Walking the Tightrope: Liquidation Agreement “Traps for the Unwary”

Amy Elizabeth Garber and Robert J. Symon | Buildsmart

When crafting a liquidation or “pass-through” agreement for a subcontractor claim against the government, the key provision from the prime contractor’s perspective is a release from any liability for the subcontractor’s claim with the exception of amounts recovered from the government related to that claim. If the release language is too broad, however, the agreement may provide the government a legal defense to the pass-through claim known as the Severin doctrine. The Severin doctrine prohibits a prime contractor from passing through a subcontractor claim to the government if the prime contractor is not liable for the subcontractor’s claimed costs. Simply put, to pass through a subcontractor claim, the prime contractor must maintain some form of liability for the subcontractor claim or risk rejection of the claim. Indeed, if the prime contractor expressly disclaims liability for the subcontractor’s claim or the subcontractor’s release of the prime contractor is too broad, the Severin doctrine may bar the claim and the government will rely on this defense before ever looking at the merit of the claim.

A recent decision issued by the Armed Services Board of Contract Appeals demonstrates how far the government has tried to stretch the Severin doctrine defense. See Alderman Building Company, Inc., ASBCA No. 58082 (May 21, 2020). Alderman Building Company was the general contractor, pursuant to a contract with the Navy, on a renovation project at a Marine Corps base. The project suffered from significant government-caused delays. Alderman sponsored a pass-through claim on behalf of its subcontractor, Big John’s Electric Co., Inc. seeking compensation for the delays. One of the recitals in the pass-through agreement between Alderman and Big John’s stated that “the Owner is the ultimate responsible party to pay for the Subcontractor’s and Contractor’s claims.” In this appeal, the Navy argued that the Severin doctrine mandated dismissal of the claim because, vis-a-vis the recital language, Alderman had asserted it was not responsible for the costs Big John’s incurred.

Fortunately, the board rejected the Navy’s argument holding that the Navy failed to demonstrate that Alderman was not responsible for Big John’s costs. First, the board noted that the pass-through agreement did not contain an “iron-bound release” and it did not contain an “express undertaking” to release Alderman from any obligation to Big John’s. Second, the board found “Alderman’s unqualified undertaking” in the pass-through agreement to promptly pay any amounts owed to Big John’s. The board stated this fact to be the “antithesis” of any release of Alderman’s liability.

Although Alderman is a victory for the contractor, it is also a cautionary tale. In terms of a “victory,” the board imposed a strict burden on the government to demonstrate that the prime contractor has no liability for a subcontractor’s claim pursuant to the Severin doctrine. Nevertheless, this case serves as a warning to carefully avoid language in a pass-through agreement that would suggest in any way, shape or form that the prime contractor has no liability for the subcontractor’s claim by factoring in the likelihood that the government will look to a Severin doctrine defense to avoid liability for an otherwise meritorious claim.

Certifying Claim Under Contract Disputes Act

David Adelstein | Florida Construction Legal Updates

Under the Contract Disputes Act (41 USC 7101 en seq.), when a contractor submits a claim to the government in excess of $100,000, the claim MUST contain a certification of good faith, as follows:

For claims of more than $100,000 made by a contractor, the contractor shall certify that–

(A) the claim is made in good faith;

(B) the supporting data are accurate and complete to the best of the contractor’s knowledge and belief;

(C) the amount requested accurately reflects the contract adjustment for which the contractor believes the Federal Government is liable; and

(D) the certifier is authorized to certify the claim on behalf of the contractor.

41 U.S.C. 7103(b)(1).  See also 48 C.F.R. s. 33.207(c) as to the wording of the certification.

The contracting officer is not required to render a final decision on the claim within 60 days if, during this time period, he/she notifies the contractor of the reasons why the certification is defective. 41 U.S.C. 7103(b)(3).   Importantly, the contracting officer’s failure to render a decision within 60 days is deemed an appealable denial.

However, “[a] defect in the certification of a claim does not deprive a court or an agency board of jurisdiction over the claim. Prior to the entry of a final judgment by a court or a decision by an agency board, the court or agency board shall require a defective certification to be corrected.”  Id.

