For any government contractor that has had a differing site condition claim denied despite relying on a government geotechnical report about the subsurface conditions of the project site, the U.S. Court of Appeals for the Federal Circuit finally has recognized your frustration. In its recent decision, Metcalf Construction Company, Inc. v. United States, 742 F.3d 984 (Fed. Cir. 2014), the Federal Circuit rejected the government’s contention, as accepted by the U.S. Court of Federal Claims, that broad disclaimer language in a request for proposals (RFP) and contract negated a contractor’s reliance on a government soils report and caused the contractor to bear all risk for any errors in the report.

The Federal Circuit’s decision provides a major victory for contractors, especially design-builders that must perform additional site investigations and design work after contract award. In these cases, the government has increasingly asserted that the contractors are assuming all risk about site conditions based on their post-award investigative and design responsibilities and, therefore, cannot rely upon initial government reports. The decision also clarifies that claims for breach of the implied duty of good faith and fair dealing do not require contractors to prove the government specifically targeted their contracts to reappropriate the benefits they expected to receive. This is another victory for contractors, as it should give them a better chance to prove breach of good faith and fair dealing claims that previously have been denied under an incorrect standard.

As background, the U.S. Navy awarded Metcalf Construction a contract in 2002 worth about $50 million to design and build hundreds of housing units at Marine Corp Base Hawaii. The RFP cited a government-commissioned report that found the soil at the construction site had slight expansion potential, meaning there was only a slight potential the soil could expand when wet – a result that could lead to voids in the soil that might cause cracks in concrete foundations and other damage. The RFP, however, said the government’s soils report was for preliminary information only, and the contract required the winning contractor to conduct an independent soil investigation after award.

Nevertheless, prior to bid submissions, the Navy clarified that the contractor could amend the contract by change order if its independent soil investigation revealed a major disparity with the government’s soils report. The RFP also incorporated Federal Acquisition Regulation (FAR) 52.236-2, Differing Site Conditions, which governs a contractor’s right to obtain an equitable adjustment if it encounters conditions at a site that differ materially from those conditions (1) indicated in the contract or (2) ordinarily encountered in the type of work provided for in the contract.

Following award, Geolabs, Inc. conducted an independent soil investigation for Metcalf, which revealed the soil had moderate to high – and not just slight – expansion potential. Metcalf immediately notified the Navy about this differing site condition and insisted on following Geolabs’ recommended design changes to address the discrepancy. The Navy, however, insisted that Metcalf follow the contract’s construction requirements, claiming the expansion potential assessments in the two reports were not materially different. After the project was delayed almost a year by these discussions, Metcalf decided it was too risky to wait any longer for the Navy to approve the Geolab design changes. Thus, Metcalf implemented the changes, despite being aware of the danger in proceeding, possibly as a volunteer, without an approved contract modification.

Metcalf ultimately incurred more than $4.8 million in additional costs to address the expansive soil problem. Metcalf filed a claim with the Navy’s contracting officer for these and other damages, arguing that the Navy had materially breached the contract and the implied duty of good faith and fair dealing under the contract. After the contracting officer denied the claim, Metcalf filed suit in the U.S. Court of Federal Claims (trial court), and the Navy counterclaimed for liquidated damages due to Metcalf’s delayed performance. The trial court found that Metcalf was not entitled to damages for its differing site condition claim, the Navy had not breached its implied duty of good faith and fair dealing under the contract, and the Navy was entitled to about $2.6 million in liquidated damages.

Metcalf appealed, arguing that the trial court applied the wrong legal standard to its good faith and fair dealing claim and misinterpreted the contract’s provisions governing its differing site condition claim. The Federal Circuit agreed and vacated the trial court’s decision. In doing so, the Federal Circuit provided two important areas of guidance for Metcalf and all government contractors – the first concerning the government’s use of broad disclaimer language regarding site condition reports as a basis to deny contractors’ differing site condition claims, and the second concerning the standard contractors must meet to prove breach of good faith and fair dealing claims against the government.

