When the Axe Falls: Terminations on Government Construction Projects

In the context of a federal contract, terminations for convenience are not afforded to both parties in a contract. For example, in a contract between the Government and a prime contractor, the Government holds the right to terminate for convenience, but the contractor does not share that right. Termination for convenience provisions typically flow downwards, with a prime contractor holding the ability to terminate a subcontractor for convenience.

As the name suggests, a termination for convenience is the Government’s virtually unilateral right to terminate a contract and stop a project for any or no reason. Even if a termination for convenience clause is not included in a contract, the Government still maintains the right to terminate for convenience. This right originated from wartime policies that ensured the Government would maintain flexibility to enter and exit contracts for budgetary and other security purposes.

Generally, when the Government invokes a termination for convenience, it does not have to pay future expenses related to anticipated profit on unperformed work. However, it maintains liability for all work performed through termination. The process, procedure, and contractual terms related to a termination for convenience are heavily regulated by statute, so it is important for contractors to be familiar with the Federal Acquisition Regulations (“FAR”) and the several nuances related to a termination for convenience. Even though the Government’s right to terminate for convenience is incredibly broad, there are still limitations, including prohibitions on terminations for convenience conducted in bad faith.

Alternatively, a termination for default provides the right to terminate a contract completely or partially due to an actual or anticipated failure to perform contractual obligations. While both a contractor and the Government have the ability to terminate for default, both parties do not maintain the same or equal rights. A contractor’s right to terminate for default is limited and only occurs when the Government does not provide payment for services. Conversely, the Government maintains broader termination rights in the event of the contractor’s material default.

The common assumption is that a terminated contractor maintains little rights and may never recover costs or damages during the termination process. Often, this may very well be the case, particularly depending on the contractor’s conduct. However, recent caselaw trends have suggested that contractors may be afforded damages or other versions of credit in unique circumstances, even when properly terminated by the Government in the default event the Government fails to mitigate. This is a remarkable and exciting trend that may change how contractors and attorneys defend against Government terminations.

Terminations for Convenience

Background

“The concept that the government may, under certain circumstances, terminate a contract and settle with the contractor for the part performed dates from the winding down of military procurement after the Civil War. It originated in the reasonable recognition that continuing with wartime contracts after the war was over clearly was against the public interest. Where the circumstances of the contract had changed so dramatically, the Government had to have the power to halt the contractor’s performance and settle.”

Termination for convenience was originally a wartime concept, and it has evolved over time to be required by law in all federal contracts. As a matter of public policy, the Government must be granted flexibility to enter and exit contracts with relative ease.

Termination for convenience clauses provide the Government a mechanism to stop a project even where a contractor is not in material breach. The FAR requires a termination for convenience clause to exist in all federal contracts. In the event that a contract inadvertently leaves out a termination for convenience clause, the Government nonetheless maintains a common law right to terminate for convenience. This requirement is known as the “Christian Doctrine,” which provides that a right afforded by law to the Government must be read into federal contracts even when language is absent from a contract.

Termination for convenience clauses are often invoked by the Government to limit its own liability and to avoid breach. Wrongful terminations, in general, are often converted by the Government into terminations for convenience. A termination for convenience can be invoked even after discovery of the Government’s own breach. For example, the practice may be upheld even after the Government failed to make payment on undisputed amounts. Additionally, terminations for convenience may even apply before contract performance has commenced.

The Government may terminate a project in whole or in part, depending on the Contracting Officer’s determination and assessment of the Government’s best interests. Through such clauses, the Government is authorized to alter course and adjust decision-making on projects without materially breaching a contract and owing damages.

The Government’s right to terminate a contract at will, however, is not unlimited. The Government must still adhere to certain standards and can run afoul for terminations for convenience that are conducted in bad faith or that occur after project completion.

Nonetheless, the Government’s authority is extremely broad, and a termination for convenience can even be implemented retroactively. Below is an analysis of several of the pertinent details and contract issues related to Government terminations for convenience.

Contract Clauses

There are five sections in the FAR that list all the prescribed termination for convenience clauses and alternate clauses. The appropriate clause is determined by the type and dollar amount of the contract. Under the FAR, there are eight contract clauses and alternatives from which to choose. The eight distinct contract clauses are as follows, but it is important to note that all versions are based primarily on the first two on the list (Fixed-Price and Fixed-Price Short Form):

1. Fixed-price “Short Form” federal contracts that are not expected to exceed the Simplified Acquisition Threshold (“SAT”) (The SAT is an annually-specified contract dollar amount where contracts falling underneath the amount are subject to simplified or expedited acquisition procedures);
2. Fixed-price federal contracts that exceed the SAT (this is the most common representation of a FAR termination for convenience clause);
3. Contracts for research and development work with an educational or nonprofit institution;
4. Contracts for architect-engineer services;
5. Contracts that require interest payments on excess partial payments;
6. Contracts that involve construction dismantling, demolition, or removal of improvements;
7. Service contracts; and
8. Subcontracts.

Below is an analysis of the standard fixed-price termination for convenience clause found in the FAR.

The fixed-price termination for convenience clause provides that “[t]he Government may terminate performance of work under this contract in whole or, from time to time, in part if the Contracting Officer determines that a termination is in the Government’s interest. The Contracting Officer shall terminate by delivering to the Contractor a Notice of Termination specifying the extent of termination and the effective date.”

After a contractor receives a Notice of Termination pursuant to a termination for convenience clause, it is required to stop work as described in the notice. Additionally, the contractor is required to (i) place no further subcontracts or orders, (ii) terminate all subcontracts, (iii) assign to the Government all rights and title related to the terminated subcontracts, (iv) settle all outstanding liabilities and termination settlement proposals with approval from the Contracting Officer, (v) transfer title and deliver to the Government all parts, works in process, completed works, plans, and project drawings, (vi) complete performance of the work not terminated, (vii) take action to preserve property related to the contract that is in the possession of the contractor and of which the Government may have an interest, and (viii) sell property as directed by the Government.

After termination, a contractor must complete termination inventory schedules no later than 120 days from the effective date of termination, unless extended in writing by the Contracting Officer. A contractor has one year from the termination date to submit a final cost proposal to the Government.

