Federal Contract Law: Ruling could make a contract's terms into a moving target

Joseph J. Petrillo

When the Supreme Court decided the Winstar case in 1996, some observers thought it marked the dawn of a new era in which the government would be treated like any other party to a contract. Maybe not.

The Winstar decision grew out of the savings and loan fiasco of the 1980s.

In its early stages, the government sought to save failing thrift institutions by merging them into solvent ones. To make this work, federal regulators agreed that the acquiring institution could count red ink on the acquired thrift's balance sheet as 'goodwill,' and therefore an asset.

This clever accounting change kept the failing company from bringing down the healthy one that took it over. But redefining a liability as an asset was a bit too clever for Congress, which outlawed the practice through legislation called FIRREA.

The resulting reversal of fortune sank some of the acquiring institutions.

So, they sued for breach of the takeover contracts. In Winstar, the Supreme Court held that the contract shifted the risk of changes in the law to federal agencies, so the acquiring banks could recover damages.

In a more recent case brought by another S&L, however, the Court of Appeals for the Federal Circuit recently stood the Winstar result on its head. The decision is Admiral Financial Corp. vs. U.S., Aug. 5, 2004.

The contract in that case included a clause that 'all references' to the regulations of the federal regulatory body, 'shall include any successor regulation thereto, it being expressly understood that subsequent amendments to such regulations may be made and that such amendments may increase or decrease the Acquiror's obligation under this Agreement.'

The Court of Appeals held that this clause included the subsequent adoption of the FIRREA rules in federal regulations. The definition of 'goodwill' that made the Admiral Financial deal economically feasible was subject to change at any time'which seems to put the risk of changes in the law back on the contractor, rather than the government.

A contract, to be binding, needs consideration. This can be the mere exchange of promises. Admiral Financial argued that the 'successor regulation' clause made the deal 'illusory' and wasn't consideration.

The Court of Appeals disposed of this argument by pointing out the general rule that an illusory promise doesn't doom a deal as long as there is some other consideration in the contract. The court held that that was 'plainly the case here,' although they did not spell out the consideration.

Black-letter law aside, this isn't the same as two private parties allocating the risk of future regulations. The government, after all, is making the rules. This is more like selling your house to someone who can later demand the refund of some or all of the purchase price.

Ripple effects

Oddly enough, the appellate court's harsh ruling wasn't necessary. The combined thrift was in such bad shape, FIRREA was irrelevant. Admiral Financial would have collapsed even if the accounting rules had not changed.

The Admiral Financial decision could be bad news for contractors, especially those with cost-reimbursement contracts. What costs the government will reimburse are subject to acquisition regulations and the Cost Accounting Standards.

Now, the government can put a standard clause in such contracts binding the contractor to any changes it makes in these rules. It can then declare various costs 'unallowable,' and refuse to pay them.

In one of the Star Wars movies, Lando Calrissian, who had struck an arrangement with Darth Vader, complained that Vader wasn't holding up his end. Vader's reply: 'I am altering the deal. Pray I do not alter it further.' Will life imitate art?

Joseph J. Petrillo is a lawyer with the Washington law firm of Petrillo & Powell. E-mail him at jp@petrillopowell.com.

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