Construction Law Blog

The Washington State Supreme Court recently issued an opinion regarding courts' scope of review of arbitration decisions.  This case shows how difficult it is to overturn an arbitration decision.[i] 

A Port of Seattle ("Port") supervisor noticed a rope hanging from a ladder and asked an employee to take it down.  Instead, as a joke aimed at the supervisor, the employee thought it would be funny to tie the rope into a hangman's noose and hang it from the ladder.  Not surprisingly, the noose was not viewed as humorous by at least one of his minority co-workers.  That co-worker made a complaint and the Port fired the amateur knot-maker for violating the Port's zero-tolerance anti-harassment policy.  The employee was a member of the International Union of Operating Engineers, Local 268 ("Union").  The Union challenged the employee's termination.  The case proceeded to arbitration, per a collective bargaining agreement.

The arbitrator found that the knot-maker violated the Port's anti-harassment policy, but that he should not have been terminated because he was "more clueless than racist," and the employee's noose-on-a-ladder prank was "not racial" in nature.  The arbitrator considered the employee's twelve year history as a Port employee with no performance problems, and his history in the Navy - where he often played with rope and tied nooses to pass time - and decided that the employee should be suspended for 20-days without pay, rather than be fired. 

The Port appealed the arbitrator's decision and a King County Superior Court judge concluded that the arbitrator's decision was too lenient and violated the public policy against workplace harassment.  The King County judge then imposed a six-month unpaid suspension, and ordered the employee to make a sincere written apology, to attend diversity and anti-harassment training, and to be subject to four years of probation with a second harassment violation resulting in termination.

The Union appealed and the Court of Appeals affirmed the King County judge's ruling to vacate the arbitrator's decision, but held that the reviewing trial court could not create its own judgment.  The Union then appealed again and the Washington State Supreme Court accepted review.  The Supreme Court noted that its review was limited to whether the arbitrator exceeded his or her authority because further review "would weaken the value of bargained for, binding arbitration and could damage the freedom of contract," but that arbitration awards can be vacated if they violate "explicit, well defined, and dominant public policy." [ii]  The Court found that the policy against workplace harassment and discrimination was explicit, well defined, and dominant so it had authority to review and vacate the arbitrator's decision if the punishment was too lenient to not deter future discrimination.

The Court reiterated that its review was limited, and that it was bound by the arbitrator's findings of fact, which included the employee's non-racial understanding of the symbolism of the noose (he believed it related to "cowboys and Indians"), and the effect of the noose on other employees in the workplace.  Based on this limited scope of review and despite the employee's unacceptable and ignorant actions, the Court held that a 20-day unpaid suspension could "provide sufficient discipline to cause this or other employees to understand the serious nature of a noose in the workplace and thus prevent a similar incident in the future."[iii]  Thus, the Court held, the arbitrator's decision was not so lenient that it violated the public policy against workplace harassment and discrimination.

Lastly, the Court reiterated that a trial court reviewing an arbitration award has the authority to vacate the award, but that it does not have the authority to fashion its own remedy.  Instead, trial courts should remand to the arbitrator for further proceedings.

Comment:  Construction contracts often employ arbitration as the dispute resolution mechanism.  Although this case does not involve construction contractors, it does provide some insight into Washington courts' scope of review of arbitration awards and how difficult it is to vacate an award.  Even with these bizarre facts regarding the noose and the employee's questionable understanding of what the noose suggested, the Supreme Court did not find that the arbitrator's decision to suspend the employee for 20-days was so lenient that it violated the public policy against workplace harassment and discrimination.  This case demonstrates the finality of an arbitrator's decision such that parties subject to arbitration proceed knowing that it is extremely difficult to vacate an arbitrator's decision.

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[i] Int’l Union of Operating Engineers, Local 286 v. Port of Seattle, 296 P.3d 736, 117 Fair Empl. Prac. Cas. (BNA) 834 (2013).

[ii] Id. at 740 (quoting Kitsap County Deputy Sheriff’s Guild, 167 Wn.2d 428, 435, 219 P.3d 675 (2009)).

[iii] Id. at 742.

Lately, competition for public works projects is fierce, and bidders, using every possible advantage to obtain contracting opportunities, seem resigned to combing through a low bid to determine if "all I's are dotted and T's are crossed."  As part of this process, the Disadvantaged Business Enterprise ("DBE") compliance requirements have turned out to be a fertile ground for bid protests, particularly on federally funded state highway projects.  The DBE program provides a vehicle for woman and minority-owned, small businesses to participate in public projects.  As part of this program, contractors on federal public contracts are required to meet certain DBE subcontracting goals (for example, 12% of the total bid amount must be subcontracted to certified woman or minority-owned firms).  The requirements for demonstrating DBE participation, however, can be complicated and fraught with pitfalls for both DBEs and contractors alike.  Failure to comply with the DBE bidding requirements to the letter is a common basis for finding a bid non-responsive, and, thus, provides numerous bidders with a basis to protest, including (i) questioning a prime contractor's achievement of the project's DBE goal or good faith efforts to meet that goal, (ii) the legitimacy or certification of a listed DBE entity, or (iii) a DBE's ability to perform a Commercially Useful Function on a project.  

For example, a general contractor who submitted a bid which came in "second," may challenge award of the project to the apparent low bidder on the basis that the DBE firm that the low bidder proposes to use is either not properly certified to perform the work proposed or is not a legitimate DBE firm.  Such protests provide a lucrative opportunity for the second low bidder who may ultimately be awarded the project.   The following information explains some of the fundamentals to consider when assessing compliance with DBE bidding requirements:

Commercially Useful Function:  When a DBE participates in a contract, only the portion of the work that serves a "commercially useful function" on the contract may be counted towards the contractor's DBE goal.  49 C.F.R. §26.55(c).  A "commercially useful function" is defined in the Special Provisions of the Project Specifications as:

The execution of the work of the Contract by a DBE carrying out its responsibilities by actually performing, managing, and supervising the work involved using its own employees and equipment.  The DBE shall be responsible, with respect to materials and supplies used on the Contract, for negotiating price, determining quality and quantity, ordering the material, and installing (where applicable) and paying for the material itself. 