The cost proposal must be “in the form and with the certification prescribed by the Contracting Officer.” The Contracting Officer may extend the year-long deadline for the contractor to submit a cost proposal, however if the contractor fails to submit the proposal in time, the Contracting Officer has discretion to make final determination of the amounts owed to the contractor. In no event can claimed costs exceed the total contract price amount, and generally, payments already received by the contractor will count against amounts owed.

1. The FAR termination clause authorizes a contractor and the Government to negotiate settlement for amounts owed in a reasonable manner, however the Government is required to pay the contractor for certain amounts even in the event the parties cannot come to final settlement. For example, the Government must pay for the following contractor costs:The contract price for completed supplies or services accepted by the Government;
2. The costs incurred in the performance of the terminated work, including initial costs and preparatory expenses;
3. The costs incurred for settling and paying termination settlement proposals under terminated subcontracts;
4. Any additional sums determined by the Contracting Officer to be fair and reasonable; and
5. The reasonable costs of settlement of the work terminated, including (i) accounting, legal, clerical, and other reasonable expenses, (ii) the termination and settlement of subcontracts (excluding the amounts of such settlements), and (iii) storage, transportation, and other costs incurred for the preservation, protection, or disposition of the termination inventory.

If the Government inadvertently overpays during the settlement process, then the contractor must repay the excess to the Government with interest. Interest is computed for the period between the date the excess payment is received to the date the excess is repaid.

The Government is not required to pay for normal spoilage or any losses of Government property. Additionally, any advance payments made to the contractor for terminated work or costs related to Government claims against the contractor must be withheld by the Government from the required termination payments.

If a termination for convenience is partial and not for the entirety of a project, the contractor may file a proposal for equitable adjustment with the Contracting Officer to cover increased performance costs resulting from the partial termination. This application for equitable adjustment must be made within 90 days of the date of termination, unless extended in writing by the Government.

The “short form” version of the FAR-prescribed termination for convenience clause is for less expensive projects that fall underneath the SAT value. As its name suggests, the short form clause is an abbreviated version of the standard termination for convenience clause found in regular fixed price government contracts. The short form clause simply allows the Government to terminate the contract at any time for any reason, at which point the parties are referred to ordinary post-contract termination obligations as prescribed in FAR Part 49.

The remainder of the contract varieties, such as termination clauses for demolition contracts, service contracts, and contracts with non-profits, have clauses that are similar to the fixed-price or “short form” clauses, but with minor nuances that address the unique contract forms. For example, as expected, the demolition terminations clause contains necessary language that pertains specifically to demolition and the disposal of property.

Constructive Termination for Convenience

Even if the Government fails to invoke a termination for convenience during the commission of a project, federal courts have recognized the Government’s ability to invoke a termination for convenience after-the-fact, or retroactively. This instance is a court-imposed doctrine referred to as a “constructive” termination for convenience.

Constructive terminations for convenience have been adopted as federal common law. Such terminations may be applied when “the government has stopped or curtailed a contractor’s performance for reasons that turn out to be questionable or invalid. Constructively, the clause can justify the government’s actions, avoid breach, and limit liability.”Constructive termination for convenience shields the Government from breach even when the Contracting Officer never formally invoked the clause or complied with notice provisions. The only requirement for a retroactive application of a termination for convenience is that the justification had to be available at the time, but not used.

When a termination for convenience is invoked, particularly a constructive termination that has occurred after a Government breach, then a contractor’s ability to collect damages is severely limited. “The contractor, instead of receiving compensation for governmental breach of contract based on classical measure of damages, is limited to recovery of costs incurred, profit on work done and costs of preparing the termination settlement proposal. Recovery of anticipated profit is precluded.” Therefore, the retroactive application of a termination for convenience, particularly after a breach of contract initiated by the Government, is particularly damaging to an innocent contractor.

Government Limitations on Termination for Convenience

Abuse of discretion, bad faith, or improper timing may rebut the government’s ability to terminate for convenience. For example, the Government cannot initiate a termination for convenience, or even a constructive termination, after performance has been completed on a contract. The Federal Circuit has rejected Government efforts to invoke constructive terminations for convenience one year after project completion and final payment solely to alter the amount of compensation owed to the contractor.

Abuse of discretion may occur when the Government chooses to pursue a termination for convenience instead of a termination for default to avoid the burden of pursuing an investigation and proving breach. For example, the Government may be required to pursue termination for default when citing breach during the invocation of a termination for convenience. In one instance, the Court of Federal Claims described circumstances as “odd” when the Government cited national security concerns when terminating a contract for convenience despite (i) never initiating investigation into security concerns and (ii) previously representing that the contract would not be terminated over security concerns.

Additionally, a termination for convenience cannot eliminate liability for events preceding termination. For example, prior claims, such as equitable adjustment or other constructive changes, are not erased upon a termination for convenience. Prior monetary claims subject to the Contract Disputes Act cannot merge with a termination for convenience cost proposal because the contractor may be entitled to CDA interest on such claims.

Settlement Procedures

Measurement of Damages

Generally, a contractor is entitled to its costs for performance up to the time of termination, plus reasonable overhead and profit on those costs, as well as costs incurred during settlement. Accordingly, the FAR caps recoverable amounts for settlement. The formula to determine the allowable settlement amount is the contract price or the settlement amount minus (i) credits, (ii) advance payments, and (iii) progress payments. As part of settlement, contractors are not entitled to anticipated profit on unperformed work.

When determining the proper amount of recovery in a termination for convenience, the contractor has the burden of establishing the amount proposed. The contractor’s proof is submitted in the form of a settlement proposal. As stated above, the FAR requires a contractor settlement proposal to be submitted within one year of the effective date of termination. The settlement proposal must be “in the form and with the certification prescribed by the Contracting Officer.” Additionally, the settlement proposal must cover all cost elements, including settlement, with subcontractors.

After the Government issues a notice of termination, a Termination Contracting Officer may be appointed to handle the termination and negotiate settlement. If the Termination Contracting Officer and the contractor cannot reach settlement, the Termination Contracting Officer has broad discretion to make a final recovery determination without contractor input. Such discretion includes whether to allow profit on completed work, or whether a contractor ultimately would have realized a loss on the project. As a matter of law, cost recovery must be adjusted for contractor losses, meaning a contractor cannot profit from a termination if it would have incurred a loss had the entire contract been completed.

