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Wednesday, January 7, 2015

A stop work order of a different order

It is clear that contract administration is a component of that range of matters falling under the "procurement" umbrella. Thus, contract disputes, particularly government contract disputes that this blawg tends to stick to as "procurement" rather than simply "acquisition", are of interest. The case reported in this post was spotted on the Lexology website, which reported the article as originally posted on the Gordon & Rees LLP Construction Law Blog.

The case is Kiewit-Turner v. Department of Veterans Affairs (CBCA 3450, December 9, 2014), decided by the U.S. Civilian Board of Contract Appeals. The decision is in the nature of an interpretation of the contract and the subsequent rights and obligations of the parties, brought by an action for declaratory relief, a uniquely useful contract remedy. As usual, this is a my own rendition of the decision and you must read the original decision for citations, fullness, context and accuracy, etc.
This decision answers the following three questions: (1) Did the contract modification known as SA-007 obligate the respondent, the Department of Veterans Affairs (VA), to provide a design that could be built for $582,840,000? (2) Did the VA materially breach the contract by failing to provide a design that could be built for that amount of money? (3) If such a breach occurred, is KT entitled to stop work?

After hearing testimony for eight days, reviewing a voluminous documentary record, and considering lengthy briefs and reply briefs submitted by the parties, we now answer each of these questions in the affirmative.

On August 31, 2010, the VA awarded to KT a contract for the performance of preconstruction services on a medical center campus in Aurora, Colorado. The contract included an option for the performance of construction services as well. The contract was described as an “integrated design and construct,” or IDc, type contract – something similar to the “construction management at risk” or “construction management as constructor” types of contract used in the private sector. A key early VA funding decision was establishing a construction cost target, known as the estimated construction cost at award, or ECCA, at $582,840,000. This ECCA was prescribed, on the same day as the KT contract was awardedThe VA had never used this type of contract before. The agency’s own project management plan recognized as a high risk that “IDc represents new contracting approach for VA; does not fit existing procedures which is complicated by VA culture that does not encourage or is [not] comfortable with new approaches.”

Indeed, the VA did not use the IDc mechanism properly right from the start. This limited the agency’s flexibility to make modifications based on KT’s pre-construction services advice. A September 2011 review by the Army Corps of Engineers, which was commissioned by the VA, confirmed that the IDc contract was not properly used: “[T]he IDc contract type may have not been appropriate for the Medical Center Replacement in Denver. . . . [P]roceed[ing] with design development to major design milestones (DD1) prior to procurement of the IDc contractor . . . did not permit the IDc contractor to integrate with the designer to achieve the benefits related to this contract type. . . . The current methodology appears to be counterintuitive to the Government’s ability to achieve best value.”

KT informed the VA at many stages that the design lacked coordination and completeness, that the design was over budget and included elements that were above the standard for a healthcare facility, and that value engineering (VE) was not being incorporated into the design. As early as October 2010, an independent advisor was cautioning the VA’s project executive that the costs of the project, per the then-current design, were increasing. In November, the project executive’s supervisor told him that “[the] DD1 packet is unsatisfactory and the JVT (the original design team) is not listening to the directions they are given from the user [side] or from the CFM [VA Office of Construction and Facilities Management] side.”

In September 2011, the agency’s project executive and contracting officer issued a critical performance evaluation of the JVT designer. They complained that the JVT had chosen form over function, placed an over-emphasis on aesthetics, had produced an unnecessarily complex design, did not believe that a budget problem existed, and was often uncooperative with the agency. In December 2011, the contracting officer denied the JVT’s request for release of retainage, “[d]ue to the ECCA above the contract stated limit and the complete design has not been accepted.” In March 2012, the contracting officer reminded the JVT that under its contract, when bids exceeded the estimated price, the JVT had to “perform such redesign and other services as are necessary to permit contract award within the funding limitation.”

