States, 17 Cl. Ct. 544 (1989), the court rejected the Government’s attempt to base a deductive change on prices, including a “Schedule of Deductions” for non-conforming work, since the Schedule did not cover deductive changes and the prices submitted did not reflect “the reasonable decrease in costs resulting from the deletion.”
As stated in J.F. Shea Co., Inc. v. United States, 10 Cl. Ct. 620 (1986), the:
“equitable adjustment due contractor for excavation work on a lump-sum government contract required the subtraction from the contract price of the cost of the work or materials as originally specified, the addition of the cost of the new work under the changed conditions and the addition of a reasonable profit and overhead computed according with government regulations on the difference between the subtraction of the cost of the work or materials originally specified and the addition of the cost of the new work”.
See also, Conner Bros. Construction Co., VABCA No. 3593, 95-1 BCA ¶ 27,409.
Contractors must act in connection with deductive changes. Contractors are usually in the best position to know what their actual costs are.
Proprietary Data Related Claims Issues
The “Rights in Data” clauses in Government contracts protect data and trade secrets developed solely by the contractor. However, when a claim is filed for work ”outside the scope of the contract”, the Government sometimes contends that this work has changed data, included in the contractor’s proposal, which previously had belonged to the contractor.
Tests for Contractor
To preserve its rights, the general rule is that the contractor must have:
stamped this information as proprietary in accordance with the FAR and DFARs, see Xerxes Group, Inc. v. United States, 278 F.3d 1357 (ed. Cir. 2002) (rejecting proprietary data claims where legend required by the FAR was absent) and
developed this data at 100% of its own cost, i.e. not through Government contracts (other than through the payment by the Government of overhead or Independent Research and Development funds.
The agency cannot appropriate this information for its own use without payment to the contractor. If it does so, the contractor has a valid claim. However, if changes made to the proprietary item cannot be segregated from the original proprietary item, the Government can claim the entire product data as its own.
A dispute over such data can also be resolved through a claim proceeding. The leading case is Padbloc Co., Inc. v. United States, 161 Ct. Cl. 369 (1963). In Padbloc, the contractor submitted an unsolicited proposal that was appropriately marked as proprietary information.
The agency did not accept the proposal; instead, it published the contractor's approach, almost word for word, in a solicitation to attempt to obtain a competitive price for the work. The court held this to be a breach of an implied contract entitling the contractor to a royalty for each item sold.
Is this a satisfactory solution? What if the Government later modifies the product? Does the royalty end?
And what of the proof problems in establishing that the item was developed 100% at private expense?
The point is that a proprietary data claim by the government, or against the Government, may be worth very little. As a practical matter, if the information being taken is critical to the company's commercial survival, contractors should consider seeking immediate injunctive relief under a criminal statute, the Trade Secrets Act, 18 U.S.C. §1905.
See: Megapulse, Inc. v. Lewis, 672 F.2d 959 (D.C. Cir. 1982).
Post-Acceptance Government Inspection Claims
The standard Government contract Inspection clause lists a narrow set of circumstances in which the agency’s formal and final acceptance is not conclusive and can be revoked. These exceptions represent a contractor warranty against (a) latent defects, (b) gross mistakes as amounts to fraud, and (c) fraud.
Latent Defects
The first element of a latent defect is that it be a “defect”. This means that the flaw in the product causes it not to perform as required by the contract terms. United Technologies Corp. v. United States, 27 Fed. Cl. 393 (1992), recon. denied 31 Fed. Cl. 698 (1994); Bart Associates, EBCA No. C-921144, 96-2 BCA ¶ 28,479.
Thus, if the product still works as required by the contract in spite of the latent flaws, this warranty does not apply.
