Construction Law Blog
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In response to reports by the U.S. Government Accountability Office and Wartime Contracting Commission highlighting weaknesses in the suspension and debarment (S&D) offices of civil agencies, Congress has pushed for a significant overhaul of the suspension and debarment procedures applicable to federal contractors.
New National Defense Authorization Act of 2013 Removes Contract Thresholds for Women-Owned Small Businesses (WOSB).
Recent Unpublished Washington Court of Appeals Opinion Concludes that Absent Waiver Language, Failure to Comply with a Contractual Claim Procedure Will Not Result in Forfeiture
This blog has frequently addressed contractual notice and claim procedures and the Mike M Johnson[i] line of decisions (for example, see blog articles from January 2, 2008, February 15, 2011, July 10, 2012). A recent unpublished decision by the Division I Court of Appeals is noteworthy because it holds that if a contract has a mandatory procedure for resolving claims, but does not state that the failure to follow that procedure will operate as a waiver of such claim, then a forfeiture will not be found despite lack of compliance.
Shepler Construction, Inc. v. Leonard,[ii] involves a residential construction dispute over a project performed in 2000 with an incredibly long litigation history dating back to 2002. The decision that is the subject of this article is the Court of Appeals’ third decision in the matter!
In 2001, the Contractor (Shepler) sent the Owner (Leonard) a letter recommending that the Owner should initiate the contractual dispute resolution process with respect to the Owner's allegations of construction defects. The Owner admittedly failed to respond and did not initiate the contractual process. The Contractor then filed a lien and brought a foreclosure action. In 2008, the Contractor obtained a Summary Judgment Order precluding the Owner from asserting counterclaims for construction defects on the grounds that the Owner failed to initiate binding arbitration as required by the parties' contract in order to resolve allegations of construction defects. That order is the subject of the appellate decision that is the subject of this article.
In dismissing the Owner's claims for construction defects, the trial court was persuaded that the Owner's breach of the agreement by failing to seek arbitration required dismissal of all of the Owner's claims for construction defects that should have been arbitrated. The Contract clause at issue provided:
If a dispute arises between owner and contractor as to the performance of contractor's obligations under this agreement, such disputes shall be resolved as follows:
Each party shall employ a contractor of his or her choice to evaluate the work completed. The contractors then will select a third contractor to act as an impartial arbiter. This contractor shall, likewise, inspect the construction to determine if the work has been performed in accordance with this agreement, applicable building codes and in a good workmanlike manner as provided hereinabove. If two of the three contractors determine that the work is not in conformity with the provisions of this agreement, then they shall state in writing the work in need of repair or replacement and contractor shall undertake to perform same as soon as reasonably practical. Contractor shall be responsible for owner's fees and costs associated with this arbitration as well as the impartial contractor's fees and costs. If no remedial work is recommended by the contractors, then the owner shall pay for the costs of the arbitration. The owner shall forthwith pay the amounts due to the contractor as established by a majority of the arbiters.
The Contractor argued to the Court of Appeals that under Absher Const. Co. v. Kent School District,[iii] and Mike M. Johnson v. County of Spokane, that the Owner's admitted failure to arbitrate its construction defect claims operated as a waiver of those claims. Division One, however, disagreed, on the grounds that unlike the contract language at issue in Absher and Mike M. Johnson, the contract between the Contractor and Owner did not explicitly provide that the failure to follow dispute resolution procedures constituted a waiver of claims. Division One ruled:
Shepler relies on Absher and Mike M. Johnson, Inc. v. Spokane County. This reliance is misplaced. Absher and Mike M. Johnson are distinguishable from the contract at issue here, because the contracts in those cases explicitly provided that failure to follow dispute resolution procedures constituted a waiver of those claims.
