Government Contract: How Can a Subcontractor Get Paid?

by Pepper Hamilton LLP

G4S Technology LLC v. US, 779 F.3d 1337 (Fed. Cir. 2015) –

A subcontractor worked on construction of wireless broadband networks for rural communities that was funded in part by a loan to the prime contractor from a US agency. After the prime contractor filed bankruptcy, the subcontractor sued the US seeking to get paid as a third-party beneficiary of the loan agreement. The Court of Federal Claims held that the subcontractor was not a third-party beneficiary, so it appealed to the Federal Circuit.

The Department of Agriculture’s Rural Utility Service (RUS) agreed to provide a $267 million loan to the prime contractor (Open Range) to finance construction in 540 RUS approved markets. Open Range also obtained $97M venture capital financing. Under the loan agreement:

  • Open Range was required to keep a pledged deposit account (PDA) to receive advances from RUS.
  • In connection with requests for advances, Open Range submitted a financial requirement statement (FRS) that outlined the purpose of the advance and included relevant invoices and purchase orders.
  • The parties contemplated that Open Range would implement the project using subcontractors. Relationships with subcontractors were documented in a master service agreement (MSA) between Open Range and a subcontractor, which included technical specifications, pricing information, target completion dates, and other information.
  • RUS reviewed and approved a generic form of MSA. Open Range and the subcontractor (G4S) executed an MSA.

The project ran into trouble when the Federal Communications Commission (FCC) suspended a spectrum permit issued to the company that licensed spectrum rights to Open Range. This meant that Open Range lost the rights necessary to operate the broadband network. RUS gave Open Range a notice that it would terminate further funding unless it could obtain replacement rights.

After the subcontractors became concerned about the project, RUS took various steps to reassure the subcontractors. RUS made money available and issued various public letters indicating that it would continue funding the project, although the scope would be downsized. Consistent with its public announcements, a loan amendment was executed decreasing the loan to $180M and downsizing the project to 160 markets.

Open Range was also required to obtain additional equity investment, which was conditioned on the loan modification and advancement of sufficient funds by RUS to pay for work designated in certain schedules. G4S’s invoices were included in the lists. Although Open Range paid $2.7M to G4S, that was not the full amount owed.

After Open Range filed bankruptcy, G4S filed a lawsuit against the federal government for payment, claiming that it was a third-party beneficiary of the RUS loan agreement. Procedurally the lower court recharacterized the government’s motion to dismiss as a motion for summary judgment, and held that G4S was not a third-party beneficiary.

On appeal to the Federal Circuit, the court began by restating black letter law: “’A nonparty becomes legally entitled to a benefit promised in a contract… only if the contracting parties so intend.’” In the context of a government contract “This intent may be either ‘express or implied,’ and it must be ‘fairly attributable to the contracting officer.’” Case law further indicates that the benefit must be directly to the third party and not just incidental.

In this case there was no express intent, so G4S had to rely on circumstantial evidence. In evaluating the evidence offered by G4S, there was a continuing theme in the court’s opinion to the effect that the government has a responsibility to “safeguard taxpayer funds and advance the public interest” – which was offered as an alternate explanation for procedures intended to allow oversight of how funds were spent.

G4S relied heavily on the procedure that required deposit of advances into the pledged deposit account in accordance with requests that indicated the purpose and included supporting materials that identified specific approved work by subcontractors. The court’s response was that the PDA was a general fund that assisted in review and approval of costs, and did not guarantee payment to subcontractors. Just because specific subcontractor work was identified in the request did not in the court’s view demonstrate that RUS intended to be liable to the subcontractors.

In addition, the court characterized G4S as benefiting only indirectly, since RUS always paid Open Range. The court contrasted this to cases where the prime contractor and subcontractor were joint payees, or where payments were held in escrow for the third-party subcontractor.

Further, the court viewed a pledged deposit account as a standard procedure that it interpreted as assisting the government in meeting its responsibilities. Similarly, the master service agreements were part of the government’s oversight consistent with its general duty to protect the public interest.

With respect to RUS statements intended to reassure the subcontractors, the court characterized these as merely rebuilding the credibility of Open Range, who in turn was responsible to the subcontractors, as opposed to showing an intent to have any obligation directly to subcontractors.

Since (1) there was no direct guarantee, (2) RUS did not pay G4S itself, (3) there were no special payment arrangements, and (4) there were no direct communications with G4S, the court concluded that RUS was merely attempting to make sure that the investment of public funds was not wasted:

If G4S were to prevail here, almost any subcontractor over which the government exerts meaningful oversight and whose work is funded indirectly by the government would be a third-party beneficiary of the government’s contract with the prime contractor. That cannot be so.

Consequently, the court agreed that G4S was not a third-party beneficiary of the RUS/Open Range loan agreement.

As suggested in the dissenting opinion, the majority opinion appears to take an overly rigid approach in its analysis of whether G4S was entitled to payment by RUS. In this case the government went out of its way to induce subcontractors to continue working by leading them to believe that they would get paid. In the view of the dissenting judge, this meant that the court should have explored the equities of the case and considered, for example, whether RUS violated its duty of good faith and fair dealing.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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