The second element is that the flaw is latentbe latent as opposed to patent. A patent defect is one that would be discovered by a reasonable inspection. Kaminer Construction Co. v. United States, 488 F.2d 980 (Ct. Cl. 1973); Hercules Engineering & Manufacturing Co., ASBCA No. 4979, 59-2 BCA ¶ 2426; accord H.B. Zachry, ASBCA No. 42266, 95-2 BCA ¶27616; D&H Construction Co., ASBCA No. 37482, 89-3 BCA ¶ 22070; Fred A. Arnold Inc., ASBCA Nos. 29639, 30854, 30610, 30613, 86-1 BCA ¶ 20624 (failure to carry out a reasonable test is no excuse); Solid State Electronics Corp. (SSEC), ASBCA No. 23041, 80-2 BCA ¶ 14,702; Herley Industries, Inc., ASBCA No. 13727, 71-1 BCA ¶8888 (whether defect is hidden is not determinative if tests other than those established in the contract should have been tried).
What constitutes a “reasonable inspection” is dependent on the facts of each case. Typically, the focus is upon whether the defect is so glaring that it should have been detected by the contractually-specified inspection. See Spandone Corp. v. United States, 32 Fed. Cl. 626 (1996).
But even if no defect was present or the defect was patent, the agency has other means to attempt to undo its acceptance—“gross mistakes as amounts to fraud” and, of course, “fraud“.
Gross Mistake as Amounts to Fraud
This warranty is ill defined. If something is a “mistake”, it need not be a “defect”. Likewise, something that “amounts to” fraud is not fraud. Generally, this warranty covers flaws so “gross” that while unintentional, vary so greatly from the contract or the practice of the industry that such conduct should not be permitted.
See generally, Catalytic Engineering & Mfg. Co., ASBCA No. 15257, 72-1 BCA ¶ 2518; and Massman Construction Co., ENG BCA No. 3443, 81-2 BCA ¶15,212 (welding conducted in violation of contractual and industry standards held to be a gross mistake even though it was performed in the presence of Government inspectors without objection).
Fraud
Fraud undoes any purported acceptance. Fraud differs from a false claim because it requires deception, not just “knowledge of falsity”. This means that an item submitted for acceptance by a contractor that may not conform to the requirements, but was not submitted to deceive the Government into believing it conforms, is not an act of fraud.
See: Crane Helicopter Services, Inc. v. United States, 45 Fed. Cl. 410 (1999) (Government failed to prove allegedly non-conforming helicopter was furnished by contractor for ferrying services with an intent to deceive).
Time Limits on the Inspection Clause Warranties
The Theoretically Infinite Warranties
There is no time limit in the standard Inspection clause. This means the Government has a limited right to revoke its acceptance forever! This is not true in subcontracts—perhaps there is six months after acceptance to revoke.
The above Inspection clause warranties are not limited by any other timeframes established in other warranties in the contract.
Delay in Bringing the Claim
An agency can waive its right to revoke acceptance if it does not bring a claim within a reasonable time. Perkin-Elmer Corp. v. United States, 47 Fed. Cl. 672 (2000) (Government delay of 6 years in asserting latent defect claim was a waiver of warranty); Traylor Bros., ENG BCA No. 5884, 99-1 BCA ¶ 30,136 (3-year delay in giving notice of latent defect held unreasonable as a matter of law); Ordinance Parts & Engineering Co., ASBCA No. 40293, 90-3 BCA ¶ 114.
Other Limitations
Some contracts can be effectively construed to provide a shorter warranty period. For example, in General Electric Company, IBCA No. 42- 6-64, 65-2 BCA ¶ 4974, the contract contained a performance requirement that required the product to perform a certain number of actions. The contractor succeeded in reducing its liability based on performing a portion of those actions.
Similarly, where the Government has used the product beyond its normal life before discovering the "latent defect", the court held that the damages for breach of warranty were zero. Midwest Industrial Painting of America v. United States, 4 Cl. Ct. 124 (1983).
The Infinite Warranties are Non-exclusive.
The Inspection clause warranties are in addition to any separate express one-year warranties covering both latent and patent defects (the Government cannot utilize implied warranties such as merchantability or fitness for a particular purpose).
“Commercial Item” Contracts
Much of what the Government procures today are defined as “commercial items” under FAR § 2.101. The FAR “commercial item” inspection clause, FAR § 52.212-4 only refers to “post-acceptance warranties” without specifying them.
