The U.S. Court of Appeals for the Federal Circuit recently reversed a U.S. Court of Federal Claims opinion relating to a dispute between the federal government and a design-build entity. In the Fall 2013 Newsletter, I joined the public criticism of the Court of Claims’ ruling in Metcalf Construction Company, Inc. v. United States as it related to its treatment of a differing site conditions (“DSC”) claim arising out of a federal design-build contract. While my Fall 2013 article focused solely on the Court of Claims’ treatment of the DSC claim, the public criticism of Metcalf has not been limited to this issue. In fact, many commentators directly criticized the Court of Claims’ reasoning relating to the duty of good faith and fair dealing.

With respect to the DSC claim, a popular critique of the Court of Claims’ ruling is that it dramatically reallocated risk among the contracting parties by turning the design-builder’s independent review of site conditions into a warranty of conditions, diminishing the reliability of reports and indications included in contract documents. In this way, the Court of Claims’ ruling arguably invited more uncertainty in project pricing and greater risk for design-builders.

On February 11, 2014, the Federal Circuit reversed the Court of Claims, vacating the holding and remanding the case back to the trial court for further proceedings. In the process, the Federal Circuit provided needed clarification on the DSC issue.

Metcalf’s DSC Claim And The Court Of Claims’ Ruling

Metcalf Construction involved a Navy project for demolition of existing housing and design and construction of new family housing units. Metcalf was the design-builder. The Navy’s original and revised request for proposal (“RFP”) included a soil investigation report. The soil report detailed characteristics of the soil as having “slight expansion potential.” Additionally, the RFP stated that the human carcinogen chlordane was present in the soils but at acceptable levels such that remediation was not required. The RFP stated that the soil investigation report was for preliminary information only and advised contractors to perform post-award site design and engineering work, including soil investigation.

After receiving its notice to proceed, Metcalf undertook performance of the project and hired an independent entity to conduct a soil investigation. Metcalf discovered moderate to high expansive near-surface soil that differed materially from the soil described in the Navy’s report included in the RFP. Metcalf submitted its DSC claim to the Navy, and the Navy rejected the claim. The Navy contended that the claim was late and that the Navy’s soil report was for “preliminary information only” such that Metcalf could not have reasonably relied upon it.

Additionally, Metcalf tested the soil conditions on multiple occasions for contamination. During testing, Metcalf found no detectable amounts of chlordane. During excavation, however, the Navy required Metcalf to conduct further tests before relocating soil stockpiles. These subsequent tests found detectable levels of chlordane. Metcalf submitted notice of the DSC to the Navy, and the Navy partially rejected Metcalf’s claim.

When Metcalf pursued its claim in the Court of Claims, the Court ruled in favor of the Navy. The Court of Claims noted the disclaimers in the RFP that detailed soil investigation reports were for informational purposes only and held that those reports could not reasonably be relied upon. Essentially, the Court distinguished between bid documents (upon which it concluded a contractor cannot rely) and other contract documents (upon which it concluded that a contractor may rely). The Court of Claims also focused on Metcalf’s contractual duty to perform an independent investigation of the conditions in denying Metcalf’s DSC claim. Metcalf appealed this ruling to the Federal Circuit.

The Federal Circuit’s Reversal Of The Court Of Claims

On appeal, the Federal Circuit reversed the Court of Claims, ruling that the Court of Claims applied the wrong legal standard and misinterpreted certain contract provisions in ruling on the implied duty of good faith and fair dealing and the DSC claim. Consequently, the Federal Circuit vacated the Court of Claims’ holding and remanded the matter for further proceedings.

The Federal Circuit’s opinion squarely addressed Metcalf’s claim of breach of the implied duty of good faith and fair dealing, concluding that the Court of Claims’ standard of review was “improperly narrow.” The Federal Circuit therefore reversed and remanded the case to the lower court on this issue. The Federal Circuit acknowledged that the thrust of Metcalf’s claim was the good-faith-and-fair-dealing claim; however, the Court noted that “any breach of that duty has to be connected, though it is not limited, to the bargain struck in the contract.” Accordingly, the Federal Circuit examined Metcalf’s DSC claim.

Initially, the Federal Circuit observed that the RFP and pre-bid documents established how the DSC clause would apply to soil conditions. While the contract anticipated that Metcalf would test and investigate the soil during performance, the RFP made direct representations about the expansive soils and the absence of any need for remediation of chlordane because those levels were deemed “acceptable.”

The Federal Circuit took issue with the Court of Claims’ interpretation of the RFP and pre-bid documents, noting that the Court of Claims 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.” The Federal Circuit did not agree that the contract required Metcalf to bear the risk for errors in the government’s affirmative representations about soil conditions. Thus, although Metcalf was required to investigate conditions once work began, it did not bear the sole risk of significant errors in the pre-contract assertions by the government of soil conditions.

The Federal Circuit considered it instructive that Metcalf’s contract with the Navy incorporated the DSC clause in FAR 52.236-2. The Federal Circuit specifically noted that the FAR provision “exists precisely in order to ‘take at least some of the gamble on subsurface conditions out of bidding’: instead of requiring high prices that must insure against the risks inherent in unavoidably limited pre-bid knowledge, the provision allows the parties to deal with actual subsurface conditions once, when work begins, ‘more accurate’ information about them can reasonably be uncovered.” For this reason, even pre-bid inspection requirements for contractors are viewed cautiously so that a duty to inspect the site will not negate a DSC clause by putting a contractor in the difficult position of discovering hidden conditions beyond the limits of an inspection appropriate to the time available to perform that inspection.

Finally, the Federal Circuit considered the reference to the soils report being “for preliminary information only” to be inconsequential. In the opinion of the Court, that provision existed solely to signal that the information may change; it did not require Metcalf to bear all risk if preliminary information provided by the government was ultimately determined to be inaccurate. For the foregoing reasons, the Federal Circuit reversed and remanded the matter to the Court of Claims for further proceedings consistent with the Federal Circuit’s opinion.

Conclusion

A long line of federal authority has embraced and advanced the public policies furthered by DSC clauses in federal contracts of enhancing the procurement process and minimizing the risk to bidders of unforeseen subsurface conditions. The DSC clause lessens the risk of unknown contingencies and simultaneously provides a direct benefit to the government by allowing for more accurate bids without inflation for unforeseen risks.

In ruling that the Court of Claims misinterpreted the contract and imposed a too-heavy burden on the design-builder, the Federal Circuit provided clarity to the issue and reached a conclusion more in line with existing precedent. For design-builders, the Federal Circuit’s opinion should provide some reassurance that an obligation to perform an independent review of the site is not automatically transformed into a general warranty of conditions. Moreover, the federal government will not be able to utilize broad disclaimers to allocate all risk of unknown site conditions on the design-builder.

For Metcalf Construction, it remains to be seen how the Court of Claims will rule on remand on issues of liability and damages. The Federal Circuit’s reversal, however, provides much needed clarification, and may also provide some peace of mind to design-builders that long-standing federal authority on the DSC clause’s fair allocation of risk between the parties to a construction contract is not in immediate jeopardy.