Cost Proposal Accounting Methods

There are two methods to account for which costs can be included in a settlement proposal: (i) inventory basis, and (ii) total cost basis. The inventory basis represents itemized accounting, and the total cost basis represents bulk accounting.

In preparing an inventory basis proposal, direct material costs, direct labor costs, and indirect factory expenses are required to be allocated into various categories of termination inventory rather than claimed as lump sums. In a partial termination, a contractor cannot include costs allocated to portions of the contract that have not been terminated. Further, all settlement costs must be distinguished and itemized separately. An inventory basis cost proposal is the Government’s preferred method, as it provides a more detailed and itemized accounting of the requested costs than the total cost basis.

The FAR states that the inventory basis is appropriate under the following circumstances: (i) the partial termination of a construction or professional services contract, (ii) the partial or complete termination of supply orders under any terminated construction contract, and (iii) the complete termination of a unit-price professional services contract.

Alternatively, the total cost basis is used when the inventory basis is either impracticable or would cause an unreasonable delay in settlement. For a total cost proposal, direct material costs, direct labor costs, and indirect factory expenses are claimed as lump sums rather than allocated into inventory categories. The FAR specifies that a total cost basis may be appropriate under the following circumstances: (i) if production has not commenced and the accumulated costs represent planning and preproduction or “get ready” expenses; (ii) if, under the contractor’s accounting system, unit costs for work in process and finished products cannot readily be established; (iii) if the contract does not specify unit prices; and (iv) if the termination is complete and involves a letter contract.

If the total cost basis is used under a complete termination, the contractor must still itemize costs incurred under the contract through the termination date. If the total cost basis is used for a partial termination, then the cost proposal cannot be submitted to the Government until final completion of the project.

Subcontracts and the Right to Terminate for Convenience

Prime contractors are required to include terminations for convenience clauses in all subcontracts. A prime contractor’s ability to terminate a subcontractor for convenience is not identical to the government’s rights. Terminations for convenience clauses have been enforceable between private parties when (i) the contract arose out of a government-funded or –initiated project, and (ii) the terms by which one party can invoke the termination clause are explicitly stated. Courts will enforce an express invocation of a termination for convenience clause in a private contract so long as the termination was not a product of bad faith or abuse of discretion.

Federal courts may find a constructive termination for convenience occurred in the event a prime contractor relieves a subcontractor from its performance responsibilities, even when the prime contractor later seeks a termination for default and the subcontractor is found to have breached. State courts have recognized distinctions related to applying termination for convenience rules to a private contract.

As discussed, a prime contractor has one year to produce a settlement proposal after a Government-initiated termination for convenience. The prime contractor must include all settlement costs with subcontractors in its settlement proposal. If the contractor does not include subcontractor settlement costs in the proposal, then the Government is not liable for subcontractor claims after it enters into final termination settlement with the general contractor.

Subcontractor Right to Challenge Government’s Termination of the Prime Contractor for Convenience

Generally, privity of contract is required to sue the Government and challenge the Government’s decision to terminate the prime contractor for convenience. “It is a hornbook rule that, under ordinary government prime contracts, subcontractors do not have standing to sue the government… or to enforce a claim for equitable adjustment under the Contract Disputes Act of 1978.” One way to bypass such privity requirements is for the subcontractor to show that it was an intended third-party beneficiary of the prime contract.

Unfortunately, this is a high burden for the subcontractor. “[T]he requirements to demonstrate third-party beneficiary status are stringent.” To prove third-party beneficiary status, the subcontractor “must demonstrate that the contract not only reflects the express or implied intention to benefit the [subcontractor], but that it reflects an intention to benefit the [subcontractor] directly.” A subcontractor can only be a third-party beneficiary to a government contract “when the [contracting officer] knew or should have known that the government’s payment on the contract was intended to directly benefit the subcontractor.” Subcontractors are only designated as third-party beneficiaries when the contract involves “a payment mechanism by which the subcontractor has direct access to payments made by the government.” Federal courts will not assume that a subcontractor is a third-party beneficiary only because the Government “(1) oversees the activities of the prime contractor; (2) becomes aware that the prime contractor has failed to timely pay its subcontractors, and/or (3) makes funds available to the prime contractor in order for the prime contractor to pay its subcontractors.”

Alternatively, a subcontractor and prime contractor can jointly challenge the Government’s termination for convenience through a liquidation or pass-through agreement. Through such agreement, the prime contractor certifies to the Government that the subcontractor’s claim has good grounds. This is referred to as a Turner Certification. Turner Certifications are used to avoid duplicative litigation. Rather than requiring multiple lawsuits for the same dispute, “a bargain [may be] struck permitting the subcontractor to prosecute its claim directly against the [Government] with the general contractor as the conduit.” Generally, any Turner Certification agreement need only demonstrate that the prime contractor remains liable to the subcontractor for reimbursement of whatever the Government pays on the claim in the future.

Terminations for Default

Background

A termination for default is the right to terminate a contract, completely or partially, because of a party’s actual or anticipated failure to perform its contractual obligations. The FAR expressly authorize the Government, as owner, the ability to pursue a termination for default.

Similar to terminations for convenience, the Government’s ability to terminate a contractor for default will be automatically read into a contract even if default language is absent from the contract. This is in accordance with the “Christian Doctrine.” The Christian Doctrine was formulated in 1963, when the US Court of Federal Claims determined that certain FAR clauses are automatically incorporated into federal contracts as a matter of law, even if the corresponding language is absent from the contract. Therefore, as a matter of law, the Government may initiate a default termination against a contractor for a material breach, even if the contract does not include any language relating to default.

Generally, courts will view a termination for default as a drastic remedy that must be fully justified, particularly when default is initiated by the Government. The Government is held to a high burden of proof to prevail on its claims for default. In applying this higher standard, courts may find a Government decision to terminate for default as unreasonable. This is a factual analysis, and courts will focus on the Government’s decision-making rationale. To sustain a termination for default, the Government decision must be based on “tangible, direct evidence” and “a court’s review of default justification does not turn on the contracting officer’s subjective beliefs, but rather requires an objective inquiry.”

A contractor subject to a default termination faces numerous consequences, in addition to being assessed reprocurement costs and other monetary damages. For example, a default termination may affect the contractor’s (i) standing with sureties and its ability to obtain future bonding, and (ii) ability to obtain other government contracts where past performance is a consideration.

