Government Contracts Monitor

Subcontractors: Don’t Rely on Government Assurances!

March 30, 2015

A recent decision by the United States Court of Appeals for the Federal Circuit (Federal Circuit) highlights the very substantial risks that subcontractors run in continuing performance under a financially troubled prime contract based upon government urgings and assurances of indirect payment for further services, as well as the difficulties faced by a subcontractor seeking to hold the government directly liable in such circumstances under a third-party beneficiary theory. G4S Technology LLC v. United States, CAFC No. 2014-5078, decided March 6, 2015. The decision does, however, provide some guidance on what subcontractors should do to protect themselves before continuing work under a troubled contract.

The case arose out of a $267 million loan from the Department of Agriculture’s Rural Utilities Service (RUS) to Open Range Communications, Inc. (Open Range) to finance construction of wireless broadband networks. As part of the loan agreement, RUS required Open Range to keep a pledged deposit account into which RUS would advance loan funds as needed. To receive these funds, Open Range was required to submit financial statements outlining the purpose of each advance, including relevant invoices and purchase orders, and Open Range was expected to use the advanced funds for the stated purposes.

RUS anticipated that Open Range would use subcontractors, and required that the subcontractor relationships be formalized through Master Service Agreements (MSAs) between Open Range and the respective subcontractors using RUS-approved format, including technical specifications, pricing information, target completion dates and other requirements. RUS edited and formally approved a generic MSA for Open Range to use, and Open Range entered into one of these MSAs with G4S.

Unfortunately, the project encountered difficulties, and Open Range began failing to meet its payment obligations to its subcontractors, who threatened to stop work. To encourage the subcontractors to continue work, RUS made additional money available to Open Range and sent a letter to Open Range stating the project was moving forward. RUS issued two further public letters, stating it intended to downsize, but would continue funding, the project. Despite further funds advances, Open Range was unable to pay G4S the full amount owed, and subsequently filed for bankruptcy. While the bankruptcy proceedings were ongoing, G4S filed suit in the Court of Federal Claims (COFC) seeking, as a third party beneficiary, to recover directly from the government monies due for work authorized and approved by RUS that G4S performed after receiving RUS’s and Open Range’s payment assurances.

The government moved to dismiss for lack of privity. The COFC rejected Open Range’s argument and granted judgment in favor of the government. G4S appealed to the Federal Circuit, which affirmed the COFC’s decision, stating that third-party beneficiary status is available “only if the contracting parties so intend” and that “[t]his intent may be either ‘express or implied,’ and it must be ‘fairly attributable to the contracting officer. . . . In addition, the benefit to the third party must be ‘direct.’”

Here, the prime contract contained no express declaration of intent. G4S therefore relied on RUS’s additional funding and letters regarding the project as evidence that RUS intended to bind itself to Open Range’s subcontractors. The Court did not dispute that RUS wanted the subcontractors to continue work. However, such circumstantial evidence has to “be considered in the context of the government’s responsibilities to safeguard taxpayer funds and advance the public interest” and, when viewed in such context, was “entirely consistent with the government’s general duty to protect the public interest” and, “If anything, this sort of governmental response should be encouraged.”

In cases where the COFC has found a subcontractor to be a third party beneficiary based on a payment mechanism, the subcontractor was paid by the government more directly, e.g., through a joint payment arrangement or escrow for benefit of the subcontractor. Here, however, the payments were made into the prime contractor’s “general fund,” even though RUS knew subcontractors were due certain portions of the fund. The Court characterized RUS’s various statements and letters as nothing more than efforts to rebuild Open Range’s credibility, and merely “reinforce[d] the conclusion that Open Range, not RUS, was the party entering into obligations with subcontractors such as G4S,” and that RUS thus “did not express any intent that it be held liable for payments to subcontractors.”

This decision demonstrates the high hurdles faced by subcontractors seeking to recover directly from the government, and the limits of a third party beneficiary theory. Before agreeing to continue work at the government’s urging, subcontractors would do well to require direct government financial commitments, such as the joint payment or escrow arrangements cited by the Court or some other similar direct payment mechanism or assurances.