In addition, Division One held that waiver of the right to arbitrate does not mean the underlying claims are waived:
...Washington courts have long held that the contractual right to arbitration may be waived through a party's conduct if the right is not timely invoked. The right to arbitrate is waived by conduct inconsistent with any other intention but to forego a known right. Simply put, a party waives a right to arbitrate if it elects to litigate instead of arbitrate. The [Owners] filed their counterclaims in 2002. [The Contractor] did not assert arbitration as a defense or move to dismiss the [Owner’s] arbitrable claims on that basis until 2008. Both parties waived the dispute resolution clause by conduct.
Comment: This unpublished case provides guidance that the failure to comply with a contractual claim procedure may not give rise to forfeiture of the underlying claim if the contract clause at issue does not include language stating that the failure to comply will operate as a waiver of the claim. In addition, the decision reinforces that a mandatory contract provision can be waived by the party it benefits, which is another basis to defeat an argument that the failure to comply results in forfeiture.
[i] 150 Wn.2d 375, 78 P.3d 161 (2003).
[ii] Shepler Construction, Inc., v. Leonard, 68227-0-I (unpublished 2013).
[iii] 79 Wn. App. 841, 917 P.2d 1086 (1996).
Michigan State Law Prohibiting Project Labor Agreements on Public Construction Projects Declared Unenforceable
In the Pacific Northwest, most public works construction is performed by union contractors. Often times the contract will include a Project Labor Agreement ("PLA") mandating that all workers on the site are subject to the terms of the union agreement. Labor relations in the U.S. are generally subject to federal regulation, particularly if the project is federally funded. Most large public works projects have some amount of federal money in them, and therefore, are subject to federal law. The National Labor Relations Act ("NLRA") is a federal law which protects an employee's right to engage in "concerted activities for mutual aid and protection." The most common of these "concerted activities" is collective bargaining.
PLAs are pre-hire agreements establishing terms and conditions of employment for the project, which are negotiated between an owner and unions, and are common form of collective bargaining agreement in the construction industry. A PLA requires all contractors, whether they are unionized or not, to subject themselves and their employees to the terms of the collective bargaining agreement (the union contract) as a condition of performing work on a construction project. Union wages, no-strike clauses, grievance procedures, and mandatory arbitration of disputes are among the terms often included in PLAs.
On July 19, 2011, Michigan enacted the Michigan Fair and Open Competition in Governmental Construction Act (the "Act") aimed at limiting the use of PLAs in Michigan public construction contracts. Section 5 of the Act states:
A governmental unit shall not enter into or expend funds under a contract for the construction, repair, remodeling, or demolition of a facility if the contract or subcontract under the contract contains any of the following:
(a) A term that requires, prohibits, encourages, or discourages bidders, contractors, or subcontractors from entering into or adhering to agreements with a collective bargaining organization relating to the construction project or other related construction projects.
(b) A term that discriminates against bidders, contractors, or subcontractors based on the status as a party or nonparty to, or the willingness or refusal to enter into, an agreement with a collective bargaining organization relating to the construction project or other related construction projects.
M.C.L. § 408.875. Additionally, Section 9 of the Act prohibits the government or any construction entity acting on behalf of the government from placing any terms described in Section 5 in bid specifications, project agreements, or other contract documents. M.C.L. § 408.879.
In Michigan Bldg. and Const. Trades Council, AFL-CIO v. Snyder,[i] several trade associations and organized labor groups (the "Unions") filed suit claiming that Michigan's Act was preempted by the NLRA. The Unions filed a motion for summary judgment, arguing the NLRA preempted the Act because it effectively banned PLAs on all government contracts, which is a form of concerted activity protected by the NLRA. Michigan argued that the Act was not regulatory, and thus not subject to NLRA preemption. The District Court agreed with the Unions and granted summary judgment holding the Act to be unenforceable because it was preempted by the NLRA, and that the "market participant" exception to NLRA preemption did not apply.
