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,
I
A
In 1984; the Department of the Navy introduced the Advanced Tactical Aircraft
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 Chеney 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 unilаterally 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,
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
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 choоse 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 cаnnot 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 оr 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-
B
On February 5, 1991, the Navy sent a letter to Contractors demanding the return of approximately $1.35 billion in un-liquidated 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 сourt: (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,
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,
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 becаuse of the government’s invocation of the “state secrets doctrine,”
see McDonnell Douglas Corp. v. United States,
The government appeals from the trial court’s decision to convert the default termination to a termination for convenience, and from the trial court’s refusal to apply a loss-adjustment ratio in calculating damages. Contractors conditionally cross-appeal the trial court’s ruling, arguing thаt the government has no power to terminate an incrementally-funded contract for fail
II
The level of discretion that must be exercised by the government before terminating a contract for default is a question of law, which we review
de novo. See Darwin Constr. Co. v. United States, 811
F.2d 593, 596 (Fed.Cir.1987);
Barseback Kraft AB v. United States,
A
The trial court held that the government’s termination, of the A-12 contract did not comport with the rule laid down in
Schlesinger
by the United States Court of Claims, our predecessor court, for a proper default termination.
Schlesinger
involved a cap manufacturer who won a contract to supply the Navy with 50,000 seiwiee caps for enlisted men. The contract required the manufacturer to submit pre-production samples of component materials, as well as two samples of the completed cap, to the government for approval prior to production. In addition, the contract included a delivery schedule which set forth delivery dates for five separate installments of the completed caps.
See Schlesinger,
The Court of Claims held that the default termination
of
Schlesinger’s contract was illegal. In doing so, the court first found that Schlesinger was indeed technically in default under the terms of the contract.
See id.
at 706-07. However, the court determined that neither the contracting officer nor anyone else in the Navy exercised independent judgment in terminating the contract for default.
See id.
at 707-08 (citing
John A. Johnson Contracting Corp. v. United States,
The illegality in
Schlesinger
stemmed from .the Navy’s reliance on contractor default as a pretext to terminate its relationship with the contractor, independent of the state of actual performance under the contract. The court characterized Schlesinger’s performance shortcomings as merely a “technical default” or “bare default,”
id.
at 707, 708, and emphasized the Navy’s total failure to consider the level of performance once it found a means for terminating by default.
See, e.g., id.
at 708 (“[T]he Navy acted as if it had no option but to terminate for default ... once the mere fact of non-delivery was found.”). In
Schlesinger,
it was improper for the Navy to terminate the contractor for default due solely to pressure from a congressional oversight committee because
In short,
Schlesinger
bars only a termination for default in which there is no considered
nexus
between the default termination and the contractor’s performance under the contract. A second case relied upon by Contractors,
John A. Johnson Contracting Corp. v. United States,
A third case cited to us by Contractors,
Darwin Construction Co. v. United States,
Properly understood, then,
Schlesinger
and its progeny merely stand for the proposition that a termination for default that is unrelated to contract performance is arbitrary and capricious, and thus an abuse of the contracting officer’s discretion. This proposition itself is but pаrt of the well established law governing abuse of discretion by a contracting official.
See, e.g., United States Fidelity & Guaranty Co. v. United States,
B
The record shows that the government’s default termination was not pretex-tual or unrelated to Contractors’ alleged inability to fulfill their obligations under the contract. Therefore, unlike the cases cited above, the government’s decision to terminate the A-12 FSD Contract for de
First, the trial court interpreted the Navy’s actions prior to termination to evince a desire
not
to terminate the A-12 program for default, but rather to continue the contract.
