CHAPTER

18

INSPECTION, ACCEPTANCE, AND WARRANTIES

Getting what the government pays for is the purpose of a contract. And the way to know whether the government gets what it pays for is to use the inspection clause. To provide a “plain English” understanding of the inspection clause, this chapter explores the inspection of construction clause (FAR 52.246-12), which tends to be typical of other inspection clauses.

    In plain English, what does the inspection clause say?

First, the definition of what’s covered by the clause is very broad. The government gets the right to inspect not only the final product but also anything along the way and, in fact, even before the work starts. The clause covers the manufacture and fabrication of any of the components that go into the final product:

a.   Definition. Work includes, but is not limited to, materials, workmanship, and manufacture and fabrication of components.

Notice that the definition does not simply cover what’s listed in the clause. The definition simply says that the work “includes” what’s specified. According to this definition, a lot more can be covered by the inspection clause.

There is an affirmative obligation on the contractor’s part to make sure that the work complies with the contract.

It’s not only up to the government to make sure the work complies—the contractor has that obligation too. And the way the contractor ensures that the work complies with the contract is by having an inspection system that verifies that what goes into the project meets the contract’s requirements:

(B)   The Contractor shall maintain an adequate inspection system and perform such inspections as will ensure that the work performed under the contract conforms to contract requirements.

A surprise government inspection is clearly allowed. All the work done under the contract can be inspected at any time and place, and the government can use any reasonable test to determine whether the work satisfies the contract requirements. The government is entitled to strict compliance with the specifications:

The government has no duty to inspect the work and alert the contractor to inadequate work. Inspections are for the government’s benefit, not the contractor’s benefit. When noncompliant work is discovered, the contractor can’t complain that the government had the right to inspect work earlier in the process and if the government had done so, the work would have been found to be noncompliant much earlier in the construction process:

(C)   Government inspections and tests are for the sole benefit of the Government and do not—

(1)   Relieve the Contractor of responsibility for providing adequate quality control measures;

(2)   Relieve the Contractor of responsibility for damage to or loss of the material before acceptance;

Whether a government inspector is on the job or not, and whether the government inspector tells the contractor to do something different from what the contract requires, the inspector’s work, or lack thereof, has no bearing on the contractor’s ultimate duty to do work that complies with the contract:

(d)   The presence or absence of a Government inspector does not relieve the Contractor from any contract requirement, nor is the inspector authorized to change any term or condition of the specification without the Contracting Officer’s written authorization.

Inspections and tests are paid for by the contractor. Government contracting assumes that the costs of inspections and tests are included in the contractor’s prices. And if the inspection does not go off at the time arranged, the contractor is responsible for any additional costs that the government incurs because the tests are rescheduled:

(e)   The Contractor shall promptly furnish, at no increase in contract price, all facilities, labor, and material reasonably needed for performing such safe and convenient inspections and tests as may be required by the Contracting Officer. The Government may charge to the Contractor any additional cost of inspection or test when work is not ready at the time specified by the Contractor for inspection or test, or when prior rejection makes reinspection or retest necessary.

The government must fix what doesn’t comply with the contract. The only alternative is that the government could take a price reduction if it wants to accept something less than full compliance with the contract:

(f)   The Contractor shall, without charge, replace or correct work found by the Government not to conform to contract requirements, unless in the public interest the Government consents to accept the work with an appropriate adjustment in contract price….

If the contractor doesn’t fix it, the contractor pays for the fix made by someone else. Or the government could simply terminate for default the contractor’s right to proceed:

(g)   If the Contractor does not promptly replace or correct rejected work, the Government may (1) by contract or otherwise, replace or correct the work and charge the cost to the Contractor or (2) terminate for default the Contractor’s right to proceed.

Who pays for interim inspections depends on whether the work after inspection is found to be done correctly. If it’s been done correctly, any damage the contractor suffers by a disruptive interim inspection gets paid for by the government. And if the contractor has lost time, it gets additional days added to the contract performance period. But it’s the other way around if the interim inspection shows that the work was not done properly. In that case, the contractor pays for the inspection and any necessary rework:

(h)   If, before acceptance of the entire work, the Government decides to examine already completed work by removing it or tearing it out, the Contractor, on request, shall promptly furnish all necessary facilities, labor, and material. If the work is found to be defective or nonconforming in any material respect due to the fault of the Contractor or its subcontractors, the Contractor shall defray the expenses of the examination and of satisfactory reconstruction. However, if the work is found to meet contract requirements, the Contracting Officer shall make an equitable adjustment for the additional services involved in the examination and reconstruction, including, if completion of the work was thereby delayed, an extension of time.

