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Government Acted in Bad Faith in Default Termination; Court Awards $17 Million in Damages to Contractor
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October 12, 2009
By Laura Thomson
Howrey LLP
Moreland Corp. contracted with the Department of Veterans Affairs to design and construct a two-story medical clinic in Las Vegas under a 15-year lease-back agreement. The VA took occupancy of the building in 1997. Five years later, the VA terminated the lease for default, claiming that the building was unsafe for occupancy and that Moreland had failed to repair structural defects in a timely manner.
Specifically, the VA identified three problems at the time of default: missing gusset plate welds on the second floor lateral bracing, exterior cracking on precast panels and on architectural covers around steel columns, and under-design of the structural steel columns. As further grounds, the VA contended that the building was not in compliance with building codes. Even so, the VA continued to occupy the building and pay rent for nine months after the default termination. Thereafter the VA moved to another facility. A year later Moreland lost the building in foreclosure.
In its wrongful termination action, Moreland sought to recover more than $17 million for unpaid rent on the balance of the lease and $20 million for the asset value of the building lost through foreclosure. The VA ’s contracting officer maintained that the default termination, if improper, converted to a termination for convenience and thus denied Moreland’s claim for unpaid rent.
The Court of Federal Claims reviewed the default termination and found in favor of the contractor on its claim for the balance of the rent, plus interest. Moreland Corp. v. United States, 76 Fed.Cl. 268 (2007). The court held that the default termination was improper. It concluded that the defects were largely cosmetic and easily could have been repaired if the VA had permitted Moreland to do so. It held that the building was safe to occupy during repairs and that the VA’s refusal to allow the repairs breached the lease. The count found that the government had contracted away the right to terminate the contract for convenience at the insistence of Moreland’s lender.
Calling the government’s conduct in its administration of the lease “deplorable by any measure,” the court held that even if the contractor had been in technical default, the VA’s “bad faith compels the Court to overturn the termination for default.” The court invited Moreland to apply for attorney fees under the Equal Access to Justice Act (28 USC §2412).
The court also found that in contending the building was unsafe to occupy and justifying default termination, the VA had relied on a report by its structural engineering expert that did not contain his professional engineer’s stamp, meaning that the engineer would not “be professionally liable for the statements” in the report. The court noted that after issuing the report, the VA’s engineer reversed his position without explanation. The court wrote that it suspected the VA engineer’s “professionalism may have been compromised to satisfy the desires of this client, the VA.”
At the outset of its decision, the court determined that Moreland was not in default of any of the lease provisions. Finding the deficiencies identified by the VA to be latent defects -- unknown to the parties at the time of completion -- the court determined that the VA’s available remedies under the lease’s “Warranty of Construction” clause (FAR 52.246-21) and “Guaranty” clause (VAAR 852.236-75) were to require Moreland to repair the defects within a reasonable time, to make the repairs itself at Moreland’s expense, or to leave the defective work in place and assess Moreland the costs it would have incurred. The VA, however, did not have the right to terminate Moreland for default after completion and acceptance of the building unless it could prove constructive eviction or a substantial interference with the beneficial use or enjoyment of the premises. Applying a two-part test, the court determined that the VA did not establish constructive eviction because the VA conceded it was able to use the building at all times and did not abandon the building until nine months after termination.
Secondly, the court found that the record did not support the VA’s position that Moreland failed to make repairs in a timely fashion. Instead, the court found that the VA prevented Moreland from making repairs – which could have been performed at nights and on weekends -- by demanding a “comprehensive remediation plan” from Moreland before the repairs could go forward. Moreland retained a structural expert to prepare a plan for the repairs. The VA rejected Moreland’s plans twice and denied it access to inspect the building. The VA later gave Moreland authorization to proceed with the repairs on the condition that it execute an Indemnification and Reimbursement Agreement. The court found that neither a comprehensive remediation plan nor the indemnification agreement were required by or proper under the lease.
Thirdly, crediting Moreland’s expert’s opinion that essential repairs could have been made within 30 days during off-hours and that the building was safe, evidenced by the VA’s continued occupancy, the court found that the contracting officer abused his discretion when he terminated Moreland for default. According to the court, rather than applying “reasoned discretion,” the contracting officer made an “irrational decision” to terminate the lease, causing the VA to incur an additional $4 million a year in rental costs to lease an alternate facility. (The VA did not claim any of the increased costs against Moreland). The court remarked that Moreland’s theory of the VA’s motive for the default termination – to accommodate rapid population grown in the area – might be correct, as the court could see “no other explanation from the record perhaps bureaucratic ineptitude, to account for such a senseless decision.”
Next, the court held that the VA breached the covenant of good faith and fair dealing – implied “into every contract, including Government contracts.” The court found two instances of bad faith by the VA. The first was when the contracting officer denied two claims for added labor costs during construction even though he believed they were meritorious and was prepared to grant nearly $300,000 in changes for them. On the advice of the VA’s counsel, the contracting officer denied claims “so that the agency would have greater leverage in negotiating other claims.” Noting that government contractors are required to submit accurate and complete claims, the court held that the government has a reciprocal obligation to act in good faith. The court held that outright denial of meritorious claims to obtain bargaining advantage over a contractor “will not be condoned by this Court.” The second act of bad faith related to the VA’s need to install an auxiliary HVAC system on the roof, not part of the contract specifications. The VA demanded that Moreland conduct a structural loading study at no cost to the VA and justified its request with a two-page report in which a VA engineer claimed there were many structural deficiencies in the building. Moreland declined to perform the study after consulting with the project’s architect and engineer. The court found that the VA report was used as a pretext to shift the cost of the structural study to Moreland and gave no credence to it because of the VA’s ulterior motive in having it prepared.
Further, the court found that the building was in compliance with local building codes and ordinances as evidenced by the Certificate of Occupancy issued by the City of Las Vegas and the testimony of the Las Vegas city building official who issued the certificate. Because Moreland was the owner and lessor, the VA “had no legal rights to terminate the lease by asserting its own interpretations of code compliance.” The VA’s position on code-compliance was largely based on Moreland’s action against its general contractor and others to recover costs of investigating and repairing the structural damage, which was resolved by settlement in 2003. The VA asserted that Moreland’s position in that action was inconsistent with its position in its case against the VA and that Moreland had effectively acknowledged the validity of the default termination by conceding non-compliance with building codes and admitting that it didn’t have the financial resources to make repairs to the building. The claims were not “clearly inconsistent,” according to the court, because they were pleaded in conditional terms (if the VA’s allegations were true) and were necessarily made to preserve Moreland’s rights against the contractor. The court held that it would not penalize Moreland “for pleading a valid cause of action in Nevada.”
Ultimately, the court awarded Moreland $17,992,215.85 plus interest from the date the contracting officer received Moreland’s certified claim (but allowing for a discount to present value for the agency’s payment of future rent on the balance of the lease) and costs. The court concluded there was insufficient evidence to prove that the termination caused the foreclosure and did not award damages for the lost value of the building.
The government noticed an appeal of the judgment but later withdrew its appeal. The court modified its judgment to $17,673,850 plus interest and awarded $438,188.90 in attorney fees to the Moreland under the Equal Access to Justice Act.
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For more information about the issues covered in this report, please contact Laura Thomson in our Washington office at 202-383-7386or at thomsonl@howrey.com or contact your Howrey attorney. For more information about Howrey’s Construction Practice Group, click here.
©2009 Howrey LLP
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