Grounds for Default Terminations

Both the Government and a contractor have the right to terminate a contract for the material breach of the other, however the Government maintains broader latitude to initiate and pursue an action for default termination. A contractor’s ability to terminate is limited to the following instances: (i) the Government does not provide payment in accordance with the contract, or (ii) the Government caused work suspension for an unreasonable amount of time.

Alternatively, the Government maintains the ability to initiate a termination for default for any form of material breach. The most common grounds for a Government-initiated default termination include the following:

• Failure by the contractor to meet the completion date;
• Failure by the contractor to make adequate progress;
• Statements or actions by the contractor that amount to anticipatory repudiation;
• Abandonment by the contractor; and,
• Material breach by the contractor of terms or conditions specific to the contract and the project.

The FAR provides a seven (7) factor test that must be considered by the Government’s contracting officer prior to initiating a termination for default. This seven-factor test includes a mandatory review of the following:

1. The terms of the contract and applicable laws and regulations;
2. The specific failure of the contractor and the excuses for failure;
3. The availability of the supplies or services from other sources;
4. The urgency of the need for the supplies or services and the time required to obtain them from other sources, as compared with the time delivery that could be obtained from the delinquent contractor;
5. The degree of essentiality of the contractor in the Government acquisition program and the effect of a termination for default upon the contractor’s capability as a supplier under other contracts;
6. The effect of a termination for default on the ability of the contractor to liquidate guaranteed loans, progress payments, or advance payments; and,
7. All other pertinent facts and circumstances.

While the contracting officer must consider these factors when contemplating a contractor’s default, nothing about these factors or any required review “confer[s] any enforcement rights on a defaulting contractor. Accordingly, a contracting officer’s failure to consider one or more of the factors does not require that a termination for default be converted into a termination for convenience.” Rather, a contracting officer’s compliance in reviewing these factors “may aid a court in determining whether a particular termination for default reflects an abuse of the contracting officer’s discretion.”

Prior to issuing any notice of default, the Government must allow a defaulting contractor notice and opportunity to cure the deficiency. The Government must provide the notice to cure in writing and allow the contractor at least 10 days (or longer as necessary) to correct the basis for default. After fully reviewing the facts and circumstances of the case, if the contracting officer still determines that a default termination is appropriate, then the contracting officer must issue a notice of termination to the contractor. Below is a summary and analysis of the unique issues that are associated with the most common grounds for a Government-initiated termination for default.

Failure to Meet Deadlines or Completion Date

Construction contract documents often set forth progress milestones whereby a contractor must complete portions of the construction and building process by certain specified dates. Determining breach is a simple analysis: if the contract calls for complete performance by a specified date, the passage of that date may constitute a breach. Untimely performance may constitute a breach and satisfy the Government’s prima facie burden of establishing the appropriateness of the default.

It is important to note that even where the Government is in material breach, if the contractor elects to continue working prior to resolving the Government’s breach, then the Government maintains the right to initiate a default termination for failure to meet contractual deadlines. Under normal circumstances, the non-breaching party has the right to discontinue performance upon the occurrence of a material breach. However, “even where there has been a material breach [by the Government], the obligations of both parties remain in effect if the injured party continues performance.” Therefore, if a contractor determines that continuing a project is feasible under the facts and circumstances of the case, it must fully commit and adhere to all contractual terms and deadlines. There is no room for partial continuance or partial performance, even if the Government causes the initial breach.

Failure to Make Adequate Progress

Even if a contractor does not fail to meet a deadline, the FAR provides the Government the ability to terminate a contractor for default for unreasonably slow or dilatory work. Of all the grounds for a termination for default, dilatory performance is one of the more difficult burdens for the Government to prove. To prevail, the Government must show more than a mere lack of confidence that the contractor will fail to meet a completion date.

Courts apply the “failure to make sufficient progress” standard of review, which is known as the Lisbon standard or the Lisbon analysis. A Contracting Officer is required to perform a Lisbon analysis, or an alternate applicable theory depending on the nature of the contract, prior to initiating a default termination for failure to make sufficient progress. An alternate theory may be required if, for instance, the contract does not have a fixed completion date. “Absent such analysis, it would be difficult, if not impossible, for the contracting officer to resolve whether there was no reasonable likelihood that the contractor could perform the entire contract effort within the time remaining for contract performance.”

That is exactly the standard that the Government must prove, whether there exists no reasonable likelihood that the contractor could perform the entire contract effort within the time remaining for contract performance. To that end, the Government must possess a justifiable insecurity about the contract’s timely completion.

When evaluating a Contracting Officer’s Lisbon analysis, “a court’s review of a default justification does not turn on the contracting officer’s subjective beliefs, but rather requires an objective inquiry. Although a contracting officer’s testimony and contemporaneous documents are relevant to that determination, the trial court may also consider other factors usually relied upon by courts and boards of contract appeals, such as 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 surrounding the decision in order to determine whether the contracting officer had a valid basis for his conclusions.”

Thus, the Federal Circuit requires courts to “focus on the events, actions, and communications leading to the default decision in ascertaining whether the contracting officer had a reasonable belief that there was no reasonable likelihood of timely completion.” The proper standard of review for a case involving failure to make progress is de novo. “[O]nce an action is brought following a contracting officer’s decision, the parties start in court or before the [B]oard with a clean slate…”

In response, the contractor may rebut with a justified excuse for delayed performance. A justified excuse may include excusable delays resulting from express or constructive changes to the contractor’s work, differing site conditions, or suspension of the work ordered by the Government before the completion date.

When resolving a claim relating to dilatory performance, courts will conduct an objective review and focus on “the events, actions, and communications leading to the default decision.” Ultimately, this places a relatively high burden on the Government to demonstrate “convincing proof” or “solid proof” that the contractor will not meet a completion date. This is a showing, based on the entire record, that timely completion is beyond the contractor’s reach. However, the Government need not show that timely completion would be impossible.

Abandonment and Anticipatory Repudiation

Abandonment occurs when a contractor leaves a project without any intention of returning. If the evidence is clear that a contractor abandoned a project or refused to continue work, the Government is not required to issue a cure notice. Abandonment must be certain, and efforts made by a contractor to repair performance deficiencies and continue work cannot constitute abandonment.

