GOVERNMENT’S TERMINATION OF CONTRACTOR FOR DEFAULT FOR FAILURE-TO-MAKE PROGRESS

Posted on June 18, 2023June 18, 2023 by David Adelstein

Whenever you elect to terminate the other party for cause or for default, you need to JUSTIFY the basis of the cause or default. The reason being is that a termination for default or cause is the harshest contractual remedy. This is why the other party will typically either (i) convert the termination for default into one for convenience, or (ii) if there is no termination for convenience provision in the contract, argue the terminating party breached the contract by terminating the contract without rightful justification.

The key is if you are going to terminate a party for cause of default, make sure you have memorialized the persuasive reasons for exercising the termination, and can otherwise reasonably support the justification. Do not, and I repeat, do not haphazardly exercise a termination for default and think you do not have to justify the basis for the termination.

In the federal arena on a federal construction project, “[w]hen a contracting officer terminates a contract for default, and the contractor appeals that termination decision, ‘the government…bear[s] the burden of proof with respect to the issue of whether termination for default was justified.’” Department of Transportation v. Eagle Peak Rock and Paving, Inc., 2023 WL 3829625, *4 (Fed. Civ. 2023) (citation omitted).

In Eagle Peak Rock and Paving, the government terminated the contractor for cause for not maintaining progress, i.e., the contractor was not going to timely complete the project. “In failure-to-make-progress cases, the government must establish that ‘the contracting officer’s decision to terminate…was reasonable given the events that occurred before the termination decision was made.’ If the government makes this showing, the contractor then bears the ‘burden of providing that its nonperformance was excusable.’” Eagle Peak Rock and Paving, supra, at *4 (internal citations omitted).

On the often-central issue of whether it was reasonable to view timely completion as not reasonably likely, the tribunal must focus on ‘tangible, direct evidence reflecting the impairment of timely completion. In particular, the [tribunal] must ‘decide the actual performance that the contract requires and the amount of time remaining for performance’ and ‘may also consider’ factors such as ‘the contracting officer’s testimony and contemporaneously documents[,]…a comparison of the percentage of work completed and the amount of time remaining under the contract, the contractor’s failure to meet progress milestones, problems with subcontractors and suppliers, the contractor’s financial situation,…a contractor’s performance history, and other pertinent circumstances.’ This is a de novo adjudication: If the adjudicatory tribunal finds, based on all the evidence before it, that the standard for termination under the contract’s default clause is met, it is to uphold that decision whether or not the contracting officer stated the basis for that finding.

Eagle Peak Rock and Paving, supra, at *4 (internal citations omitted).

Importantly, “the termination-for-default decision must be performance-based and not pretextual.” Eagle Peak Rock and Paving, supra, at *5 (citation omitted). There must be a connection between the decision to terminate for default and the terminated contractor’s performance. Id. (citation omitted).

[A]s long as ‘the termination for default was predicated on contract-related issues,’ i.e., ‘the government’s default termination was not pretextual or unrelated to Contractor’s alleged inability to fulfill their obligations under the contract,’ the reasoning of the contracting officer at the time of termination is not the subject of the [Contract Disputes Act] adjudication, must proceed on the evidence and arguments made in the adjudicatory proceeding, not through arbitrary-and-capricious or abuse-of-discretion review. Of course, the substantive contract standard in its endangerment-of-timely-completion component, doubly considers what is ‘reasonable’—whether it was ‘reasonable’ to find that there was no ‘reasonable likelihood’ of timely completion.

Eagle Peak Rock and Paving, supra, at *5 (internal citation omitted).

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

BURDEN SUPPORTING TERMINATION FOR DEFAULT

Posted on December 12, 2020December 12, 2020 by Edward Garber

Terminating a contractor for default is a “‘drastic sanction’ and ‘should be imposed (or sustained) only for good grounds and on solid evidence.’” Cherokee General Corp. v. U.S., 150 Fed.Cl. 270, 278 (Fed.Cl. 2020) (citation omitted). This is true with any termination for default because terminating a contract for default is the harshest recourse that can be taken under a contract. It is a caused-based termination. For this reason, the party terminating a contract for default needs to be in a position to carry its burden supporting the evidentiary basis in exercising the default-based (or caused-based) termination. Stated differently, the party terminating a contract for default needs to justify the reasonableness in terminating the contract for default.