See also 49 C.F.R. §26.55(c)(1).  The federal regulations further explain: 

A DBE does not perform or exercise a commercially useful function if its role is limited to that of an extra participant in a transaction, contract, or project through which funds are passed in order to obtain the appearance of DBE participation. 

49 C.F.R. §26.55(c)(3) (emphasis added); See also General Elec. Co. v. County of Cook, 2001 WL 417321 (N.D. Illinois, 2001) (asserting a pass-through role does not serve a commercially useful function).   Most commonly, protests that involve a lack of a commercially useful function revolve around whether a DBE is simply purchasing materials for the project for which it is not responsible. 

For example, often in large federal projects, the government will require the purchase of a certain item or certain materials from a single supplier.  With respect to obtaining materials, however, to obtain DBE credit for the purchase, the DBE must perform all four functions identified in CFR section 26.55(c)(1): (1) negotiate price; (2) determine quality and quantity; (3) order the material; and (4) pay for the material itself. If the DBE does not perform all four of these functions, it has not performed a commercially useful function with respect to obtaining the materials, and the cost of the materials ccould not be counted toward DBE goals.  Thus, in the case of sole source items or "furnish and install" contracts, often if the DBE has no say in price or the quantity/quality of the materials or item, for this purchase, these materials are simply being "passed through" the DBE and the DBE will not receive any credit which can be counted towards the overall goal.  Accordingly, if a bidder improperly counts the purchase price towards its DBE goal, other bidders have a basis to protest award to that bidder.

Appropriate NACIS Codes:   Another protest basis is if the DBE listed by the general contractor is not properly "classified" to perform the intended scope of work.  Under the DBE regulations, DBEs are classified according to the North American Industry Classification (NAICS) code.  In turn, a general contractor can only count a DBE's performance towards its overall goal if the DBE has been assigned the proper NAICS code to perform the type of work in question.  For example, if a DBE is certified to perform only landscaping and site preparation, although it can perform other types of work (e.g., installation of road signs), the general contractor will only receive DBE credit for the landscaping and site preparation portion of that DBE subcontract.  Despite this fact, given the often last minute bid preparation, occasionally a general contractor will list a DBE as receiving credit (i.e., its basis for meeting the DBE goal) for work it is not certified (i.e., lacks the proper NAICS code) to perform.  In Washington, given the strict requirements set forth by the Washington State Department of Transportation ("WSDOT") and WSDOT's new "DBE Written Confirmation Document," this, unfortunately, has become an all too frequent basis for bid protests and rejection of otherwise valid bids.  We detailed the relatively new WSDOT requirements in a previous blog posting and recommend both DBEs and general contractors become well-versed in these requirements so that a protest on this basis can be avoided.  

Failure to Meet the DBE Goal/Failure to Demonstrate Good Faith Efforts:  The DBE goal on a Project is a "Condition of Award," meaning that, to be awarded the Project, each bidder must either (1) meet the stated DBE percentage goal, or (2) if it failed to meet the goal, demonstrate it satisfied the "Good Faith Effort" requirement.   Ultimately, "good faith efforts" require the bidder to demonstrate that it did not fail to meet the goal for lack of trying.  The federal DBE regulations (49 CFR, Part 26, Appendix A) provide a series of factors to determine whether the bidder meets this requirement.  These factors include:

(a)             Soliciting through all reasonable and available means and with sufficient time for the DBEs to respond:  The bidder cannot wait until the last minute to seek DBE bidders;

(b)            Selecting portions of the work which are more likely to be performed by DBEs for DBE participation:  A bidder cannot rely on the fact that it attempted to secure DBE participation when it only solicited DBE participation for the most complicated or obscure scopes of work and no DBE was qualified to perform that work; trucking, site preparation, traffic control are some of the scopes with the highest concentration of DBE subcontractors;

(c)             Providing interested DBEs with adequate information about the plans, specifications, and requirements of the contract in a timely manner to assist them in responding to a solicitation:  This factor prohibits a bidder from relying on form over substance.  For example, simply providing the solicitation on its own without providing other pertinent information  may be insufficient;

(d)            Negotiating in good faith with interested DBEs.  If only a few DBEs submit bids to perform work on the Project, the bidder cannot simply reject the bids without further inquiry and rely on "good faith efforts."  Rather, it is the bidder's responsibility to attempt to reach an agreement or modification of the DBE bid to find mutually agreeable terms; 

(e)             Providing sound reason for rejecting DBEs as unqualified: A bidder is not forced to work with an unqualified DBE just so that the bidder can meet the DBE goal or the good faith effort requirement.  A bidder, however, must demonstrate a legitimate basis to reject the DBE as unqualified;

(f)             Making efforts to assist interested DBEs in obtaining resources or financing that may assist the DBE in performing the work: These factors are more time consuming, but will likely go a long way in demonstrating the bidder attempted to reach the goal in good faith;

(g)            Utilizing local resources for assistance: Often local agencies (e.g., the Office of Minority and Women's Business Enterprises) can assist general contractors in reaching out to or locating qualified DBEs. 

49 CFR, Part 26, Appendix A.  Although the above list is neither exhaustive nor a checklist, it demonstrates what steps agencies and owners will look to in determining if the bidder has made "good faith" efforts to meet the DBE goal.  Another critical component of this analysis is whether other bidders were successful in reaching the DBE goal.  If all other bidders met or exceeded the DBE goal, the low apparent bidder will face a larger obstacle in demonstrating it met its good faith efforts.  Accordingly, it is key for general contractors to establish a DBE "game plan" or strategy to meet the DBE goal and document each step (failed or successful) so that, should the contractor fail to meet the goal, this information and, more important, documentation can be submitted with the bid.  