Under commercial law, there are no infinite warranties and generally because contractors can expressly protect themselves for whatever period they believe is reasonable, there will be no warranty against patent defects or gross mistakes for periods except for short “revocation of acceptance” results depending on the product.
Contractors should be aware however that “commercial item” solicitations often contain “tailored” warranties that can encompass latent defects or gross mistakes. See: Shelby Gourmet Foods, ASBCA No. 49833, 01-1 BCA ¶ 31,200.
These “tailored” warranties, like their standard Government counterparts, are limited only by the time periods in the clause and whether post-acceptance tests conform to the requirements. United Electronics Company, ASBCA No. 15825, 72-2 BCA ¶ 9642; Teltron, Inc., ASBCA No. 14894, 72-2 BCA ¶ 9272.
Defective Pricing
One of the most common government claims filed against federal contractors are those based on the Truth in Negotiations Act (“TINA”), 41
U.S.C. § 2306(g), commonly known as defective pricing. These claims are found in negotiated procurements for non-commercial items where adequate price competition does not exist.
Many times when a claim is filed, an audit has been or is conducted. The auditor typically looks at information that can lead to defective pricing claims—(a) the basis for the bid and (b) the manner in which the work was actually performed.
If the work was performed in a manner that was known, but, not disclosed by the contractor, the government can assert a defective pricing claim to offset a contractor’s claims.
Definition of Cost and Pricing Data
Cost and pricing data claims have been one of the most utilized methods used by federal agencies to recover money from contractors. These claims can be filed long after the contract has been performed and memories have faded.
“But why find out through an audit, and litigation whether some item of data is considered significant. If you are wondering whether some data is significant, it probably is. So DISCLOSE it.”
Thus, it is important for contractors to understand the concept so that proper preparations can be made to avoid allegations of “defective” pricing. The definition of “cost and pricing data” is seemingly straightforward.
In negotiated, non-competitive procurements, the contractor must supply to the government all “current, accurate and complete” cost data and factual information that a reasonable buyer could contend would have a “significant” impact upon the final price that the agency would pay for the items in question. The disclosure is measured on the date of the agreement on price.
In essence, those clauses require a contractor at the time of agreement on price to (in effect) warrant that it had given the Government all cost and pricing data that could significantly affect the price and that it be current, complete and accurate at that specific point in time.
These rules apply to contract modifications as well, as they are non-competitive. What do these terms mean?
“Significant”
What is significant in a negotiation? It is in the eye of the beholder and given the case law, the government is likely to consider almost anything that is not disclosed to be significant, particularly in retrospect.
Compare Aerojet Solid Propulsion Co. v. White, 291 F.3d 328 (Fed. Cir.2002) (the existence of unopened bids for a key ingredient of the propellant which fluctuated in price was held to be significant) with Lockheed Martin Corporation d/b/a Sanders, ASBCA Nos. 50464, 51350, 02-1 BCA ¶ 31,784 (where neither the contractor nor the Government had understood the significance of the production and testing data at issue during prior negotiations, and the Government had “equal access” to the data, contractor’s failure to submit such data was not defective pricing).
But why find out through an audit, and litigation whether some item of data is considered significant. If you are wondering whether some data is significant, it probably is. So DISCLOSE it.
“Complete”
The requirement that the data be “complete” at the date of agreement on price has been interpreted very strictly. If the data exists within the company, or even the parent companies, absent unusual circumstances, it is required to be disclosed. Lockheed Aircraft Corporation, ASBCA Nos. 36,420 et. seq., 95-2 BCA ¶ 27,722.
Fact versus Judgment
Contractors often argue whether certain information is in the nature of a “pure judgment” and thus not “factual” data. Contractors also argue that the data is not “significant”.
These esoteric arguments are faced with a hard reality. While a contractor can succeed with these claims in some limited circumstances, it often is a very difficult burden and usually requires litigation.
See United States v. United Technologies Corp., Sikorsky Aircraft Division, 51 F.Supp.2d 167 (D.D.C. 1999) (contractor’s judgment of future costs based on actual quotes was not more reliable than actual quotes upon which judgment was based, which were disclosed.)
