The contractor’s duty to proceed with performance pending the resolution of disputes is a basic concept in the law of government contracts. It is laid out explicitly in FAR 52.233-1(i), the mandatory disputes clause that appears in nearly all federal contracts: “The Contractor shall proceed diligently with performance of this contract, pending final resolution of any request for relief, claim, appeal, or action arising under the contract, and comply with any decision of the Contracting Officer.”

But the duty to proceed has important limits. A contractor is excused from its duty to proceed and may stop work if the government materially breaches its own obligations under the contract.

Breaches occur in many contexts. A cardinal change in the scope of work is a breach that excuses a contractor’s performance. Terminating a contract just to get a lower price is a breach. Refusing to pay for a contractor’s work without an adequate excuse is also a breach.

According to the decision in Kiewit-Turner v. Dep’t of Veteran Affairs, CBCA No. 3450 (Dec. 9, 2014) [pdf], the government breaches the contract by ordering a contractor to continue performance when it is clear that there will be no funds available to pay for the work. The Civilian Board of Contract Appeals recognized Kiewit-Turner‘s right to stop work when the Department of Veteran Affairs failed to provide a design that would have allowed construction to be completed within the budget established by the available appropriations. Despite the general duty to proceed, Kiewit-Turner was not required to continue performance because it was clear that the construction costs would exceed the available funds and the VA refused to seek additional funding or incorporate value engineering changes to reduce the overall construction cost.

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Facts of the case

In August 2010, the VA awarded KT a contract for pre-construction services for a medical center campus in Aurora, Colorado. The contract was an integrated design and construct type contract, which the VA had never used before. Although such contracts are intended to involve the construction contractor in the project at an early stage, the design of the medical center was well underway by the time that KT got involved. The same day that VA awarded the contract to KT, the VA set the medical center’s construction funding limit—the Estimated Construction Cost at Award—at $582,840,000. The ECCA was based on design drawings that were only 50% complete and was established without any input from KT.

Almost immediately, KT began informing the VA that the medical center could not be constructed for the ECCA amount. In January 2011, KT estimated that the construction cost would exceed the ECCA by approximately $7 million. Three months later, when the design drawings were just 65% complete, KT estimated that the construction costs would exceed the ECCA by $76 million. Despite these warnings, the VA asked KT to submit a firm target price proposal to construction the medical center and to offer a price that would not exceed $603 million. KT submitted its proposal in August 2011 and proposed a total price of $599.6 million, which was based on the condition that the VA implement $23 million worth of value engineering design changes.

The VA refused to implement the necessary value engineering changes and negotiations over KT’s proposal ensued. Based on KT’s insistence that the project could not be constructed for the VA’s maximum acceptable construction amount, in November 2011, the VA and KT entered into modification SA-007, which provided that both parties would expend resources to get the project price at or below $604 million. The modification required the VA to “ensure” that its design team would produce a design that could be constructed for the ECCA amount of $582,840,000.

The VA issued KT a notice to proceed the same day that modification SA-007 was signed and KT promptly began soliciting subcontractor bids based on the 95% drawings. The 100% drawings were provided to KT in August 2012 but were far from complete. The VA’s design team ultimately supplemented the design with numerous supplemental instructions, which required KT to submit an “unusually large number” of requests for information. As a result, project costs continued to increase. In December 2012, KT estimated that the construction costs would total $769 million—nearly $200 million more than the ECCA amount.

Despite these estimates, the VA refused to implement any value engineering changes and instead directed KT to proceed with construction. When KT indicated that it could not construct the project within the available funding limits, the VA responded that it intended to hold KT to the firm target price of $604 million established in modification SA-007.

In April 2013, KT asserted that the VA had breached its obligation to provide a design that could be constructed for the ECCA amount and that as a result, KT was authorized to stop work. The VA contracting officer denied any breach and again directed KT to proceed with construction of the project.

Based on testimony at the hearing, the CBCA found that at the time of the directive to proceed, the VA did not have any plans to redesign the project, had only $630 million appropriated for construction, and did not have any plans to seek additional funding. As of June 2014, the Board found that KT had already performed $20 million worth of work for which it had not been paid. That number was expected to grow by to as much as $100 million by December 2014.