See McDonnell Douglas IV,
The trial court’s factual findings do in fact establish that the Navy did not want to terminate the A-12 program. Instead, at all times up until the very end, the Navy hoped to preserve the program and its A-12 aircraft.. That is not to say, however, that Contractors were not in default under the contract, or that the government did not have the right to terminate the contract for default. A party to a contract, faced with a breach by the opposing party, can choose either to terminate the contract or to continue the contract, perhaps extracting other concessions or consideration from the breaching party in return for its willingness to modify the contract. See, e.g., 3 Samuel Williston & Richard A. Lord, A Treatise on the Law of Contracts § 7:36 (4th ed.1992). A party that chooses to proceed with the contract — even if it is the government, and even if it manifests a strong desire to procure the item that is the subject of the contract — does not thereby waive its right to terminate for default. Indeed, the trial court’s finding that the Navy went to greаt lengths to preserve the A-12 program suggests that it would not have terminated the contract but for its belief that Contractors had breached the contract or would not perform the contract.
More importantly, however, the record demonstrates that the government properly terminated the A-12 program for reasons related to contract performance. Admiral Morris, the contracting officer, testified at length about his decisional process that led to the termination for alleged default. He thought that he had three choices: to terminate for convenience, to terminate for default, or to do nothing. He rejected the latter as “irresponsible,” thus focusing his attention on the other two choices. He eliminated the termination for convenience first, because he believed Contractors to be in material breach of the contract. This was sо, in his words, because, as conceded in Contractors’ response to the cure notice:
They were in default because they acknowledged they would not be able to achieve the contract specifications and the contract requirements. Two, they had indicated that the would not be able to meet the delivery schedule that was currently in the contract. And three, they would not be able to perform the contract without extraordinary relief or additional funding for the contract. So they basically said they can’t perform under the contract and they were in default of it.
Joint Appendix at 3,898-99. In further elaboration of his decision, again in the context of Contractors’ response to the cure notice, Admiral Morris testified as to why he thought Contractors’ default was material:
They had failed to fabricate parts so as to endanger performance .of the contract, and in my judgment, as would relate to the production options, failed to make progress, and it was clear to me that that is where they stood on the 7th of January when I terminated the contract for default.
[B]ecause I felt very strongly that as a result of the contractors’ default, it would be nothing short of unconscionable for me to put the burden of the contractors’ failure to make progress and the contractors’ failure to fabricate parts, so as to endanger performance of the contract, put that burden on the government and the taxpayer to reimburse all costs and to pay the contractors a profit for their failures.
Id. at 3,920. Therefore, Admiral Morris terminated the contract for failure to make progress and for failure to meet contract requirements.
Failure to meet contract specifications and inability to meet the contract delivery schedule are of course relevant considerations to whether a contractor is in default.
See Discount Co. v. United States,
The trial court also found that Secretary Cheney denied extraordinary relief, which led to the termination, because of concerns about the A-12 program’s “cost and schedule.”
McDonnell Douglas IV,
The government had specific concerns about when—and if—the A-12 aircraft would ever be delivered and how much it would cost. Secretary Cheney stated in testimony before Congress that the A-12 program was terminated because “no one could tell me how much the program was going to cost even just through the full-scale development phase or when it would be available. Data that had been presented at one point a few months ago turned out to be invalid and inaccurate.”
Hearings on National Defense Authorization Act for Fiscal Years 1992 and 1993—H.R. 2100 and Oversight of Previously Authorized Programs Before the House Comm, on Armed Servs.,
102nd Cong. 60 (1991) (statement оf Richard Cheney, Secretary of Defense). The evidence in the record demonstrates that the Secretary of Defense denied relief under Pub.L. 85-804, and Admiral Morris chose to terminate the contract for default, for reasons related to Contractors’ state of performance of the contract. The trial court emphasized that although Contractors failed to meet the aircraft weight limit, the Navy essentially waived this requirement because the overweight aircraft would still meet all operational requirements.
See McDonnell Douglas IV,
We think it clear beyond any doubt that Admiral Morris, unlike the contracting officer in
Schlesinger,
or in other cases that have upset terminations for default for lack of nexus to contract performance behavior, made his choice for reasons related to contract performance. Admiral Morris certainly knew that Contractors took another view of events transpiring during
To summarize, the government may not use default'as a pretext for terminating a contract for reasons unrelated to performance; instead,- there must be a nexus between the government’s decision to terminate for default and the contractor’s performance. The record and the facts found by the trial court establish that the government denied additional funding for the A-12 program and terminated the contract for default because of concerns about contract specifications, contract schedule, and price — factors that are fundamental elements of contract performance. Therefore, the trial court erred by vacating the termination for default without first determining whether a default existed. On remand, if the government can establish that Contractors were in default, then the termination for default would be valid.
