Introduction

A participant on a construction project will invariably find itself in the position of having to address the cost impacts of changes to work.  Under federal procurement laws and regulations, contractors must certify in writing that they are submitting claims in good faith.  The question naturally arises whether the Federal Government (“Government”) must also adhere to a good faith standard when administering contracts and negotiating claims.

It is generally recognized that standards of good faith and fair dealing are implied in both public and private contracts.  Nonetheless, Government officials had long enjoyed a presumption that they performed their duties in good faith.  Proving that a government official did not act in good faith was said to require “well-nigh irrefragable proof” of a specific intent to injure the contractor.  In recent years, however, courts have confronted the question whether it is appropriate for government officials to be cloaked by a presumption of good faith when performing their contractual responsibilities.  A number of courts over the past fifteen years have addressed the legal doctrines underpinning the covenant of good faith and fair dealing as it applies to Government actors.  The modern trend has been to conclude that the Government is not afforded a presumption of good faith when administering a contract, which would include its responsibility for managing the change order process.

While it is generally the case that Government officials will no longer enjoy an insuperable presumption when administering contracts, the scope of the Government’s obligation to act in good faith and deal fairly, and the evidence necessary to prove a breach, continue to draw significant attention among construction industry participants and commentators on federal procurement law.  In a two-part contribution to this Newsletter (our editors did not think our audience could handle the excitement all at once), we will explore the boundaries of the Government’s duty of good faith and fair dealing in the administration of contracts and in the claims process.  In this edition, we will consider the specific duties required of contracting parties under the umbrella of “good faith.”  This article also presents cases in which courts have held that the Government breached its duty of good faith in the claims process and the consequences attached to those transgressions.  In a subsequent edition of the newsletter, we will address the evidentiary standard applied when challenging the Government’s actions under the doctrine of good faith and fair dealing and the consequent erosion of the presumption of good faith afforded to Government officials.  In that context, we will also examine the current state of the good faith and fair dealing doctrine in federal government contract law as it continues to evolve.

The Implied Duty Of Good Faith And Fair Dealing Defined

At the outset, it is important generally to consider the duty of good faith and fair dealing as it has developed in the common law.  The duty of good faith and fair dealing is an implied term found in most every contract, public or private. Centex Corp. v. United States, 395 F.3d 1283, 1304 (Fed. Cir. 2005); N. Star Alaska Hous. Corp. v. United States, 76 Fed. Cl. 158 (2007) (“The need for mutual fair dealing … is no less required in contracts to which the government is party, than in any other commercial arrangement”).  The implied duty of good faith and fair dealing prevents a contracting party from interfering with the benefits its counterpart reasonably expects to receive from the contract.  The implied duty of good faith and fair dealing includes the obligations to act with honesty, to cooperate by not hindering or interfering with its counterpart’s performance, and to not willfully render imperfect performance of contractual obligations.  See Malone v. United States, 849 F.2d 1441, 1445 (Fed. Cir. 1988).

In recent cases applying the doctrine of good faith and fair dealing, the Government has been held liable for a breach of the implied duty of good faith and fair dealing in the administration of contractor claims.  In the context of the claims process, courts have recognized that the implied duties of good faith and fair dealing may bar the Government from employing unfair bargaining tactics to secure an unjust settlement or result in litigation.  See John Cibinic, Jr. Ralph C. Nash, Jr., & James F. Nagle, Administration of Government Contracts 298-312 (4th. Ed. 2006); Restatement (Second) of Contracts § 205.  The commentary accompanying § 205 of the Restatement specifically considers the duty of good faith and fair dealing in the handling of contract claims.  The commentary generally describes actions that may amount to unfair bargaining and consequently, a breach of the implied duty of good faith and fair dealing, as follows:

The obligation of good faith and fair dealing extends to the assertion, settlement and litigation of contract claims and defenses.  The obligation is violated by dishonest conduct … such as taking advantage of the necessitous circumstances of the other party to extort a modification of a contract for the sale of goods without legitimate commercial reason.  Other types of violation have been recognized in judicial decisions: harassing demands for assurances of performance, rejection of performance for unstated reasons, willful failure to mitigate damages, and abuse of a power to determine compliance or to terminate a contract (internal references omitted).