A party looking to terminate a contract for default should smartly work with counsel to best position its justification in exercising the termination for default. Likewise, a contractor terminated for default should immediately work with counsel to best position the unreasonableness or the lack of justification for the default-based termination.

The recent Court of Federal Claims opinion in Cherokee General Corp. contains a worthwhile discussion on termination of contracts for default in the federal government contracting arena (including the contractor’s argument that the termination for default should be converted into a termination for convenience). As explained by the Cherokee General Corp. Court, a contracting officer is given broad discretion to terminate a contract for default. Cherokee General Corp., 150 Fed. Cl. at 277 (citation omitted). This discretion may be overturned if the contracting officer’s decision to terminate the contract for default is “arbitrary, capricious, or an abuse of discretion. Id. (citation omitted). In support of this broad discretion, however, a court can “sustain a [contracting officer’s] default termination ‘for all of the reasons noted by the contracting officer at the time [of his/her default termination letter],’ or ‘for any additional valid reason [justifiable by the circumstances].’” Cherokee General Corp. at 280 (citation omitted).

A termination based on the contractor’s refusal or inability to perform the work with the necessary diligence is appropriate where the contracting officer reasonably believed that “there was ‘no reasonable likelihood that the [contractor] could perform the entire contract effort within the time remaining for contract performance.’ If, however, “[t]he delay in completing the work arises from unforeseeable causes beyond the control and without the fault or negligence of the Contractor,” then “[t]he Contractor’s right to proceed shall not be terminated nor the Contractor charged with damages.” “Examples of such causes include (i) acts of God or of the public enemy, (ii) acts of the Government in either its sovereign or contractual capacity, (iii) acts of another Contractor in the performance of a contract with the Government, (iv) fires, (v) floods, (vi) epidemics, (vii) quarantine restrictions, (viii) strikes, (ix) freight embargoes, (x) unusually severe weather, or (xi) delays of subcontractors or suppliers at any tier arising from unforeseeable causes beyond the control and without the fault or negligence of both the Contractor and the subcontractors or suppliers.”

The government bears the initial burden of proving a contractor’s “demonstrated lack of diligence” which “indicat[ed] that [the government] could not be assured of timely completion. The “factors usually relied upon by courts and contract boards” to determine whether the government has met its burden include “a comparison of the percentage of work completed and the amount of time remaining under the contract; the contractor’s failure to meet progress milestones; problems with subcontractors and suppliers; the contractor’s financial situation; as well as a contractor’s performance history; and other pertinent circumstances.” If the government meets its burden of proof, then the burden shifts to the contractor to show that its default was excusable.

Cherokee General Corp., 150 Fed.Cl. at 278.

Mentioned above, but worthy of repeating, a party terminating another based on a contractual default needs to appreciate that it maintains a burden supporting the basis of the termination. Ignoring this burden, or not appreciating the significance of this burden, can result in a party not being able to substantiate the reasonableness and justification for the termination for default. Noteworthy, the discretion afforded a contracting officer under a federal government contract is not the same discretion afforded to every party under every contract. Knowing this makes the appreciation of the burden supporting the basis of the termination for default a very important consideration.

FEDERAL GOVERNMENT TERMINATING FOR DEFAULT “SEPARABLE” CONTRACT

Posted on February 28, 2016February 28, 2016 by Edward Garber

If a contractor is terminated for default on a federal project (really, any project), the objective for the contractor is to convert that termination for default into a termination for convenience so that the contractor can get paid for work performed and associated profit on that work through the date of the termination. For more information on termination for defaults and convenience, check out this article and this article.

The Armed Service Board of Contract Appeals (ASBCA) decision, Nelson, Inc., ASBCA No. 57201, 2015 WL 959241 (ASBCA 2015), provides an example of the government terminating a prime contractor for default where the prime contractor argued the termination was improper. The prime contract called for the construction of stone dikes at four sites along the Mississippi River. Each site had separate pricing, separate notices to proceed, and separate performance periods and durations for the construction of the stone dikes. After the prime contractor had started to perform at two of the four sites, the government terminated the prime contractor for default based on the prime contractor’s failure to timely perform in accordance with the schedules for those sites.