This is important.  In a recent decision out of the Federal Circuit, DAI Global, LLC v. Administrator of the United States Agency for International Development, 945 F.3d 1196 (Fed. Cir. 2019), a government contractor submitted a claim to the government with a defective certification.   The contracting officer waited 70 days (not the required 60 days) before notifying the contractor that the claims did not contain the required certification.   The contractor (smartly interpreting the contracting officer’s untimely notification as a denial of the claim) appealed to the Civilian Board of Contract Appeals.   The Board dismissed the contractor’s claims for lack of jurisdiction claiming the contractor failed to certify the claims and the contractor’s errors in preparing the certification were not correctible.  The contractor appealed to the United States Court of Appeals, Federal Circuit.

First, the appellate court held that the Contract Disputes Act states that a defect in the certification does NOT deprive a board over jurisdiction.  Whether the defect is technical in nature or not is of no moment since a board is not deprived of jurisdiction if there is any defect in the certification.

Second, the appellate court held that that the contracting officer failed to timely notify the contractor of the defective certification.  It was required to either issue a final decision on the claim or notify the contractor of the defective certification within 60 days.  “Because the contracting officer failed to issue a decision within the statutory period [60 days], [the contractor’s] claim was deemed denied and became appealable to the Board.” DAI Global, LLC, supra.

It is always good practice to work with counsel when preparing or submitting a claim.  Here, the contractor had good counsel as counsel treated the contracting officer’s untimely notification to the contractor of a defective certification as an appealable denial of the claim.

Don’t Forget to Certify Within Six Years: Recent Opinion Addresses Timeliness of Government Contractor’s Appeal

Douglas L. Patin, Aron C. Beezley & Amandeep S. Kahlon | Buildsmart

On May 19, 2020, the Federal Circuit upheld summary judgment against a government contractor for failure to file a claim timely within the six-year time limit prescribed by the Contract Disputes Act (CDA). In Electric Boat Corp. v. Secretary of the Navy, the Federal Circuit determined that the claim from the contractor, Electric Boat, accrued no later than August 15, 2005, the date when it first became entitled to a cost adjustment under its contract with the Navy. By certifying its claim more than seven years later, Electric Boat’s claim and appeal were untimely.

In 2003, Electric Boat signed a contract with the Navy to construct up to six submarines.  The contract included a change of law provision providing for a price adjustment if compliance with a change in federal law increased or decreased Electric Boat’s costs. For the first two years of the contract, no cost adjustment was allowed under that provision, but, after August 15, 2005, for cost increases in excess of $125,000, Electric Boat could qualify for an adjustment under the clause. The clause required that Electric Boat provide the Navy prompt notice of any change of law and submit a request for equitable adjustment for any cost increase.

In September 2004, OSHA issued a new regulation requiring Electric Boat to post a “fire watch” if certain conditions were present during “hot work” at its shipyard. Five months later, Electric Boat submitted a notice of change to the Navy stating that Electric Boat anticipated a cost increase from the new regulation in excess of $125,000. Electric Boat submitted a cost proposal to the Navy in 2007, and the Navy formally denied the proposal in May 2011.

After certifying its claim in December 2012 and receiving a Final Contracting Officer’s Decision from the Navy denying the claim, Electric Boat filed an appeal with the Armed Services Board of Contract Appeals (ASBCA). The Navy moved for summary judgment, arguing that Electric Boat did not file its claim within the six-year limitations period provided under the CDA. The ASBCA agreed, finding that Electric Boat knew of its claim no later than February 2005 and suffered injury no later than August 15, 2005. Because Electric Boat did not certify its claim until December 2012, some seven years later, the claim was untimely.

Electric Boat appealed the ASBCA’s decision to the Federal Circuit. Affirming the ASBCA’s decision, the Federal Circuit noted that claims under the CDA must be submitted within six years of “accrual.” Per the Federal Circuit, claim accrual is set as “the date when all events, that fix the alleged liability of either the Government or the contractor and permit assertion of the claim, were known or should have been known,” and, while monetary damages need not have been incurred, “for liability to be fixed, some injury must have occurred.”

