THE RISK OF A FIXED PRICE CONTRACT IS THE MARKET

Posted on July 10, 2022July 10, 2022 by Edward Garber

When performing work on a fixed price or unit, there is risk that is being assumed on your end. One risk is the market. You are ultimately banking on the fact that the market is not going to make your fixed prices unprofitable. That’s not an unforeseeable occurrence because the market shifts and that shift can have a negative ripple effect.

In a recent case out of the Federal Circuit, U.S. Aeroteam, Inc. v. U.S., 2022 WL 243176 (Fed.Cir. 2022), this market risk played a role in a fixed price contract. Here, a contractor was hired by the federal government to produce ground support trailers. A key component of these trailers was a running gear. The contractor relied on a vendor for these running gears. Due to financial difficulties, the vendor had to raise its unit price for the running gears. Based on the increased price, the contractor elected to manufacture the running gears itself. The contractor asked the government if this was ok and the government approved the request. Once the contractor started manufacturing these running gears, it had an “awe” moment – the manufacturing costs were higher than anticipated. The contractor submitted a request for equitable adjustment which the government denied. The Contractor than sued the government raising three arguments to support its entitlement to additional costs: (1) constructive change; (2) cardinal change; and (3) commercial impracticability. The contractor lost on all arguments. It probably should have lost on all arguments.

Constructive Change

“To demonstrate a constructive change, a contractor must show (1) that it performed work beyond the contract requirements, and (2) that the additional work was ordered, expressly or impliedly, by the government.” Aeroteam, supra, at *2 (internal citations and quotation omitted).

The problem with this argument was that the government did NOT order the contractor to manufacture the running gears. It merely approved the contractor’s request. The contractor made the decision since it thought it could manufacture the running gears when its vendor increased the unit price. An approval of a request, is NOT an order. Aeroteam, supra, at *3.

Cardinal Change

A cardinal change, discussed in prior postings, “is so profound that it is not redressable under the contract, and thus renders the government in breach.” Aeroteam, supra, at *3.

The problem with this argument was there was no alteration in the contractor’s contract. The contractor chose to manufacture the running gears and it was not forced to do this by the government.

Commercial Impracticability

“To prove commercial impracticability, a contractor must show that because of unforeseen events, [the contract] can be performed only at an excessive and unreasonable cost or all means of performance are commercially senseless.” Aeroteam, supra, at *4 (internal citations and quotation omitted).

The problem with this argument was that the contractor could have used its vendor to manufacture the running gears at a higher unit cost. The contractor did not want to pay the higher unit cost. Moreover, there was no evidence that the higher unit price was even excessive. In this regard, the Court expressed that an increase in market price of the running gears is the risk the contractor assumed in a fixed price contract.

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

DOES YOUR JURISDICTION RECOGNIZE THE CARDINAL CHANGE DOCTRINE?

Posted on June 26, 2022June 26, 2022 by Edward Garber

The contract was cardinally changed. Have you heard that before? It is a “sexy” doctrine, but, in actuality, cardinal change is hard to demonstrate. Under certain factual scenarios, it could have traction, but whether it will be recognized in the jurisdiction is typically a question of law.

An unreported 2002 case out of Northern District of Ohio, Ebenisterie Beaubois Ltee v. Marous Brothers Construction, Inc., 2002 WL 32818011 (N.D. Ohio 2022), contains a short discussion on cardinal change. I know what you are thinking – 2002 that was 20+ years ago. True. But the short discussion is interesting because the issue was whether Ohio would recognize the cardinal change doctrine.

A cardinal change breach of contract occurs when one party “effects an alteration in the work so drastic” that the contractor is forced to perform duties materially different in scope from those originally contemplated by the parties. “The doctrine is couched in terms which apply generally to modifications which are so fundamental that they cannot be redressed within the contract by an equitable adjustment to the contract price….” Thus, the doctrine of cardinal change provides an extracontractual remedy to a contractor where changes ordered by the owner are so significant that they cannot be said to fall within the “changes clause” contained in the contract.

Ebenisterie Beaubois Ltee, supra, at *3 (internal citations omitted).

Ultimately, by arguing cardinal change, the party is seeking damages OUTSIDE of the contract, essentially arguing that the contract itself should not apply to govern recourse and damages. I’ve argued this doctrine before and I’ll argue this doctrine again. However, this cardinal change doctrine cannot be the only doctrine alleged meaning you can’t solely assert this doctrine while ignoring any breach of contract action.