The prime contract included the F.A.R. 52.249.10 clause (set forth in full at the bottom of this posting) relating to termination for defaults. Applicable here, F.A.R. 52.249-10(a) and (c) provide:

(a) If the Contractor refuses or fails to prosecute the work or any separable part, with the diligence that will insure its completion within the time specified in this contract including any extension, or fails to complete the work within this time, the Government may, by written notice to the Contractor, terminate the right to proceed with the work (or the separable part of the work) that has been delayed. In this event, the Government may take over the work and complete it by contract or otherwise, and may take possession of and use any materials, appliances, and plant on the work site necessary for completing the work. The Contractor and its sureties shall be liable for any damage to the Government resulting from the Contractor’s refusal or failure to complete the work within the specified time, whether or not the Contractor’s right to proceed with the work is terminated. This liability includes any increased costs incurred by the Government in completing the work.

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(c) If, after termination of the Contractor’s right to proceed, it is determined that the Contractor was not in default, or that the delay was excusable, the rights and obligations of the parties will be the same as if the termination had been issued for the convenience of the Government.

This case focused on the language “separable part” in F.A.R. 52.249-10(a) to determine whether the government properly terminated the prime contractor from ALL four of the sites along the Mississippi River when the termination focused on the prime contractor’s delay at only two of those sites.

“The government has the burden of proving that the termination for default was justified.” Nelson, Inc., supra, citing Libson Contractors, Inc. v. U.S., 828 F.2d 759, 764 (Fed. Cir. 1987). When a contract is separable, or divisible, “and a contractor is delinquent only as to a separable part of the contract work, it is improper for the contracting officer to terminate for default the entire contract.” Nelson, Inc., supra, citing Overhead Electric Co., ASBCA No. 25656, 1985 WL 16703 (1985).

The ASBCA found that the four sites were separable because each site had separate performance periods, notices to proceed, and pricing. The commencement of the prime contractor’s work at one of the sites was not dependent on or related to its completion of work at another site. (To support the divisibility of the work, the ASCBA stated: “Work at each of the locations did not involve sequential or incremental and interdependent progression of construction, e.g., of one building or levee at one contiguous site.” Nelson, Inc., supra.) Therefore, the ASBCA found that terminating the prime contractor for default from all four of the sites was improper since the prime contractor’s work was separable (and the government based the termination on delay of two of the four separable sites).

Importantly, even when a prime contractor challenges a termination for default claiming it should be converted to a termination for convenience, the prime contractor needs to comply with the Contract Disputes Act. In other words, the prime contractor needs to submit its termination for convenience costs / claim. For more information on this important issue, check out this article.

F.A.R. 52.249-10 Default (Fixed-Price Construction)

(a) If the Contractor refuses or fails to prosecute the work or any separable part, with the diligence that will insure its completion within the time specified in this contract including any extension, or fails to complete the work within this time, the Government may, by written notice to the Contractor, terminate the right to proceed with the work (or the separable part of the work) that has been delayed. In this event, the Government may take over the work and complete it by contract or otherwise, and may take possession of and use any materials, appliances, and plant on the work site necessary for completing the work. The Contractor and its sureties shall be liable for any damage to the Government resulting from the Contractor’s refusal or failure to complete the work within the specified time, whether or not the Contractor’s right to proceed with the work is terminated. This liability includes any increased costs incurred by the Government in completing the work.

(b) The Contractor’s right to proceed shall not be terminated nor the Contractor charged with damages under this clause, if—

(1) The delay in completing the work arises from unforeseeable causes beyond the control and without the fault or negligence of the Contractor. Examples of such causes include (i) acts of God or of the public enemy, (ii) acts of the Government in either its sovereign or contractual capacity, (iii) acts of another Contractor in the performance of a contract with the Government, (iv) fires, (v) floods, (vi) epidemics, (vii) quarantine restrictions, (viii) strikes, (ix) freight embargoes, (x) unusually severe weather, or (xi) delays of subcontractors or suppliers at any tier arising from unforeseeable causes beyond the control and without the fault or negligence of both the Contractor and the subcontractors or suppliers; and

(2) The Contractor, within 10 days from the beginning of any delay (unless extended by the Contracting Officer), notifies the Contracting Officer in writing of the causes of delay. The Contracting Officer shall ascertain the facts and the extent of delay. If, in the judgment of the Contracting Officer, the findings of fact warrant such action, the time for completing the work shall be extended. The findings of the Contracting Officer shall be final and conclusive on the parties, but subject to appeal under the Disputes clause.

(c) If, after termination of the Contractor’s right to proceed, it is determined that the Contractor was not in default, or that the delay was excusable, the rights and obligations of the parties will be the same as if the termination had been issued for the convenience of the Government.

