Construction Law

The Government Owes a Duty of Good Faith in Exercising its Contract Termination Rights:

By John P. Ahlers

Moreland Corp. ("Moreland") contracted with the Department of Veterans Affairs ("V.A.") to design and construct a two-story medical clinic in Las Vegas, Nevada under a fifteen (15) year lease-back agreement. The V.A. took occupancy of the building in 1997. Five years later, the V.A. terminated the lease for default, claiming the building was unsafe for occupancy and that Moreland had failed to repair structural defects in a timely manner. The V.A. identified three (3) problems at the time of the default: (1) missing gusset plate welds on the second floor lateral bracing; (2) exterior cracking on pre-cast panels and on architectural covers around the steel columns; and (3) under design of the structural steel columns. The V.A. contended the building was not in compliance with building codes. Regardless, the V.A. continued to occupy the building and pay rent for nine (9) months after the default termination. Thereafter, the V.A. moved to another facility, a year later Moreland lost the building in foreclosure. In its wrongful termination action, Moreland sought to recover more than $17 million for unpaid rent on the balance of the lease and $20 million for the asset value of the building lost through foreclosure. The V.A.'s Contracting Officer maintained that the default termination, if improper, converted to a termination for convenience and thus denied Moreland's claim for unpaid rent.

The Court of Federal Claims reviewed the default termination and found in favor of the contractor on its claim for the balance of the rent, plus interest. The court ruled that the default termination by the government was improper. It concluded the defects were largely cosmetic and easily could have been repaired if the V.A. had permitted Moreland to do so. It held that the building was safe to occupy during the repairs and the V.A.'s refusal to allow repairs breached the lease. Terming the government's conduct in its administration of the lease as "deplorable by any measure," the court held that even if the contractor had been in technical default, the V.A.'s bad faith compels the court to overturn the termination for default." The court invited Moreland to apply for attorneys' fees under the Equal Access to Justice Act. The V.A. breached it covenant of good faith and fair dealing implied into every contract, including Government contracts." The court found two instances of bad faith by the V.A., the first was when the Contracting Officer denied two claims for added labor costs during construction, even though he believed they were meritorious and was prepared to grant nearly $300,000 in changes for them. The Contracting Officer denied the claims on advice of the V.A.'s legal counsel, "so the agency would have greater leverage in negotiating other claims."

Noting that government contractors are required to submit accurate and complete claims, the court held that the government has a reciprocal obligation to act in good faith. The court held that the outright denial of meritorious claims to obtain bargaining advantage over a contractor "will not be condoned by this Court" The second act of bad faith related to the V.A's need to install an auxiliary HVAC system on the roof, not part of the contract specifications. The V.A. demanded that Moreland conduct a structural loading study at no cost to the V.A. and justified its request with a two page report in which a V.A. engineer claimed there were many structural deficiencies in the building. Moreland declined to perform the study after consulting with the project's architect and engineer.

Finally, the court found that the V.A. report was used as a pretext to shift the cost of the structural study to Moreland and gave no credence to it because of the V.A.'s ulterior motive in having it prepared. The court awarded Moreland $17,673,850, plus interest and $438,188 in attorneys' fees under the Equal Access to Justice Act.

Moreland Corp. v. United States, 76 Fed.Cl. 268 (2007)

Full post as published by Construction Law Blog on January 13, 2010 (boomark / email).