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McDonnell Douglas Corp. v. United States

July 01, 1999


Before Mayer, Chief Judge, Michel and Clevenger, Circuit Judges.

The opinion of the court was delivered by: Clevenger, Circuit Judge.

Appealed from: United States Court of Federal Claims Judge Robert H. Hodges, Jr. United States Court of Appeals for the Federal Circuit

This dispute arises out of the government's default termination of a contract between the United States Navy and defense contractors McDonnell Douglas Corporation and General Dynamics Corporation ("Contractors") to develop a carrier-based, low-observable "stealth" aircraft known as the A-12 Avenger. After several years of litigation, the United States Court of Federal Claims held that the government's termination of the contract for default could not be sustained because the government did not exercise the requisite discretion before entering a default termination, see McDonnell Douglas Corp. v. United States, 35 Fed. Cl. 358, 368-71 (1996) (hereinafter McDonnell Douglas IV), and converted the termination for default into a termination for convenience, awarding Contractors costs totaling $3,877,767,376. See McDonnell Douglas Corp. v. United States, 40 Fed. Cl. 529, 555-56 (1998) (hereinafter McDonnell Douglas IX). We hold that, because the termination for default was predicated on contract-related issues, it was within the discretion of the government. Accordingly, the Court of Federal Claims' conversion of the termination for default into a termination for convenience was in error. We reverse the trial court's judgment and remand the case to the trial court for a determination of whether the government's default termination was justified, an issue upon which we express or intimate no view.



In 1984, the Department of the Navy introduced the Advanced Tactical Aircraft Program, known as the A-12 program, to develop a carrier-based stealth aircraft for the Navy. In January 1988, Contractors entered into a Full Scale Engineering Development contract (the "A-12 FSD Contract") with the government to produce eight FSD aircraft at a target price of $4,379,219,436. See McDonnell Douglas IV, 35 Fed. Cl. at 361. The contract was structured as an incrementally funded, fixed-price incentive contract with a ceiling price of $4,777,330,294, and recited a schedule of installment payments over the five-year term of the contract. The first aircraft was originally scheduled to be delivered in June 1990, and subsequent aircraft were to be delivered each month through January 1991. See id. at 361-62.

From the outset, Contractors encountered difficulties in performing the contract. Particular problems included meeting the contract schedule and keeping the aircraft weight within specifications. At the beginning of 1990, the Department of Defense initiated a Major Aircraft Review to evaluate various major aircraft programs in view of recent changes around the world and the corresponding reduced threat to national security. See id. at 362. The A-12 program was included in this Review, and Defense Secretary Richard Cheney visited the McDonnell Douglas plant as part of the review process. By the early part of 1990, the Navy's contracting officer knew that Contractors would not meet the delivery date for the first aircraft. See id. However, although Secretary Cheney was apprised of some concerns in the A-12 program, the review concluded that there was a continuing need for the A-12 and that the Navy should pursue the program. See id. at 363. Secretary Cheney reported these results during his testimony before Congress in April 1990.

In June 1990, Contractors informed the Navy that they could not meet the contract schedule, that the cost of completing the contract would substantially exceed the ceiling price, and that Contractors could not absorb the loss that would result from the contract. Contractors asserted that a fundamental problem with the FSD contract was its structure as a fixed-price contract and proposed that the contract be modified. Thereafter, Contractors submitted a proposal to change the contract schedule, but the Navy and Contractors failed to reach an agreement on that issue. Instead, on August 17, 1990, the Navy unilaterally issued a contract modification that changed the delivery schedule for the aircraft. Under this modification, the delivery date of the first aircraft was delayed until December 1991, and the remaining aircraft became due periodically between February 1992 and February 1993. See Contract Modification P00046 ¶ 1(b), Joint Appendix at 15,657.

In November 1990, Contractors submitted a formal request to the Navy to restructure the contract as a cost-reimbursement type contract. At the end of the same month, two reports were published which documented the handling of the A-12 program under the Major Aircraft Review. The Navy's "Beach Report," dated November 28, 1990, found that the A-12 program manager had been unreasonable both in reaching a Conclusion that the contract could be performed within the ceiling price and in evaluating the risk of failing to meet the contract schedule. See McDonnell Douglas IV, 35 Fed. Cl. at 363. The Beach Report criticized several Navy officials involved in the A-12 program. Separately, a November 29, 1990 Department of Defense Inspector General report concluded that problems in the A-12 program were inaccurately identified during the Review because the Review did not accord with specified procedures and was otherwise handled poorly. See id.

During the Secretary's briefing to the President of the United States in early December 1990, the Secretary indicated his disappointment with the Navy's handling of the A-12 program and promised to take appropriate actions. On December 3, the Secretary directed the Deputy Secretary of Defense to review and report on the status of the A-12 program within ten days. This resulted in several meetings by the Defense Acquisition Board and Defense Procurement Review Boards. In addition, on December 12, the Secretary of the Navy responded to Secretary Cheney's December 3 request with a memorandum that expressed concern about Contractors' ability and willingness to perform under the contract, and which noted in particular Contractors' belief that the government should assume responsibility for failure to meet goals under the contract, and that the government should restructure the contract. The memorandum concluded with a statement that the Navy would examine whether the contract should be terminated for default, and would make a recommendation to the Secretary by January 5, 1991. See id.