See Lisbon Contractors, Inc. v. United States,
Ill
We turn next to the government’s argument that the trial court erred in refusing to apply a loss ratio to Contractor’s termination for convenience recovery, and the trial court’s related treatment of Contractors’ claims under the superior knowledge theory and for reasonable profits. In government contracts law, under certain circumstances the government owes a duty to disclose critical information to a contractor that is necessary to prevent the contractor from unknowingly pursuing “a ruinous course of action.”
Helene Curtis Indus., Inc. v. United States,
After a series of security breaches and discovery abuses, the trial court concluded that it could not litigate further the related issues of loss adjustment, superior knowlеdge, and reasonable profits.
See id.
at 272, 276-78. Contractors do not directly appeal this ruling; they contend only that if we upset the trial court’s decision on loss adjustment, a remand of all three is appropriate. The government argues that Contractors’ superior knowledge and reasonable profits claims were properly removed from litigation because they jeopardized state secrets, but that its loss adjustment
IV
Turning finally to Contractors’ cross-ap- ■ peal, we consider whether the nature of the A-12 contract as a fixed-price, incrementally-funded contract affects the government’s ability to terminate the contract. Contractors first argue that the government cannot apply a loss adjustment factor, based on the estimated cost of completing the cоntract, to Contractor’s recovery under a termination for convenience because the government was not obligated to fund the contract to completion. Because we reverse the trial court’s conversion of the default termination to a termination for convenience, we do not address this point.
Contractors similarly argue that the government cannot legally terminate the A-12 FSD Contract for failure to make progress toward work that the government was not obligated to fund, and which it in fact did not fund in full. Contractors argue that because the government limited its potential liability to Contractors through the incremental funding arrangement, see A-12 FSD Contract, ¶ H — 7(c), Joint Appendix at 15,073, there was no mutuality of obligation for the full FSD contract, and the contract was only valid to the extent of the funds already obligated. Under Contractors’ theory, it follows that the government could not terminate the contract for failure to make progress toward work that they were not legally obligated to perform. In essence, Contractors assert that the government was precluded from terminating them for default due to failure to make progress toward the completion of the A-12 contract, unless and until the government had funded the contract in full.
We reject Contractors’ arguments, however, for the following reasons. First, the A-12 FSD Contract explicitly recites the grounds upon which the government may terminate the contract for default, which grounds include Contractors’ failure to make progress.
See
48 C.F.R. § 52.249 — 9(a)(l)(ii) (1984); A-12 FSD Contract § I ¶ I, Joint Appendix at 15,251 (incorporating FAR 52.249-9). Contractors agreed to installment funding of the contract because the government could not obligate the full ceiling price at the time of. contracting.
See id.
§ H-7(a), Joint Appendix at 15,072. In order to comply with the Anti-Deficiency Act,
see
31 U.S.C. § 1341(a) (prohibiting expenditures, obligations, and contracts exceeding appropriations), the parties specified that the government’s total obligation, including termination costs, would never exceed the amount obligated at the time of termination.
See
A-12 FSD Contract § H-7(c), Joint Appendix at 15,-073. In return, Contractors were not required at any time to incur costs in excess of the total obligated amount.
See id.
§ H-7(b), Joint Appendix at 15,072. Despite this funding arrangement, however, the parties agreed that the government had the right to “terminate this contract in whole or in part if the Contractor fails to ... [pjrosecute the work so as to endanger performance of this contract.” 48 C.F.R. § 52.249 — 9(a)(1)(ii) (1984). Therefore, installment funding
Second, we disagree with Contractors regarding their obligations under the A-12 FSD Contract. Contractors emphasize that, because of the incremental funding, there has never been a binding contract for completion of full FSD performance. Contractors acknowledge that the government could have default terminated the contract for failure to meet specific requirements associated with a particular installment of funding, but assert that failure to meet such specific requirements constitutes the
only
basis for a valid default termination. Because the contract did not link any specific objectives to a particular level of funding, Contractors argue, there was no basis for a default termination. We agree with Contractors that, at the time of termination, they were not obligated to
complete
all contract requirements. That does not mean, however, that Contractors did not have any obligations with respect to the full FSD requirements. As we noted above, the A-12 FSD Contract recites failure to make progress as a basis for contractor default and contract termination.