The Requirement to Disclose
The better course is to disclose such information. Indeed, the fact that a question about whether to disclose certain information is even being asked usually indicates that the information is significant.
Rules on How to Disclose.
One legal rule about disclosure must be kept in mind—“dumping” the information on the agency or making the files available is not enough to be an effective disclosure.
Contractors must provide a “road map” to the agency that generally tells them where they can find the information and what it is. Singer Company, Librascope Division v. United States, 576 F.2d 905 (Ct. Cl. 1978); M-R-S Mfg. Co. v. United States, 492 F.2d 835, (Ct. Cl. 1974) (Kardex file not enough).
Many contractors have devised electronic methods of disclosing cost and pricing data. Some contractors use a computer system that publishes lists to the Government of available information inside of the corporation of items that have been or are being considered for purchase or which may cause a decrease in price.
However, if there is little time available, contractors are not required to create new cost data in order to disclose it unless presenting the data as is would be “inaccurate”. See Litton Systems, Inc., Amecom Division, ASBCA Nos. 34435, et al., 93-2 BCA ¶ 25,707 at p. 127,910 (no duty to convert raw data where doing so would require an inordinate amount of time).
Likewise, in Central Navigation and Trading Company, S.A., ASBCA No. 23946, 82-2 BCA ¶ 16,074, the Board excused a contractor from providing more ”current” data due to the lack of a reasonable time to compile it. But these are cases resolved through litigation. Why take this risk?
A Disclosure Obligation; Presumption of Damage from “Defective Data”
If the Government can contend that undisclosed data on virtually any issue would have caused the agency to negotiate a lower price, the failure to disclose that data in negotiations will constitute “defective pricing”.
The government’s recovery is greatly assisted by a legal presumption that a nondisclosure of data would have resulted in a dollar for dollar reduction in contractor’s price in negotiations.
See: Sylvania Electric Products, Inc. v. United States, 479 F.2d 1342 (Ct. Cl. 1973); But, compare: Universal Restoration, Inc. v. United States, 798 F.2d 1400 (Fed. Cir. 1986) (contractor rebutted presumption where it proved that it did not use non-disclosed overhead rate in its own calculations).
Although this presumption is nonsensical in many situations, that is the established law. This presumption effectively eliminates the agency’s burden of proving its loss and makes defective pricing a very attractive government claim basis.
Cost and Pricing Data Trouble Areas
Cost and pricing data problems arise in three areas: labor, materials, and overhead.
Labor
In the labor area, contractors often fail to disclose their most current projections or labor data. We typically receive questions about whether data that is “preliminary” has to be turned over. The typical response is that if you are asking, it will be argued to be significant by the Government’s auditors—so turn it over.
Material
In the material area, contractors often fail to disclose the latest quotations because they are too difficult to keep track of. This will not be a defense later so some kind of mechanism must be developed to keep track of this data.
Another troublesome area is quotes that are considered “unacceptable”, “unreliable” or “non-responsive”.
The wiser course is to disclose these unacceptable quotes and explain why they are unacceptable in negotiations, if they come up. And of course, keep a record of what was disclosed in the negotiations.
Overhead
In this area, contractors must make certain to check their own overhead projections and the latest data affecting overhead. If rates are proposed that drop precipitously after the date of agreement on price, DCAA will immediately suspect that expected rate changes were not disclosed.
Defective Pricing Scenarios
Set forth below are some real life examples of how these government claims can develop.
Example 1— Disclosure of “Wish Lists”
Assume that a contractor is making 105-millimeter tank ammunition rounds for the Army. It submits to the government its cost and pricing data for a new contract based upon the historical cost for the last several contracts for the 105 round with the Army.
The contractor has numerous other machining operations for both government and commercial purposes in a very large series of ten plants in the Midwest.
As with most contractors, it has a series of forward looking budget plans. One plan is called a capital/ machinery improvement budget plan. It is formulated and updated once a year. The current plan is approximately one thousand pages long.