Improperly Certified/DBE Eligibility:  The most complicated basis for bid protests is whether or not a DBE is properly certified in the first place.  Although in most cases it is not the public agency's duty or role to decertify a DBE firm,[i] it does not stop public agencies from occasionally overstepping their authority and deeming bids non-responsive based on a "determination" that the DBE is not properly certified or has allegedly graduated from the program.  For example, as discussed in a previous blog article, under the similar Service-Disabled Veteran-Owned Small Business Program ("SDVOSB"), the Department of Veterans Affairs ("VA") received a protest on a federal project regarding whether the veteran-owner complied with the SDVOSB requirement that he own 51% of his company and, therefore, was ineligible for award of the Project.   Whether or not the agency awarding the contract possesses the authority to make this decision is another story, but it does not change the fact that in the fast-paced nature of bid protests, public agencies might make determinations that can substantially impact a DBE or other minority program's certification, all of which is at the expense of general contractor who has no control over that DBE. 

The lessons from the above examples are twofold:  First, if you are submitting a bid on a Project with a W/M/DBE project goal, review the goal and documentation requirements carefully and well in advance of the bid opening date.  Regrettably, a simple or careless typo or failure to fully comply with these often complicated requirements can leave your bid vulnerable to protest and may ultimately result in your company losing a lucrative project.  Many of these oversights could have been easily and quickly corrected prior to submitting the bid, but are fatal after-the fact.   Second, if you have submitted a bid but are not the apparent low bidder, review the low bidder's bid submissions carefully, but quickly to confirm they are compliant.  If the low bid is not compliant, there may be an opportunity for a successful protest. 

Finally, regardless of whether you think you have a basis to protest, or if you are the low bidder and someone has submitted a protest, timing is critical.  Depending on the Project, the specifications or related regulations typically include strict time requirements to file a bid protest or a response (in some cases just a few days).  Thus, as soon as there is even a rumor of a protest, it is best to review the notice requirements and get legal counsel involved to ensure that you do not inadvertently waive any rights you might have.  This same advice goes to the DBE entities themselves.  Often, there is a miscommunication regarding the DBE's certification or scope of work, yet the DBE is the last to know.  It is important for both the DBE and the general contractor to work together to try to overcome these protests or bid rejections as well as protect the DBE's certification.

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[i] The Washington State Office of Minority and Women's Business Enterprises ("OMWBE") is the only entity in the state authorized to make decisions with regard to DBE certification status.  RCW 39.19.120 (“[OMWBE] shall be the sole authority to perform certification of minority business enterprises, socially and economically disadvantaged business enterprises, and women's business enterprises throughout the state of Washington.”).

Technological innovation has brought us telecommuting-that is, working remotely from home, a coffee shop or vacation and nevertheless staying connected with the office.  Airports, coffee shops, and restaurants are full of people checking their smart phones and staying in touch with what is going on in their respective business.                                

The issue of whether a telecommuter is actually in charge of his or her business was recently addressed by the Veterans Administration ("VA") in KWV, Inc. v. United States.[i]  A Rhode Island based service-disabled, veteran-owned business ("SDVOSB"), owned by a Korean war veteran who had more than 30 years of experience, was awarded a federal government set-aside for SDVOSB by the VA.  A competitor, likely disappointed that it was not awarded the contract, challenged KWV's SDVOSB status, asserting that the service-disabled veteran did not actually "control" his company within the meaning of 38 CFR §74.4, because the Korean war veteran lived in Florida for part of the year.  The allegation was that the veteran's sons, who were not veterans, worked for the company and actually controlled the company in Rhode Island.

The agency (VA) Office of Small and Disadvantaged Business Utilization ("OSDBU") agreed with the protestor and found that because the service-disabled veteran resided in Florida for part of the year, he could not effectively and sufficiently control the day to day management of KWV.  The OSDBU therefore held that KWV was ineligible for the contract and revoked KWV's SDVOSB status, making it unable to bid on future SDVOSB contracts issued by the VA.  KWV then appealed this decision to the United States Court of Federal Claims, seeking injunctive relief, and prevailed.  The court found that the service-disabled veteran's decision to live in Florida for part of the year did not preclude him from "controlling" KWV within the meaning of 38 CFR §74.4.  The court held that the owner of KWV "employs various electronic means to keep track of the day-to-day business of KWV," and concluded this was an acceptable means of controlling KWV's operations per the requirements of 38 CFR §74.4.  Based on this finding, the court issued a preliminary injunction setting aside the VA's decision to sustain the protest and the court ordered the VA to restore KWV's SDVOSB eligibility.

Comment:  This case is pertinent and relevant for Disadvantaged Business Enterprises (DBEs), as well as MBEs and WBEs.  The VA must now recognize that "control" under 38 CFR §74.4 is not dependent on the owner's physical presence at the office or the project.  Rather, service-disabled veterans can remotely manage the day-to-day affairs of their SDVOSBs, provided they fulfill the other prerequisites regarding control.

This firm represented a DBE in a recent application to the Washington State Office of Minority and Women Business Enterprises (OMWBE).  In our case, the owner of the DBE business lived in California, but remained in control of his Washington business by working remotely and traveling from time to time to the state of Washington.  Initially, the agency challenged the DBE owner that he was not in control of the business because he did not spend full time in the state running the day-to-day affairs of the local enterprise.  The owner of that business was able to successfully demonstrate to the OMWBE that he satisfied the control requirements of 49 CFR §26.71.  This case should provide future DBE/MBE and WBE businesses with precedent that managing the affairs of an enterprise from afar is now recognized as "control" of the business.

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[i] 108 Fed. Cl. 448 (Fed. Cl. 2013).

