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Holds Government Cannot Bar Differing Site Conditions Claims with Broad Disclaimer Language, AND Government is Bound by a Broad Duty of Good Faith and Fair Dealing

In a major victory, not only for the contractor, but also for historic federal contract principles, the U.S. Court of Appeals for the Federal Circuit reversed a decision of the U.S. Court of Federal Claims (hereinafter “claims court” or “trial court”) that had permitted the Government to use broad disclaimer language in the contract to disavow reliance on government provided reports and data, and to thereby deny any chance of contractor relief on a differing site condition claim.  This new decision also held that the Government is held to a higher standard with regard to the duty of good faith and fair dealing owed to the contractor than had been applied by the Claims Court. Specifically, the court states that the government can be found liable for breach of this duty without a showing that the government specifically targeted the contractor to reappropriate the contractor’s contract benefits to the government and abrogate the government’s obligations under the contract.  Much less than that is required to prove breach of duty of good faith and fair dealing.

This is an important aspect of the decision because it clarifies (almost reverses without saying so) a standard that had become increasingly onerous through a line of cases beginning with Precision Pine & Timber v. U.S.  The importance of this new decision correcting several problems that have developed in government contracts in recent years cannot be overemphasized.  It will be one of the most cited cases for years to come, and is truly one of the most important decisions.   It comes at a critical time as the government (perhaps due to budgetary reasons), seems to have adopted increasingly unfortunate and aggressive strategies to avoid paying reasonable contractor claims. Metcalf Construction Co. v. United States, (U.S Ct. of Appeals for the Federal Circuit, Case No. 2013-5041, Feb. 11, 2014).

The factual background of the case is similar to what contractor’s often experience on projects when, in reliance upon subsurface conditions reports provided by the Government, they have provided a fixed-price bid to design and construct a building based on reasonable assumptions about the nature of the underlying soil and the types of footings, foundations, and structures that can be built.

In this case, Metcalf was a design-build contractor.  It was awarded a contract to design and build housing units at a Marine base in Hawaii.  Almost immediately after notice to proceed, Metcalf encountered “expansive soil” swells that, when wet, can lead to cracks in concrete foundations and other damage.  The extent of the expansive soil was far greater than had been indicated in a government-commissioned report that had been prepared prior to bidding.  That report found that the soil had only a “slight expansion potential.”

The Government Request for Proposals (RFP) cited the soil report as relevant to certain features of the project such as concrete foundations.  But, as explained by the court, the government made clear that its pre-request soil report was not the final work on the soil conditions.  In fact, a revised RFP stated that the requirements in the soil report were “for preliminary information only.”  The design-build contract required the contractor to conduct its own independent soil investigation and it incorporated FAR 52.236-2 that addresses site conditions that differ from those disclosed in the contract (i.e., Type I differing site conditions).

Once the contractor began its work, it did as required under the contract with regard to conducting its own investigations of the soil and other aspects of the project that would be needed to finalize the design and then perform the construction.  It retained a geotechnical firm (Geolabs, Inc.) to further investigate the soil.  After several months of doing soil borings and testing the soil, the geotech firm determined that the soil’s swelling potential was “moderate to high” and not “slight” as had been indicated in the government’s soil report.

This constituted soil conditions differing materially from what was indicated by the government’s soil report, and the Geolabs recommended a different design and construction to accommodate this different soil condition.   Metcalf promptly notified the government of the differing condition of the alternative design that would be necessary. Incredibly, the government insisted that Metcalf follow the construction requirements set out in the original contract despite Metcalf’s evidence that this would be inappropriate in view of the actual soil conditions.  As explained in the underlying claims court decision, the government inspector acted unreasonably on this and other matters affecting the contractor.

In any event, after being delayed by almost a year while the government refused to act upon the new soil information, “Metcalf decided that the cost of waiting for the Navy to approve the Geolabs-recommended design changes had become too high, and it began to implement those changes by over-excavating the soil and replacing it with non-expansive fill, despite awareness of the risk of proceeding without a contract modification.”