An anticipatory repudiation occurs “when a party renounces a contractual duty before performance is due.” Repudiation can be implied by an unequivocal showing of the contractor’s inability to perform, even in the absence of an express communication by the contractor. For example, the Court of Federal Claims has found anticipatory repudiation where a contractor was disabled from performing. Further, the Federal Circuit has found a contractor’s failure to provide assurance of timely performance as a breach justifying the termination of the contractor for default.

Interestingly, a failure to “provide assurance of timely performance” is not one of the seven factors specified in the FAR that the Government must consider to determine a default termination. The Federal Circuit appears to have a broad reading of the seventh factor, “all other pertinent facts and circumstances” in order to conclude that a failure to provide assurances of timely performance is a material breach. Perhaps this broad interpretation of “all other pertinent facts and circumstances” can be applied elsewhere to grant maximum leeway to the Government in a default termination proceeding.

“Repudiation can be effected either by a voluntary affirmative act indicating that the promisor will breach … or by a statement by the obligor to the obligee indicating that the obligor will commit a breach that would of itself give the oblige a claim for damages for total breach.” Generally, the finding of anticipatory repudiation discharges any remaining performance obligations of the other party. “The aggrieved party must treat the repudiation as a total breach, terminate the contract, and file suit.” Determining the scope and culpability of a repudiation is dependent on the facts and contract of each matter.

Other Material Breach

As expected, if the contractor materially breaches the contract, the Government will have grounds to initiate a termination for default. The nature of the contract will dictate the details and facts necessary to establish breach.

With respect to a federal construction contract, all terms and conditions that are fundamental to the project may be grounds for a default termination in the event of breach. For example, material breach can include a contractor failing to maintain required bonding with an approved surety during contract performance.

Payment and Performance Bond Implications from Default

Background

In accordance with the FAR, all construction projects over $150,000 require performance and payment bonds. Performance bonds represent a promise of surety to the Government that once the contract is awarded, the contractor will perform all obligations under the contract. Payment bonds represent a promise of surety of payment to all persons supplying labor or materials for the contract work.

The penal amount of each performance bond is 100 percent of the original contract price plus 100 percent of any price increases, unless the contracting officer determines that a smaller amount will adequately protect the Government. Similarly, the penal amount of each payment bond is 100 percent of the original contract price plus 100 percent of any price increases, unless the contracting officer makes a written determination that a payment bond in this amount is impractical. Additionally, regulations prohibit the amount of the payment bond from being less than the amount of the performance bond.

Federal Bond Standards

Federal construction contracts use the Standard Form 25 for the performance bond. This form creates a type of statutory indemnity bond that simply provides “payment” as the only performance option. Standard Form 25 provides as follows:

Obligation

We, the Principal and Surety(ies), are firmly bound to the United States of America (hereinafter called the Government) in the above penal sum. For payment of the penal sum, we bind ourselves, our heirs, executors, administrators, and successors, jointly and severally. However, where the Sureties are corporations acting as co-sureties, we, the Sureties, bind ourselves in such sum “jointly and severally” as well as “severally” only for the purpose of allowing a joint action or actions against any or all of us. For all other purposes, each Surety binds itself, jointly and severally with the Principal, for the payment of the sum shown opposite the name of the Surety. If no limit of liability is indicated, the limit of liability is the full amount of the penal sum.

Conditions:

The Principal has entered into the [bonded contract].

Therefore:

The above obligation is void if the Principal

(a)(1) Performs and fulfills all the undertakings, covenants, terms, conditions, and agreements of the contract during the original term of the contract and any extensions thereof that are granted by the Government, with or without notice to the Surety(ies), and during the life of any guaranty required under the contract and (2) performs and fulfills all the undertakings, covenants, terms conditions, and agreements of any and all duly authorized modifications of the contract that hereafter are made. Notice of those modifications to the Surety(ies) are waived.

(b) Pays to the Government the full amount of the taxes imposed by the Government, if the said contract is subject to the Miller Act, (40 U.S.C.A. § 270a to 270e), which are collected, deducted, or withheld from wages paid by the Principal in carrying out the construction contract with respect to which this bond is furnished.

Although Standard Form 25 is an indemnity bond, federal contracting officers are authorized to consider options allowing the surety to arrange completion. The bond does not expressly grant to the surety the right to cure the default by takeover and completion, or by tender of another contractor, although such options are frequently considered by contracting officers. Rather, Standard Form 25 leaves it to the courts or boards of contract appeals to determine and define the scope of the surety’s obligations. Accordingly, although written as a pure indemnity bond for “payment of penal sum,” the surety’s options upon default are guided by whatever the Government agrees to accept.

Surety Performance Upon Default

The FAR sets forth the proper Government procedures necessary to terminate the prime contractor for default and place both the contractor and surety on notice. A performance bond is triggered when the Government terminates the prime contractor for default. After termination, the Government will turn to the performance bond surety to remedy the default. Procedures for triggering the performance bond surety’s obligations are specific to (i) the express and implied terms of the bond and the bonded contract, and (ii) the type of bond.

Typically, performance bonds and bonded contracts require the Government, as obligee, to provide a notice of default to the surety. It is important to note that the surety relationship is tri-partite, where the surety is required to consider both the Government (obligee) and the contractor (principal) during this process. The purpose of timely Government notice is to permit the surety to review its options and minimize liability. Where the surety’s performance bond options include contract completion by takeover, tender, or financing of the principal, timely notice of default is an essential prerequisite to the surety’s contract completion obligation and loss mitigation efforts. Lack of proper and timely notice of default to a performance bond surety has resulted in discharge of the surety’s bond liability.

The surety faces almost immediate pressure upon default. First and foremost, the surety must decide whether to admit or deny liability under the applicable performance bond. Within the limited time available, the surety must next consider the Government’s stated grounds for default and assess the contractual and bond defenses, all within the context of complex construction and engineering problems at the heart of many disputes. The surety is required to conduct an independent and thorough investigation to protect any of its interests, as well as the possible overlapping interests of the terminated contractor.

Any claims and defenses presented by the surety must be reasonably thorough to assure the preservation of the surety’s later right to recover losses. In almost any default scenario, a surety’s failure to promptly investigate the default termination will result in a future controversy between the parties. Allowing too much time to pass before the surety conducts its investigation may transform what was a patent defect into a latent defect, where a once discoverable problem becomes hidden due to the nature of the project or the nature of the termination. For example, if a project was only partially terminated, the non-terminated provisions could inadvertently “cover up” patent defects and turn them into hidden latent defects. This is relevant because latent defects are routinely not covered by agreements between the surety and the Government.

