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Good-faith negotiation and discretion. (Case Commentary).

Since 1981, Systems Management American Corporation (SMA) was signed on as subcontractor for the Small Business Administration (SBA) U.S. Navy program, to handle the Snap II computer systems on surface ships and submarines. Contract #173--its fourth--was a letter contract for base and options years through 1991, which required price agreement by September 30, 1987. Internal documents and public comments by navy officials made it clear that exercise of the options would follow "soon after definitization."

During the successful negotiation of base year pricing, it was learned that SBA policy precluded option exercise unless prices were "definitized" before "graduation" from the SBA 8a program. SMA was due to "graduate" on October 21, 1987. The navy, SMA, and SBA executed a contract modification intended to satisfy the SBA restrictions, which provided that by October 21, 1987, option prices (for options "if [exercised] at all") would be negotiated at "ceilings" subject to downward-only revision for variation in overhead rates and specific cost reductions.

Shortly thereafter, the parties agreed that ceiling prices for options, "if (exercised) at all" should be the same as the prices for the base year. This resulted in a total price of $101 million, higher than the authority of the contracting officer (CO). On October 16, 1987, the proposed contract modification was submitted to the assistant secretary of the navy (ASN) for approval.

On the same day, the U.S. attorney for the Eastern District of Virginia issued a press release that an employee of SMA had pleaded guilty to fraud in a kickback scheme involving senior SMA officials. On October 20, 1987, the ASN refused to sign the modification because of current SMA investigations. On November 2, the U.S. attorney informed the ASN that he could not assess the potential criminal liability of SMA or its officers. This erased ASN concerns, and on November 5, 1987, he was willing to approve the modification. This was too late to save SMA contract options. It had graduated from the SBA program on October 27, 1987.

Two years later, after SMA solicitations, amendments, and protests, the option quantity was awarded to another contractor. In July 1991, SMA and two of its senior officers were convicted of conspiracy to defraud the navy on Snap II contracts between 1981 and 1986. None of these related to contract #173.

SMA claimed damages for breach of contract for failure of the navy to definitize and exercise the options on contract #173, in a total amount of $23.4 million. Of that claim, $31,000 was allocated to labor and travel to prepare and negotiate the option-year price proposal. The claim was denied in its entirety, and the decision of the Armed Services Board of Contract Appeals (the board) is published as Systems Management American Corporation, ASBCA 45704, 49607, 52644, 00-2 BCA 31,112 (September 2000).

SMA argued that the navy should be "estopped" from denying that option exercise would have followed price definitization. It relied on the course of conduct and the expressions of senior navy officials that SMA would be the contractor until the end of the program. The board noted that the program was set forth in a series of formal contract documents, none of which committed the navy to exercise the options under contract #173, whether or not the prices were definitized. In fact, the expression in the contract modifications, regarding option exercise "if at all," was contrary. None of the comments of senior navy officials or expressions of intention constituted binding obligations. Therefore, there could be no breach of contract for failure to exercise the options.

The board noted that the proposed option pricing modification did not commit the navy to any action and preserved all its interest in contractor responsibility and option exercise until some future date. The refusal of the ASN to approve that modification before October 21, 1987, had the effect of "immediate and irretrievable loss of the options from its contract." It was "contrary to the parties' agreement" to definitize prices by October 21, 1987. The board held that the ASN exercise of discretion was done in neither bad nor good faith; rather, it was "arbitrary and unreasonable." The appeal was sustained in the amount of $31,000, the costs SMA incurred for labor and travel to prepare and negotiate the option prices.

There was a dissenting opinion of two judges, who questioned the reasoning that the action of the ASN was an abuse of discretion. The agreement to definitize was merely an agreement to negotiate in good faith, not as the majority deemed it to be--"a warranty that options would be definitized by October 21." Even assuming such a binding commitment, how could the agreement of a subordinate without authority limit the discretion of the superior with authority? Didn't such an assumption of power limit the discretion of the ASN to that of a "ministerial clerk bound to sign the definitization modification without regard to any delay he felt was necessary"?

Was the time taken by the ASN unreasonable? The modification was presented on October 16, the day of the notice of the criminal investigation. By November 5, less than three weeks later, after investigation and coordination with the U.S. attorney, the ASN was ready to sign the modification. The law identifies the elements to apply to the exercise of discretion as evidence of subjective bad faith, no reasonable basis for the decision, and the degree of discretion granted to the decision maker. The dissent noted that the board had not discussed any of these elements.

Here, the navy did not consider the October 21 date to be important. It was the SBA's deadline, SMA's graduation date from the 8a program, and SMA's criminal conduct that were under investigation. Having cooperated from the outset, the navy was confronted by the intervening factors of the criminal conviction and the investigation. "Why the navy should bear the responsibility attendant to such revelation escapes us....We find it incredible that this board would conclude that a senior officer of an agency is acting arbitrarily and capriciously, when he delays a decision for a short period of time to secure additional the face of serious criminal issues."

Finally, noted the dissent, the majority opines that the question of the effect of the criminal matters could have been considered by the navy at a later date without impeding the approval of the definitization modification. Thus, the majority would have made a different decision at the time. However, noted the dissent, "the board was not charged with making the ASN's decision at the time, and is not charged with making it retroactively now."

The board's authority is to decide whether the decision of the ASN was in bad faith or arbitrary and unreasonable. It is asked to apply the legal standards that it failed to apply here. The dissent would have denied this aspect of the claim along with all the others.

About the Author

ROBERT D. WITTE is a senior partner in the firm of Witte & Lestz, P.C., White Plains, New York. One of the original members of NCMA, he is an Honorary Life Member. Fellow, Charles J. Delaney Memorial Award winner for his articles, and a member of NCMA'S South East Florida Chapter. NCMA's Blanche Witte Memorial Award was founded in memory of his mother. Send comments to this article to
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Author:Witte, Robert D.
Publication:Contract Management
Geographic Code:1USA
Date:Feb 1, 2003
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