Unclear contracts can spell trouble down the road

The challenges are even greater when the acquisition and payment methods are complex.
Creative techniques such as seat management and asset management call for careful
attention to the contract terms and conditions.

A recent Court of Federal Claims decision in Cray Research Inc. vs. United States shows
what can happen when the contract isn’t clear.

This case arose from a seemingly straightforward lease-to-ownership deal. When the
parties sought to change the terms and conditions, however, the contract became, in the
words of the late Judge Oscar Davis, “a study in the toils of ambiguity.”

The CIA had awarded a contract to Cray Research for a supercomputer. The lease was for
a base period, followed by successive one-year options. After making lease payments for 72
months, the CIA would own the computer.

Shortly into the contract, however, the CIA sought to replace this system with a
different Cray supercomputer. This time, the parties referred to the changed arrangement
as an alternate payment plan. The CIA would first acquire a so-called encumbered title to
the computer. After five annual payments, the CIA would get clear title.

The modification for the other computer contained two added provisions. One stated that
“any reference to a lease arrangement of any kind under this modification is
invalid.” The second stated that all terms and conditions of the contract would
remain in force and effect, except as provided in the modification.

Those terms and conditions already included two provisions regarding exercise of
options, each containing different conditions.

Before the last annual payment, however, the CIA decided not to exercise the option for
the last contract year. Cray filed a claim for the unpaid last payment, contending that it
was still due under the alternate purchase plan. The matter proceeded to court.

One important limitation on a lease or other multiyear agreement is whether the
contract is funded by annual appropriations. If so, the contract is limited in duration to
one year.

Options must be subject to congressional appropriation of funds adequate to continue
paying the contractor.

In a famous 1976 opinion, the General Accounting Office ruled that computer contracts
funded with annual appropriations could not contain a monetary penalty for failure to
exercise an option. Such a provision, although common in commercial contracts, ran afoul
of the legal restrictions on appropriated funds.

This restriction did not figure in the Cray case. There, the court sought to determine
whether the modification substituting the newer model of computer also converted the lease
agreement to an agreement to purchase with installment payments. Both parties asked the
court to rule in their favor based on the contract language.

The court reached a stalemate. It could not decide, on the basis of the contract alone,
which party’s interpretation was correct. Instead, the court found that an ambiguity
was created by the modification’s “incorporation of both lease and purchase
language, its purported deletion of lease references elsewhere in the contract, and the
use of inconsistent language in later contract modifications, viewed in conjunction with
the lease provisions of the base contract.”

To resolve the meaning of the contract, the court said it would need extrinsic evidence
on the meaning of the modification. This is evidence outside the four corners of the
contract document and would include matters such as the communications during negotiations
on the contract modification and the course of dealings between the parties before the
dispute arose. It would require a trial.

Obviously, neither party wanted to go to court on this dispute, much less to trial. The
only way around such a problem is to make sure from the start that contract language is
unambiguous. The faulty phrasing of the modification doomed the parties to disagreement
when the contract did not run its full term. As a result, almost a decade after the
modification was signed, its meaning is still uncertain, and only costly litigation will
clarify it.  

Joseph J. Petrillo is an attorney with the Washington law firm of Petrillo &
Powell, PLLC. E-mail him at [email protected].


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