Nevertheless, the VA asked KT to prepare a proposal for the optional work under its contract – constructing the medical facilities. In July 2011, the parties agreed that KT would submit a firm target price (FTP) proposal in the amount of $603 million. On August 25, 2011, KT submitted such a proposal. The price was $599.6 million for construction itself and $3.4 million for all pre-construction activities, with a ceiling price of $609 million. The FTP was based on a detailed analysis of DD-2 enhanced drawings. The proposal included many pages of general, technical, and pricing clarifications, which noted assumptions on which the proposal was based. We credit the testimony of KT’s former managing partner that including these sorts of assumptions and qualifications in a proposal is typical in the commercial world for an IDc-type contract where the design is incomplete. The proposal assumed that the VA would ensure that the design include $23 million of value engineering (VE) items and that KT would negotiate price reductions of nearly $31 million from its subcontractors. KT’s detailed FTP proposal became known as “The Book.” By the time that KT submitted its proposal, the VA also had in hand an independent estimate which showed that the cost of construction would be $677,697,408.

Chris Kyrgos, the VA contracting officer’s supervisor demanded that KT remove the clarifications, qualifications, and assumptions from The Book and present a proposal based on the most recent set of drawings. KT’s managing partner explained further that in light of the contractor’s estimate that the current design would cost more than $664 million to construct, KT could not possibly build the project for only $603 million. At this point,it was proposed that if the VA would agree to present a set of drawings that could be constructed for the ECCA, KT would agree to perform the construction work for the price it had offered. A handwritten statement entitled “Agreements – Path Forward” was signed. The three key paragraphs of this statement read:
1. All parties agree that they must get price to $604 mil. They will each expend resources to keep that goal.
2. VA shall cause JVT to produce a design that meets their ECCA with use of alternates and other methods as a safety net.
3. Agreed: . . . FTP set to $604m[illion]/clg.[ceiling]@610. (The difference between the ECCA of $582,840,000 and the FTP of $604 million was that the latter included pre-construction and off-site infrastructure work, as well as other items, but the former did not.)

Both parties understood that by making this agreement, the VA recognized that it would have to ensure that through the use of VE and other means, the JVT would produce a design which could be constructed for less than the current estimated cost of the project. KT’s managing partner testified that “[t]he big caveat there is they have to produce a design that meets the ECCA because the current design didn’t come anywhere close to that.” Demonstrating that both parties understood this, in March 2012, KT’s deputy managing partner and the VA contracting officer gave to personnel from both parties a presentation entitled “SA-007 and Managing to the $604M.” The presentation asked, “Does SA-007 clearly define the scope of work?” and provided the answer, “No. Defines the box.” The VA adhered to this understating well into 2013.

KT expected, based on communications from the VA, to receive 100% complete construction documents by the end of January 2012. In late 2011, however, the VA let lapse its architect/engineer peer review contract, and without a peer review, the agency would not release the 100% design package. KT told the VA that the “lack of this information is currently creating numerous negative impacts in material procurement/fabrications, obtaining approvals of submittals, coordination of trades, putting work in place in the field, as well as obstructing our ability to maintain the schedule as currently planned.” KT proposed that it solicit subcontractor bids based on 95% drawings, but the VA rejected this request.

The 100% documents were finally delivered to KT on August 31, 2012. These documents turned out to be far from finished, however. The incomplete design, and changes to it, prompted KT to issue an unusually large number of requests for information (RFIs), seeking clarification as to design elements. Responses to RFIs were often late and/or incomplete.

KT planned to subcontract about 85% of the work on this project. All subcontracts valued at $300,000 or more were required by the contract to be secured through a competitive process in which at least three bids were made. The subcontracting process required consent to each subcontract from the VA’s contracting officer. By the fall of 2012, according to witnesses from KT, the VA medical center, and a VA resident engineer on the project, prospective subcontractors were reluctant to submit bids for project work because subcontractors were not being timely paid for work they had performed. Sureties were also refusing to participate in the project due to the lack of timely payment to subcontractors. Those firms that did bid on subcontracts increased their prices to account for the risk of not being paid timely, or even not being paid at all. Meanwhile, the project’s cost was increasing.