See
48 C.F.R. § 52.249 — 9(a)(l)(ii) (1984). Therefore, Contractors’ assertion that failure to meet contract requirements that are linked to already-funded work is the sole basis for default is simply incorrect. Failure to satisfy such requirements forms a ground for default under 48 C.F.R. § 52.249 — 9(a)(l)(i) (stating that the government may terminate a contract for default if the contractor fails to “[pjerform the work under the contract within the time specified in this contract or any extension”). Subsection (a)(1)(h), in contrast, provides a separate basis for default: it obligates Contractors to make enough progress so that contract performance is not endangered.
See Universal Fiberglass Corp.,
Third, the authorities cited by Contractors fail to establish that they were under no contractual duty to make progress. Contractors rely heavily on an internal government memorandum prepared by the Defense Department’s Contract Finance Committee to support their proposition that a fixed-price incrementally funded contract imposes no obligations on a contractor beyond those associated with funding that has already been provided. The memorandum expresses the committee’s view that:
[I]f incremental funding is used, the contractor cannot be required to expend any effort beyond the Government’s limitation of obligation. Failure to provide additional funding increments not only results in contract termination, but also makes it necessary to define, after the fact, what part of the effort should have been completed for the amount of funding actually provided. Since this division was apparently not possible in the first place, the contract, for all practical purposes, is converted to a best effort cost-type vehicle; the Government gets whatever the contractor was able to complete with the money provided.... Any advantages gained from use of a fixed price R & D contract are at risk until that point when incremental funding is replaced with full funding.
Memorandum from Chairman, Department of Defense Contract Finance Committee, to Director, DAR Council ¶ 3(c) (June 5, 1992), Joint Appendix at 68,695 (emphasis added). Setting aside questions аbout the legal significance of this memorandum, we conclude that Contractors’ duty to make progress toward completing the A-12 FSD contract is consistent with the views expressed in the memorandum.
Having determined that Contractors were obligated to make enough progress such that contract performance was not endangered, we must now address what progress Contractors should have made, corresponding to the funding actually provided by the government, in order to avoid default for failure to make progress. We disagree with Contractors’ argument that it is “not possible” to answer this question, and that the сontract must be converted into a cost-reimbursement type contract. Id. In litigation over a contractor’s failure to make progress — unlike a dispute over failure to meet a specific contract requirement or schedule — courts must always determine ex post the threshold of performance that a contractor must meet to avoid, endangering performance of a contract. See Cibinic & Nash, Administration of Government Contracts 980-32 (tracing the evolution of the test applied by courts for failure to make progress). The same is true in this case.
Contractors rely on
Electronics of Austin,
ASBCA No. 24,912,
The question of whether Contractors satisfied their duty is of course that of breach, and must be determined by taking into account all of the relevant facts and testimony, such as Contractors’ statements that they could not meet the contract specifications, the contract delivery schedule, nor complete performance at the specified contract price. See supra Part II.B. We leave it to the trial court to resolve these issues in the first instance.
CONCLUSION
We reverse the trial court’s ruling that the government’s default termination of the A-12 FSD Contract must be converted into a termination for convenience because the government did not exercise the necessary discretion. Of course, we do not hold today that the government’s default termination is justified. As Contractors correctly point out, they have never been found to be in default of the сontract. Because the trial court focused on the legitimacy of the government’s default termination decision, rather than on whether Contractors were in fact in default, the parties have not yet been afforded the opportunity to fully litigate default.
See McDonnell Douglas Corp. and General Dynamics Corp. v. United States,
No. 91-1204C, slip op. at 2 (Fed. Cl. June 17, 1993). If the government fails to establish at trial that Contractors were in default
REVERSED-IN-PART, VACATED-IN-PART, AND REMANDED.