The timing of the government inspection can’t be delayed. If a project can be finished in pieces, the government is supposed to inspect and accept individual pieces as soon as possible. Once something has been accepted, that’s it. It’s final. The only exceptions to this “finality of acceptance” are if there are latent defects, fraud, gross mistakes amounting to fraud, or warranty rights:

(i)   Unless otherwise specified in the contract, the Government shall accept, as promptly as practicable after completion and inspection, all work required by the contract or that portion of the work the Contracting Officer determines can be accepted separately. Acceptance shall be final and conclusive except for latent defects, fraud, gross mistakes amounting to fraud, or the Government’s rights under any warranty or guarantee.

Having looked at the clause in detail, let’s look at some common questions that arise during the inspection process.

    If the government had a chance to inspect the work but didn’t, can the government later complain that the work was not done correctly?

The government always has the right to inspect, and reject, the work at any time before acceptance. The inspection clause says that the government inspection is solely for the benefit of the government. It is not for the benefit of the contractor. The government has no duty to inspect the work while it is going on.

There are, however, benefits to the government inspecting as the work proceeds, rather than waiting until after all the work is done. The first benefit is that the government will have a chance early in contract performance to see if the work is being done properly. If it is not, the government has the right to terminate the contract for default. When the government waits until the end to inspect, and then finds the work improper and wants to default the contractor, the government may have lost significant rights.

Second, if there is a delivery date specified in the contract but the government does not inspect until after that date, the contractor has a good argument that the government waived the original contract completion date.

Third, a government inspection as the work proceeds gives the contractor a good idea of what the government will ultimately demand at the end of the contract. Periodic interim inspections indicate the government standards that will be applied at the end of the project. Periodic interim inspections, therefore, can avoid extensive punch list work at the end of the project. These inspections alert contractors to what the government will demand and allow a contractor to meet the government standards as it goes along.

    What are the differences in the concepts of “strict” compliance, “substantial” compliance, and “substantial performance”?

Strict compliance means that the government always has the right to demand that the contractor fully comply with a specification. It is not the contractor’s job to decide that “close enough is good enough for government work.” For example, a contractor wanted to use a slightly different shade of an undercoat of paint, having no effect on the top coat. The court ruled that the government had the right to demand whatever color of undercoat it wants to use, even though it had little or no impact on the top coat.

This is strict compliance with a vengeance. But it is justifiable. Any other rule would allow contractors to run the government procurement system. It would also lead to the waste of government money.

Sometimes, however, close enough gives a contractor some rights. In supply contracts, substantial compliance gives a contractor a second chance to get it right and avoid a default. If the contractor doesn’t get it right the second time, it’s in default.

Under substantial compliance, the contractor that delivers, on time, goods that are close, but not quite up to what the government wants, gets a second chance to deliver conforming supplies.

There are other requirements. The company must reasonably believe that the goods comply with the contract. The defects must be minor and easy to correct.

A company that complies with all this gets a reasonable period of time to present supplies that fully comply with the contract. If the company does not do so, the contract can be terminated for default. Again, ultimately, the company is held to strict compliance.

A construction company is also ultimately held to strict compliance. If a construction company wants to get paid 100 percent of the contract price, it must strictly comply with a contract. But the substantial compliance exception also applies in construction. This allows a contractor to get paid for the value of what’s been installed, even though it doesn’t fully comply with the contract. Substantial compliance avoids the injustice of having the construction company build a building, typically on government land, and then be paid absolutely nothing because the company, for example, used plastic pipes instead of copper pipes. The contractor is entitled to get paid the value of what was completed because the pipes, whether plastic or copper, will do the job they are intended to do.

This is especially true where the cure is worse than the disease. For example, if the construction company installs between the bricks of a dam a water stop that will do the job but is not 100 percent what the contract called for, it might well cost millions of dollars to pull out the nonconforming water stop and replace it with a water stop that fully complies with the specifications. The water stop may cost only thousands of dollars to install. It would be wasteful to spend millions to correct what cost thousands—an example of economic waste. Where correction of the defect in construction would lead to economic waste, the government’s remedy is a reduction in the price paid to the contractor. The government does not have the right to require replacement and strict compliance.