Recent Federal Cases Finding A Government Breach Of The Duty Of Good Faith And Fair Dealing In The Claims Process

Consistent with § 205 of the Restatement, courts in the Federal Circuit have recently held that the Government breaches the duty of good faith and fair dealing when it unfairly uses its authority as a Government owner in an effort to obtain one-sided contract modifications or claims settlements.  For instance, in Rumsfeld v. Freedom NY, Inc., 329 F.3d 1320 (Fed. Cir. 2003), the Court of Appeals for the Federal Circuit held that the Government could not condition the payment of due and owing progress payments upon the execution of a contract modification.  During the course of a troubled contract, the Government in Freedom NY withheld an approved progress payment from a financially-distressed contractor solely to pressure the contractor into signing a modification that released the Government from separate claims of the contractor.  In reaching the conclusion that the Government improperly coerced the contractor to waive its claims, the court explained that “[t]he contract did not allow the government to withhold progress payments simply to pressure the contractor into giving up its rights under the contract.  The government could not have had a good faith belief that withholding for this purpose was permissible.”

Moreland Corp. v. United States, 76 Fed. Cl. 268 (Fed. Cl. 2007) is another case where the Government was found to have breached the implied duty of good faith and fair dealing by improperly administering the claims process.  Moreland involved a challenge to the Government’s lease termination based on the developer’s alleged failure to repair structural defects.  The Court of Federal Claims concluded that the Government had breached its duty of good faith and fair dealing by refusing to settle the developer’s meritorious claims for extra labor costs so that the Government could gain leverage in negotiating its separate claim that the developer was responsible for structural repairs.  The court also found that the Government lacked good faith in claiming that the developer was responsible for the costs of a structural loading study presented as necessary to analyze the alleged structural concerns, when the Government had actually intended to use the study to determine whether it could safely install extra-contractual backup HVAC systems.

Underlying the Moreland court’s decision was its view that the duty of good faith and fair dealing reciprocally binds the contractor and the Government in the claims process.  The court reasoned that the obligation to act in good faith flowed from the Government as a matter of fairness to the contractor:

The [Contract Disputes Act] requires contractors to certify that their claims are made in good faith, that all supporting data are accurate and complete to the best of the contractor’s knowledge and belief and that the amount requested accurately reflects the contract adjustment for which the contractor believes the government is liable.  Certainly, a reciprocal obligation to act in good faith should apply to the Government … a contracting officer is obligated to put his own mind to the problems and render his own decisions.  Such decisions must be personal and independent, and even the appearance of coercion must be avoided.  The Contracting Officer’s outright denial of meritorious contractor claims to gain some advantage over the contractor will not be condoned by this Court.  (Internal citations and quotations omitted).

The Government has also been found to be in breach of the implied duty of good faith and fair dealing by requiring a contractor to go through unnecessary obstacles in the claims process.  In Orlosky, Inc. v. United States, 68 Fed. Cl. 296 (2005), the contractor performed electrical work for the United States Navy at its Air Weapons Station at San Nicholas Island. Towards the completion of the project, the contracting officer informed the contractor that the Navy was terminating the contract for convenience and requested a proposal for an equitable adjustment to cover the termination costs.  On the same day that the contractor wrote to confirm the termination, a letter was crossing in the mail from another Navy official who declared the contract “usably complete,” effective six months earlier.  The contractor requested the Navy to clarify whether the Navy considered the contract terminated or completed, but no clarification was provided.  As a result, the contractor proceeded with the expense of preparing and submitting the request for an equitable adjustment.  Thereafter, the Navy led the contractor through a four and one-half year period of negotiations, two Defense Contract Audit Agency audits, and proposal resubmissions.  All of this occurred when the Navy was not actually terminating the contract for convenience.  The court concluded, based on the Navy’s requiring the contractor to partake in an unnecessary claims process, that the Navy was liable for a breach of the duty of good faith and fair dealing, maintaining that:

[t]he Navy’s reversal of its termination for convenience violated its obligations of good faith and fair dealing.  The Navy should have clarified whether the termination was for convenience or acceptance of the project as usably complete.  The Navy, through its negligence, caused plaintiff to incur unnecessary costs in complying with the Navy’s request for an REA for a non-existent termination for convenience; this is a breach of defendant’s duty to cooperate.