In March 2013, KT submitted to the VA a firm fixed price proposal, based primarily on competitive subcontractor bids, in the amount of $897,584,831 (with clarifications and qualifications). The VA rejected this proposal, with the contracting officer stating that the agency “will continue to hold Kiewit-Turner responsible to the firm target price and ceiling price established in SA-007.” (The parties never agreed on a firm fixed price, as opposed to a firm target price, for KT’s work.) In June, KT told the VA that the cost could be as high as $1.085 billion.

KT proposed many multi-million-dollar VE changes to modify the design so as to bring it within budget. Most of them were rejected by the VA. Often, however, even if a VE proposal was approved at all levels of the VA, the JVT refused to incorporate it into the design. In February 2014, the VA adopted the figure of $630 million as the “independent government estimate.” Even at the amount of $630 million, JVT members complained that the estimate was $48 million over the ECCA and would cause the JVT to have to redesign the project to lower its cost.

In January 2013, the VA brought together KT and the JVT to discuss how the project might be redesigned to be within budget. A VA executive explained that “the VA’s intent [was] to focus on the JVT’s obligation to deliver a design at or below the ECCA.” The three-day meeting which ensued – called the “blue ocean” meeting – was devoted to brainstorming to develop cost-cutting ideas. The agency tells us in its brief that it ultimately accepted only about $10 million of the blue ocean ideas.

On April 30, 2013, KT requested a final decision from the contracting officer as to whether the VA had breached its obligation under the contract to provide a design that could be built for the ECCA of $582,840,000 and whether KT consequently had the right to suspend work. The contracting officer issued a decision denying that the VA had breached the contract and directing KT to proceed with construction of the project. The agency has no plans to redesign the project. According to VA witnesses, the agency has approximately $630 million appropriated for construction of the project.

In June 2013, the contracting officer wrote to the JVT, “Please do not proceed with any cost cutting items from the January 2013 meeting.” Also in June, the VA’s director of cost estimating determined that the Jacobs estimate of nearly $785 million should be rejected because Jacobs’ failure to use actual known costs was a “fatal flaw” that undermined the reliability of the estimate. (The reason that Jacobs had not used actual known costs, however, was that the contracting officer had specifically directed the firm not to use them. The contracting officer did not disclose this fact to the cost estimating director.) And the contracting officer told KT that it must use pricing from The Book, the contents of which had been made irrelevant when SA-007 was agreed to, as the basis from which pricing change orders would be considered.

A KT executive testified at our hearing in June 2014 that KT had already financed $20 million worth of work for which it had not been paid and projected that this figure could reach $100 million by December 2014.
(1) Did contract modification SA-007 obligate the VA to provide a design that could be built for $582,840,000?

SA-007 could not be more clear: “The VA shall ensure the A/E (Joint Venture Team) will produce a design that meets their Estimated Construction Cost at Award (ECCA) with use of alternate and other methods as a safety net.” The ECCA was $582,840,000 at the time that SA-007 was agreed to, and it remained at that number throughout the period discussed in this decision. Because the language is unambiguous on its face, its plain language dictates an affirmative answer to the question. Use of the words “shall” and “ensure” demonstrates that the VA must make certain that the design will meet the ECCA.

“Although extrinsic evidence may not be used to interpret an unambiguous contract provision, [the Court of Appeals for the Federal Circuit has] looked to it to confirm that the parties intended for the term to have its plain and ordinary meaning.” TEG-Paradigm Environmental, Inc. v. United States, 465 F.3d 1329, 1338 (Fed. Cir. 2006). The extrinsic evidence here confirms that the SA-007 paragraph regarding the ECCA means exactly what it says. The VA’s commitment to produce a design that could be built for the ECCA was the key to the parties’ agreement.

The agency maintains that KT is obligated to perform construction work for the FTP, altered only by the cost of scope changes and adjustments to the profit percentage pursuant to a clause contained in SA-007. The ECCA provision, according to the VA, is inconsistent with the profit adjustment clause. These contentions are not well taken. The mention of the ECCA in SA-007 is not just material to the agreement – it is critical to the agreement. SA-007 clearly links the ECCA and the FTP, providing that the latter is dependent on the former. Altering the contract price to account for scope changes is not possible, for reasons we discuss later in this opinion. There is no inconsistency between the ECCA provision and the profit adjustment clause; if the VA had produced a design which could be constructed for the ECCA, the profit adjustment clause could have been implemented in accordance with its terms.