A few months later, the Navy apparently realized the work needed to proceed as modified by the contractor and the Navy approved contract modifications accordingly.  In doing so, however, the Navy came up with another idea for how it could deny relief to Metcalf.  “The Navy denied that there was any material difference between the pre-bid and post-award soil assessments and thus concluded that no additional compensation was warranted.”  Metcalf’s claim for the expansive-soil problems was over $4.8 million – mostly for over-excavating the soil under certain building units and using post-tension concrete slabs.

Metcalf alleged that its final cost of construction was roughly $76 million and the government only paid it $50 million.  The court explains that in addition to the differing site condition, there were other disputes and interruptions along the way – with Metcalf alleging for example that the Navy imposed requirements not found in the written contract and that an uncooperative inspector hindered the project.  The court does not go into the allegations concerning the inspector, but from the description of his actions in the underlying Claims Court decision, it seems generous and charitable to call his actions merely uncooperative.

Metcalf filed a claim with the Navy’s contracting officer, and he issued an adverse decision.  Metcalf then filed suit in the Court of Federal Claims (“Claims Court”). The Navy countersued for liquidated damages.  The claims court found that Metcalf was not entitled to damages for the differing site condition.  But the court found that Navy violated the contract by failing to investigate the expansiveness of the soil in a timely manner.

The claims court also held that the Navy failed to issue a proper notice to proceed until months later than contractually required.  This delay was deemed by the trial court to be a contract breach that rendered Metcalf unable to work for a period of time, but did not excuse Metcalf for all delays.  The court awarded Metcalf about $300,000 on the notice-to-proceed breach, and awarded the government about $2.6 million in liquidated damages because Metcalf failed to complete the project by the agreed upon completion date.

In reaching that decision, the trial court rejected Metcalf’s argument that the two delay-causing breaches by the government nullified any liquidated damages based on late delivery.  It also rejected Metcalf’s argument that the government breached its duty to act toward the contractor with good faith and fair dealing.

In its appellate decision vacating and remanding the trial court decision, the Federal Circuit decided the court applied an incorrect standard when deciding that the government did not violate its duty of good faith and fair dealing, and that the court misinterpreted the provisions of the contract pertaining to differing site conditions and conducting site inspections.

On the question of the duty of good faith and fair dealing, the court explicitly rejected the trial court’s holding that “a breach of the duty of good faith and fair dealing claim against the Government can only be established by a showing that it ‘specifically designed to reappropriate the benefits [that] the other party expected to obtain from the transaction, thereby abrogating the government’s obligations under the contract.’”

The trial court had found that “incompetence and/or the failure to cooperate or accommodate a contractor’s request do not trigger the duty of good faith and fair dealing, unless the Government ‘specifically targeted’ action to obtain the ‘benefit of the contract’ or where Government actions were ‘undertaken for the purpose of delaying or hampering performance of the contract.’”

The Federal Circuit court concluded, “The trial court misread Precision Pine, which does not impose a specific-targeting requirement applicable across the board or in this case.”   The court went on to say, “neither Precision Pine nor other authority supports the trial court’s holding that specific targeting is required generally or in the present context ….”  The government argued that almost impossible legal standard established by the claims court was correct because the precedent relied upon from Precision Pine held the duty “cannot expand a party’s contractual duties beyond those in the express contract or create duties inconsistent with the contract’s provisions.”  In rejecting that argument, the Federal Circuit stated:

“As we have already explained, all that the quoted language means is that the implied duty of good faith and fair dealing depends on the parties’ bargain in the particular contract at issue…. The government suggests a more constraining view when it argues, for example, that there was no breach of the implied duty because, ‘Metcalf cannot identify a contract provision that the Navy’s inspection process violated….’   That goes too far: a breach of the implied duty of good faith and fair dealing does not require a violation of an express provision in the contract.” (Emphasis in original).

***

Proper application of the implied-duty standard thus depends on a correct understanding of the contract.  Metcalf contends that the trial court misinterpreted several contract provisions related to its claim.  We agree.  The first set of provisions pertains to site conditions….”