1.  Bonding and Insurance - There is a Difference.

Although many of the major insurance companies provide both insurance and bonding services, insurance differs drastically from bonding. One of the primary differences between insurance and bonding is that if a carrier pays a loss under an insurance policy, generally the insurance company has no recourse against its own insured (the entity covered by the insurance policy). If an insured submits a claim to its insurance company, if the occurrence is covered (there is always a dispute about this issue), after the insurance company pays an insured (contractor) the contractor owes its insurance company nothing (but perhaps the deductible or Self-Insured Retention (SIR)). By agreement, the insurance company took the risk of the covered occurrence (claim) and thus, must pay when the occurrence arises. Bonding (suretyship), on the other hand, involves an entirely different arrangement. In suretyship, the bonding company (surety) guarantees payment and performance of the contractor.  Only if the contractor defaults (is unable to perform or pay) does the surety step in and complete the performance; the bonding company pays the contractor's obligations. The distinction in bonding, however, is once the surety pays it has a right to recover those payments from its principal (the contractor). The contract between the bonding company and the contractor termed a "General Indemnity Agreement" (GIA) requires that the contractor reimburse the bonding company for the costs the bonding company incurs in curing a contractor's potential default. The GIA generally also obligates the construction company's owners (shareholders) personally.

2.  Bonding Company's Right to Settle Disputes.

A question in bond defaults which often arises is: what obligation does the bonding company have to conduct an investigation to determine whether the contractor in fact is in default before it pays? For example, on a school district project plagued by errors and omissions in the contract drawings, a condition for which the contractor is generally not liable, the contractor may become so overwhelmed by the design changes that it no longer is able to meet its payment and performance obligations. This is particularly true when the owner disputes the changes and the contractor is left to finance the extra work. If under these circumstances the school district places the contractor on notice of default and notifies the bonding company to complete the remaining performance and payment obligations, the question becomes what are the surety's rights in settling that claim. May the surety take the easy way out and simply pay the claim, recovering those funds from the contractor's shareholders (i.e., go after what is left of the shareholders' equity in their home(s)). Alternatively, if the bonding company performs an investigation and determines that the extra costs are due to the contractor's poor bid and not based on the alleged defective contract documents, is the bonding company obligated to support the contractor and risk a potential bad faith claim by the school district?  A bad faith claim is generally not something for which the bonding company could be reimbursed under the GIA.  The decision to settle or not, thus can place the bonding company on the horns of a dilemma.  This issue arose in a recent Washington Court of Appeals case.

3.  Bond Safeguard Ins. Co. v. Wisteria Corporation.[i]

This matter involved a dispute between a timber company-Wisteria Corporation ("Wisteria") and a bonding company-Bond Safeguard Insurance Co. ("Safeguard"). Wisteria contracted with the Washington State Department of Natural Resources ("DNR") to purchase, cut, and remove certain timber. To secure Wisteria's performance, DNR required Wisteria to post payment and performance bonds. Wisteria obtained the bonds from Safeguard. As part of the bond obligation, the shareholders (a husband and wife) of Wisteria signed a GIA, which provided that Wisteria and the shareholders would hold the bonding company harmless if Safeguard was called upon to cure a default in the Wisteria/DNR contract. As with most GIAs, this agreement included a "right to settle" provision:

"The Company" [Safeguard] shall have the exclusive right to determine for itself and the Indemnitors [Wisteria and the shareholders] whether any claim or suit brought against the Company or the Principal [Wisteria] upon any such bond shall be settled or defended and its decision shall be binding and conclusive upon the Indemnitors [Wisteria and its shareholders].

During performance of the timber contract, DNR alleged that Wisteria harvested more trees than DNR had marked. Wisteria countered that DNR had mismarked the trees and contributed to the over harvest (this defense is neither fully explained nor elaborated on in the Court's decision). Eventually, DNR terminated Wisteria's contract and tendered its damages to Safeguard for payment. Safeguard failed to pay DNR for over seven months.  DNR filed a complaint with the Washington Insurance Commissioner and Safeguard's home state (Illinois) insurance regulators. Shortly after the complaint against the Insurance Commissioner was filed, Safeguard paid DNR. After paying DNR, Safeguard then sued the shareholders (husband and wife) of Wisteria for indemnity. Wisteria claimed that Safeguard was not entitled to indemnification because it failed to perform a reasonable investigation and simply paid off DNR to avoid a bad faith action by the Insurance Commissioner. Safeguard urged that Wisteria's defenses "paled in comparison to the overwhelming evidence produced by DNR" and that it did perform a reasonable investigation. Wisteria urged the Court to adopt the legal test that the bonding company has the burden to demonstrate that it acted both in good faith and reasonably in settling with DNR. Safeguard asserted that its only burden was to show that it acted in good faith.

The Court did not decide whether the test involved both good faith and reasonableness or only good faith because the Court determined that Wisteria did not offer sufficient evidence to demonstrate that Safeguard acted either in bad faith or unreasonably.  The record simply did not support Wisteria's position. Thus, the bonding company prevailed and the test to which the bonding company's actions will be held, whether it has to act both in good faith and reasonably or only in good faith, was not determined by the Court.

If the test is that the surety has to act both in good faith and reasonably, that burden would effectively abrogate the bonding company's "right to settle" provision.  Sureties would no longer have the exclusive discretion to settle claims because their settlements would be subject to inquiry by the court at a later date. There is no Washington legal precedent that defines the standards governing the surety's ability to settle a claim and seek reimbursement. This case was not reported, and thus cannot be cited by lawyers in the written submissions to Washington Courts. Regardless, even if reported, this case gave no indication as to whether Washington Courts will require both that the surety act in good faith and reasonably or whether its only burden is to show that it acted reasonably.

Comment:  The impression in this case is that the bonding company simply settled with DNR to avoid a bad faith claim by the insurance commissioner and gave its principals (Indemnitors) no opportunity to defend themselves against the DNR's allegations. Regrettably, the facts in this case are so sparse as to provide little insight as to what might happen were a similar case to arise in the future. There is no dispute that the bonding company must act in good faith when settling. Whether that settlement must also be reasonable, however, is a question for a later court to answer.  Washington Administrative regulations require that insurance companies (bonding companies are insurance companies) promptly investigate and settle claims.  A prompt and thorough investigation by the bonding company will allow the surety to make an informed decision and prevent the type of issues reported in the above case.