In effect, the contractor gathers from all of its various Government and commercial divisions and operating units company wide their projections of what additional plant, machinery and hardware improvement items they would like to have for whatever purpose. It is a type of plant and machinery improvement “wish list.”
Historically, it can be shown that the contractor permits its business units on the average to receive only four percent of the machinery improvement requests that are asked for.
While the capital improvement budget is being processed for the current year, the new 105 round contract for the next several years is negotiated, priced and signed. Buried on page 825 of the corporate capital and equipment improvement budget is a request by a plant in the Midwest (not currently engaged in 105 round production) for an advanced boring and turning machine.
In fact, in year two of the new contract for the 105 rounds this machine is purchased and installed. At an internal conference, the 105 company program manager learns that he could probably save money in his machining operations by using this resource.
Note that the company program manager learns this two years after the date of agreement on price with the agency and that no one at the 105 contract negotiations had any idea about what was on page 825 of the capital and machinery improvement budget.
The program manager makes arrangements for the machining operations to be done at a different plant with the high-speed equipment and projections indicate that approximately $1.5 million was saved on a
$100 million contract for years three, four and five each.
After year five, DCAA conducts a post award performance audit, learns about the $1.5 million material savings in years three, four and five and asserts a cost and pricing data refund claim for $4.5 million.
Will the government’s claim succeed?
Given the facts above, the government’s claim has some probability of success. The fact that neither the company nor the government negotiators, nor the project manager knew about potential cost savings is irrelevant legally. The fact that the cost savings actually occurred after the fact (after signing of the contract) is irrelevant.
The fact that numerous contractor personnel or negotiation experts testify that no one would ever give a one hundred percent credit to the government for an item on a material equipment budget “wish list” is irrelevant.
What is important is the fact that the “data” was available at the time of negotiations, i.e. the item existed inside of the corporation on the material and machinery improvement budget.
If the corporation had disclosed this information, it would likely have negotiated no decrease in its price or a very small decrease based upon the then remote possibility that the equipment would be bought and actually used on the project.
Recall the 4% purchase rate for items on each year’s wish list. Would it have made a difference if the company program manager had not actually used the plant with the new cost saving machine?
Answer: Yes. How would this have come up? Audit: no there would be no cost savings.
This seems a very harsh result for the contractor. Yet, this is exactly the problem with cost and pricing data refunds (and for that matter many types of after-the-fact administrative price adjustment mechanisms.) It produces odd and unfair results at times.
Scenario 2—Unreliable Vendors
The prime has solicited quotes from various vendors of a complex circuit board used in radio development. The contractor has obtained 20 quotes. Of the 20 quotes, some very low quotes came from vendors that had poor performance records.
Another group of quotes came from new vendors with whom the prime had no history. These vendors were contacted.
The purchasing agent determined that the new vendors did not understand what they were doing. As a result, only 8 of the 20 quotes were evaluated and the award was made to a higher priced but high quality vendor. Only the 8 quotes were disclosed to the agency.
A year after award, one of the prime contractor representatives attended a trade show. One of the new vendors demonstrated a product that employed new technology that the prime had only vaguely heard of.
When the prime representative asked the vendor the types of applications for the technology, the vendor replied that it could be used in circuit boards and that in fact, the vendor had submitted a quote to the prime for the procurement at issue.
Seeing the possibility of improving the quality of the products it was selling with this recently discovered information, the prime conducted an evaluation of the vendor’s circuit board and discovered that it was a vast improvement. Better still, the vendor’s circuit boards were significantly less expensive.
A decision was made to cancel the current circuit board subcontract and use the vendor’s new boards in their place. The agency was advised of the change and the reasons for it. It was welcomed as a technological advance. The result was a significant profit.
Three years after the contract was completed, the DCAA audited the contract and concluded that the Prime had defectively priced the circuit boards.
Who wins? Answer: The government.
See Aerojet Solid Propulsion Co. v. White, 291 F.3d 328 (Fed. Cir. 2002) (unopened bids were cost and pricing data), and Hughes Aircraft Company, ASBCA No. 46321, 97-1 BCA ¶28,972 (contractor should have disclosed “unreliable” data).
