Government Contracts Monitor

Options are Options

June 5, 2016

In the often complicated context of government contracting, it can sometimes be easy to forget basic principles. For example, a contractor awarded a contract with a base period and option years knows that the government’s exercise of the option years is not guaranteed. Still, barring a performance issue, such options are overwhelmingly exercised. Many contractors count on this practical reality when determining how to allocate resources for contract capture and bid preparation efforts and similar business decisions. As demonstrated by the saga of Northrup Grumman Computing Systems, Inc., v. U.S., 120 Fed. Cl. 460 (Fed. Cl. 2015), affirmed by the Court of Appeals for the Federal Circuit (CAFC) on May 24, such reliance may on occasion be misplaced, particularly when the contractor has made undisclosed assignments and then seeks to recover for unexercised options.

In July 2011, U.S. Immigration and Customs Enforcement (“ICE”) awarded Northrop Grumman a delivery order for network software. The award was for one base year and 3 option years. Each year was priced at about $900,000.00; the total potential value of the contract including all base years was nearly $3.6 million. Soon after award, the government and Northrop executed a modification under which the government stated it would “use its best efforts to secure funding for the option years.”

During the base year, unbeknownst to ICE, Northrop entered into an agreement with a 3^rd party IT contractor, ESCgov, Inc. Under that agreement, Northrop assigned ESC its payment rights on the ICE delivery order in exchange for a payment that included $191,751.00 to cover Northrop’s anticipated profits under the original order with ICE. ESC then assigned its rights to another entity. Both Northrop and ESC clearly counted on the options being exercised. But neither notified the government of either of the assignments, in violation of the Anti-Assignment Act (31 USC 3727).

Because ICE never used the software during the base year, the agency notified Northrop that it would not be exercising any of the contract’s options. Northrop filed a claim with the contracting officer (CO) objecting to this decision, arguing that the government had breached the contract by not using its best efforts to secure funding for options. When the CO denied the claim, Northrop filed a complaint with the Court of Federal Claims (COFC). During this litigation, Northrop revealed the assignment of its payment claims to ESCgov. Thereafter, COFC dismissed the lawsuit for lack of jurisdiction. Northrup appealed the dismissal to CAFC, which reversed the holding. The CAFC decision held that Northrop’s initial claim to the CO satisfied the Contract Disputes Act’s claim requirements and was not, as COFC had ruled, a pass-through claim on behalf of the assignee. CAFC remanded the case to COFC, where the government argued that Northrop had not shown any damages from the alleged breach. COFC agreed and dismissed Northrop’s claim a second time.

Again, Northrop appealed the loss to CAFC. This time, however, CAFC upheld the COFC decision, agreeing that Northrop had failed to demonstrate that it suffered any damages even if there had been a breach. Since damages are an essential element of a breach of contract claim, Northrop’s claim could not succeed. According to CAFC, even if Northrop could demonstrate that one of the assignees suffered damages, it would fail because those entities did not have a contract with the government and, therefore, had no standing to bring a claim against the government. And because Northrop had received all of its potential profits from ESCgov when those two parties entered their initial agreement, Northrop had no right to compensation from the government. In fact, CAFC found that Northrop’s position was as good as it would have been if the government had exercised all the options on the contract. Any damages the assignees may have suffered were not appropriate to assert against the government.

On this point, Northrop had argued that the government should not be able to rely on the fact that its agreement with ESCgov had prevented it from suffering financial damages because the agreement was between Northrop and ESCgov and the government was not a party. In response, COFC ruled, and CAFC agreed, that a calculation of contract damages should take into account a party’s losses and any losses that party avoided. Additionally, Northrop was precluded from relying on its agreement with ESCgov to pursue a claim on behalf of ESCgov because it had failed to notify the government of its assignment of payment rights as required by the Anti-Assignment Act.

Thus, Northrop found itself in the doubly unfortunate position of being unable to assert a claim on behalf of its assignee, and being vulnerable to the government’s defense that Northrop had not suffered damage, because it could not prove economic harm. And any claims ESCgov or its assignee had could not be asserted against the government.

Contracts assigned to a third party in violation of the Anti-Assignment Act—as here—are generally unenforceable against the government. So, even if Northrop had been able to demonstrate harm, it likely would not have prevailed because it did not notify the government of the change as was required by federal law. While the Act serves the important purpose of ensuring government accountability in fiscal matters by preventing multiple parties from collecting on the same government debt, it can create an additional burden for a contractor in its business decisions. It pays to both avoid excessive reliance on the government’s exercise of options and to strictly adhere to the Anti-Deficiency Act’s requirements.