Per the Federal Circuit, the Navy’s liability became fixed for purposes of claim accrual on August 15, 2005, when Electric Boat became eligible for costs associated with the new OSHA regulation under the change of law clause. The Federal Circuit rejected Electric Boat’s argument that its claim did not accrue until formal denial of its cost proposal in May 2011. The Federal Circuit found that, in the absence of any “mandatory pre-claim procedures” that prevented certification of Electric Boat’s claims, the date for claim accrual should not be linked with the May 2011 denial. The contract did not require Electric Boat to await a unilateral price adjustment or denial from the Navy prior to filing a claim, so the formal denial by the Navy did not excuse Electric Boat’s failure to timely file its claim in accordance with the CDA six-year limitations period.

The Federal Circuit’s decision in Electric Boat is an important reminder for government contractors to be conservative when calculating the time for filing any certified claims against the government. Government review of potential changes and requests for equitable adjustment can lag substantially during a project and even extend well-beyond project completion. However, the government’s delay in reviewing and assessing requests for equitable adjustment will not toll the running of the statute of limitations under the CDA for filing a certified clam. When you first anticipate a claim might require appeal to the U.S. Court of Federal Claims, the ASBCA or the Civilian Board of Contract Appeals, it is a good idea to calendar a date six years from the earliest date when your claim may have accrued regardless of whether you have received a response to a request for an equitable adjustment. Being mindful of the limitations period will help you avoid Electric Boat’s unfortunate fate.

Now is the Time for Construction Impact Claims

Alexandra Elena Busch and Christopher Moore Sweeney | Cozen O’Connor

As most states, counties, and municipalities across the country lift restrictions on businesses and travel, it is easy to think the worst is behind us, especially for the construction industry. However, this is exactly when contractors should be evaluating their records and considering whether to submit impact claims due to COVID-19-related restrictions.

In March, as governments began shutting down and adding restrictions to businesses and travel, many contractors issued broad notices of potential impacts upstream. At that time, the impact from government actions in response to the COVID-19 pandemic were difficult if not impossible to predict, much less quantify. We recommended that contractors carefully and thoroughly document the potential impacts on a rolling basis. As the country shifts to the reopening stages, now is the perfect moment for contractors to draw a baseline and measure the impacts to date and start measuring future impacts.

PAST IMPACTS — CLOSURES TO REOPENING

When governments first started closing businesses and restricting travel, many anticipated that there would be a variety of impacts on contractors from delayed receipt of materials and equipment to reduced workforces to project-wide shutdowns. Some of the more obvious and significant impacts are likely easing as we enter into the reopening phases. Projects that were entirely shutdown will reopen. Material and equipment suppliers that were closed or working on reduced staff will begin clearing backlogs. This means contractors may start seeing an end to disruption periods for these larger, discrete impacts, such as delayed materials finally shipping. Though, as discussed below, many impacts will be ongoing or even just beginning.

So, what should contractors do for these past impacts?

Determine if you were impacted

Impacts, disruptions, and inefficiencies are often the type of you-know-it-when-you-see-it claims. They are claims that develop over time as small daily or weekly changes and minor delays add up to tangible and materials impacts. A good starting point is to talk to field personnel. Did they feel impacted, delayed, or less efficient over the past couple of months? What are the sort of things that impacted them?

After getting feedback from field crews, review the project record. What issues were your team reporting internally and/or upstream? Were other contractors or subcontractors identifying similar issues? Does the documentation support the verbal accounts? If after this review you believe you have been impacted, you need to know by how much.

Quantify impacts and package claim

As these types of claims are often based on aggregate impacts, it can be challenging to calculate costs of the disruptions or inefficiencies. Frequently, contractors will need to engage experts to analyze their records and determine an appropriate calculation for the impacts. However, at the early stage, contractors should be able to determine a rough order of magnitude (ROM) from the impacts. Usually, this is done by comparing costs incurred to date against projections and bid data from before the effects of the pandemic were known. While the ROM will likely not suffice as a final claim number, it can be used to determine whether the costs are even worth pursuing.