When the surety takes over for a terminated contractor, the rights held by the contractor prior to the takeover do not automatically transfer to the surety. A surety does not hold contractual privity to assert claims held by a contractor prior to the surety takeover. A transfer of pre-takeover claims from the contractor to the surety can only occur (i) where the Government consents to the transfer of claims or (ii) where there has been a valid assignment of such claims from the defaulted contractor to the surety. Government consent and a valid transfer can occur at the same time if the Government, surety, and defaulting contractor enter into a three-party takeover agreement that specifically assigns to the surety the right to pursue the defaulted contractor’s claims.

Costs and Damages Resulting from Default Termination

Government Recovery

In the event of a Government-initiated termination for default, the defaulted contractor is liable for costs incurred by the Government, including reprocurement costs and liquidated damages. This is the most frequent outcome when a contractor is terminated for default, however as discussed below, the trend in the law has led to defaulted contractors recovering in specific instances.

The Government may also be entitled to reasonable administrative expenses, depending on the nature of the default. It is settled law that the Government, when faced with a contractor in default, has the option either to terminate the contractor or to replace, correct, or perform the work. When the Government chooses the latter course, the contractor will be liable for the costs to the Government.

Reprocurement costs refer to the costs associated with the hiring of another contractor to complete the terminated work. For the Government to successfully recuperate reprocurement costs, it must prove three elements:

1. The scope of the work of the reprocurement contract was the same or similar to the terminated work (the Government cannot recover for betterments);
2. The Government actually incurred costs associated with reprocurement; and,
3. The Government acted reasonably to minimize or mitigate any costs incurred.

One important factor related to the Government’s recovery of reprocurement costs is the Government’s conduct in awarding a new reprocurement contract. For example, the Government may limit the field of competition, so long as it has no reasonable basis for believing that a solicitation with a greater number of bidders would decrease the price.

In addition to reprocurement costs, the defaulting contractor may be required to reimburse the Government for costs associated with delay in the form of liquidated damages. Liquidated damages are assessed if the contractor fails to meet a completion date, by way of a daily rate, for each day the completion of the project is overdue. However, liquidated damages may not be assessed if the project is “substantially complete” or if the Government has contributed to the delay. Generally, when a contract is terminated for default, the contracting officer must promptly assess and demand any liquidated damages to which the Government may be entitled under the contract, in addition to any excess repurchase or reprocurement costs.

The Government can “set-off” any amounts owed to the contractor as liquidated damages. A contracting officer’s request for liquidated damages using set-off procedure is proper whether or not a final default termination notice has issued since the Federal Acquisition Regulations contemplate a claim for liquidated damages either at the time of a default termination or earlier.

A federal court may award liquidated damages simultaneously with reprocurement costs. Note, however, that a contract appeals board lacks jurisdiction to entertain a government demand for excess reprocurement costs unless and until a contracting officer issues a decision, consistent with the requirements of the Contract Disputes Act, formally demanding payment of a sum certain from the contractor and notifying the contractor of its appeal rights.

After default termination, contractors often fail to file claims for withheld liquidated damages. Once a contractor fails to perfect a claim, it cannot reach back to pursue remission of liquidated damages. This is a practice trap for attorneys representing prime contractors in government contracts.

Contractor Recovery

Generally, a contractor is not entitled to be paid for “undelivered work,” and it must reimburse the government for advance and progress payments related to that work. However, the Court of Federal Claims has formulated a four-part test that, if met, permits the defaulted contractor to recover costs incurred when attempting to perform a contract validly terminated for default. The four-part test is as follows:

1. The defaulted contractor must not default willfully or deliberately, but only after a bona fide attempt to perform;
2. The defaulted contractor must incur additional costs as a direct result of improper actions by the Government;
3. The defaulted contractor must seek recovery only of the excess costs incurred because of the improper action of the Government; and,
4. The Government’s improper action must be something that it has no right to do under the contract.

Common examples of improper Government actions include the provision of impossible or defective specifications, or the misrepresentation of site conditions. In one instance, the Court of Federal Claims has allowed a defaulted contractor to recover for costs incurred to correct deficient contract drawings provided by the Government.

Recovery Pursuant to the Equal Access to Justice Act (“EAJA”)

The EAJA authorizes a prevailing small business contractor to recover attorneys’ fees and other expenses necessary to defend against an “adversary adjudication” initiated by the Government. An adversary adjudication is defined as (i) any matter subject to trial of the law and the facts in court, (ii) proceedings in which decisions rest solely on inspections, tests, or elections, (iii) cases in which an agency is acting as an agent for a court, (iv) the certification of worker representatives, (v) any appeal of a decision made by a Contracting Officer, (vi) any hearing conducted under the Veteran Readiness and Employment Program, or (vii) a proceeding conducted pursuant to the Religious Freedom Restoration Act. An “adversary adjudication” does not include an adjudication for the purpose of establishing or fixing a rate or for the purpose of granting or renewing a license.

For the purposes of the EAJA, a small business contractor is defined as (i) an individual whose net worth does not exceed $2 million at the time the adversary adjudication was initiated, or (ii) any owner of an unincorporated business, or any partnership, corporation, association, or organization with less than 500 employees and whose net worth did not exceed $7 million at the time the adversary adjudication was initiated.

Once an EAJA claim has been filed, the Government must prove its position was either (i) substantially justified, or (ii) that special circumstances exist that would render an award of attorneys’ fees unjust. If the Government can prove one of those two prongs, then the small business contractor may not recover, even if it was the prevailing party in the original adversary adjudication.

The Supreme Court has held that the term “substantially justified” means “justified to a degree that could satisfy a reasonable person and is equivalent to having a reasonable basis in law and fact.” As applied to federal contracts, “the Government’s position is substantially justified when issues involve close evidentiary questions, and the proper application of the governing legal principles is not clear until after the record is fully developed.

EAJA applications must be filed “within thirty (30) days of a final disposition in the adversary adjudication,” meaning a disposition that is no longer appealable. The 30-day period for filing an application for attorneys’ fees under the EAJA is jurisdictional and cannot be waived. EAJA claims will be stricken as premature if the claim is raised in a pending appeal, without prejudice to the contractor’s later filing of a formal EAJA application after a decision on the merits of appeal. A decision becomes final 120 days after the party receives a copy of the final decision. Accordingly, the EAJA fee application must be filed within 150 days from the receipt of the decision.