(d) The rights and remedies of the Government in this clause are in addition to any other rights and remedies provided by law or under this contract.

GOVERNMENT CONTRACTS AND TERMINATION FOR DEFAULTS: SURETY TAKEOVER AGREEMENTS, TENDER AGREEMENTS, ETC.

Posted on March 1, 2015March 1, 2015 by Edward Garber

On federal government construction projects, the prime contractor provides the government with a performance bond (pursuant to the Miller Act) guarantying the prime contractor’s performance under the prime contract. Under normal course and in accordance with the Federal Acquisition Regulations (“FAR”), the performance bond is triggered when the government terminates the prime contractor for default and then looks to the performance bond surety to remedy the default by completing the defaulting prime contractor’s contractual obligations. (See FAR 49.402-3 regarding the government’s procedure to terminate the prime contractor for default and put the contractor and surety on notice.)

Subpart 49.4 of FAR deals with termination for defaults. Prime contractors as well as sureties should familiarze themselves with this subpart especially if they received notification from the contracting officer of the possibility of a terminatin for default or the notices seem to indicate that the terminatiion for default is imminent.

Let’s presume the contracting officer moves forward and terminates the prime contractor for default or the termination is imminent. Now what? Clearly, the contracting officer will be looking to the prime contractor’s performance bond surety to remedy the default. Below are considertaions that will be explored and are the reasons why prime contractors and sureties in this situation should absolutely ensure they are consulting with counsel.

A. Takeover Agreements

One common option under FAR 49.404 that can be implemented is a surety-takeover agreement with the government (see below). This is when the surety takes over the contractual obligations of the prime contract. Typically, the surety will enter into a takeover agreement with the government that outlines the obligations of the takeover and will enter into a separate contract with the completion contractor the surety engages to complete its defaulting prime contractor’s scope of work. While FAR ideally prefers a tripartite takeover agreement with the government, surety, and defaulted prime contractor, this generally does not happen with a prime contractor that challenges the termination for default and looks to convert the termination into one for convenience.

49.404 Surety-takeover agreements.

(a) The procedures in this section apply primarily, but not solely, to fixed-price construction contracts terminated for default.

(b) Since the surety is liable for damages resulting from the contractor’s default, the surety has certain rights and interests in the completion of the contract work and application of any undisbursed funds. Therefore, the contracting officer must consider carefully the surety’s proposals for completing the contract. The contracting officer must take action on the basis of the Government’s interest, including the possible effect upon the Government’s rights against the surety.

(c) The contracting officer should permit surety offers to complete the contract, unless the contracting officer believes that the persons or firms proposed by the surety to complete the work are not competent and qualified or the proposal is not in the best interest of the Government.

(d) There may be conflicting demands for the defaulting contractor’s assets, including unpaid prior earnings (retained percentages and unpaid progress estimates). Therefore, the surety may include a “takeover” agreement in its proposal, fixing the surety’s rights to payment from those funds. The contracting officer may (but not before the effective date of termination) enter into a written agreement with the surety. The contracting officer should consider using a tripartite agreement among the Government, the surety, and the defaulting contractor to resolve the defaulting contractor’s residual rights, including assertions to unpaid prior earnings.

(e) Any takeover agreement must require the surety to complete the contract and the Government to pay the surety’s costs and expenses up to the balance of the contract price unpaid at the time of default, subject to the following conditions:

(1) Any unpaid earnings of the defaulting contractor, including retained percentages and progress estimates for work accomplished before termination, must be subject to debts due the Government by the contractor, except to the extent that the unpaid earnings may be used to pay the completing surety its actual costs and expenses incurred in the completion of the work, but not including its payments and obligations under the payment bond given in connection with the contract.

(2) The surety is bound by contract terms governing liquidated damages for delays in completion of the work, unless the delays are excusable under the contract.

(3) If the contract proceeds have been assigned to a financing institution, the surety must not be paid from unpaid earnings, unless the assignee provides written consent.

(4) The contracting officer must not pay the surety more than the amount it expended completing the work and discharging its liabilities under the defaulting contractor’s payment bond. Payments to the surety to reimburse it for discharging its liabilities under the payment bond of the defaulting contractor must be only on authority of—

(i) Mutual agreement among the Government, the defaulting contractor, and the surety;

(ii) Determination of the Comptroller General as to payee and amount; or

(iii) Order of a court of competent jurisdiction.

