The Economic Waste Doctrine and its History

Posted by: on Mon, Nov 30, 2015

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The Origins of the Economic Waste Doctrine.

The Economic Waste Doctrine finds its roots in the well-known 1921 decision of Jacob & Youngs, Inc. v. Kent, 129 N.E. 889 (NY. Ct. App. 1921) involving a contract for the construction of a $77,000 custom residence.  One of the specifications in the contract called for Reading brand all wrought iron pipe.  However, through neither fraud nor intent, the builder installed pipe which did not meet the contract specifications in parts of the home.  Upon discovery of this breach, the owner instructed the builder to remove the non-conforming pipe and replace it with Reading pipe.  The builder refused and requested that the owner pay the remaining balance on the contract, arguing that the owner’s demand would require demolition of substantial portions of the completed structure.  Upon the owner’s refusal to pay the balance, the builder bought suit for recovery of the unpaid balance.

At trial, the builder offered to show that the pipe used had the same quality, appearance, cost, and market value as Reading pipe.  The trial court refused to admit this evidence and directed a verdict for the owner.  The appellate court then reversed in a now famous opinion written by Judge Cardozo of the New York Court of Appeals, which gave birth to the “Economic Waste” doctrine.  Although the usual measure of damages for failure to perform a contract is the cost of remedying the defect, the Jacobs & Young decision concluded that this measure was inappropriate when “the cost of completion is grossly and unfairly out of proportion to “the good to be obtained” from compelling specific performance.  In these situations, the proper measure of damages is the difference in value between the work performed and the work promised.  Cardozo went on to define four criteria that courts should review in determining whether unreasonable economic waste would result from strictly enforcing contract terms:  “the purpose to be served, the desire to be gratified, the excuse for deviation from the letter, and the cruelty of enforced adherence.”  The Court then found that replacement of the pipes at a high cost constituted unreasonable economic waste because the difference in value between the two brands of pipe was probably nominal.

The Economic Waste Doctrine in Government Contracts.

Some parties will no doubt rely on a strict compliance rule, to aver the government is entitled to require the contractor to repair any defect in performance at the contractor’s own cost.  However, despite the strict compliance rule, the Economic Waste doctrine has been successfully raised against the government for decades.  The board of contract appeals for various federal agencies have also had opportunities to consider the application of the Economic Waste doctrine in government contracts.  The Army’s Services Board formally adopted the Economic Waste doctrine in its 1974 decision in Valley Asphalt Corp., ASBCA No. 17595, 74-2 B.C.A. ¶10,000, 680 (May 30, 1974).  In that case, Valley entered into a contract with the government to repave a runway at the Wright Patterson Air Force Base in Ohio.  The contract specifications incorporated extremely precise final grade elevation requirements, with low deviation tolerances.  Valley failed to comply with the contract’s specifications for elevations and the contracting officer reduced the contract price by the cost of repair of these purported defects.  In its defense, Valley contended that the specifications were impossible to meet in some areas and that requiring repair of the defects was wasteful since the runway, as delivered, was fully functional.  In holding that the government was not entitled to diminish the contract price by the cost of repair, the Board determined that the proposed repairs would have involved economic waste.  The court stated that the government is entitled to expect compliance with contract specifications, but when the contractor “substantially performs” the government cannot require repairs that do not increase the value of the project proportionally.  The Board found that the value of the runway, as completed, insofar as elevations are concerned “was not measurably less than the value of the completed runway as promised.”  Therefore, the government’s proposal to bring the runway into compliance with the contract’s specifications, amounted to a demand which would have led to unreasonable economic waste.  Consequently, the government was only permitted to nominally adjust the contract price to reflect the difference in value.  The Board found it relevant that Valley had acted in good faith, throughout its performance, by attempting to satisfy the contract requirements.

A similar ruling would be appropriate in this case, and would substantially decrease the claimed damages.

In 1992, the United States Court of Appeals for the Federal Circuit announced its first decision on the applicability of the Economic Waste doctrine to government contract litigation.  See Granite Construction Co. v. United States, 962 F.2d 998 (Fed. Cir. 1992) cert. denied, 113 S.Ct. 965 (1993).  In that case, Granite Construction Co. (“Granite”) entered into a $36 million dollar contract with the Army Corps of Engineers for the construction of a dam in Mississippi.  The walls of the dam consisted of giant concrete monoliths, and the contract called for the placement of PVC waterstop at the vertical joints between the walls to prevent leaks.  The specifications for the waterstop required that it meet the detailed requirements of a certain specification.  The specification described performance characteristics of an off-the-shelf waterstop that the Corps had previously determined would satisfy all such projects.  After about 10% of the waterstop was permanently embedded in the walls, the Corps tested the waterstop, determined that it did not meet the contract specifications, and instructed Granite to remove and replace all of the waterstop placed to date.  Granite proposed several repair schemes short of removal of the waterstop, but the Corps rejected each proposal because they entailed leaving the non-conforming waterstop in place.  Granite performed the replacement and filed a claim with the contracting officer for the cost of the repair work for $3.8 million dollars, which was initially denied.  At the hearing before the Corps of Engineering Board, Granite produced an expert witness who testified that although the waterstop did not meet the contract specifications, it was more than adequate for the project’s requirements.  The United States Court of claims affirmed the Board’s conclusions, but on appeal, the Federal Circuit Court held that based on the testimony of the expert witness, the Board and the Court of Claims erred in holding that the replacement of the waterstop did not constitute unreasonable economic waste.