The NLRA Preempts Michigan's Act
Although the NLRA does not expressly preempt state law, the Supreme Court of the United States has articulated two distinct NLRA preemption principles - state and local governments are prohibited from regulating: (1) activities that are protected by Section 7 (which protects an employee's right to negotiate and secure a PLA) or constitute an unfair labor practice under the NLRA,[ii] and (2) areas that Congress intended to be left unregulated.[iii]
In this case, the District Court found that the Act violated both preemption principles. First, the Act regulated employees' ability to negotiate and secure a PLA - activities protected by Section 7 of the NLRA. Specifically, Section 5 of the Act prevented governmental entities from entering into PLAs, and Section 9 prohibited the state from "expending funds" if a contract or subcontract contained a PLA. Based on these facts, the District Court held that the Act created an impermissible obstacle to employees' right to bargain on government construction projects, and therefore, the Act was preempted by the NLRA because the two laws could not "move freely within the orbits of their respective purposes without impinging upon one another."[iv]
Similarly, under the second preemption principle, the District Court found that the Act regulated areas that Congress intended to be left unregulated by the states because Congress had specifically authorized certain behaviors in the construction industry under Sections 8(e) and (f) of the NLRA. The District Court held that Congress intended to balance the power for bargaining in the construction industry when it enacted Section 8(e), which exempts the construction industry from the general prohibition of "hot cargo" agreements (agreements between a union and employer which require the employer to boycott goods or services of another person), and Section 8(f), which authorizes pre-hire agreements that set terms and conditions of employment. The District Court found that Congress, in enacting Section 8(e) and (f) of the NLRA, intended PLAs to be permissible in the construction industry. Thus, the NLRA preempted the Act because it impermissibly prohibited PLAs on all government construction projects, which Congress had expressly allowed.
The Market Participant Exception Does Not Apply
Michigan argued that even if the NLRA preempted the Act, the Act was exempt because the state was acting as a "market participant" (i.e., acting in a proprietary/private function, rather than a regulatory/governmental function). The NLRA does not preempt state laws when a state acts as a "market participant" furthering its proprietary interests, as opposed to its regulatory interests. For example, when a state owns and manages property, it must interact with private entities (i.e., the state is a "market participant") and is not subject to preemption by the NLRA because it is acting in a proprietary function, as a private business would act.
In this case, however, the District Court rejected Michigan's argument that the Act was proprietary because it was not narrowly tailored to a specific project, but was an across the board ban on PLAs on all public works projects, and because the Act impermissibly affected private conduct unrelated to efficient procurement of goods or services (as in a private business relationship). The District Court found that the Act's "rigid, unbending policy smacks of regulation" and, therefore, was preempted by the NLRA, and that the state was not a "market participant."
Comment: Employers in the construction industry should proceed cautiously when dealing with PLAs. The NLRA forbids employers from interfering with, restraining, or coercing employees in the exercise of rights relating to organizing, or from working together to improve terms and conditions of employment. Employers may not threaten their employees with loss of jobs or benefits if they join or vote for a union advocating for PLAs, promise benefits to employees to discourage their union support, or otherwise punish employees because they participated in an investigation conducted by National Labor Relations Board.
[i] 846 F. Supp. 2d 766 (E.D. Mich. 2012).
[ii] See San Diego Bldg. Trades Council, Millmen’s Union, Local 2020 v. Garmon, 359 U.S. 236, 79 S.Ct. 773 (1959).
[iii]See Lodge 76, Int’l Ass’n of Machinists and Aerospace Workers, AFL-CIO v. Wisconsin Empl. Relations Comm’n, 427 U.S. 132, 96 S.Ct. 2548 (1976).
[iv] 846 F. Supp. 2d at 783.
Court Review Of Arbitration Decision Limited: Port Employee Only Receives 20-Day Unpaid Suspension For Hanging Noose In Workplace
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.
[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.
[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.”).
Court Rules That A Construction Company Owner Can Telecommute And Nevertheless "Control" His Or Her Business
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.
[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.
[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.
[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).
[i] Thank you to the “Federal Contracting Blog” (March 25, 2013) for bringing this issue to our attention.