June  28, 2002

Bulletin #58, The Chameleon Contract (June 28, 2002)

ZZZ Sheet Metal had a reputation as a quality HVAC contractor, but had also developed a sub-specialty in air filtration systems. In the course of design and construction of a large research facility, the Federal Energy Agency (“the Agency”) had identified the need for a fabric filter system, commonly called a “baghouse.” The system was designed to extract particulate matter from a gaseous stream as a form of pollution control. ZZZ had constructed a number of baghouses, and was very comfortable with its ability to design such a system and complete the project. Management at the Agency facility had retained a private engineering firm to prepare bid solicitation materials for the filtration system. ZZZ and a number of other HVAC contractors received the solicitation materials, and ZZZ responded with a technical and price proposal. The Agency project team concluded that the ZZZ proposal was the only one of six submissions that was technically responsive, although it was priced substantially above what the Agency was initially prepared to pay. More funding was obtained, and a design/build contract was signed between the parties for a lump sum price. With the specifications in hand, ZZZ designed a baghouse that would filter the gas stream, and remove the required particulate matter. It was a fairly standard design incorporating a large sheet metal box, grids, fabric filters, intake and exhaust openings, and pressure relief valves. The specifications had referenced to intake pressure of 3.0 PSI, and ZZZ designed the system accordingly. Because the gas intake would be diffused inside the baghouse, the “box” itself was designed to sustain an explosion or pressure build-up of up to 1.0 PSI. ZZZ followed the specifications as best it could, although there were some aspects that were somewhat vague.

Over the ensuing months, ZZZ performed an on-site fabrication of most components of the system, and received one progress payment. However, work came to a standstill four months into the project when the Agency contacted ZZZ about issues with the temperature of the gas stream. The system had to be changed since the Agency did not have funding for a cooling tower that had originally been contemplated. Therefore, the gas stream coming through the intake pipe would be at approximately 500 F°, far higher than originally specified. The Agency inquired of ZZZ as to what changes to the system would be necessary based upon the temperature change, and the contractor responded with several modifications at an additional cost of $46,450.00. The Agency was also unable to decide what type of controls it wished to use with the modified system. (The Agency had previously changed its position several times as to the type of controls that would be required.) The controls were within the ZZZ’s contract scope, and the contractor regularly followed up requesting direction as to how it should proceed with the controls. However, no consistent direction was forthcoming.

After a delay of several more months, the Agency approved the contractor’s proposed additions to the work, but did not approve a change in the price. Assuming that the price issue could be worked out, ZZZ again commenced the installation work. Within weeks, almost all of the baghouse components were installed at the Agency facility. The only significant items left resulted from the still pending decisions as to the controls. ZZZ submitted another application for payment. The Agency rejected the payment request based upon the absence of the controls, the absence of operating manuals (which could not be finalized until the control systems had been specified), and alleged structural deficiencies of the baghouse. As to the structural issues, the Agency asserted that its original specifications had called for a pressure capacity in the baghouse itself of 3.0 PSI, but that ZZZ had designed the “box” to a 1.0 PSI specification. The Agency indicated that no further payments would be forthcoming until ZZZ had corrected this “deficiency.” The contractor argued vigorously that the Agency was misinterpreting the original specifications, and had never raised any issues with the baghouse capacity when it had reviewed the original design. In an effort to defuse the situation, the project director for the Agency assured ZZZ that the “check was in the mail” as to its prior payment request. The check never arrived. The hostility between the Agency and the contractor continued to build, and ZZZ insisted that the Agency’s interpretation of the specifications was absurd. To build a baghouse meeting the Agency’s requirements, would mandate going from a sheet metal box assembled on site to a cylindrical system using much thicker steel, which could not be fabricated on site. It would be much more expensive, and was totally inconsistent with ZZZ’s original proposal. The contractor refused to proceed with the alternate system, and again requested instructions concerning the controls. The response from the Agency was a Show Cause Notice alleging the contractor’s breach of the contract. ZZZ did its best to respond, documenting that it had followed the instructions of the Agency at each stage. Unpersuaded, the Agency terminated the contract for default, and asserted that no further amount was owing to the contractor, even though less than 10 percent of the contract price had been paid, and ZZZ had performed over 90 percent of the project work. The contractor sued. At trial, the Agency did not dispute the existence of changes in the work. However, it argued that ZZZ had a contractual duty to proceed with the changes, and that its remedy was to seek an equitable adjustment at the end of the job. The Agency asserted that the contractor did not have the right to stop work, and should have addressed the situation by installing a baghouse able to tolerate an internal operating pressure of 3.0 PSI. The Agency’s attorney argued that ZZZ’s failure to do so was a blatant breach of the contract, justifying termination for cause. He concluded by indicating that the court must find, if the requirements that the Agency imposed on ZZZ were within the general scope of the contract, that the contractor was obligated to perform the work, even if the Agency had misinterpreted the original specifications. It looked bad for ZZZ.

Then came a surprising development. The court ruled that if ZZZ was required to follow the Agency’s pressure specification for the “box” it would, in essence, be producing an entirely different type of system. There was no way that the existing ZZZ system design could be made compatible with the Agency’s interpretation of the specifications. Therefore, the court considered the Agency’s re-interpretation to be a “cardinal change” to the original contract. As a result, what the Agency was demanding was not what the parties had bargained for when entering into the contract, and ZZZ was not required to perform the changed work. Since the contractor could not be compelled to perform the changed work, it could not be terminated for failing to do so. The court held that the contractor was entitled to damages as if the contract had been terminated for the Agency’s convenience. ZZZ was awarded all amounts that had been invoiced to the Agency to that point, plus interest and costs.

The fact situation set forth in this Bulletin is adapted from an actual case (Airprep Technology, Inc. v. The United States (1994)). The case addresses the concept of a “cardinal change” in a strange fact situation where the parties never seem to have achieved a “meeting of the minds” as to what was intended. As in that case, the determination of what constitutes a permissible change versus a cardinal change will almost always come down to a question of fact and intent. However, from the contractor’s perspective, if a project seems to be “morphing” into something that was never originally intended, the contractor should ask itself whether what is really occurring is a cardinal change requiring a re-thinking and re-negotiation of the entire project. This is one weapon the contractor has available in protecting itself against the


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