Government’s Bad Faith Material Breach Justifies Work Stoppage

Construction and Procurement Law News, Q1 2015

Firm Alert

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In the recent decision Kiewit-Turner v. Department of Veterans Affairs, the Civilian Board of Contract Appeals (“CBCA”), the judicial body with authority over claims against the non-military agencies of the United States Government, held that the Department of Veterans Affairs (“VA”) materially breached its contract with its contractor, Kiewit-Turner (“KT”), by failing to provide a design that could be built for the estimated construction cost at award (“ECCA”). The CBCA ruled that as a result of the material breach, KT was permitted to stop performance.

In August 2010, VA awarded KT an IDC-type contract (integrated design and construct) for preconstruction services on a medical center in Colorado. The contract contained an option for the performance of construction services. The contract was intended to allow KT to review and advise VA on its design, allowing VA to procure additional funds or direct its architect-engineer (“AE”) to make changes to meet the ECCA. However, this project was troubled from the start. By the time KT’s contract was awarded, the design was 50% complete and funding decisions had been made, limiting VA’s ability to make modifications based on KT’s input. Throughout the preconstruction phase, KT warned VA and its AE that the design lacked coordination and completeness, was over budget, was over-designed, and that value engineering (“VE”) was not being implemented.

Once the design was 65% complete, KT submitted its proposal for construction. KT’s proposal price of $609 million was significantly above the established ECCA of $582,840,000 and contained important assumptions and clarifications that KT noted would result in additional costs if not met.

Rather than VA increasing its budget for the contract, VA and KT negotiated a contract modification that required VA to produce a design that could be built for the ECCA. The modification did not specify any set of drawings because, in KT’s view, the most recent drawings could not be built for the ECCA. Subsequently, VA provided drawings that it purported to be the 100% drawings. These drawings were incomplete and required substantial supplementation. As KT acquired more information, it became clear to KT that the design could not be built for anywhere near the ECCA. Thereafter, multiple estimates were performed by KT, the AE, and a VA consultant, and every estimate exceeded the ECCA, with KT’s last estimate reaching $1.085 billion. The parties engaged in extensive VE efforts, but ultimately VA instructed the AE to disregard the VE options and directed KT to proceed with construction, holding KT to the firm target price established in the contract modification.

KT objected to the direction, started work, and, most significantly, given the extraordinary circumstances, sought declaratory relief from the CBCA as to whether VA had breached its obligation to provide a design that could be built for the ECCA and whether KT consequently had the right to stop construction. The CBCA found that VA had obligated itself to produce a design that met the ECCA and that VA’s commitment to do so was “critical” to the agreement. The CBCA found—applying a five-part test—that VA’s breach of this obligation was material because (i) KT had been deprived of the benefit of a design that met the ECCA; (ii) KT could not be adequately compensated for VA’s breach, in part, because VA did not have sufficient funds allocated; (iii) any forfeiture suffered by VA was limited; (iv) there was little likelihood that VA would cure its breach, given its insistence that it would neither redesign the project nor seek additional appropriated funds; and (v) VA breached its duty of good faith and fair dealing. More specifically, VA failed to control its AE, disregarded VE suggestions and cost estimates, delayed progress of construction, and adopted an estimate developed by the AE as its independent government estimate—an estimate that was “an academic exercise” and that was so far below any previous estimate “as to be of dubious accuracy.” The Court rejected VA’s argument that KT had waived its right to stop work by obeying the directive, noting that KT continued to work under specific and written protest. In light of the material breach, KT was entitled to stop performance.

This decision strongly reaffirms the Government’s duty of good faith and fair dealing in its contracts, and reaffirms a contractor’s right to stop work for a material breach. However, the facts of this case were very extreme, with repeated bad faith by VA and a refusal by VA to recognize its own failures. Contracts often afford both parties the right to stop work for material breaches such as a party’s non-payment. However, the decision to implement a work stoppage should not be taken lightly, as an improper stoppage could carry serious consequences, such as a termination for default. Any decision to stop work should only be made after careful consideration, including discussion with legal counsel, regarding the basis for, the strength of the basis, and the potential ramifications of a decision to stop work, or to continue work under protest.