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[i] Bond Safeguard Insurance Company v. Wisteria Corporation, 2013 WL 690665 (Wash. Ct. App. Feb. 25, 2013).

A frequent question that arises in federal government contracts and, in some instances, also in state public works contracts is: what is the difference between a "claim" and a "request for equitable adjustment" ("REA")?  There is not a lot of precedent in state law that defines a distinction between "claims" and REAs, thus, federal law provides insights on the differences.[i]

a. "Claim" Defined in FARs.  In federal law, a claim is well defined in FAR §2.101 as:

 "A written demand or written assertion by one of the contracting parties seeking, as a matter of right, the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to the contract. However, a written demand or written assertion by the contractor seeking the payment of money exceeding $100,000 is not a claim under the Contract Disputes Act of 1978 until certified as required by the Act."

As indicated, a claim that exceeds $100,000 must be submitted to the Contracting Officer in a manner that clearly provides the factual, technical and legal basis for an equitable adjustment to the contract.  Whether the claim exceeds $100,000 or not, the best practice is to identify the request as a claim under the Contract Disputes Act of 1978, 41 U.S.C. 601-613, together for a request for a Contracting Officer's Decision (COD).  When those procedural steps have been complied with, the interest clock starts running from the date the claim is submitted.  The term "equitable adjustment" appears in the FARs in 111 places, and the term "request for equitable adjustment" appears in 11 places.  That being said, there is no definition provided for the words "request for equitable adjustment" in the FARs, or anywhere else.  Regardless, an REA is commonly understood to be a request for compensation (of money, time, or both) that falls short of a "claim" in terms of its procedural requirements. 

b.  REA distinguished From Claim.  An REA does not require a certification under the Contract Disputes Act.[ii] There are a number of FAR clauses that allow an equitable adjustment to the contract if the government is responsible for additional costs, or time. The most significant clauses are:

• Variation and Estimated Quantity (VEQ), FAR 52.11-18
• Differing Site Conditions (DSC), FAR 52.236-2
• Suspension of Work (SoW), FAR 52.42.14
• Changes - Fixed Price (Changes), FAR 52.243-1 and
• Termination for Convenience (T for C), FAR 52.249-2

In general terms, an equitable adjustment means that the contractor is entitled to its costs, plus reasonable profit (except for suspensions and profit on uncompleted work with regard to termination for convenience) and overhead.  The additional costs must be allowable, allocable and reasonable.

Another difference between REAs and claims is that, in REAs, claim preparation costs are generally considered part of the contract administration cost and, therefore, compensable.[iii]  Thus, the distinction between a claim and an equitable adjustment is that if the contractor submits the extra work as a "claim," a contractor is entitled to the interest, but not claim preparation costs.  If, however, the extra work is submitted as a request for equitable adjustment, the contractor is entitled to compensation for its claim preparation costs, but not interest. 

Comment:  Interest rates are presently extremely low (1.35% per annum on government claims) as of the posting of this blog.  Claim preparation costs, experts, and attorneys' fees, seem to more than keep up with the rate of inflation, and are generally higher than the statutory interest expected on most construction claims.  Therefore, if an extra work issue arises, the contractor should consider whether it is in its interest to not immediately certify a claim, but instead submit a request for equitable adjustment in which the contractor's claim preparation costs are compensable.  In today's low interest environment, it generally is in the contractor's interest, particularly if it appears that the government will settle a demand for the extra payment to submit the payment as an REA, and, rather than certify it as a claim, forgo the interest but include the claim preparation costs as part of the REA submission. 

Finally, though most of the legal authority in the blog pertains to federal contract claims and requests for equitable adjustment, the same argument can be made in state public works contracts that use the same term "request for equitable adjustment" in various contract provisions.  Since state courts will look to federal courts for precedent if there is no precedent in state court, it is likely that a state court will be persuaded by the same logic that exists in federal contracts on a state public works project.

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[i] This post is based in part on the Federal Construction Contracting Blog (3/26/13), an excellent resource for up to date federal government contracting news and developments.

[ii] REAs submitted to the Department of Defense require the certification found in DFARS 252.243-7002. 

[iii] Build Strong Enterprises, Inc. v. Shannon, 49 F.3d 1541 (Fed Circ. 1995); See also Tip Top Construction, Inc. v. Donahoe, No. 2011-1509,  2012 W.L. 4094851 (Fed Circ. September 19, 2012) (holding a contractor’s consultant costs and attorneys’ fees incurred in negotiations over the price of a change order is an administrative cost compensable by an equitable adjustment). 

In addition to telecommuting, which appears to be a good thing, the technology revolution has some downsides.  For example, the distraction involved with texting while driving.  We can now conduct business from almost anywhere, but there are certain times and locations where checking voice mail or email may present a danger to others.   Thus, the government regulates certain behavior.  According to recent statistics, texting while driving is a major cause of accidents, and has been made illegal in many states, including Washington.  Not to be left behind, through the Federal Acquisition Regulations (FARs), the federal government has joined in prohibiting texting and driving on federal projects.[i]

In accordance with FAR Subpart 23.11, federal government contractors must adopt and enforce a policy which bans employees from texting whenever an employee is: (1) driving a vehicle owned by the company; (2) driving a vehicle owned by the government; or (3) driving a privately owned vehicle when performing any work on behalf of the government.  This requirement, FAR Subpart 23.11, is incorporated into every government contract through FAR 52.223-18.  Specifically, if the value of the subcontract exceeds the "micro-purchase threshold" (presently $3,000), general contractors are required to incorporate ("flow down") this anti-texting provision to all of their subcontractors.

Further, federal contractors, to meet the requirements of FAR 52.223-18, must "conduct initiatives to educate their employees about the danger of texting while driving; these initiatives should be commensurate of the size of the business."  Large government contractors will be expected to engage in some type of training in addition to having a written policy and employee handout which covers this topic.  This anti-texting message can be incorporated into the orientation session for all new employees and updated when conducting periodic ethics training (also required by the government) (see previous Ahlers & Cressman PLLC blog Government Ethics).

