CHAPTER

21

CONTRACT INTERPRETATION

If a construction drawing includes a note “Est. 2000 ft.” next to a pile of dirt that has to be removed, does “Est.” mean established or estimated? What difference does it make? The difference becomes important when it turns out that the pile of dirt is 2200 feet tall. If the drawing tried to convey the idea that the height of the pile of dirt was established at 2000 feet, a contractor would be entitled to the costs incurred in removing an unexpected additional 200 feet of dirt. On the other hand, if the drawing tried to convey the idea that the height of the pile of dirt was simply estimated at 2000 feet, the contractor’s argument for getting paid to remove the additional 200 feet is much weaker.

What we have here is a problem of contract interpretation: The contract has an ambiguity. The abbreviation Est. can mean two different things. And each of the two meanings could be reasonable in context. A pile of dirt can be either established or estimated at 2000 feet.

When the parties entered into the contract involving the pile of dirt, it’s unlikely that anybody noticed the problem with Est. The drawing was probably one of many, if not hundreds, of drawings that the government prepared and all the bidders probably ignored in their rush to prepare a bid for the project.

Contracts have ambiguities all the time. When a specification of the building maintenance contract tells a company to clean as well as to stock the restrooms, what does “stock the restrooms” mean? With what? We can guess that paper products would be required. But of what quality? Do the paper towels in the dispensers have to be one-ply or two-ply? What about the quality of the toilet tissue?

    What are some of the rules for contract interpretation?

There have to be some guidelines to help contracting parties resolve these contract interpretation issues. And there are. Over the years, rules have been developed and applied to help resolve contract interpretation problems.

At the heart of all these rules of contract interpretation is the concept, or the problem, of ambiguity. Many of the contract interpretation problems that arise are caused by ambiguities.

What is an ambiguity? Curiously, the word ambiguity is itself ambiguous. It can mean three different things: It can mean that words are vague, such as the phrase “stock the restroom.” It can also mean words that have two or more different meanings, even though spelled the same way, such as the abbreviation, Est. Or, it can mean words that have contradictory meanings.

The primary rule of contract interpretation is that “the contract interprets itself.” What this means is that, ideally, any problem with what one part of the contract means should be resolved by looking at the other parts of the contract.

But this primary rule does not work with an ambiguity. Looking elsewhere in the contract for its meaning doesn’t help because the word has several different but equally reasonable meanings. So the parties can’t look to the contract for help. In legal terms, they must go “outside the contract” to find assistance. Or maybe instead of going outside the contract, the parties should simply rely on mechanical rules, such as that the contract is interpreted against the party who drafted the language.

    What is the parol evidence rule?

The parol evidence rule allows the parties to go outside the contract to find an interpretation of the contract that makes sense. Other interpretation aids become available under the parol evidence rule. For example, you can look at what the parties did, what they said during negotiations leading to the contract, and what the ambiguous words would mean in that particular business.

Looking at what ambiguous words mean in a particular business is called trade practice. For example, a contract required a building to be built and as it was built, light bulbs were to be installed. The contract also said that “new lamps” had to be installed immediately prior to completion of a construction project. To lay people, this means that any lamp previously installed during construction had to be replaced. But that is not what it means to the lighting industry. New lamps in the lighting trade means only that defective, burned out, or broken lamps had to be replaced. Installing all new lamps is called relamping. To lay people, the word new is not ambiguous. To the lighting industry, it is. How does a contracting officer interpret this language?

Two questions have to be answered. Before you can use trade practice, you have to have an ambiguity. Is the phrase new lamp ambiguous to you? No. New means new. So, to us nonexperts, there is no ambiguity and so there is no need to resort to trade practice. But new lamps in the lighting industry raises problems because there are several meanings of the phrase. So, first, in deciding whether there is an ambiguity, you must look at the context of the word.

Contract interpretation law allows the use of trade practice to establish the context of the parties. In the industry, replacing all the lamps is not putting in new lamps—it is relamping. So because the government wanted all new lamps, the term new lamps became ambiguous in context.

That allows us to go to step two: What does this ambiguous phrase mean? If the context discloses an ambiguity, contract interpretation law allows trade practice to be used to resolve it. New lamps is replacing burned out ones; relamping is replacing all the lightbulbs, whether they’re burned out or not. A court held that a government new lamp requirement meant that only burned-out bulbs had to be replaced.

    The contract says one thing, which is different from the way it’s being carried out. Does this change affect the interpretation and meaning of the words of the contract?

The way a contract is actually carried out (in legalese, the course of conduct) can affect the interpretation of the contract. A course of conduct involving the same contract, the same contracting agency, and essentially the same contract provisions can give meaning to, supplement, or qualify an agreement between two parties. So it is critical that the parties watch carefully the way the words of the contract get carried out. Conduct can add, subtract, or otherwise change a signed contract. Actions speak louder than words.

