Latest decisions by Supreme Court are boon to contractors

This past session of the Supreme Court was an unusually active one in the field of
government contract law.


In a June column, I discussed the Hercules case in which the government escaped
contract liability for damages paid to soldiers by the companies that made Agent Orange [GCN, June 24, Page 69]. The contractor side
lost that case, but two recent decisions against the government tip the scales the other
way.


One case rose out of local government contracting, but because the holding is based on
the Constitution, it applies to federal contracts as well. A Mr. Umbehr hauled trash for
Waubaunsee County, Kansas. He also was an outspoken critic of the County Board of
Supervisors, which decided not to renew its contract with Umbehr. Umbehr took umbrage,
believing that the board had punished him for criticizing the supervisors. He filed suit,
but the lower court dismissed his case.


The Supreme Court held in a seven-to-two decision that Umbehr should have a chance to
prove his case. To win, said the court, he would need to show that his speech on a matter
of public concern motivated the board's contract termination. The board could defend its
action by proving the termination valid apart from Umbehr's public statements. The board
also could win if it could show that its interests as a contractor outweighed the free
speech interests at stake.


Justice Antonin Scalia, joined by Justice Clarence Thomas, dissented. Scalia seems to
believe that if a constitutional right wasn't established in the 19th century, then it
cannot be created in the 20th.


The second decision resulted from the celebrated savings-and-loan case Winstar
Corp. et al vs. United States
, which I discussed in a column a couple of years ago [GCN,
Aug. 16, 1993, Page 96]. Again, the contractor won by a seven-to-two decision. But the
justices couldn't agree on why the contractors should have won, so the legal picture is
clouded by a pair of decisions, one written by Justice David Souter and the second by
Scalia.


The case arose from promises made by the Federal Home Loan Bank Board and the Federal
Savings and Loan Insurance Corp. The bank board and FSLIC had promised that when buying a
failed S&L, a solvent thrift could count the red ink on its acquisition balance sheets
as "supervisory goodwill" and therefore an asset. It was crystal clear that
without this accounting trick, the transactions would never have taken place.


But as the S&L crisis worsened, Congress decided the approach was bad economics. It
passed legislation abolishing supervisory goodwill. Without it, the acquiring thrifts fell
short of their minimum capital requirements. Winstar, along with some other buyers that
had taken advantage of the clause to acquire failing thrifts, sued the government for
breach of contract.


In writing one of the two majority decisions, Justice David Souter concluded that the
thorny issue of sovereign acts was not the key to the case. The contracts with the
S&Ls simply shifted the risk of change in the law to the bank board and the FSLIC. So
the agreements did not limit the power of Congress to legislate or the executive branch to
regulate. If such changes denied the purchasing banks the benefit of the bargain (as they
undoubtedly did), then the government became liable under the merger contract.


This was a fairly bold end-run around the troublesome sovereign acts doctrine, and
three justices, led by Scalia, refused to follow. Using a more traditional analysis in the
second plurality decision, they interpreted this doctrine to mean simply that any promise
by the government regarding future sovereign acts had to be expressed in unmistakable
terms. The S&L acquisitions met that test, in their view, so they agreed that the
contractors had won.


The net effect of the Umbehr and Winstar holdings is to enhance the status of
contractors. The notion that they cannot be denied contracts for free speech violations
implies that there must be some rational basis for awarding a contract in the first place.
This cuts against the current trend toward unlimited government discretion in
procurements.


Also, the government cannot simply legislate or regulate away a deal it no longer
likes. The government's power to change the law is intact, but it now will be responsible
for the consequences wrought by those changes. This is likely to have a continuing effect
in areas such as changes in cost allowability rules.


Joseph J. Petrillo is an attorney with the Washington law firm of Petrillo &
Associates.


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