The contract contained the standard “Differing Site Conditions” clause of FAR 52.236-2.  The trial court interpreted the pre-bid site representations and related RFP provisions to be nullified by Metcalf’s investigative responsibilities during performance, concluding, “the Contract required Metcalf to conduct an independent soil analysis [and so] Metcalf was on notice that it could not rely on the ‘information only’ report.”  The trial court said Metcalf was entitled to rely on the government soils report only “for bidding purposes,” but not in performing the project.   Similarly, with respect to the chlordane contaminant, the trial court found that because Metcalf could assess the soil after its contract award, it could not rely on the representations that remediation was not required since Metcalf “was on notice to seek more information.”    In rejecting the trial court reasoning, the Federal Circuit stated:

“The Court thus treated the contract as placing on Metcalf the risk and costs of dealing with newly discovered conditions different from those stated by the government before the contract became binding….  These rulings about an important allocation of risk were based on a misinterpretation of the contract.  Nothing in the contract’s general requirements that Metcalf check the site as party of designing and building the housing units, after the contract was entered into, expressly or impliedly warned Metcalf that it could not rely on, and that instead it bore the risk of error in, the government’s affirmative representations about the soil conditions.

To the contrary, the government made those representations in the RFP and in pre-bid questions-and-answers for bidders’ use in estimating costs and therefore in submitting bids that, if accepted would create a binding contract.  The natural meaning for the representations was that, while Metcalf would investigate conditions once the work began, it did not bear the risk of significant errors in the pre-contract assertions by the government about the subsurface site conditions.”

The Federal Circuit went on to explain that the Differing Site Conditions clause of the contract exists precisely to take some of the gamble on subsurface conditions out of bidding instead of requiring the contractors to submit high prices to insure against the risk.  The court explains,

“For that reason, even requirements for pre-bid inspection by the contractor have been interpreted cautiously regarding conditions that are hard to identify accurately before work begins, so that ‘the duty to make an inspection of the site does not negate the changed conditions clause by putting the contractor at peril to discover hidden subsurface conditions or those beyond the limits of an inspection appropriate to the time available.”  (citing Foster v. U.S. and Hollerbach v. U.S.)

And finally, of great importance for future federal contractors asserting differing site conditions claims, the Court reiterates that the government cannot avoid contractor reliance on data and reports provided by the government merely by including broad disclaimers of liability for differing site conditions in the contract.  That is not acceptable to the court.  With regard to government’s legal responsibility for pre-bid information, the court stated,

“The conclusion is not changed by the statement in a revised RFP that the expansive-soil report was ‘for preliminary information only…. That statement merely signals that the information might change (it is ‘preliminary’).  It does not say that Metcalf bears the risk if the ‘preliminary information turns out to be inaccurate.  We do not think that the language can fairly be taken to shift that risk to Metcalf, especially when read together with the other government pronouncements, much less when read against the longstanding background presumption against finding broad disclaimers ‘of liability for changed conditions. United Contractors v. United States, 368 F.2d, 585, 598 (Ct.Cl. 1966).”

For these reasons, the court vacated and remanded the case for further review and decision by the claims court.

Comment:  This may be one of the most important decisions affecting government contractors to be decided by the courts in the last 10 years.

The government’s misinterpretation of the law pertaining to its duty of good faith and fair dealing has been most unfortunate, and it seems the court seized on the opportunity of this case to right what had become a serious wrong.

On the issue of differing site conditions claim, the government has been increasingly relying upon broad disclaimer language in contracts to attempt to avoid paying for legitimate differing site conditions claims.

In the context of design-build contracts, the government has been adding insult to injury by insisting that a design-builder, by virtue of having to do further site investigation and final design after contract award, is assuming all the risk of the site and cannot rely upon initial subsurface information and reports provided by the government.  This decision lays that spurious argument to rest.

Such broad disclaimers will not be tolerated to excuse the government from honoring the intent of the Federal Acquisition Regulation to pay claims where the subsurface conditions are materially different from those indicated in the contract and pre-bid information.

 

 

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report (February 2014 Special Edition).

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