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[i] Thank you to the “Federal Contracting Blog” (March 25, 2013) for bringing this issue to our attention. 

Contractors across the nation are increasingly using Building Information Modeling (BIM) technology to test design details through virtual, three-dimensional models. Although it is difficult to define, BIM essentially builds a complex system of databases, which integrates the work of all project team members into a centralized storage vehicle. The project is modeled in the computer and conflicts among mechanical, electrical, plumbing, and structural features are resolved "on paper rather than in the field." The BIM model is "intelligent" in the sense that the objects in the model contain their own physical characteristics, as well as their relationship to other objects.

The benefits of using BIM are numerous. Contractors employ BIM models primarily for clash detection purposes, but also to ensure code compliance, proper sequencing, adequate supply lead time, energy efficiency, and effective cost control measures. BIM is capable of providing more detailed designs and reducing costly mistakes in the field. By allowing the team members to visualize every detail, contractors can discover problems much earlier in the process, decreasing the overall degree of risk that something might go wrong during construction.

More than a mere technology, BIM is a methodology. A basic premise of BIM is collaboration and the successful implementation of BIM necessarily depends upon the cooperation of the project participants. BIM projects allow the parties to collect data, share ideas, and communicate more effectively. If used in this way, BIM has the potential to redefine the relationships between the parties.

In contrast with the collective nature of BIM projects, the American legal system focuses on individual rights and responsibilities. As the construction industry moves forward with more collaborative relationships, legal rights and liabilities will need to be clearly allocated among the parties. Some of the most important legal issues are:

• Data Loss, Corruption, or Manipulation: Computers are inherently susceptible to data loss, corruption, and manipulation. The risks involved are significant because even a small data loss or minor mistakes can result in significant design errors. Thus, appropriate data protection and backup strategies are essential. The parties in a BIM project should specify who is responsible for the integrity of the data, how the changes in the data will be tracked, and what additional steps will be taken to ensure accuracy in the data.

• Design Defects: Due to the high degree of collaboration, one of the greatest risks for contractors in BIM projects is the unintended assumption of responsibility for design defects. Under the Spearin Doctrine, owners warrant the adequacy of plans and specifications that they require contractors to follow, and thus a contractor will not be liable for damages resulting from a defect in those designs. In a BIM project, the owner is not necessarily in charge of the creation and modification of the data that forms the BIM model. Therefore, contractors should be cautious that the collaborative process during the design phase does not deprive them of implied warranty protection if the designs contain errors.

• Intellectual Property: Designers, in particular, have long been concerned with the improper use of their concepts and ideas. Copyright law alleviates some of these concerns by protecting the design professional's expression of ideas, but a complete BIM model is the result of a collaborative effort. No single party can claim "originality" for the end product. Therefore, early in the contracting process, the parties should reach an understanding of who will own the BIM model, and whether anyone is entitled to licensing and access rights.

Today, two-dimensional drawings continue to serve as the contract documents. The construction industry really has not changed how risks get allocated in BIM projects. But as technology continues to advance, it is likely that BIM models will become far more important during the contracting process. Several industry groups have already developed contract documents that specifically address the concerns raised by BIM technology:

• Associated General Contractors: providing a detailed examination of specific aspects of a BIM project, focusing on how the data is exchanged and used. It allows parties flexibility by requiring fill-in-the-blank responses to a variety of hardware, software, and application issues. It expressly reserves access rights for certain parties to ensure that copyright-protected information can be safely shared.

• American Institute of Architects: The AIA's Digital Data Protocol Exhibit focus on the functional aspects of communication, utilizing an open-ended matrix that defines how information will be exchanged, what formats are to be used, and the permitted uses of the information. The Digital Data Licensing Agreement expressly addresses the use of protected intellectual property through licensing provisions. Together, these documents were designed to be comprehensive and usable BIM forms.

• Current Engineers Joint Contract Documents Committee: Section 3.06 of EJCDC Document 700 takes the most conservative approach. Reflecting an underlying concern with the inherent reliability of electronic data, it states that the contractor may only rely on printed copies of the electronic files and requires the party receiving any electronic information to test the data to detect errors. The form does not provide any specific protection of the electronically stored intellectual property.

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Sources:

• Lee Fehrenbacher, BIM's big question: Who's legally liable?, Daily Journal of Commerce - Oregon, December 14, 2012.
• Harvey M. Bernstein & Stephen A. Jones, New Research Shows Contractors Are Big BIM Users, Engineering News-Record, November, 28, 2012.
• Dmitri Alferieff, Blazing the BIM Trail, Constructor Magazine, January/February 2013.
• Lonny Simonian, Legal Considerations Associated with Building Information Modeling, http://www.caed.calpoly.edu/pdci/research-projects/simonian-10.html (last visited Feb. 25, 2013).

This is the first in a multi-post analysis regarding tax saving opportunities available in Washington to "Speculative Builders."  Prior to the economic downturn, the Seattle office of a large accounting firm promoted tax saving opportunities on Washington projects though formation of joint ventures structured to appear as a "Speculative Builder," a single entity with both the developer and construction contractor as members.  The objective was to avoid B&O Tax and Washington State Sales Tax on the portion of the construction "self-performed" by the Speculative Builder entity.  Under this program, a project specific entity was created with the developer entity holding a significant percentage interest and the construction contractor holding a small membership percentage in the entity.  This became the "Speculative Builder" entity. 

Not surprisingly, the Department of Revenue ("DOR") took the position that the Speculative Builder tax exemption was being abused, and as would be expected when tax revenue declined due to the economic downturn, challenged many of these structures.  This has resulted in tightened requirements that must be met in order to qualify as a Speculative Builder. 

