Public Contract Law Journal

Retroactive Cost Disallowances Revisited: Did the Federal Circuit Commit Error by Failing to Recognize Relevant Supreme Court Precedent When It Decided Rumsfeld v. UTC?

by James J. Gallagher

Jay Gallagher is a recently retired (as of December 31, 2018) partner in the Government Contracts & Disputes Group at Pillsbury Winthrop Shaw Pittman LLP in Los Angeles. For more than three decades, his practice has concentrated on litigation and counseling on contract financial issues, including: civil and criminal fraud investigations and litigation; defective pricing; terminations; claims; breach of contract; and cost allowability matters. Mr. Gallagher has served as lead counsel in more than three dozen False Claims Act and qui tam cases, two of which resulted in favorable Supreme Court decisions. He would like to thank Kevin Massoudi, a Government Contracts associate in Pillsbury’s Los Angeles office, for his editorial assistance in the preparation of this article.

I.  Introduction

Since 2003, the United States Court of Appeals for the Federal Circuit (Federal Circuit) has issued a series of decisions rejecting Retroactive Cost Disallowance1 (RCD) arguments raised by contractors based on their failure to show affirmative misconduct by the government. The relevant caselaw equates the RCD issue to equitable estoppel, which in the commercial world requires that four elements be established:

1.   “The party to be estopped must know the facts;

2.   [The party] must intend that [its] conduct shall be acted on or must so act that the party asserting the estoppel has a right to believe it is so intended;

3.   [T]he latter must be ignorant of the true facts; and

4.   [The latter] must rely on the former’s conduct to [their] injury.”2

The Federal Circuit cases in question rely on United States Supreme Court and federal appellate court decisions holding that to establish equitable estoppel against the government, there must be, in addition to the four standard elements required to establish equitable estoppel, a showing of some form of affirmative misconduct by a government representative.3 However, all of these Supreme Court and appellate court decisions involve situations in which the claimant attempted to obtain authorizations (e.g., immigrant status) or payments (e.g., social security entitlement) from the federal government based on erroneous advice received from a governmental representative in a circumstance where the approval or payment was not permitted by a federal statute or regulation.4 Significantly, not one such case involved a government contract. The importance of this distinction is that the Supreme Court consistently has held in a series of decisions spanning at least sixty-five years, that when the government enters into a contract, it is to be treated like any other contracting party.

None of the Federal Circuit decisions addressing RCDs have discussed the different consequences that flow from the government acting in its sovereign capacity as opposed to its acting in its proprietary or contractual capacity. The distinction between the two concepts is critically important in the historical caselaw on the issue of when equitable estoppel may lie against the government. That caselaw holds that the government is not subject to estoppel where the acts complained of are “public and general,”5 but is so subject when it is acting in a proprietary capacity.6

That distinction is particularly significant in relation to the frequent recitation in those estoppel cases in which the government is a party, but which do not involve a contract, that the government may not be estopped on the same terms as any other litigant with respect to laws enacted by Congress.7 Over time, the differentiating term adopted by the Court in cases in which the government was a party has been to require, in addition to the traditional four elements of estoppel, a showing of “affirmative misconduct” by a government representative.8 None of those Supreme Court cases involved the government or its agents acting in a proprietary capacity. However, despite that fact, the Federal Circuit has extended that extra requirement to government contract caselaw. This was despite the fact that none of its or its predecessor’s, the Court of Claims, prior decisions9 that involved an RCD or an equitable estoppel allegation had imposed that requirement on a government contractor.10 In addition, the Federal Circuit has done so without taking notice of the Supreme Court’s treatment of how the government is to be treated when it acts in its proprietary capacity as a contracting party.

In numerous cases the Supreme Court has discussed whether there might be conduct by a government official or agent of a type that would estop the government from enforcing the law. For example, in Montana v. Kennedy, the Court noted erroneous advice given to a pregnant woman regarding her immigration status “falls far short of misconduct such as might prevent the United States from relying on petitioner’s foreign birth.”11 In INS v. Hibi, the Court found that failure to publicize in the Philippines a right to apply for naturalized citizenship is not a type of affirmative misconduct to establish estoppel.12 In Schweiker v. Hansen, the Court found a Social Security Administration representative’s erroneous eligibility advice “‘fall[s] far short’ of conduct which would raise a serious question whether petitioner is estopped from insisting upon compliance with a valid regulation.”13 Then in INS v. Miranda, the Court stated proof that the government failed to process promptly an immigration application “falls far short” of establishing affirmative misconduct.14 The Court notably stated in Heckler v. Community Health Service that, “Thus, assuming estoppel can ever be appropriately applied against the [g]overnment, it cannot be said that the detriment” here is such that the government “ought to be estopped from enforcing the law in this case.”15 Finally, in OPM v. Richmond the Court reversed a Federal Circuit finding that affirmative misconduct (erroneous advice) supported finding estoppel; the Court found the government is not estopped from refusing to pay a claim for money from the Public Treasury contrary to a statutory appropriation where a retiree received erroneous advice regarding eligibility for disability annuity payments. 16

In none of those cases has the Supreme Court found, though requested to do so by the government, that there should be a blanket prohibition on estoppel against the government.17 In addition, in only one of those cases, Heckler v. Community Health Service, was the government arguably acting in a proprietary capacity (government claim for reimbursement of overpayments to a health care provider).18 However, the Court decided Heckler on the basis that the provider failed to establish two of the four elements necessary to find estoppel (change of position and reliance), not on the basis of a failure to establish affirmative misconduct.19

Other than Heckler, and independent of decisions by the Federal Circuit, none of the other federal appellate court decisions that have addressed affirmative misconduct by a government representative as an element required to establish estoppel involved a government contract or the government acting in its proprietary capacity. This is significant because a number of Supreme Court decisions have held that when the government enters into a contract, generally it is to be treated the same as any other contracting party,20 a status that would not require a party to a commercial contract to establish affirmative misconduct as part of an equitable estoppel defense. As noted above, none of these Supreme Court cases have been addressed in any of the Federal Circuit decisions that have rejected contractors’ equitable estoppel and RCD defenses for failure to establish affirmative misconduct.

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