Defective Pricing Claims Issues
For Contractors:
Disclosure, Again. The key in defending against defective pricing claims is DISCLOSURE. It is an absolute defense. Time must be taken to assure that complete data is provided before the date of agreement on price and to develop a “mapping” process.
Sweeps. There usually is no reason to conduct further “sweeps” after the date of agreement. However, if you learn of undisclosed data that could be interpreted as an intentional non-disclosure, a post-agreement “sweep” and disclosure may temper the penalty.
Documenting Negotiations. Contractors must recognize the context in which defective pricing allegations typically arise—through post-award audits occurring years after the contract has been closed, and years after the personnel familiar with the negotiations on price have moved to other jobs or left the company. The same will be true for the government negotiators.
Thus, it is of critical importance to accurately document what has been disclosed and negotiated and attempt to have the Government sign off on those facts (or at least provide a copy of the negotiation memorandum that you have prepared).
Since subcontractors are subject to TINA, the subcontract should contain a clause requiring the subcontractor to indemnify the prime for any damages caused by its defective pricing.
For the Government:
Controlling the Auditors. As noted above, these cases tend to arise after performance of the contract has been completed as a result of an audit. Often the relationship between the parties during negotiations and performance was cordial or the rough spots have been harmonized as a result of the ultimate success of the mission.
Yet, 3 years later, when the DCAA or GSA auditor places a potential defective pricing claim before the Contracting Officer (“CO”) and/or intimates that there may be fraud, waste and abuse issues, it may be very difficult for the CO to resist pursuing it.
Even if he or she has a vague recollection of disclosure of the same or similar information that is now the subject of the claim, given the legal presumptions, it is often easier to rely on documents and to let the process take its course. The recovery of program funds and their potential use on current projects can also create pressure to proceed with the claim.
COs should be aware however that embarrassment and unnecessary effort may be the bottom line result of this process. Auditors are often unfamiliar with the contract or the negotiation process; further, they are often rewarded based on “recovering” funds long before the final result of the defective pricing case is completed.
There are many examples of defective pricing cases that had to be dropped after years of effort because the auditor had neglected to discover or disclose to the CO a key document exonerating the contractor.
In fact, the government loses over 50% of these cases that are litigated. COs who signed off on the claim and planned to use the funds will be left holding the bag.
We recommend that COs carefully monitor cases and particularly those that the auditors assert should be referred to criminal investigators. Many defective pricing cases can be characterized in a manner that would appear to create a false statement or false claim, as described below.
However, contracting officers should be aware that the requirement to disclose “all” data and the difference between fact and judgment is the cause of many innocent errors. Ill-advised investigations generate bad feelings and can cause a good contractor to abandon the government market entirely.
Further, a criminal referral often means that the contract cannot be closed out for years. Therefore, COs must press the auditors to be certain that they have a legitimate reason to believe that such referrals are proper.
Fraud/False Claims Act Claims
When a contractor files a claim, agency claims’ personnel and Government litigation counsel routinely explore whether the agency can assert a False Claims Act (“FCA) or fraud counterclaim. Often, these allegations are based on a failure to communicate or are caused by an overly aggressive view of what a "false" statement is in connection with a contractual submission to the Government.
See: UMC Electronics v. United States, 249 F.3d 1337 (Fed. Cir. 2001) (misrepresentation of “estimates” as “actual costs” in request for equitable adjustment required forfeiture of claim under 28 U.S.C. § 2514); Crane Helicopter Services, Inc. v. United States, 45 Fed. Cl. 410 (1999)(Government failed to meet burden of proof of showing contractor’s knowledge of erroneous information submitted in claim).
Based on the erroneous belief, the agency may argue that the contractor "knowingly" substituted a non-conforming product, i.e. with "willful" or "reckless" disregard of the facts. U.S. ex rel. Hagood v. Sonoma County Water Agency, 929 F.2d 1416, 1421 (9th Cir. 1991).
Given the serious nature of these allegations, it is extremely important for contractors to carefully prepare claims to the agency and to be aware of any facts that could lead to such a counterclaim.