This post explains what a Speculative Builder is, while subsequent articles will address steps the Washington legislature has taken to narrow the availability of speculative builder tax treatment and our analysis of the structure and terms that will be required in order to pass DOR scrutiny.

What is a Speculative Builder?

WAC 458-20-170 provides an exemption for Washington State Sales Tax and B&O Tax on a Speculative Builder's self-performed work, profit and overhead.  Key provisions of the code definition of a Speculative Builder follow:

      (2) Speculative builders.

      (a) As used herein the term "speculative builder" means one who constructs buildings for sale or rental upon real estate owned by him.  

* * *

      (e) Speculative builders must pay sales tax upon all materials purchased by them and on all charges made by their subcontractors.

* * *

      (f) Persons, including corporations, partnerships, sole proprietorships, and joint ventures, among others, who perform construction upon land owned by their corporate officers, shareholders, partners, owners, co-ventures, etc., are constructing upon land owned by others and are taxable as sellers under this rule, not as "speculative builders."

A person who constructs buildings for sale or rental on real estate owed by that person is a Speculative Builder.  WAC 458-20-170(2)(a).  Speculative Builders are the consumers of the materials and construction services they purchase.  WAC 458-20-170(2)(c).  While a Speculative Builder must pay sales tax on all materials purchased and all charges by subcontractors, it does not have to pay sales or use tax on its own labor and overhead.  The following diagrams illustrate this:

Traditional Owner-Contractor Transaction:

Owner Pays Retail Sales Tax on

Full Contract Value

↓ 

General Contractor Pays B&O Tax on

Full Contract Value

↓ 

Subcontractors and Suppliers

Speculative Builder Transaction:

Owner/Contractor

[No sales or use tax on its own labor or overhead]

 ↓ 

Subcontractors and Suppliers

[Sales tax is paid on all charges by Subcontractors and Suppliers]

If a Speculative Builder self-performs significant aspects of a project - concrete and steel for example - the tax savings on this self-performed scope can be significant and give a competitive advantage. The key is that the contractor is part of the owner entity, not a construction contractor to the owner entity.

The next article on this topic will explore RCW 82.32.655, enacted by the legislature effective May 1, 2010, known as the "tax avoidance" statute, which has significantly narrowed the ownership structure that DOR will deem to qualify as a Speculative Builder.

In January 2011, USDOT issued a new rule which made several significant changes to the DBE program, including (a) an increase to the Personal Net Worth limit (from $750,000 to $1.32 million) and (b) providing an avenue for interstate certification.  These two changes, both of which provided for increased certification opportunities for potential DBEs, were the subject of previous blogs. (here and here).  On September 6, 2012, USDOT issued a Notice of Proposed Rulemaking (NPRM) that proposes a series of new, more technical changes that will likely decrease certification opportunities and increase the burden on previously certified firms.  Comments to the USDOT proposed rule must be received by November 5, 2012.  Given the implications of these rules, we encourage your comments to these rules and have provided more information on how to do so below.  We have also prepared our own comments to the rule, if you would like assistance in submitting your own or would like us to include your comments in ours, please let us know. 

The following is a summary of the most significant proposed changes:

Rebuttal of Economic Disadvantage: The most troubling proposed revision is USDOT's desire to broaden the areas which automatically rebut a presumption of disadvantage.  Currently, a Personal Net Worth ("PNW") exceeding $1.32 million automatically rebuts the presumption of economic disadvantage, but the Office of Minority and Women Business Enterprises ("OMWBE") may rebut the presumption if it has a "reasonable basis to believe the individual is not socially or economically disadvantaged."  USDOT proposes including, as part of that rule, a second statement taken from USDOT's guidance (which is currently not an official mandate):

If the person demonstrates an ability to accumulate substantial wealth, has unlimited growth potential, or has not experienced or has not had to overcome impediments to obtaining access to financing, markets, and resources, the individual's presumption of economic disadvantage is rebutted, even if it individual's PNW is less than $1.32 million.

USDOT states that with this language, it is appropriate for recipients (certifying agencies such as OMWBE) to review the total fair market value of the individual's assets and determine if that level appears to be "substantial" and indicates an ability to accumulate substantial wealth.  The purported purpose of this provision is to give recipients a tool to exclude an individual who, in overall asset terms, is what a reasonable person would consider to be a wealthy individual, even if their liabilities bring their PNW below the $1.32 million cap.  Notably, USDOT also seeks comment as to whether a more bright-line approach would be preferable, such as saying that someone whose Adjusted Gross Income on his or her Federal income tax return was over $1 million for two or three years in a row would lose the presumption of economic disadvantage regardless of PNW.

Although we disagree that there should be an avenue to rebut the presumption of economic disadvantage at all (why have a PNW cap if it can easily be disregarded), if USDOT is including the provision, the bright line approach is the only reasonable approach.  Simply mandating the vague guidance language (above), which recipients have already been enforcing, has and will continue to produce arbitrary results, allow recipients to bar applicants with impunity, and provide no objective basis to check overzealous administrator's personal biases.  Specifically, the above guidance leaves the fate of DBE certification to subjective interpretation, forcing DBEs to guess at what the recipient will consider "an ability to accumulate substantial wealth" or what constitutes an impediment to obtaining financing.  Moreover, this "standard," which will vary among states and even among administrators in a recipient's office, authorizes and encourages arbitrary enforcement. For example, should the State of Washington's OMWBE feel a $1,000,000 house with a $900,000 mortgage be enough to constitute "substantial" resources there is nothing prohibiting the State of Oregon or Idaho from enforcing a different standard.  

New Personal Net Worth Form: USDOT proposes a newly designed PNW statement required of all applicants.  The new form would include all assets owned by the individual, including ownership interests, personal assets, and the value of the personal residence.  This revision is a welcome change.  Currently OMWBE uses the Small Business Administration's ("SBA") Personal Financial Statement.  This form can be confusing and does not account for the specific PNW calculation rules.  For example, under the DBE rules, an individual's PNW does not include his or her personal residence or ownership interest in the applicant firm.  The SBA form, however, provides no instruction as to where to include this information, if at all. Without instruction, the various methods applicants use to fill out the form can potentially cause misunderstandings during the application review process.   A copy of the revised form can be found here.  USDOT also seeks comment on whether the spouse of an applicant owner should have to file a PNW statement, again an overly intrusive and irrelevant requirement in our view. 

