The Court of Federal Claims issued a lengthy decision in a case arising from a construction project gone awry in which the contractor was terminated for default (T for D), ended up in bankruptcy, and lost a fraud counterclaim to DOJ. The contractor had taken a substantial risk by agreeing to a firm-fixed price that was substantially lower than it had originally proposed—then (after a few problems) lacked the necessary liquidity to complete the project. The decision in Liquidating Trustee Ester Du Val of Ki Liquidation, Inc. v. US is a reminder that contractors agreeing to a firm-fixed price are accepting substantial risk, and when entering into this type of contract in unpredictable circumstances, they must be able to bear that risk, as a lifeline is unlikely to be forthcoming from the agency.
The dispute arose out of a 2002 sole-source contract to build an embassy in Tajikistan. Kullman Industries initially offered to perform the contract for $85.8 million, which was more than $25 million greater than the Government’s estimate. After negotiations, the contractor agreed to a firm-fixed price of $60.7 million. When performance began, so did Kullman’s problems.
Among other things, the cost to perform the geotechnical work exceeded the amount allocated under the contract. Although the Government agreed to allow Kullman to transfer money from transportation to the geotechnical work, that short-term solution was insufficient. In addition, the geotechnical work required more time than anticipated. The agency soon determined that Kullman was not making satisfactory progress and began retaining a portion of the company’s progress payments.
The agency’s retainage decision began a downward spiral. Kullman found itself in a financially precarious position and was unable to pay its subcontractors in full. Unhappy subcontractors (and other jobsite issues) presumably resulted in Kullman falling even further behind in performance. To try to save the project, Kullman attempted to convince the Government to release all or part of the retained money; alternatively, the company sought private funding. Neither effort succeeded. Ultimately, Kullman pulled out of the job site and instructed its subcontractors to cease performance. The agency terminated Kullman’s contract for default.
Kullman filed suit at the Court of Federal Claims, challenging the T for D, seeking $4.3 million for geotechnical work, and claiming $1 million for security remediation and mold mitigation. The Government asserted counterclaims under the False Claims Act and Forfeiture of Fraudulent Claims Act (FFCA).
The most interesting part of the court’s opinion from the Government contractors’ point of view relates to the Government’s counterclaims. (Many in the Government contracts community believe that DOJ is increasingly going on offense with fraud counterclaims when claims are pursued in the CFC.) DOJ’s fraud claims were based on Kullman’s representations that it was paying subcontractors during contract performance. To receive progress payments, Kullman submitted invoices certifying that the company had made full payment from the proceeds of prior payments and that it would make timely payment to its subcontractors in accordance with their agreements. Because of the financial distress created by the difficulties experienced during performance (and the Government’s retainage), Kullman was unable to pay its subcontractors in full. The CFC found that Kullman’s certifications were false, rejecting Kullman’s argument that paying out the monies received in the Government’s earlier progress payments—though not fully paying the subcontractors—was consistent with the certification: “The fact that he thought it was accurate under a strained view of the circumstances does not make it any less false in the sense meant by the statute.” The CFC also rejected Kullman’s assertion of the Government knowledge defense. The agency knew Kullman was in financial distress; it did not know that Kullman was failing to pay its subcontractors in full.
On a positive note for the contractor, the Government did not succeed on its FFCA claim. In the Federal Circuit’s 2013 KBR decision, the court had held the FFCA was limited to fraud in the proof, statement, establishment, or allowance of a claim. The CFC applied the KBR ruling and held that Kullman had not perpetrated any fraud on the court in trying to establish its claim.
Although no FFCA violation had occurred regarding Kullman’s claim for the additional costs it incurred for the geotechnical work, the CFC rejected the claim. Kullman asserted that it agreed to the $60.7 million firm-fixed price because it believed it would be able to renegotiate a price when Phase 1 was complete or submit a claim for differing site conditions. That’s a risky strategy for any contractor, and the court held that Kullman assumed the risk for how much the work would cost. However, the court determined that Kullman was entitled to recover all of its costs associated with the after-the-fact security inspections and repairs and 75% of its costs associated with mold remediation because the work was performed under a constructive change order, and the Government was responsible for the delays.
With respect to the termination for default, the CFC held that the agency’s decision was justified because Kullman abandoned the project when there was work to be completed. “[F]inancial distress is not a defense” or a sufficient reason to walk off a jobsite relative to a T for D finding.
At the end of the court’s long opinion, there is a brief discussion of “one final issue” that the court characterizes as whether Kullman’s T for D can be excused because the “agency employees” purportedly “acted in bad faith toward plaintiff.” Kullman argued that when, among other things, the CO inaccurately told Kullman’s potential lender that the contractor was engaged in litigation with the Government, she improperly destroyed Kullman’s ability to obtain private funding necessary to complete the project. Notably, in its post-trial briefs, Kullman had accurately described the issue as whether the actions breached the “duty of good faith and fair dealing,” which is a long-standing contract doctrine (e.g., ECF Docket No. 260 at 44-45).
In its opinion, the court described the issue raised by Kullman as a “bad faith” claim related to the CO’s actions, and the court rejected plaintiff’s contentions, explaining that a plaintiff must overcome a “heavy burden” to demonstrate “bad faith”—i.e., it must overcome the fact that “government employees are presumed to act in good faith”. However, as explained in Tecom, Inc. v. US, the “presumption of good faith” applies when Government officials act in the capacity of the sovereign; it is irrelevant to a whether there has been a violation of the “duty of good faith and fair dealing” applicable to all types of contracts. The court also referenced the Federal Circuit’s Centex Corp. decision and noted that the plaintiff’s purportedly high burden “can be met in circumstances . . . in which the government officials act with specific intent to injure the other party.” But, as we explained in this post, the Federal Circuit recently clarified its “specific targeting” jurisprudence in the Metcalf decision, and nothing in the facts of this case is analogous to Centex or Precision Pine, in which that higher “specific targeting” standard applied. Accordingly, the court appears to have applied excessively high standard to Kullman’s breach of the duty of good faith allegations.
The court’s opinion was critical of the relevant Government witness, who is characterized as not “an impressive witness at trial,” who was “frequently emotional and defensive,” and presumably “would not have reacted well to the tension created in contemplating terminating a contract of this size for default and may well have resented [Kullman’s] continued efforts to get her to release funding.” Nevertheless, the court declined to “presume that [she] intended to injure” Kullman, and that her “carelessness” was an insufficient basis for a finding of bad faith. As explained, that presumption of good faith is unwarranted in this context, as is the requirement that the plaintiff show “bad faith.”