B. Tender Agreements

Another option the surety can implement is by tendering a completion contractor to the government for the government to complete the work. Oftentimes the surety will obtain pricing to complete the defaulting prime contractor’s scope of work. The surety will then tender a completion contractor to the government so that the government can hire this contractor directly. The surety will also tender the difference between the balance of the defaulted prime contractor’s contract amount and the completion contractor’s contract amount to complete the work. (For example, if the balance of the defaulted prime contract is Twenty Million but it will cost a completion contractor Twenty Five Million to complete the defaulted prime contractor’s scope of work, the surety will tender the additional Five Million.) A tender agreement is generally entered into between the surety and the government and outlines the parameters of the tender including monetary responsibilities of the surety.

C. Government Completion (if surety does not takeover or tender)

FAR 49.405 gives the government authority to engage a completion contractor if the surety does not arrange for the completion of the defaulted prime contractor’s scope of work (see below). If the government moves forward with this option, it will certainly look to the surety for all costs it incurs associated with the prime contractor’s default and any delay associated with bringing a completion contractor on board.

49.405 Completion by another contractor.

If the surety does not arrange for completion of the contract, the contracting officer normally will arrange for completion of the work by awarding a new contract based on the same plans and specifications. The new contract may be the result of sealed bidding or any other appropriate contracting method or procedure. The contracting officer shall exercise reasonable diligence to obtain the lowest price available for completion.

D. Procedures Government Can Utilize Instead of Termination for Default

FAR 49.402-4 identifies certain procedures that the government can utilize instead of terminating the prime contractor for default, although these procedures are generally implemented after the prime contractor and surety are on notice of an impending termination for default (see below). The government is probably not going to move forward with these procedures unless its rights are reserved against the prime contractor and performance bond for any resultant damages (see FAR 49.406 below) associated with defaults asserted by the government against the prime contractor (e.g., liquidated damages for delays, correction of deficient work, etc.). If these procedures are considered and utilized, there is a good chance the procedure was suggested by the prime contractor and surety as a protocol to best mitigate potential damages asserted by the government. (By way of example, one option a surety can present is to agree to fund the prime contractor through completion in order to keep the project moving forward with the contractor most familiar with the scope of work.)

49.402-4 Procedure in lieu of termination for default.

The following courses of action, among others, are available to the contracting officer in lieu of termination for default when in the Government’s interest:

(a) Permit the contractor, the surety, or the guarantor, to continue performance of the contract under a revised delivery schedule.

(b) 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.

(c) If the requirement for the supplies and services in the contract no longer exists, and the contractor is not liable to the Government for damages as provided in 49.402-7, execute a no-cost termination settlement agreement using the formats in 49.603-6 and 49.603-7 as a guide.

49.406 Liquidation of liability.

(1) The contract provides that the contractor and the surety are liable to the Government for resultant damages. The contracting officer shall use all retained percentages of progress payments previously made to the contractor and any progress payments due for work completed before the termination to liquidate the contractor’s and the surety’s liability to the Government. If the retained and unpaid amounts are insufficient, the contracting officer shall take steps to recover the additional sum from the contractor and the surety.

E. Preservation of Surety’s Rights

When a surety takesover the completion of the work, tenders a completion contractor, or even funds the original prime contractor through completion, the surety will do so while preserving its rights. In other words, a surety will want to best preserve rights to pursue potential claims against the government while contemporaneously mitigating its exposure under the performance bond through the takeover, tender, or funding of the completion work. See, e.g., Transamerica, Ins. v. U.S., 31 Fed.Cl. 532 (1994) (finding surety can pursue equitable subrogation claim against government for funds held by government when surety tendered and paid completion contractor); see also In re Appeal of Fireman’s Fund Ins. Co., ASBCA No. 50657, 2000 WL 246620 (2000) (“When a terminated contractor assigns such [pre-takeover / tender] claims to the surety to which assignment the contracting officer consents, or incorporates such an assignment in novation or takeover [or tender] agreement executed by the contracting officer, the surety has standing to prosecute such claims before the Board.”); In re Hackney Group, ASBCA No. 51453, 2000 WL 655950 (2000) (surety’s argument that it has standing to assert defaulted prime contractor’s pre-takeover claims against government based on surety’s indemnity agreement with prime contractor failed since government was not a party to indemnity agreement and never consented to prime contractor’s assignment of pre-takeover claims to surety).