As the Court’s discussion began in this 2002 case, it recognized the doctrine of cardinal change started under federal contract law in a dispute between a government contractor and the government. Contracts with the federal government contain a changes clause that allows the government to modify the contractor’s scope of work. Such contracts also contain equitable adjustment provisions to address a contractor’s rights in the event of such changes. These provisions are not limited to government contracts but are also included in private construction contracts. The question, as this Court delved into, was whether this doctrine that began in the federal contract arena could be extended as a matter of law to private construction contracts in Ohio.

At this time, the Court held Ohio would not recognize the cardinal change doctrine:

This Court finds that the Ohio Supreme Court would decline to adopt the cardinal change doctrine as a rule of law in Ohio. The cardinal change doctrine is based on the notion that even though an express contractual provision exists governing changes to the contract, as well as the contractor’s compensation for the changes made, some changes are nonetheless “so severe” that extracontractual relief is appropriate. Ohio courts, however, consistently refuse to allow recovery in quasi-contract where an express contract governs the subject matter of the dispute.

Ebenisterie Beaubois Ltee, supra, at *4

The Court’s rationale is why cardinal change is challenging to prove. The circumvention of a contract is NOT an easy feat and certain jurisdictions are going to put their foot down regarding such arguments. Other jurisdictions will let facts play out in determining whether the facts fit the doctrine. But this Court (in the 2002 unreported decision) maintained that as a matter of law this doctrine would not exist under the current state of Ohio’s law.

ARGUING CARDINAL CHANGE IS DIFFERENT THAN PROVING CARDINAL CHANGE

Posted on March 6, 2021March 6, 2021 by Edward Garber

The cardinal change doctrine has become a popular doctrine for a contractor to argue under but remains an extremely difficult doctrine to support and prove. Arguing cardinal change is one thing. Proving cardinal change is entirely different. As shown below, this is a doctrine with its origins under federal government contract law with arguments extending outside of the federal government contract arena. For this reason, the cases referenced below are not federal government contract law cases, but are cases where the cardinal change doctrine has been argued (even though these cases cite to federal government contract law cases).

A party argues cardinal change to demonstrate that the other party (generally, the owner) materially breached the contract based on the cardinal change. In reality, a party argues cardinal change because they have cost overruns they are looking to recover and this doctrine may give them an argument to do so. But it is important to recognize the distinction between raising it as an argument and the expectation that this (difficult doctrine to prove) will carry the day.

The cardinal change doctrine is a doctrine that originated under federal governments contracts law–the doctrine developed based on drastic unilateral modifications of the contract from the federal government that were not contemplated by the contract’s changes clause. IES Commercial, Inc. v. Manhattan Torcon A Joint Venture, 2018 WL 4616029, *5 (D. Maryland, 2018). See also U.S. v. Peter R. Brown Construction, Inc., 674 Fed.Appx. 901, 909 (11^th Cir. 2017) (explaining cardinal change doctrine has applied when a contractor is directed by the government to perform a scope “that fundamentally alters the contractual undertaking” such that it is “not comprehended by the normal Changes clause.”) (citation omitted).

The cardinal change doctrine applies “when the government effects an alteration in the work so drastic that it effectively requires the contractor to perform duties materially different from those originally bargained for.” Durr Mechanical Construction, Inc. v. PSEG Fossil, LLC, 2021 WL 303030, *2 (D.New Jersey 2021) (quotation and citations omitted). These are changes that “fundamentally alter the nature of a contract” and constitute a “drastic modification beyond the scope of the contract that altered the nature of the thing to be constructed.” Latex Construction Company v. Nexus Gas Transmission, LLC, 2020 WL 7386358, *8 (S.D.Texas 2020) (internal quotations and citations omitted). See also Amex Construction, Inc. v. Clark County, 2020 WL 3488736, *6 (D.Nevada 2020) (“A cardinal change must drastically alter the work agreed to such an extent that the contractor effectively performs duties that are materially different from those for which the contractor originally bargained.”) (internal quotation and citation omitted).

Noteworthy, out of sequence work, delays, and even increased costs do not amount to a cardinal change. Ames Construction, supra.