(2) Did the VA materially breach the contract by failing to provide a design that could be built for the ECCA of $582,840,000?

“Not every departure from the literal terms of a contract is sufficient to be deemed a material breach of a contract requirement.” “A party breaches a contract when it is in material non-compliance with the terms of the contract.” “A breach is material when it relates to a matter of vital importance, or goes to the essence of the contract.” “The standard of materiality for the purposes of deciding whether a contract was breached is necessarily imprecise and flexible. The determination depends on the nature and effect of the violation in light of how the particular contract was viewed, bargained for, entered into, and performed by the parties.” We consider also the factors enunciated in section 241 of the Restatement when determining whether a breach is material:
In determining whether a failure to render or to offer performance is material, the following circumstances are significant:
(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected;
(b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived;
(c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture;
(d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;
(e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.
The VA’s breach of its contract with KT, by failing to provide a design which could be constructed for the ECCA, is of vital importance, as it goes to the essence of the agreement. The breach is material under each of the Restatement standards (as detailed meticulously in the decision). Applying these principles, we find that the behavior of the VA has not comported with standards of good faith and fair dealing required by law. The agency failed to provide a design that could be constructed within the ECCA because it did not control its designer, the JVT. It paid no heed to VE suggestions for cost reductions which were made by KT and Jacobs (or even those which were accepted by the agency’s own medical center personnel following the “blue ocean” meeting). The agency delayed progress of construction, such as by delaying the processing of design changes and change orders, as described under factor (a) above. The agency disregarded cost estimates by KT and Jacobs, even to the point of rejecting a Jacobs estimate because it was developed under restrictions which the agency itself had imposed. The agency adopted as an independent government estimate a document which was neither independent (it was developed by a subcontractor to the JVT, an entity which had a strong interest in the result), nor by the Government (it was by the JVT), nor an estimate (it was by admission of the chief estimator an academic exercise), and the number was so far below any previous estimate as to be of dubious accuracy. The agency did this notwithstanding the testimony of every witness who addressed the matter, including several VA witnesses, that an “independent” estimate should not be made by a party with a vested interest in the outcome. The agency ultimately directed KT to continue its construction work for the FTP, even though the agency refused to fund that work appropriately.

We do not know what the cost of construction of this project ultimately will be. Whether it is any of these figures, however, it will be significantly in excess of the ECCA of $582,840,000. We find that beyond doubt, the VA’s breach of its contract with KT was material.

(3) Is KT entitled to stop work?

The Court of Appeals for the Federal Circuit has held that “[u]pon material breach of a contract the non-breaching party has the right to discontinue performance of the contract.” The Court has explained further, “The choice of remedy is generally with the non-breaching party, and only in exceptional circumstances will equity require the non-breaching party to continue to perform the remainder of the contract.” “[I]f a contract is not clearly divisible, in accordance with the intention of the parties, the breaching party can not require the non-breaching party to continue to perform what is left of the contract.”

The VA draws our attention to Northern Helex Co. and Cities Service Helex, Inc.), two cases in which the Court of Claims held that if a contractor continues performance under a contract, without protest, notwithstanding the Government’s breach, “the obligations of both parties remain in force and the injured party may retain only a claim for damages for partial breach.” The VA’s analysis, however, ignores the phrase “without protest” which is part of the teaching of these decisions. The record is clear that KT has been proceeding with the construction (to avoid any possibility of being charged with being in default) under strenuous protest, including the very constructive advancement of VE proposals, throughout the post-SA-007 history of the project. As a matter of law, KT has the right to stop performance.

As enunciated in this opinion, we afford Kiewit-Turner the declaratory relief it seeks.

Another similar tale of contract dispute over claimed misrepresentations of material facts by the government, entitling the contractor to damages, is reported in:
Court of Federal Claims determines that government contractor may recover for losses attributable to omissions and inaccuracies in data provided by government in negotiated procurement .

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