If the numbers and documentation support a potential claim, contractors should promptly prepare appropriate claim documents to submit upstream. The mechanisms for seeking these costs can vary based on applicable contract terms. Sometimes a change order proposal is appropriate. In other cases, it is better to submit a request for equitable adjustment (more common in government contracting or contracts borrowing language from government projects or the FAR). Either way, the devil is in the details in these claims. The claim package should contain sufficient detail to show the extent of the impacts as well as an explanation of what reasonable actions you took to try to avoid the impacts given the circumstances.

Continue tracking long-tail impacts and new impacts

After submitting a claim, it is important to verify that any additional costs of the disruptions are tracked going forward. Consider whether assigning the claim a cost code would help to track costs as they are incurred during the project. Depending on the response from upstream contracting partners to your claim, now may be the right time to engage an attorney and/or expert consultant to help refine the claim. Experts can also help set up a stronger framework to catch ongoing cost increases for specific disruptions.

FUTURE IMPACTS — CONTINUED OPERATIONS WITH RESTRICTIONS

Just because we have entered the reopening phases does not mean that construction will not continue to be impacted. In fact, many of the more subtle impacts may likely be ahead of us. Most jurisdictions that have reopened have only done so by requiring strict compliance with CDC and other health department recommendations for safe workspaces. This includes screening at project entrances, increased use of PPE such as face coverings, social distancing, reduced crew sizes, and substantially increased cleaning and/or prohibitions on use of common areas such as lunchrooms, breakrooms, meeting/conference rooms, storage areas, elevators, and lavatories.

These new requirements for day-to-day life on projects will likely create inefficiencies, prolong basic activities, require resequencing of work, and may lead to critical path adjustments. Even the reduction of daily huddles may mean key project information is spreading more slowly and/or making it more difficult to coordinate among contractors. These smaller but ever-present disruptions are dangerous to contractors as the full cost impact (or even the fact that there is a tangible impact) sometimes is not felt for weeks or months.

Contractors must be more vigilant in identifying these potential impacts and tracking them on a daily basis. Additionally, as we previously warned, contractors must be careful to not execute lien waivers or payment applications that extinguish their rights before the impacts are even known. It is also important to check and recheck the applicable contract requirements for timing of notice and whether or what types of claims may be barred. To fully understand their rights, contractors should consult with attorneys about specific contract language. For instance, “no damages for delay” language may not necessarily preclude claims for increased costs due to disruptions or impacts, even if related to time-based costs.

Even if you do not think you have been impacted or will be impacted, now is as good a time as any for any contractor to ensure their project documentation is contemporaneous, accurate, and complies with contract requirements. Whether the project is delayed or impacted due to COVID-19 or related government actions or whether the project is impacted from more garden-variety issues like site coordination or inefficient work direction, good documentation is critical. Months or years from now when project impacts, whether from this pandemic or otherwise, are being arbitrated or litigated, this documentation will be the difference between a potentially successful claim and unrecoverable costs.

An Insurer’s Duty to Defend does not Extend to a Construction Claim that Falls Clearly Within a Policy Exclusion

Amandeep Kahlon and Alex Purvis | Build Smart

On May 14, 2020, in James G. Davis Constr. Corp. v. FTJ, Inc., the Virginia Supreme Court upheld a judgment on an unjust enrichment claim in favor of FTJ, a drywall supplier on a condominium project, against Davis, the general contractor. Notably, FTJ did not have a purchase order with Davis, but FTJ was able to rely on the existence of a joint check agreement and Davis’s multiple assurances regarding payment and the resulting inducement for FTJ to continue performance to succeed on its theory of unjust enrichment.