The appeals court found that while the government usually has the right to require strict compliance with contract specifications, the contract contained a clause which provided that Granite was required to replace any non-conforming material “unless in the public interest the government consents to accept such material or workmanship with an appropriate adjustment in the contract price.”   The Court found that this provision placed a duty on the Army Corps of Engineer to consider the “public interest” in determining whether to force replacement of a non-conforming material.  The court interpreted this duty to include an obligation to consider the waterstop relative to the performance requirements of the project.  The Court concluded that the Corps’ rejection of the waterstop was arbitrary and capricious.  The court found, however, that Granite had the burden of proving that the existing work, or the proposed remedial work, substantially complied with the contract specifications.  It further found that Granite had satisfied this burden through the expert testimony provided at the Board hearing.  The Court held that Army Corps may not require strict compliance with contract specifications when the existing work or the remedial work meets its intended purpose and when replacement of the work is economically wasteful.  The Court concluded that the waterstop was clearly adequate for the dam and that replacement of the waterstop was “an economically wasteful course of performance.”  Therefore, Granite was permitted to recover the costs of the remedial work offset by the nominal difference in value between the confirming material and the waterstop used.  Thus, with this landmark decision, the Federal Circuit Court of Appeals formally sanctioned and approved the use of the Economic Waste doctrine by the various contract appeals boards and federal courts, in federal public works contracts.  The failure of the United States Supreme Court to grant certiorari on the issue of the inapplicability of the Economic Waste doctrine to government contract litigation, suggests that the Granite ruling is unlikely to change in the near future.

Furthermore, a government agency has a duty to share its superior knowledge of any design issues, and may itself be held liable to a contractor if it provides its contractor with defective specifications.  In Northrop Grumman Corp. v. United States, 63 Fed. Cl. 12 (2004), the United States Court of Claims upheld a breach of contract claim against the government, for breaching its government implied duty to share its superior knowledge with its contractor, and for providing its contractor with deficient specifications.  The government can be liable for breach of contract based on non-disclosure of its superior knowledge when (1) the contractor undertook to perform without vital knowledge of a fact that affects costs or direction, (2) the government was aware the contractor had no knowledge of and had no reason to obtain such knowledge, (3) any contract specification supplied mislead the contractor or did not put it on notice to inquire, and (4) the government failed to provide the relevant information.  This decision and legal theory relative to defective specifications and failure to share superior knowledge by the government may also be relevant in the concrete specifications at the Tonopah test site.  The Air Force had a long maintenance history of the concrete runway in Tonopah.  If this case does not settle, discovery will focus on whether the government adequately shared all of their information accumulated over the years as to various climate and ASR concerns at the site.

The Economic Waste doctrine was discussed in a case involving a military contract in Redland Company, Inc. v. United States, 97 Fed. Cl. 736 (U.S. Ct. Claims 2011).  In Redland, the contract required plaintiff to resurface an aircraft parking area for jets at the Homestead Air Reserve Base located in Florida, by removing the existing asphalt and concrete and then laying new asphalt and new concrete.  The contractor sued claiming a variety of different site conditions including encountering excess asphalt to be removed, and the contractor also objected to being forced to remove a newly poured concrete runway section.  The Air Force rejected the concrete that the plaintiff had initially poured claiming it had not been poured within 45 minutes from leaving the batch plant.  The contractor argued that the concrete initially poured was adequate for its intended purpose.  The court indicated as follows:

[P]laintiff’s argument could provide relief under the doctrine of economic waste. See, Granite Constr. Co. v. United States, 962 F.2d 998, 1007 (Fed.Cir.1992) (holding that the government should not have required a contractor to replace work not meeting contract specifications when the work was adequate for its intended purpose and the cost of replacement was approximately $3.8 million). In general, the government, like any party to a contract, “has the right to insist on performance in strict compliance with the contract specifications and may require a contractor to correct nonconforming work.” Id. at 1006–07. However, the government may not “direct the replacement of work in situations where the cost of correction is economically wasteful and the work is otherwise adequate for its intended purpose. In such cases, the government is only entitled to a downward adjustment in the contract price.” Id. at 1007. Supporting applicability of the economic waste doctrine to this case is the fact that the rejected concrete passed all testing required by the contract. . . .

 

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