A GUIDE TO PROFITABILITY OF CHANGED WORK

Many, if not most, contractors have been smart enough to build the effects of inflation into their initial pricing on government contracts. Some of them, however, did not get it exactly right. And then some did not price the risk of extraordinary inflation for one reason or another. We are here to sympathize with those of you who are being killed by inflation, which you did not reasonably expect to help you recover from the impact of inflation, and show you how you can be made whole on your contract. Our approach to making the contractor whole is based on the words used by the appellate court in 1963 to describe the objective regarding remuneration on a contract that has been changed.  In describing the process by which contractors are compensated when there are changes, the court, referring to the mechanism of an equitable adjustment, stated:

“Equitable adjustments in this context are simply corrective measures utilized to keep a contractor whole when the Government modifies a contract. Since the purpose underlying such adjustments is to safeguard the contractor against increased costs engendered by the modification, it appears patent that the measure of damages cannot be the value received by the Government but must be more closely related to and contingent upon the altered position in which the contractor finds himself by reason of the modification.”  Bruce Construction Corporation v. United States, 324 F.2d 516 (Ct. Cl. 1963).

This is not your definitive treatise on recovery of damages for breaches of construction contracts in the private sector. Here, we address those contractors who also deal in the public sector and are concerned about sufficient recovery in the event of changes and how to make contracts attractively profitable. Stated another way, some contractors are wary of or even leaving the public sector based on their perception of stringent restrictions on recovering damages if things go wrong. They may primarily be concerned about the effects of inflation and what to do about it because much has been written about how there are no clauses in public contracts that protect contractors from inflation. And that is correct except for limited assistance by the DOD.

In private contracting, damages fall roughly into three categories: direct, incidental, and consequential.

In public contracting, damage calculations are made in the context of the changes clause, which provides an equitable adjustment. That concept was articulated in Bruce to mean that the contractor should be made whole. The idea of making the contractor whole has been the basis for the development of the law on the meaning of equitable adjustment. Traditionally, equitable adjustment includes the direct cost of performing change, the indirect associated costs, and the profit on those costs. It is important to note that actual costs are required, although estimates are permitted. In addition, the direct and incidental costs associated with the change are included in an equitable adjustment. However, the changes clause itself contemplates the recognition of consequential damages. The requirement to make the contractor whole is embodied in the notion that the change may affect the original work.

Early in the development of the law of federal government contracts, it became evident that the concept of equitable adjustment could well include the impact of the change on the unchanged work. Therefore, the changes clause was amended to include “whether or not changed”, meaning that increased cost could be recovered on the original work.  So-called delay and disruption costs traditionally have been included in the equitable adjustment calculation because of this language in the changes clause permitting the impact on unchanged work.

But when the Court of Appeals for the Federal Circuit decided an equitable judgment was to make the contractor whole, what did that concept include? How far does it go? Making a contractor whole is more than just remuneration. For one thing, it's been well recognized that the concept includes reevaluating profit on the costs. Profit, arguably, is correctly increased in the calculation to account for the fact that changed work is uncertain and requires greater risk and, presumably, the prospect of greater rewards. Not enough attention has been paid to the calculation of profit. The Armed Services Board of Contract Appeals has permitted 13% profit on changed work on a shipbuilding claim. The 10% profit often used as a benchmark should be increased to at least 13%.

It is not far-fetched to suggest that the concept of equitable adjustment, as interpreted by the Court of Appeals for the Federal Circuit, should include elements that would make the contractor whole, such as non-remunerative. The delay permits the calculation of costs but also implicates the design and performance aspects of the contract. The effect of the change on the unchanged or original work could well include a need to redesign the structure or item of equipment. Likewise, the original work may well be affected by the change to the extent that the means and methods of performance of the contract need to be changed, making them entirely different than originally planned. Manpower may be necessary to be replaced with workers with different expertise. Certain aspects of the project may have to be demobilized, and others mobilized. So, it's not just the costs of the impact on the unchanged work that are recoverable. The concept of making the contractor whole could include restructuring the project and its management.

In public contracting, it's the government's job to scrutinize the contractors’ claims to be sure that the contractor is not carrying the concept of making itself whole to the extreme. The same applies to the private sector, where the owner must scrutinize the contractor’s damage claim. Contractors articulate their entitlement and then throw in the kitchen on damages. Folks often misinterpret the entitlement side to justify throwing every damaged item they can think of against the wall to see what sticks. They hold to the concept that if you do not ask for it, you will never have a chance to get it.

It is difficult to fault the contractor for being aggressive.  The concept of being made whole seems to support their position.  It is possible to reprice all original work affected by the change and, in the process, lessen the effects of inflation.