After a decision overturning the default termination, the parties may engage in settlement negotiations relating to termination costs. Settlement discussions, however, do not toll the 150-day deadline to file an EAJA application after a final decision. Therefore, an EAJA application that relates to the parties’ negotiations of termination costs will be untimely if filed beyond 150 days from the final decision.

If costs are ultimately awarded in an EAJA claim, any costs incurred to pursue settlement will not be granted. Only costs related to appealing or defending against a Government-initiated termination for default can be included in an EAJA claim.

Wrongful Termination

Wrongful termination is a breach of contract that typically will relieve a party of liability for a preceding breach. The Government converts a wrongful termination into a termination for convenience. There are several ways a Government termination can be deemed wrongful.

Notice and Cure Requirements

First, contractual notice requirements represent the initial step to determine whether a termination has been properly executed. For example, if the Government terminates a contract without providing the contractually required notice and timely opportunity to cure, that termination is wrongful. A proper notice must list with particularity the performance failures which have placed the contract in danger of termination for default.

Waiver and Forbearance

Under certain circumstances, the Government can waive its right to terminate through forbearance. To successfully invoke the defense of waiver, the contractor must prove there was (i) a failure to terminate within a reasonable time after the defaulting event, (ii) reliance by the contractor on the failure to terminate, and (iii) continued performance under the contract with the Government’s knowledge and implied or express consent.

The circumstances surrounding a Government waiver are factual: “[T]he question of whether the default termination is proper depends on the facts and circumstances of each case.” For instance, if the Government reserves its rights to terminate, it may defeat the defense of “waiver” even if the Government failed to terminate within a reasonable time after the defaulting event. When the Government expressly reserves its rights, it places a “heavier” burden on the contractor to prove that such rights have been waived. “Where the right to terminate has been expressly reserved […] the other party has a heavier burden of proving that the right to terminate […] has been waived. […] The Government’s express reservation of its rights […] surely made clear to [the contractor] that the Government was not excusing the breach.”

In a construction contract, continued performance alone will not ordinarily support a claim of waiver. The Government may encourage a construction contractor to continue performance without establishing a new completion date, in the context of determining the validity of a termination. Detrimental reliance cannot be found “merely from a period of government forbearance coupled with continued contractor performance in reliance thereon.” “Unusual circumstances” must exist for the waiver doctrine to apply to a construction contract.

Additional Factors and Case Law

A defaulted contractor must consider several principles and factors to determine the appropriateness of the Government’s actions and prove wrongful termination. For example, a contractor’s substantial performance of a construction contract may limit the Government’s right to terminate for default or assess liquidated damages. A defaulting contractor may defend against a termination for default if there was a superseding breach by the Government. In seeking a default termination, the Government must cooperate and may not hinder the contractor’s performance under the contract. Lastly, the Government’s failure to make progress payments without good reason may constitute a material breach that excuses abandonment of performance, and contractors are justified in refusing to proceed with performance upon non-payment for completed work;

As stated above, even when the Government’s actions are deemed wrongful, the Government will nonetheless typically revert back to a termination for convenience to limit its exposure and avoid breach.

Legal Trends

The courts have continued to award damages to defaulted contractors under circumstances where the government’s failure caused the contractor to incur additional costs in attempting to perform (but the government’s failure was not the ultimate cause of the contractor’s default) such as failing to deliver a product on time. Accordingly, terminated contractors that successfully recover damages continue to be rare. The following three cases helped set the framework for defaulted contractor recovery.

First, in Laka Tool & Sampling Co. v. United States, 226 Ct. Cl. 83, 639 F.2d 738 (1980), the issue before the Court was whether plaintiff contractor was entitled to have the default termination of its contract converted to one for the convenience of the government or whether it was otherwise entitled to recover on the ground that the contract or part of it was impossible or commercially impracticable of performance. The Court held the government’s default decision was justified, but also awarded damages to the defaulted contractor for costs incurred in correcting the government’s deficient contract drawings. The contractor’s default did not negate its entitlement to recover from the government, “those excess costs, if any, which it expended in attempting to comply with the impossible specification requirements.”

In the second case, Clay Bernard Sys. Int’l. Ltd., ASBCA No. 25382, 88-3 B.C.A. ¶ 20,856 (1988), rev’d in part, 22 Cl. Ct. 804 (1991), a contractor brought an action challenging a decision of the Armed Services Board of Contract Appeals (ASBCA), upholding default termination of a contract to design, develop, deliver, and install a mechanized materials handling system for Defense Logistics Agency (DLA). The Court held that a “Contractor that is not without fault or negligence, [], does not wholly forfeit otherwise valid claim” against the agency. There, the defaulted contractor was permitted to recover for interface specifications that were impracticable if not impossible to meet.

Lastly, in West Point Research, Inc., ASBCA No. 25511, 83-1 B.C.A. ¶ 16,443 (1983), the Appellant’s contract was terminated for default upon the failure of its second submission of first article samples to pass inspection. The government’s testing of first articles, on both the first and second submission, was not accomplished within the time required by the contract.

The Appellant in West Point Research claimed damages for increased costs attributable to Respondent’s testing delays and, also, requested that the default termination be converted to one for the convenience of the government. While upholding the default termination, the Board also held that the defaulted contractor may recover damages for the government’s delay beyond ninety days to test the first article samples. However, the Board limited the defaulted contractor’s recovery to those costs directly attributable to the government’s delay, such as: (1) additional administrative costs and (2) possible increased labor/overhead costs.

Despite the uphill battle in recovery of damages for a defaulted contractor, it is worth emphasizing that the courts have continued to apply the high burden of proof to government default terminations, holding that the government “cannot satisfy its burden by merely showing that the contractor was behind schedule.” This has furthered the trend of damages being awarded to defaulted contractors.

In Alutiiq Manufacturing Contractors, LLC v. United States, 143 Fed. Cl. 689, 696 (2019), the National Guard Bureau awarded a firm-fixed-price construction contract to Alutiiq Manufacturing Contractors, LLC (“AMC”), in 2014, to repair asphalt roads at an Air Force base. From the outset of the project AMC experienced performance issues, none which would have prevented it from timely completing the contract.