Transfers:  USDOT proposes to directly add a paragraph into the regulation restating the requirement (currently in Appendix E) that assets transferred to an immediate family member for less than fair market value within the last two years can be counted toward an individual's PNW calculation.  USDOT also proposes that transfers from business owners to the companies be counted toward the owner's PNW to avoid artificially depressing that owner's PNW. This represents a positive change aimed at reducing fraud in the program.

Certification Related Provisions:  USDOT also proposes several changes to how ownership and control are determined.  Specifically, the rule will require applicants to submit additional proof as to the sufficiency of their initial capital contribution and the circumstances of any funding streams to the firm since its inception, including collateral value, proof of asset ownership, and more stringent guidelines relating to deposits made by the applicant. 

Good Faith Efforts:  USDOT adds some clarification for establishing Good Faith Efforts to meet the DBE goal.  USDOT states that prime contractor bidders whose bid includes a promise to include DBEs after the contract awarded is not to be considered as a good faith effort. USDOT proposes that bidders would have two options: (1) bidders may submit Good Faith Effort documentation along with original bids, or (2) Bidders may submit good faith documentation within one day of being notified of their winning bid.  USDOT also provides examples of Good Faith Efforts to Appendix A. 

Counting Trucking Operations:  In one of the only areas favorable to DBE firms, USDOT proposes to revise the current requirements for how much of a DBE trucking company's involvement can be counted towards a DBE goal. The proposal would give credit to a DBE that leases trucks from non-DBE entities but uses its own employees as drivers.  This "change" is already implemented in many states.

We are currently drafting comments to USDOT's proposed rules.  Should you wish to submit a comment of your own, you may submit comments (identified by the agency name and DOT Docket ID Number OST-2012-0147) by any of the following methods:

- Federal Rulemaking Portal: Go to www.regulations.gov and follow the online instructions for submitting comments.

 - Mail: Docket Management Facility: U.S. Department of Transportation, 1200 New Jersey Avenue SE., West Building Ground Floor, Room W12-140, Washington, DC 20590-0001.

 - Hand Delivery or Courier: West Building Ground Floor, Room W12-140, 1200 New Jersey Avenue SE., Washington, DC 20590-0001 between 9 a.m. and 5 p.m. ET, Monday through Friday, except Federal holidays.

 - Fax: 202-493-2251.

Please note that all comments received will become part of the docket and will be posted without change to www.regulations.gov including any personal information provided and will be available to internet users.

Dear WBE, MBE, and DBE Contractors,

Approximately every three years, the Office of Minority and Women's Business Enterprises ("OMWBE") reevaluates your certification and issues a letter hopefully congratulating you on your renewed certification. While this OMWBE letter generally means you can continue going about your business as usual, it is important to review the wording carefully, especially the portion that lists the NAICS codes OMWBE has assigned to your firm.

The North American Industry Classification System ("NAICS") is the standard used by both Federal and State agencies to classify businesses activities. A list of the NAICS codes can be found here. At the time of application for WBE, MBE, or DBE certification, the applicant firm is asked to identify its primary business and professional activities and the associated NAICS codesThe OMWBE grants certification only for the specific NAICS Codes which the firm has listed and that OMWBE has verified the firm is capable of performing. A certified firm can only perform and receive credit for work associated with the specific NAICS codes it is assigned.

Thus, it is crucial to check that your firm is assigned the correct NAICS codes because, in determining whether your firm is small enough to remain in the WBE, MBE, or DBE program, OWMBE applies the current Small Business Administration ("SBA") size standards related to those NAICS codes (expressed in either millions of dollars or employees). For example, the current SBA size standard for most building specialty trade contractors is $14 million while the size standard for building general contractors and heavy and civil engineering general and special trade contractors is $22.41 million (although the chart shows $33.5 million, this number is modified by the federal regulations for USDOT/WSDOT projects). Thus, if you are a building specialty contractor and the average of your last three years of revenue exceeds $14 million, you will be graduated (decertified) from the program. The current SBA size standards can be found here.

In the three-year certification letter, OMWBE usually states language similar to the following paragraph:

The state program requires the firm to notify OMWBE in writing of any changes in its ownership, control, size or activities, and provide supporting documentation describing the change(s).  This information must be submitted within thirty (30) days of the change(s).

(emphasis added). Although a firm may have been performing work in an area with a higher size limit for years, OMWBE may rely on these letters and a firm's failure to modify its assigned NAICS code to challenge a firm's appeal of its graduation from the program. Therefore, if you fail to notify OMWBE in writing of changes that need to be made within 30 days of the certification letter, you may waive your right to add or change NAICS codes down the line.

Recommendation: To avoid possibly waiving your right to change or add NAICS code classifications, be sure to review your current NAICS Code classifications and make sure you have been assigned all of the appropriate NAICS code classifications. These will be listed in OMWBE's certified directory. For DBE code classifications, click here. For MBE/WBE code classifications, click here.

If the appropriate codes are not listed, contact OMWBE to request the appropriate NAICS codes. You will likely need to provide additional support to establish that your firm performs this work (e.g., past or current contracts, evidence of activity specific equipment, etc.). In addition, it is also wise to see where your firm stands with regard to the SBA size limitation so you can track and anticipate a potential graduation from the program. To do so, compare the SBA limit with the average of your last three years of revenue.

Ahlers & Cressman PLLC's lawyers have been assisting numerous general contractors, and small women and minority owned firms with their DBE questions over the last twenty-five years. Should you have any issues correcting your assigned NAICS codes or have any other questions, please contact Lindsay Taft ( or 206-529-3017).