On Friday, December 14, Secretary Cheney directed the Secretary of Navy to show cause by January 4, 1991 why the A-12 program should not be terminated. The following Monday, December 17, the Navy issued a cure notice to Contractors stating that unless they were able to meet contract specifications by January 2, 1991, the government might choose to terminate the contract for default. In particular, the cure letter stated that, inter alia, Contractors had "failed to fabricate parts sufficient to permit final assembly in time to meet the schedule for delivery," and had "fail[ed] to meet specification requirements." Joint Appendix at 16,524. The letter asserted that "[t]hese conditions are endangering performance of [the] contract." Id.

High-level meetings between the responsible government personnel, including the contracting officer and the general counsels of the Department of Defense and of the Navy, and Contractors, including the Chief Executive Officers of McDonnell Douglas and General Dynamics, occurred on December 18 and 21. During these meetings, Contractors asserted that they "[c]an't get there if we don't change contract," id. at 16,533, and "[i]t has got to get reformed to a cost type contract or we cannot do it." Id. at 16,549. When asked by the government on December 21 "can you correct deficiencies to provide an aircraft that meets the requirements," Contractors replied "[a]ll deficiencies cannot be corrected. Can we deliver a satisfactory aircraft for the Navy? Mother nature won't allow correction of all defects. We'll do the best we can and the Navy has to decide if that's good enough." Id. at 16,548-49.

Contractors responded to the cure notice on January 2 by admitting that they "[would] not meet delivery schedules or certain specifications of the original contract, or the revised FSD delivery schedule." Id. at 18,175. Contractors did not contest that they had failed to fabricate parts in time to meet the delivery schedule for the FSD aircraft. Nonetheless, Contractors asserted that they were not in default because, in their view, the delivery schedules were invalid or unenforceable. See id. at 18,175-78. As suggested cure, Contractors submitted a proposal to restructure the contract, pursuant to which Contractors would absorb a $1.5 billion fixed loss on the cost overrun from the contract, the contract would be restructured to a cost reimbursement contract, and Contractors would waive their claims for equitable adjustment. Contractors proposed to restructure the contract pursuant to Pub. L. No. 85-804, which gives the President of the United States the power to authorize departments or agencies connected with national defense to grant extraordinary relief under contracts if such an action facilitates the national defense. See 50 U.S.C. § 1431 (1994).

On Saturday, January 5, Secretary Cheney met with Undersecretary of Defense for Acquisition Yockey, the Secretary of the Navy, and the Chairman of the Joint Chiefs of Staff to discuss the budget and the A-12 program. At the meeting, Secretary Cheney noted that a scheduled payment of $553 million--one of the largest installment payments under the A-12 contract--was due on Monday, January 7. Later that day, Secretary Cheney, acting under authority pursuant to Pub. L. No. 85-804, decided not to grant relief. On Sunday, January 6, Undersecretary Yockey informed Rear Admiral William R. Morris, who at this time was acting as contracting officer over the A-12 contract, that Secretary Cheney had denied 85-804 relief and that no further funds would be obligated under the A-12 program. The next day, Admiral Morris issued the termination letter to Contractors stating that the government was terminating the A-12 contract due to Contractors' default.


On February 5, 1991, the Navy sent a letter to Contractors demanding the return of approximately $1.35 billion in unliquidated progress payments under the terminated contract. On June 7, Contractors filed suit in the United States Court of Federal Claims under the Contract Disputes Act, 41 U.S.C. § 609(a) (1994), requesting that the court: (1) grant their equitable adjustment claims dated December 31, 1990, (2) convert the government's termination for default into a termination for convenience, (3) deny the government's demand for return of progress payments, (4) award Contractors costs and a reasonable profit under the contract, (5) award them settlement expenses, and (6) award damages for breach of contract. See McDonnell Douglas Corp. v. United States, 25 Cl. Ct. 342, 346 (1992).

After several years of litigation in the Court of Federal Claims, that court ruled, in a decision dated April 8, 1996, that the government's default termination was invalid according to Schlesinger v. United States, 390 F.2d 702 (Cl. Ct. 1968). See McDonnell Douglas IV, 35 Fed. Cl. at 368-71. The trial court held that under Schlesinger, the government is required to exercise "reasoned discretion" before terminating a contract for default, and that the government failed to meet this requirement because the Secretary of Defense's actions effectively forced the Navy to terminate the A-12 contract for default. See id. at 369-71. Therefore, the trial court vacated the government's termination for default and converted it into a termination for convenience. See id. at 361.

In further litigation over damages, Contractors claimed that they were entitled to recover a reasonable profit under the contract, whereas the government argued that any recovery should be reduced by an appropriate loss-adjustment ratio. Contractors further alleged that the government possessed knowledge regarding how difficult it would be to perform the A-12 contract, and that under the "superior knowledge" doctrine, the government had a duty to either disclose such knowledge or otherwise protect Contractors against suffering unreasonable losses under the contract. The court held that the government's claim for a loss adjustment, Contractors' claim for reasonable profits, and the superior knowledge claim could not be further litigated because of the government's invocation of the "state secrets doctrine," see McDonnell Douglas Corp. v. United States, 37 Fed. Cl. 270, 272 (1996) (hereinafter McDonnell Douglas V), which grants the Executive the exclusive right to bar discovery into specific classified areas that affect state secrets. See United States v. Reynolds, 345 U.S. 1, 7 (1953). The court ultimately denied the government's claim for return of $1.35 billion in unliquidated progress payments, and allowed ...

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