To prove that conduct has changed the actual words of a contract, a contractor has to prove that it justifiably relied on a prior course of dealing with the same contracting agency, the same contractor, and essentially the same contract provisions. For example, the Department of Defense had an indefinite quantity contract for vehicle parts with a company. The contract called for two types of service: delivery of the parts to a warehouse (a cheaper method) and delivery to the user (a more expensive way). Over the years, the contract was mainly a warehouse-delivery contract. Suddenly, it became mainly a user-delivery contract. A board found that the course of conduct over the earlier part of the contract established a warehouse contract so that when it became a different kind, the company was entitled to an equitable adjustment as a constructive change to the contract.

    What is the difference between a design specification and a performance specification? Why does it matter?

Money. This is an ongoing battle in procurement circles: whether a specification is a design specification or a performance specification. The consequences are significant: The government is responsible for any errors in a design specification, while it is much more difficult to hold the government responsible under a performance specification.

“If you follow these government plans, the project will work or we’ll pay.” That’s the warranty the government gives to contractors when the government provides a design specification. With a performance specification, there is no warranty because the government essentially is paying the contractor to figure out how to do something.

The warranty that comes with a design specification is a valuable warranty, since any problems a contractor encounters caused by the specification get paid for by the government. Obviously and unfortunately, the government does not put in big bold letters the words design or performance on the first page of a specification. When the government and a contractor get into a dispute, the contractor often argues that the problem is caused by the specification, which the contractor labels a design specification. Predictably enough, the government responds that the specification is a performance specification.

Are there any clear indicators of a performance specification? Yes—discretion. If a contractor has discretion in how the work gets done, it’s a performance specification. All a performance specification sets forth is an objective or standard to be achieved. The winning company has to use its ingenuity to achieve that objective or standard of performance, selecting the means and assuming responsibility for it.

For example, in a construction contract, the contractor sued the government for damage caused by “over blasting.” The contractor said the government had to pay because the specification was a design specification since it set forth all the required elements of the blast plan and set out in detail all aspects related to the blasting, such as the amount of concrete to be removed; the height, width, and depth of removal; and the length, size, and depth of embedment of all anchor and reinforcing steel. A court disagreed, finding it a performance specification. The specification gave the contractor the discretion to specify the diameter, depth, and spacing of the drilled holes; the size and location of charges; the blasting sequence; and the personnel who would be working with the explosives. The contractor had complete discretion in the development of a blasting plan. The government didn’t require any specific blasting procedure or the contractor to use certain explosives or equipment. The contractor therefore determined how the blasting would be executed and what explosives and materials would be employed. The specification, accordingly, was a performance specification for which there was no warranty—so the contractor was responsible for the damage.

On the other hand, a design specification is a road map. It lays out in pretty precise detail the materials to be employed and how the work is to be performed.

For example, a government contract required the construction company to remove and control water from the construction site. The government was responsible for getting all necessary permits. The government submitted drawings indicating that a 24-inch pipe would be used to dewater the construction site. On the basis of these drawings, the government was issued a permit. The contractor followed the drawings and laid a 24-inch-diameter pipe to dewater the site. The construction site, however, flooded and suffered significant damage. The contractor tried to get the damage paid for by the government. The contractor argued that the 24-inch pipe was required by the government but the pipe was too small for the site and that damage resulted. The government argued that the contractor could have used any size pipe it wanted because the drawings were only conceptual and part of a performance specification.

A court concluded that the contractor was following a design specification. If drawings show the location, width, and depth of certain elements, the drawings “approach design specifications.” The court based its conclusion on the facts that “the drawings are precisely detailed; that the permit was obtained, in part, based on the basis of the drawings; and that the plaintiff was required to perform the contract in accordance with the permit.”

    How does the principle of words being construed against the drafter work?

This is the principle of “contra proferentum.” It means that words are construed “contra,” or against, the party that proffered or offered it. The theory behind this principle is that it is fair to construe language against the party who did not draft it correctly or clearly the first time. Typically, this rule hurts the government because, in government contracts, the government typically drafts the language.

But, it is not automatic. If a contractor takes an unreasonable interpretation of the contract provision, the language will not be construed against the government. It is only when a contractor makes a reasonable interpretation of language drafted by the government that the principle of contra proferentum applies.

    What’s the harm in a contractor making an aggressive or at-the-fringe argument? It might win!

The harm in a contractor making an “aggressive” argument is fraud. A frivolous interpretation can lead to a false claim.

Parties are allowed creative and “interesting” interpretations. But at some point, an interesting interpretation becomes frivolous and therefore fraudulent.

In one case finding a frivolous interpretation to be fraud, a contractor placed additional fill above the fill lines specified in the contract drawings and billed the government for that extra fill, even though the contract provided that the contractor was to be paid only up to the fill lines. The contractor admitted that it billed for fill over the lines, but said that there was an interpretation of the contract to support it. The contract clearly contradicted the contractor’s interpretation. In addition, its subcontractor told the contractor that its interpretation was wrong. Moreover, the interpretation was contrary to industry practice. As one court put it, a contractor can be liable for fraud “even in the absence of any deliberate concealment or misstatement of facts. Under such circumstances, when the contractor’s purported interpretation of the contract borders on the frivolous, the contractor must either raise the interpretation issue with the government contracting officials or risk liability under the federal fraud statutes.”