The Board’s holding and rationale

KT’s appeal presented the Board with three distinct questions: (1) whether modification SA-007 required the VA to provide a design that could be constructed for the ECCA amount; (2) whether the VA materially breached the contract by failing to provide such a design; and (3) whether KT was entitled to stop work. The Board answered all three questions in the affirmative.

     1. The VA was required to provide an ECCA-compliant design.

With respect to the first question, the Board found that modification SA-007 “could not be more clear” in requiring that the VA provide a design that could be constructed for the ECCA amount of $582,840,000. The VA argued that the ECCA amount was not material because KT’s firm target price construction proposal required that KT build the project for $604 million, subject to scope changes. The Board rejected the VA’s arguments and found that the ECCA amount was not only material, but critical.

     2.  The lack of an ECCA-compliant design was a material breach of the contract.

In determining whether the VA materially breached the contract, the Board considered the five factors set out in the Restatement (Second) of Contracts:

  1. the extent to which KT was deprived of its reasonably expected benefit;
  2. whether KT could be adequately compensated for the deprived benefit;
  3. whether the VA would suffer forfeiture;
  4. the likelihood that the VA would cure its failure to perform; and
  5. the extent to which the VA’s behavior complied with the standards of good faith and fair dealing.

Based on these factors, the Board found that KT was deprived of the benefit of a design that could be constructed for the ECCA amount. KT could not be adequately compensated for the lack of an appropriate design because the VA did not have adequate funding and did not intend to ask for more. Because the VA had also insisted that it would not redesign the project, the Board found that there was little likelihood that the VA would cure its breach and held that the VA’s behavior violated the standards of good faith and fair dealing. The Board also found that the VA’s forfeiture of the project would be limited because the VA retained possession of the land and the work that had already taken place.

     3. The VA’s material breach entitled KT to stop work.

In light of the VA’s material breach, the Board concluded that KT was entitled to stop work. Relying on the Federal Circuit’s decision in Stone Forest Indus., Inc. v. United States, 973 F.2d 1548 (Fed. Cir. 1992), the Board reasoned that KT was entitled to stop work.

The Board also rejected the VA’s argument that KT lost its right to stop work by continuing performance in the face of an earlier VA breach. Although a contractor may be forced to continue work if they continue performance without protest, the Board found that KT had strenuously protested the VA’s directive to proceed and only continued performance to avoid the possibility of a default termination.

The relevance of the exhaustion of funds

One important fact behind the decision in Kiewit-Turner was the certainty that construction costs would exceed the amount of funds appropriated for the project. Accepting the government’s argument that KT was bound to continue performance despite the unavailability of funds would have required KT to do the work without any expectation of payment. That fact strongly supported KT’s right to stop work. On contracts in which performance is subject to the availability of funds, contractors are explicitly instructed to stop work before funds are exhausted. That issue is discussed in our earlier post on the Armed Services Board’s decision in Dynamics Research Corp., ASBCA No. 57830 (Mar. 26, 2013).

But there is no indication in the Board’s decision in Kiewit-Turner that the looming exhaustion of funds is necessary to establish the contractors’ right to stop work. That is not the test.

The promise of “eventual payment” was an issue in Emery Worldwide Airlines, Inc. v. United States, 47 Fed. Cl. 461 (2000) [pdf], another case involving disputes in the “hundreds of millions” and the scope of the contractor’s right to stop work. There, the government argued that its conduct could not be deemed a breach because the contractor “will eventually . . . receive all of the money it is entitled to . . . .” As a legal argument, the court explicitly found that approach unpersuasive.

The Emery decision nevertheless suggests that the short-term burden of financing performance is not enough to justify stopping work. On this point, the court took a broad view of the disputes clause. Even though there were hundreds of millions of dollars in dispute, “the language of the disputes clause . . . is unequivocal in its direction to [the contractor] to continue performance under the type of scenario that is presently before us.”