Just because the cardinal change doctrine applies to federal government contract law does not mean it universally applies to state law. For instance, in Durr Mechanical, the court refused to apply the cardinal change doctrine because it had not been adopted by New Jersey law. Durr Mechanical, supra, at *5 (“I find no compelling reason to recognize a cardinal change doctrine claim under New Jersey law, and decline to do so.”). On the other hand, in Latex Construction Company, the court found that while the plaintiff faces significant hurdles in proving a cardinal change, the doctrine applied to private construction contracts. Latex Construction Company, supra, at *8.

When arguing cardinal change, outside of the federal government contract arena, please remember that there may be an argument that the doctrine does not apply to the state law claims. And, even if there is an argument that the cardinal change doctrine does apply, keep in mind that the origin of the doctrine and its historical context will apply. The change should apply to a drastic change/modification (unilateral modification) that fundamentally alters the contract because it is so materially different than what was bargained for–this is difficult to prove!

THE CARDINAL CHANGE DOCTRINE

Posted on May 15, 2012November 8, 2024 by Edward Garber

The cardinal change doctrine is a doctrine that originated from government contract work in the United States Court of Federal Claims and, until recently, was not really discussed or applied in a Florida case. This changed when the Southern District of Florida in Hartford Casualty Insurance Co. v. City of Marathon, 825 F.Supp.2d 1276 (S.D. Fla. 2011), applying Florida law, discussed the cardinal change doctrine and used it to relieve a performance bond surety of obligations under a performance bond. While the specific facts of this case will not be discussed in detail, the Court’s discussion of the cardinal change doctrine will be because it is a doctrine that contractors on very difficult projects (i.e., completed project is substantially different than original plans, there were never-ending or wholesale, material changes, and the completed project cost substantially more than original contract amount) may want to argue under.

In this case, the Court held:

“To determine whether a change order is outside the general scope of the underlying construction contract so as to qualify as a cardinal change, courts look to the following factors:

(i) whether there is a significant change in the magnitude of work to be performed; (ii) whether the change is designed to procure a totally different item or drastically alter the quality, character, nature or type of work contemplated by the original contract; and (iii) whether the cost of the work ordered greatly exceeds the original contract cost.”

City of Marathon, 825 F.Supp.2d at 1286 citing Becho, Inc. v. United States, 47 Fed.Cl. 595, 601 (Fed.Cl.2000).

The Court expressed that these factors are all fact-intensive analyzed on a case-by-case basis and the party utilizing this doctrine must prove the factors with particularity. Id. citing PCL Const. Serv., Inc. v. United States, 47 Fed.Cl. 745, 804 (Fed.Cl. 2000).

Regarding the first factor—whether there is a significant change in the magnitude of work to be performed—the Court will look to see whether the completed project is substantially different than the project called for in the original plans and specifications. Id. citing Wunderlich Contracting Co. v. United States, 173 Ct.Cl. 180 (1965). For instance, in City of Marathon, the Court found this factor applied because the government gave the contractor a change order that added a new water treatment plant to the contract that was to be built on a separate location with different plans and specifications. Additionally, the cost of the new water treatment plant was more than 100% of the contract amount.

Regarding the second factor—whether the change is designed to procure a totally different item or drastically alter the quality, character, nature or type of work contemplated by the original contract—the Court will look to see whether the change is contemplated by the contract. City of Marathon, supra, citing Becho, 47, Fed.Cl. at 601. In City of Marathon, the Court found that while the contract contemplated changes (as most construction contracts do), the magnitude of the change from both a scope and cost standpoint was not contemplated.

And, regarding the third and last factor—whether the cost of the work ordered greatly exceeds the original contract cost—the Court will look to see the total increase of the original contract amount due to the change or changes. In this regard, the Court noted that increases of the original contract amount of 100% or more tend to suggest a cardinal change whereas increases less than this percentage tend not to. In City of Marathon, as previously stated, the change increased the original contact amount by more than 100%, thus satisfying this factor.

Although the application of this doctrine carries a heavy burden, there are certain projects where it may apply. Contractors that end up constructing a project substantially different then the plans and specifications their contract is based on which results in extensive change orders / wholesale, material changes and massive cost increases may, depending on the circumstance, want to argue under this doctrine in order to circumvent harsh contractual provisions to recoup their costs, etc. for performing additional work.