With respect to Metcalf’s breach of good faith and fair dealing claim, the Federal Circuit rejected the trial court’s decision that Metcalf had to prove the Navy “specifically designed to reappropriate the benefits [Metcalf] expected to obtain from the transaction, thereby abrogating the [Navy’s] obligations under the contract.” Metcalf, 742 F.3d at 992. The Federal Circuit also disagreed with the trial court’s conclusion that “incompetence and/or the failure to cooperate or accommodate a contractor’s request do not trigger the duty of good faith and fair dealing, unless the Government ‘specifically targeted’ action to obtain ‘the benefit of the contract’ or where Government actions were ‘undertaken for the purpose of delaying or hampering performance of the contract.’” Id.

The trial court had relied on a recent good faith and fair dealing case, Precision Pine & Timber, Inc. v. United States, 596 F.3d 817 (Fed. Cir. 2010), in which the Federal Circuit found that the government may be liable when its actions specifically target a contract to reappropriate benefits the contractor expected to receive. The Federal Circuit, however, noted that the Precision Pine opinion said the government may be liable (not the government is only liable) if the contractor proves that such specific targeting occurred. Thus, the Federal Circuit clarified that contractors are not required to prove the government specifically targeted them – an onerous and incorrect standard that agencies, such as the Navy, had embraced as a basis to deny good faith and fair dealing claims. Instead, general contract principles control, i.e., a contracting party may not interfere with the other party’s performance and may not act in a way that destroys the reasonable expectations of the other party. The Federal Circuit then remanded the case for the trial court to reconsider Metcalf’s good faith and fair dealing claim under the correct legal standard – one that is more favorable to contractors than the “specifically targeted” legal standard.

After establishing the correct legal standard, the Federal Circuit analyzed the underlying contract provisions that formed the basis of Metcalf’s breach of good faith and fair dealing claim. In particular, the Federal Circuit disagreed with the trial court’s interpretation of how risk was to be allocated if Metcalf encountered site conditions that differed materially from those indicated in the contract. The trial court determined the representations in the government’s soils report were nullified by (1) the RFP provision that said the report was for preliminary information only and (2) the contract requirement that Metcalf conduct an independent soil investigation after award. The trial court found that a reasonable contractor reading the contract documents as a whole would not interpret them as making a representation about site conditions and Metcalf was, therefore, on notice that it could not rely on the “for preliminary information only” report. The trial court also said Metcalf was entitled to rely on the report for bidding purposes only; not for performing the contract. Thus, the trial court treated the contract as placing the risk on Metcalf for dealing with differing site conditions.

The Federal Circuit rejected these conclusions, finding that nothing in the contract documents regarding Metcalf’s obligation to conduct a soil investigation after award warned Metcalf that it (1) could not rely on the government’s representations about soil conditions and (2) bore the risk of any error in the report. Instead, the Federal Circuit found the “natural meaning of the representations was that, while Metcalf would investigate conditions once the work began, it did not bear the risk of significant errors in the pre-contract assertions by the government about subsurface site conditions.” Metcalf, 742 F.3d at 996. Importantly, the Federal Circuit also found the “for preliminary information only” language in the soils report could not be interpreted to mean that Metcalf bore the risk if the preliminary information turned out to be inaccurate. Rather, the language only meant that the information in the soils report might change because it was, after all, preliminary.

Furthermore, the Federal Circuit found that FAR 52-236-2, as often incorporated into government contracts, exists precisely to take some of the risk about subsurface conditions out of bidding. Instead of requiring contractors to submit high bids to ensure against the risk that the pre-bid information may contain errors, the FAR provision allows parties to deal with actual subsurface conditions after work begins and more accurate information about the conditions is discovered.

The Federal Circuit’s decision in Metcalf is a victory for contractors, especially design-builders, and should make it easier for them to prevail on differing site condition and breach of good faith and fair dealing claims against the government.