When it’s better for a subcontractor to walk away from a federal deal

Bad things can happen when contractors fail to include their subs in negotiations with the government. The Air Force decided to redo its approach to a small construction contract. It drove up costs. But the prime signed on to a new price without agreement of its subcontractor, so the whole thing ended up before the Armed Services Board of Contract Appeals. For more,  Federal Drive with Tom Temin spoke with Boone Haynes procurement attorney Dan Ramish.

Interview transcript:

Tom Temin And Dan outlined this case for us. I guess it started out when the Air Force totally changed the ground rules of a small project to install an alarm system that it had agreed to.

Dan Ramish Yeah, that’s right. So this was a small $2 million job to replace a fire alarm control panel and fire suppression system at Eglin Air Force Base. And the contractor, which does business is optimum construction, learned from the Air Force at the pre-construction conference that there was going to be a change in the contract work hours in sequence. So the contractor had planned in its proposal and the original contract had anticipated that the work would happen during normal business hours, and that the fire suppression system would be replaced on each floor and that the whole floor would be effectively cleared and unoccupied, so the contractor could handle one floor and then handle the next floor and then handle the next floor. And the Air Force talked to its customer in the building. And unsurprisingly, the customer didn’t like this idea that they were going to have to clear out their offices. So the Air Force said, no, no, this work is going to have to be performed nights and weekends, and we’re going to handle it office by office instead of the entire floor. So it’s a classic change, of course, the change in sequence and the change of work hours affected the contractors costs, and it also affected the cost of its major subcontractor Pugh. So Optimum here, initially, talked to Pugh in negotiating a modification to capture these changes with the Air Force and got an initial price. But then they had subsequent negotiations with the Air Force to come to agreement on a bilateral modification, and it turned out that the Air Force ultimately played hardball and said that the contractor had to agree to a $200,000 modification, or at least this is what Optimum says, or the Air Force would terminate the contract for convenience. So Optimum agreed to a $200,000 modification, but this meant dramatically decreasing the costs that were for it’s subcontractors working.

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Tom Temin Right. Optimum had demanded another almost $1,000,000, and the Air Force sort of bargained them down to 200,000. And the subcontractor wanted about 100,000 more, and it ended up with only $13,000, unbeknownst to it, correct?

Dan Ramish That’s right. And Optimum decided not to go back to its subcontractor and get their buy off before agreeing to a bilateral modification. Actually, they submitted the proposal for about $200,000 without talking to the sub. And then the sub actually learned about it afterwards before the Mod was signed and said, Wait a minute, this doesn’t capture all of our costs. And they explained the reasons for it, that because the work was going to happen every night and the officers weren’t being cleared, they were going to have to demobilize and remobilize every day. So there was tool scaffolding, equipment, materials, And they couldn’t just leave it in the office, because people were going to use the office during the day. So it was easy to see why this affected their costs.

Tom Temin But Optimum went ahead, did the contract and then paid whatever it could pay extra to its subcontractor Pugh. Pugh wasn’t too happy. What happened next?

Dan Ramish So Pugh went ahead and submitted an [Request for Equitable Adjustment (REA)] after the work was completed for the extra costs, which did end up being more like what its original proposal had provided for, so an extra $90,000. And optimum received the REA and passed it through to the Air Force, but made some kind of disparaging comments suggesting that it caught them off guard, and they didn’t feel that the subcontractors claim was warranted and that they didn’t stand behind it, things like that. And unsurprisingly, the Air Force rejected the REA. And then when Optimum converted the REA to a claim, the Air Force’s contract officer denied that in a final decision as well.

Tom Temin We’re speaking with Dan Ramish, a procurement attorney at Haynes Boon. So done, paid, but it wasn’t over yet. And what was the reasoning for the board in deciding what it decided?

Dan Ramish So the board came back and noted that there wasn’t a constructive change in so far as a modification had already been executed for the changes that the subcontractor was complaining about. So there hadn’t been additional changes, they were covered by the modification pretty clearly, and they pointed out that Pugh would raise this issue with the prime contractor at the time and went ahead anyway. And they also pointed out that the modification, as is standard, included, release language. So the government had an accord and satisfaction defense that this was effectively settlement for the changes. And the contractor had been paid for them, it was a fixed price and that was the end of the issue. There were a couple of kind of side arguments that Optimum had made in its appeal. They argued that they had signed the modification under duress, because the contracting officer had supposedly threatened to terminate the contract for convenience. And the board said, well, the government has the right to terminate the contract for convenience. And so it didn’t constitute duress to say that they might do that.

Tom Temin Right. So now the resulting argument then potentially is between the sub and its prime, because the government got its alarm system paid for it and they’re done.

Dan Ramish That’s right. The challenge that prime contractors face when they’re dealing with modifications that affect subcontractors, costs and schedule, is not getting stuck in the middle. So it’s preferable for the prime to deal with it when they’re negotiating the modification and include the sub enough so that the sub feels that their interests are aligned and that the sub prime contractors buy off on the ultimate result in the modification. And the way it went down here, not getting final approval from the subcontractor and then kind of disparaging the REA in submitting it. The subcontractor can’t be very happy with that result and risks a follow on action by the subcontractor against the prime.

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Tom Temin So maybe, there are some times when a sub should say to a prime, you know what, sorry, forget about it. Even though it’s hard to turn down business, but it might be better to not have the revenue than to lose money.

Dan Ramish Well, the sub here, if it had been engaged through to the end and had been faced with the joint decision to either move forward with the much lower $200,000 modification instead of million dollar modification, or walk away or face a re competition, the subcontractor might have made the same decision. But because they weren’t engaged at the time of the Mod, now the Prime may be stuck in the middle having to pay some cost to the subcontractor that it can’t recover from the government.

Tom Temin All right, so what would your advice be to your prime client say?

Dan Ramish Well, whenever you’re dealing with a bilateral modification, read it carefully and understand that it will cover the subject matter of the Mod. And it will be difficult and potentially impossible to recover more for that same work, because there will be a standard release involved. And to the extent that there are subcontractor costs and schedule, it’s always preferable to deal with those issues upfront, particularly when the sub is raising their hand and saying, Hey, this doesn’t cover my needs.

Tom Temin Right. And don’t assume that, because the government has greatly modified the terms of work that you can get away with a gigantic price increase, if in reality it’s only a fourth of what you thought it might be.

Dan Ramish That’s true. The board pointed out here that the initial proposal from the prime contractor was more than $800,000, $900,000, and their ultimate cost were only $300,000. So there was a big drop off between what the prime originally said it was going to cost extra to perform the changes in the work and what they ultimately incurred.

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