What if the issue is not just a price reduction because everything isn’t 100 percent per the specification? What if the issue is whether the government can terminate a construction contract after the building is finished simply for minor deviations from the specification? At this point, two phrases, closely related to each other and to the phrases “strict compliance” and “substantial compliance,” come into play. Substantial performance or substantial completion is used in construction contracting when the possibility of a default is being considered. Substantial performance or completion prevents the government from terminating a construction contract for default when the deviations from the specification are minor.

    The government approved something with defects it knew about. Now the government rejects it. Can it do that?

As usual, it all depends. It depends on whether it seems fair to hold the government to its original acceptance of the product. This is called estoppel, which means that the government can’t do something after the company has justifiably relied on what the government did. To prove estoppel, however, requires a very specific set of circumstances. The action must involve someone with “actual authority” to waive the requirements, like the CO. The person with authority also must have “actual or imputed knowledge” that the product does not conform to the specifications. And even though the work did not conform to the contract specifications, the government accepted the work to get the contractor to continue to work. And the contractor, relying on this, actually did continue to work and would be harmed if not paid for the work. Under these circumstances, who wouldn’t think it fair to pay the contractor?

    The government used it. It bought it, right?

Not necessarily, especially if it’s a construction project. In a construction project, there’s a special clause: “use and possession prior to completion.” That clause clearly states that “the government’s possession or use shall not be deemed an acceptance of any work under the contract.”

And another sentence, one from the “permits and responsibilities” clause (FAR 52.236-7), says that the contractor “shall also be responsible for all materials delivered and work performed until completion and acceptance of the entire work, except for any completed unit of work, which may have been accepted under the contract.” As a result of all this, the government is liable only if its use or possession causes damage. If the damage is caused by a third party or by acts of nature, the contractor is still responsible until acceptance. Use by the government therefore doesn’t mean that the government accepts it. All it means is that the government will pay for any damage it causes.

    Under a warranty, does the contractor have to prove that it did the work right, or does the government have to prove that the contractor did it wrong?

The government has to prove that the contractor did it wrong and that the defect existed at the time it was accepted. This can be tough to do. This is based on the idea that warranties are to be strictly construed against the government. For the government to win on a warranty issue, it must show that the contractor was given timely notice of the defect, the affected work was the contractor’s responsibility, and the government did not cause or contribute to the failure.

This last point can be difficult, so there has been a little relaxation of what the government has to prove. All the government now has to prove is that the contractor was “the most likely or probable clause of the failure.” The government doesn’t have to prove that the contractor unequivocally caused the defect.

    Is the contractor off the hook when the warranty period ends?

The contractor isn’t necessarily off the hook when the warranty expires. The contract clauses typically say that any remedies under the warranty clause are in addition to those given under the inspection clause. And the inspection clause excludes from “the finality of acceptance” any defects that are latent or that result from fraud or gross mistakes amounting to fraud. As a result, the contractor stays on the hook for latent defects, fraud, and gross mistakes amounting to fraud. The theory behind this is that the government has to use reasonable but not extreme diligence in its inspection process.

It’s valuable to examine more closely each of the exceptions. Latent defects are defects that are not obvious and cannot be found through a reasonable inspection—they are hidden defects. Patent defects are those that are obvious or known. The government has an obligation to identify patent defects that exist at the time of acceptance, but that’s all. Latent defects are still a contractor’s responsibility. Of course, if something would be a latent defect but the government knows about it when the government accepts it, the defect becomes a patent defect.

Fraud is a knowing misrepresentation or hiding of something with the intent to mislead the government. The inspection clause, however, is rarely used in fraud situations because the government has much bigger guns: the False Claims Act and the False Statements Act. The False Claims Act gives the government civil and criminal remedies, and the False Statements Act gives the government criminal remedies.

Gross mistake amounting to fraud is all of the above without the intent to deceive. It’s a major mistake that no responsible contractor could justify. For example, a contractor decided to submit to the government bolts that were not heat-treated (the industry routinely uses heat-treated bolts). This would be a gross mistake amounting to fraud.