Remedies Available For A Government Breach Of The Implied Duty Of Good Faith And Fair Dealing In The Negotiation And Settlement Of Claims

The Government’s breach of the duty of good faith and fair dealing will have significant consequences.  Courts have remedied these breaches by: (1) discharging a contractor from further performance; (2) overturning a termination for default; (3) invalidating a contract modification unfairly obtained by the Government; and (4) awarding claims preparation costs.

1.   Failing to Perform in Good Faith Has Been Held To Be A Material Breach Of The Contract Which Discharges The Contractor From Further Performance.  A contractor may be discharged from further performance of a contract when the Government is found to have breached the implied duty of good faith and fair dealing.  In Malone v. United States, 849 F.2d 1441 (Fed. Cir. 1988), the Federal Circuit held that a contracting officer’s willful interference with the contractor’s performance violated the duty of good faith and fair dealing.  The contracting officer misled the contractor to perform roughly 70% of the work relying upon an inapplicable workmanship standard, which the contracting officer later rejected.  The contracting officer also refused for several months to answer the contractor’s request for clarification of the proper workmanship standard.  Finding this conduct to be a material breach of the contract, the court stated that the contractor had “a legal right to avoid the contract, discharges [the contractor’s] duty to perform, and relieves [the contractor] of the default termination and its consequences.”

2.   A Termination For Default May Be Overturned If The Contractor’s Failure To Perform Resulted From The Government’s Lack Of Good Faith.  As stated in Malone, a termination for default will not be upheld when the Government breaches the duty of good faith and fair dealing during the administration of the contract.  Malone v. United States, 849 F.2d at 1446; see also Moreland Corp., 76 Fed. Cl. at 293; Libertatia Assocs., Inc. v. United States, 46 Fed. Cl. 702 (2000).  The contractor will be relieved of the default termination in such a circumstance even when the contractor was technically in default of the contract.  Moreland Corp., 76 Fed. Cl. at 293.  Courts have expressed that a lack of good faith will lead to the reversal of a termination because it cannot be determined if the Government’s complicity in the contractor’s failure to perform was the reason for the default.  Libertatia Assocs., 46 Fed. Cl. at 712 (“In view of the court’s finding of bad faith on the part of the government, it is difficult – if not impossible – to assess whether the administration of the contract and the resulting termination for default was arbitrary and capricious because the evidence of default itself is tainted by bad faith”); see also Abcon Assocs., Inc. v. United States, 49 Fed. Cl. 678, 690–91 (2001) (converting a termination for default to one for convenience due to the Government’s breach of the duty of good faith).

3.  A Contract Modification Secured In An Unfair Negotiation Is Rendered Unenforceable.  A contractor may seek to void a contract modification that was negotiated without the requisite good faith on the part of the Government.  In Freedom NY, Inc. v. Rumsfeld, discussed above, the contractor alleged that the Government pressured the contractor into signing a modification by withholding due and owing progress payments.  The Federal Circuit concluded that conditioning payment of approved contract funds upon releasing claims amounted to duress and a lack of good faith and fair dealing.  As a result, the court held that the contract modification, including the contractor’s waiver of certain claims against the Government, was not binding upon the contractor.

4.   Claim Costs Are Recoverable Damages When The Government Breaches The Duty Of Good Faith And Fair Dealing In The Claims Process.  In addition, courts have also awarded contractors claims preparation costs that were incurred due to the Government’s breach of the duty of good faith and fair dealing.  In Orlosky Inc. v. United States, discussed above, the court determined that the contractor engaged in a claims process unnecessarily protracted by the Government’s lack of good faith in administering the contract.  The contractor was forced to prepare a needless request for equitable adjustment and partake in an “obstacle course of claim verification and proposal resubmissions.”  Finding that the contractor’s efforts in the claims process resulted from the Government’s negligence and failure to cooperate, the court awarded the contractor its claim preparation costs.

To Be Continued

The Government’s obligation of good faith and fair dealing continues to be the subject of litigation in the federal courts.  Our upcoming conclusion to this article will consider how the doctrine has evolved over time and where it has come to rest, even if only for the time-being.  Stay tuned.

Reprinted with the permission of AACE International, 1265 Suncrest Towne Centre Dr., Morgantown, WV 25605 USA. Phone 800-858-COST/304-296-8444. Fax: 304-291-5728. Internet: http://www.aacei.org   E-mail:  info@aacei.org  Copyright © 2013 by AACE International; all rights reserved.