Once a surety receives a declaration of default, show cause notice or even a letter of concern, it is imperative that the surety take immediate action to best prepare and position itself should the government terminate the surety’s principal on the project. A declaration of default oftentimes is a result of an acrimonious relationship between the contracting officer and the surety’s principal. This can lead the government to quickly terminate for default, and more importantly, a demand to the surety to complete the project. Obviously, a termination for default is a serious step that can have long term consequences for a contractor. Courts consider a default termination a drastic measure and place the burden on the government to demonstrate the validity of the default termination.

 

If the government does terminate for default, the surety has numerous options, such as tendering the penal sum of the bond, executing a takeover agreement, tendering a new contractor, financing the surety’s principal, or doing nothing. However, before default-termination occurs and the surety selects one of its rights, there is a brief, yet important, period of time when options are available that may avoid a termination for default.

 

This article focuses on the alternatives a surety and the government, as well as the contractor, should examine in order to avoid the costly and contentious default-termination process as provided in the Federal Acquisition Regulation (“FAR”). The FAR is intentionally vague and there is little to no case law interpreting the alternatives provided in lieu of termination. The FAR, however, provides alternatives in lieu of termination for default that both minimize costs and potential losses, while at the same time allowing for completion of the project in a timely and efficient manner. The government, the surety and the contractor all have an interest in fully exhausting these options prior to termination.

 

Alternatives In Lieu Of Termination For Default

 

The alternatives in lieu of termination set forth in the FAR allow the government to choose one of three options: 1) permit the contractor, the surety, or the guarantor to continue performance of the contract under a revised delivery schedule; 2) permit the contractor to continue performance of the contract by means of a subcontract or other business arrangement with an acceptable third party, provided the rights of the Government are adequately preserved; or 3) execute a no-cost termination settlement agreement. FAR §49.402-4.

 

• Option 1 – Revised Delivery Schedule
In those rare instances where time is not of the essence, this may be a viable option. Notwithstanding, the government will likely not receive a completed project in a more timely manner should it decide to terminate a contractor for default. With this option, the surety can submit a revised delivery schedule in order to permit the contractor to continue performance on the contract. If the government agrees to the revised delivery schedule, termination for default will be avoided. Under this option, the government may also accommodate delayed delivery of service or materials in exchange for a reduced price.
If the working relationship between the contractor and the government is sound and additional time is available, this option would be the most appropriate option. This option also allows the contractor to retain control of its work.
• Option 2 – Permit The Contractor To Continue Performance By Means Of Subcontract
Option 2 ensures that the contract will continue, and substitutes the contractor by transferring the work to a third party. This option is beneficial to both the government and the surety, because the government’s project continues with minimal interruption, while the surety is not required to take any further action.
In LB&B Assocs., Inc. v. United States, the plaintiff contractor was required to perform maintenance and repair, including removal of hazardous waste material, for various Navy facilities. 91 Fed. Cl. 142, 147 (2010). Within two years of signing the contract, deficiencies arose concerning the maintenance, repair and handling of the hazardous waste material. Id. at 148-49. Instead of immediately terminating for default, the government attempted to avoid termination by allowing the contractor to continue performance through a subcontractor for a certain portion of the work. Id. at 150. The government informed the contractor of the failures, allowed it the opportunity to cure the defects, and informed the contractor that default would occur if the deficiencies were not fixed. The contractor subsequently filed claims for additional costs for subcontracting the hazardous material handling.
In granting the government’s motion for summary judgment on the claim, the court held that the government’s actions were permissible in lieu of termination. Id. at 156. By providing an alternative to default-termination, the government provided an option to immediate termination and allowed the contractor to retain some, though not complete, control over the project.
This option can be utilized in the event the relationship between the contracting officer and the principal is not irrevocably damaged. Perhaps the contractor underbid the project, has manpower issues, or just needs a portion of the scope subcontracted to a different party. Perhaps a majority of the contractor’s scope of work is subcontracted out to one subcontractor that could increase its role on the project. Despite project issues, the government may not want to lose the original contractor’s expertise or project experience.
• Option 3 – Execute A No-Cost Termination Settlement Agreement
This option would allow the parties to essentially rescind the contract and allow the parties to go their separate ways. Courts recognize that a termination for default is “the most drastic of remedies” and a “contractual death sentence.” Pipe Tech, Inc., ENGBCA Nos. 5959, 6005, 94-2 BCA ¶26,649; Martin Constr., Inc. v. United States, 102 Fed. Cl. 562, 573 (2011). Termination should only be imposed in limited situations and on “good grounds and on solid evidence.” Lisbon Contractors, Inc. v. United States, 828 F.2d 759, 765 (Fed. Cir. 1987).
A termination for default remains a risky measure on the part of the government, because if a court ultimately finds the default excusable, a termination for default converts to a termination for convenience. Dynalectron Corp. v. United States, 518 F.2d 594, 602 (Ct. Cl. 1975); FAR §52.248-10. If a default termination is converted to a termination of convenience, recoverable damages are limited to costs sustained before termination, a reasonable profit on the work that has been performed, as well as other additional costs. Pinckney v. United States, 88 Fed. Cl. 490, 506 (2009). However, other damages typically associated with breach of contract actions may be available if it is determined the government terminated the contract in bad faith. Id.
This option is more viable early in the project, especially if there are other available contractors that submitted similar bids. Option 3 is a more likely option where the termination for default would be contested, additional litigation likely, and a favorable ruling on the government’s decision unclear. A surety must also consider the contractor’s subcontractors and potential payment bond liability prior to the parties entering into a no-cost termination. One final consideration is whether the contractor desires to bargain for an acceptable evaluation from the relevant agency. The FAR provides examples of no-cost termination settlement agreements for complete or partial termination. See FAR §§ 49.603-6; 49.603-7.
The Government Is Required To Balance
Certain Factors Before Termination For Default
If the government elects not to utilize one of the above alternatives, the government must balance specific factors in evaluating whether to terminate for default. Importantly, the FAR requires the government to notify the surety if termination is imminent. FAR § 49.402-3(e). Prior to any action by the surety, the surety should confirm that the government has complied with the balancing requirements for default-termination. Noncompliance with these factors may provide evidence that a contracting officer abused his discretion in terminating a contract for default. DCX, Inc. v. Perry, 79 F.3d 132, 135 (Fed. Cir. 1996). Courts review these factors and determine on a case-by-case basis whether the default termination is proper. Decker & Co. v. West, 76 F.3d 1573, 1580 (Fed. Cir. 1996) (quoting Olson Plumbing & Heating Co. v. United States, 221 Ct. Cl. 197, 602 F.2d 950, 955 (Ct. Cl. 1979)).
The FAR factors include, among others, the terms of the contract, the specific failure of the contractor and any excuses for the failure, the contract schedule, and the work remaining on the contract. FAR §49.402-3(f). In addition, the FAR provides the contracting officer with broad discretion under a catchall of “any other pertinent facts and circumstances.” FAR §49.402-3(f)(7). After the contracting officer reviews these factors and determines the default termination is warranted, the contracting officer shall issue a notice of termination detailing, among other things, the reasons for the termination and the contractor’s right to appeal. FAR §49.402-3(g).
Conclusion
Although a surety has numerous options and rights after the government terminates for default, the government, the surety and the contractor benefit by avoiding termination. The FAR provides alternatives in lieu of termination in order to provide flexible options to mitigate damages for all parties involved and deliver a satisfactory project to the government in a timely and efficient manner.