However, the government was concerned and issued a letter of concern and multiple cure notices to AMC. AMC responded by (a) adopting corrective measures to help move the project forward, including developing a recovery schedule that would allow it to complete some portions of the work two days ahead of the original contract deadlines and (b) working to get the project back on schedule.

Simultaneously, the government was holding internal discussions on when and how to terminate AMC’s contract for default. The government ultimately reviewed AMC’s proposed recovery schedule and determined it was not viable. However, the agency did not conduct a critical path analysis of the recovery schedule and terminated the contract. AMC challenged the government’s termination.

In reviewing the termination decision, the Court focused two things. First, the government’s demonstrations of an objective “reasonable belief on the part of the contracting officer that there was no reasonable likelihood that the [contractor] could perform the entire contract effort within the time remaining for contract performance.” Second, the Court focused on the seven factors in Federal Acquisition Regulations, 49.402-3(f) (the “FAR factors”) that must be considered by a contracting officer prior to issuing a termination for default. Ultimately, the Court held that the termination decision was unreasonable and dismissed the bulk of the agency’s reasons for default.

Alutiiq Manufacturing Contractors raises several critical takeaways. First, government objectivity: The government cannot support a default termination based solely on its subjective belief that a project is incurably off course. Similarly, government agencies are required to objectively consider any recovery plan. Evidence of government bias against a contractor will always play a crucial role in a default termination case.

Second, communication: Clear communication is integral to performance disputes — particularly when it comes to developing a recovery plan on a troubled project. Here, the Court found that both the contractor and the government could have done a better job of communicating with their counterparts to set expectations and raise concerns.

Third, raise all FAR factors: In responding to a notice to cure, a contractor should make sure it raises all points favorable to it listed in FAR 49-402-3 (48 C.F.R. § 49–402–3). Those factors include excuses for the failure and the time it would take for the government to bring on a replacement contractor, as opposed to allowing the tardy contractor to finish performance.

As discussed above, only in limited circumstances is a contractor entitled to damages upon its termination for default. Typically, the money arrow goes only one way. However, the contractor is always entitled to credit for government directed changes. Recently, there have been a few cases suggesting that the default termination may be upheld, but the defaulted party recovers damages. Below are instances in which the defaulted party was awarded damages.

Chesapeake Tunnel Joint Venture v. Brasfond USA Corp., No. 01-19-0004-0820 (Aug. 4, 2022) (Constr. Indus. Arb. Trib.) involved a subcontractor’s “technical” default. Despite the subcontractor’s default, it prevailed on damages related to (i) termination for convenience; (ii) delays; (iii) attorneys’ fees; expert fees and arbitration costs, representing 50% of the damages it sought. Conversely, the arbitration panel determined that the defaulting party had several failures, including (i) failure to mitigate damages, (ii) hiring a more expensive replacement subcontractor (betterment), (iii) seeking a severely disproportionate claim damages, and (iv) no notice in some instances. The award to the defaulting party was only 7% of the damages it sought.

Barlovento v. AUI, Inc., et al., 2021 WL 3879072 (D.N.M. Aug. 31, 2021), is a case that involved both a prime contractor’s partial termination for cause and its constructive partial termination for convenience without fault, against its subcontractor on a government contract. As in Chesapeake Tunnel, both parties recovered damages.

In March 2017, the United States Air Force hired Barlovento, under a $5.5 million construction contract, to replace a 2,225-foot taxiway at Kirtland Air Force Base, New Mexico. One week later, Barlovento hired AUI, under a $3.7 million Subcontract, to perform the “lion’s share” of this taxiway replacement work.

On July 7, 2017, after an unexpected delay, the Air Force authorized the commencement of the work and required its completion by December 12, 2017. After removing the existing taxiway and its underlying “base course,” AUI encountered certain unsuitable soils in the subgrade, which according to AUI, delayed the project completion by one month.

Barlovento then removed the concrete phase from AUI’s scope of work and could not include this reason as its basis for default termination, although it had been the subject of a cure notice. Barlovento later terminated AUI for default on the base course when AUI failed to meet the deadline to provide a complete base course submittal. Barlovento failed to pay AUI for its satisfactory performance prior to the default termination, and therefore breached the parties’ subcontract.

The Court awarded AUI, the defaulting subcontractor, $211,762.75 for the work it had satisfactorily performed prior to the termination for default that was converted to a partial termination for convenience. The prime contractor, Barlovento’s proven recoverable costs of $234,340.00 was offset by $211,762 owed to the subcontractor. Thus, the prime contractor recovered a net balance of $22,577.25, which was only a fraction of the amount of damages it sought. This case demonstrates the Court’s willingness to award damages to a defaulted party when the evidence shows the defaulting party failed to mitigate.

Conclusion

There are two categories of terminations on government construction projects: (1) terminations for convenience; and (2) terminations for default. A termination for convenience clause gives the government the right to terminate a contract without having to pay anticipated profit on unperformed work, assuming the Contracting Officer determines that the termination for convenience is in the government’s interest. The Government can invoke the termination clause before performance commences or even at a later period to thwart the government’s liability for its own expected breach. However, the government may not invoke a termination for convenience after a contractor has completed performance under the contract. This type of termination can be settled using an inventory basis or total cost basis. A terminated contractor can recover its incurred costs, profits on work completed, and costs of preparing the termination settlement proposal. Recovery of anticipated profits is precluded unless the termination was wrongful.

A termination for default gives the government the right to terminate a contract, completely or partially, because of the contractor’s actual or anticipated failure to perform its contractual obligations, and to reprocure at the breaching party’s expense. Courts view the termination for default as a drastic remedy (draconian) that must be fully justified with tangible and direct evidence. Nonetheless, the government has solid grounds to terminate if the contractor materially breaches the agreement without justification. The most common grounds for government-initiated termination for default are failure to meet a deadline or completion date, failure to make (sufficient) progress, abandonment and anticipatory repudiation. Contracting officers must consider seven specific factors according to the regulations before issuing a termination notice to the contractor and surety (if applicable). A defaulted contractor is liable for costs incurred by the Government, including reprocurement costs and liquidated damages. Though rare, a defaulted contractor may be awarded damages (or receive a credit) if it incurred costs due to the government’s failure.