Davis subcontracted with a drywall company to complete the drywall and metal framing for the building. The subcontractor hired FTJ to supply the drywall materials for the project. According to the court, to ensure the smooth operation of the project, Davis, its subcontractor, and FTJ executed a joint check agreement for Davis to make any and all checks out to both the subcontractor and its supplier. When the subcontractor fell behind on invoices for drywall, FTJ repeatedly contacted Davis about these past due payments, and each time, Davis assured FTJ that a check had been written or would be written for the materials at issue. As a result, FTJ continued to ship materials that it would have typically withheld on a past due account. During these interactions, Davis learned that its subcontractor was having trouble meeting payment obligations and worried that it would be unable to pay FTJ for materials.

When the subcontractor defaulted, Davis requested that FTJ not ship further materials and, again, assured FTJ that there were funds available to pay FTJ on past due amounts. FTJ did not file a lien, in part, because of its confidence that Davis would satisfy its subcontractor’s debts. However, after terminating the subcontractor, Davis incurred additional costs to complete the subcontractor’s work and informed FTJ that Davis could only pay a fraction of the past due invoices. FTJ filed suit, and, after finding the joint check agreement void for lack of consideration, the trial court ruled in FTJ’s favor on its claim for unjust enrichment.

On appeal, Davis argued the trial court decision should be overturned based on the following:

  1. The joint check agreement was valid, and the existence of a contract covering the subject matter of a dispute precluded recovery for unjust enrichment.
  2. The unjust enrichment claim should be barred because it forced Davis to pay for the same goods twice, first, under the subcontract and, again, under the court’s judgment.
  3. Because the joint check agreement required Davis to make payments only when Davis actually owed money to the subcontractor, and no such payments were actually owed, FTJ failed to satisfy one of the key elements of an unjust enrichment claim — that a defendant must reasonably have expected to repay the plaintiff for the benefit conferred.

The Virginia Supreme Court rejected each of these arguments finding:

  1. The existence of the joint check agreement, even if valid, did not foreclose recovery under a theory of unjust enrichment, where the benefit conferred was outside the scope of that agreement. The court concluded the joint check agreement governed the parties’ interactions only as to the form of payment, and, thus, FTJ’s claim regarding nonpayment of delivered materials fell outside the plain terms of the joint check agreement. The court also reasoned that Davis’ repeated assurances that it would pay FTJ for materials after the subcontractor fell behind on payment created separate expectations regarding payment outside the confines of the joint check agreement.
  2. Davis was not being asked to pay twice for the same goods because the dispute with FTJ involved payment for specific supplies and not the overall cost of the project. The evidence established that Davis did not pay for the delivered materials, Davis used the materials, and, absent those materials, Davis would have had to procure replacement supplies elsewhere, so, the court reasoned, Davis was only being required to pay once for those materials.
  3. The language in the joint check agreement limiting Davis’s obligation to payment for amounts actually owed to the subcontractor was undone by Davis’s course of conduct in repeatedly assuring FTJ of payment to induce further delivery of materials. Based on that course of conduct, the trial court could plausibly conclude that Davis expected to pay for the drywall delivered by FTJ.

In upholding the trial court’s decision, the Virginia Supreme Court emphasized the narrowness of its holding as to the specific facts at issue. The court appeared particularly troubled by Davis’s intrusion into the subcontract-supplier relationship by providing repeated promises of payment to encourage FTJ’s continued performance. The opinion also includes a lengthy dissent criticizing a number of legal positions staked out by the majority.

What lessons can be learned from this decision?

Under these circumstances, any broad takeaways or lessons from the court’s ruling are limited. The decision creates as many questions as it answers.  For example, progress billings often do not itemize expenditures from individual suppliers, but the court’s decision suggests a contractor will not be able to rely on progress payments to demonstrate payment of suppliers whose work should have been incorporated into the work during the applicable pay period.  How, then, can a contractor be expected to avoid double payment for work when sub-subcontractor raises a claim for unjust enrichment?

Regardless, contractors should be mindful of the court’s approach in Davis. Strong legal arguments will not always be enough to overcome certain factual scenarios, and the reverse may also be true. The dispute in Davis was only over $160,000, and after extensive and expensive litigation, the court found the contractor responsible for the full amount. To avoid unfortunate and unpredictable results like the decision in Davis, it is important to spend time evaluating claims on the front end and exploring reasonable commercial resolutions to any dispute.