IBM Corp. v. United States—A Study in the Risks and Rewards of Including a Reservation of Rights in an Offer
Including a reservation of rights in a proposal is a delicate matter. On the one hand, it is in the contractor’s best interest to identify clearly the assumptions on which its proposal is based. This not only ensures a “meeting of the minds” but, also, protects the contractor from post-award interpretations that contradict those assumptions, or the proverbial “basis of the bargain.” On the other hand, an explicit reservation of rights can be reasonably viewed as an exception to or contingency upon material solicitation requirements, and render an otherwise winning proposal nonresponsive. In light of these competing pressures, who should bear the risk of noncompliance when a proposal deviates from a solicitation’s express criteria? This question was most recently considered by the Court of Federal Claims in IBM Corp. v. United States, No. 14-864-C (Nov. 25, 2014).
This case involved a Time and Materials Solicitation issued by the Department of the Army for audit readiness services. The Performance Work Statement identified six specific labor categories and, as required for T&M contracts, set a limit on the contractor’s level of effort. Thus, the PWS identified a maximum number of hours to each of the six labor categories and offerors were instructed to propose labor rates based upon those hours. Price was then determined by multiplying the hours times the proposed labor rates.
During pre-award Questions and Answers, the Army was asked: “Will the successful offeror have flexibility to reallocate the hours among the labor categories during project execution, so long as we do not exceed the ceiling?” The Army responded: As approved by the [COR], the successful offeror will have the flexibility to reallocate hours as long as the ceiling is not exceeded.”
With this Q&A in mind, Ernst and Young submitted a proposal that reserved its right to (1) reallocate hours between labor categories, “provided the reallocation does not result in exceeding the ceiling price established in the contract,” and (2) use additional labor categories, at hourly rates mutually agreeable to the parties. IBM’s proposal, on the other hand, stated that (in accordance with the Q&A), “we have the flexibility to reallocate hours by labor categories within the overall task order value without a contract modification.” Comparatively, IBM chose the more conservative, or risk averse approach, since its proposal reflected the language used in the Q&A.
EY received slightly lower technical marks than IBM, who happened to be the incumbent contractor. But IBM’s price was over $30 million higher. After a tradeoff assessment, the Army concluded that EY’s proposal represented best value, and awarded to EY. IBM then protested, asserting that (1) the Army unlawfully relaxed the solicitation’s requirements when it accepted and then incorporated into the final contract EY’s proposal containing the aforementioned reservations; and (2) if the contract did not incorporate EY’s reservation of rights language, the Army must have, in effect, permitted EY to revise its proposal and remove the nonconforming language.
The Court swiftly dismissed the first argument, holding that the executed contract did not, in fact incorporate EY’s proposal (despite considerable evidence to the contrary). But more important, the Court also held that IBM’s second argument was unavailing because EY’s proposal, including the reservation language, “bound [EY] to follow the maximums set forth in the Solicitation.”
Respectfully, this holding is puzzling when considering the record evidence and case law. The PWS included a table identifying a specific number of hours to each of the six labor categories that was prefaced by the following statement: “The Contractor level of effort to complete deliverables shall not exceed the following.” In addition, the language of EY’s reservation evidences an unmistakable intent to reallocate hours among labor categories, and even add additional labor categories, subject only to the limitation that “the reallocation does not result in exceeding the ceiling price in the contract.” (emphasis added). This is inconsistent with the PWS, which included not-to-exceed hours figures per labor category. Indeed, prior to award, the Contracting Officer recognized this problem: After consulting with legal counsel, the CO removed the aforementioned Q&A response from the execution copy of the contract awarded to EY because, as he himself testified, “the inclusion of that language could have resulted in an inconsistency.”
Interestingly, the Court cites to Blackwater Lodge & Training Ctr., Inc. v. United States, 86 Fed. Cl. 488 (2009) for the proposition that an agency’s finding that a bid satisfies the material requirements of a solicitation should only be overturned if it is arbitrary and capricious. The Court also noted that “[a] solicitation term is material where it has more than a negligible impact on the price, quantity, quality, or delivery of the subject bid.” Id. (citing Centech Grp., Inc. v. United States 554 F.3d 1029, 1038 (Fed. Cir. 2009)) (emphasis added). Here there can be little doubt that if EY exercised its reserved right to reallocate labor hours, there would be a direct and significant impact upon the quantity and price of labor hours in each category.
By way of comparison, the Federal Circuit in Centech (which the Court also cited) held that a bidder’s proposal failed to satisfy the explicit requirements of a solicitation. The solicitation included a Limitation on Subcontracting (LOS) clause requiring “an offeror to agree that at least 50 percent of its personnel costs under the contract will be based upon work of its own employees.” Much like the Q&A issued by the Army here, the Agency disclosed to prospective offerors that it would interpret the LOS clause in accordance with a Policy Memorandum. That Memorandum allowed for a mix of prime and subcontractor performance to meet the 50 percent requirement imposed in the solicitation. As such, the proposal in question suggested that the offeror would combine its own employees and its subcontractor’s employees to arrive at the 50 percent threshold, pursuant to the LOS clause as interpreted by the Policy Memorandum.
Unfortunately for the offeror, the Policy Memorandum was later retracted and the Federal Circuit therefore found that the offeror did not comply with the express mandates of the solicitation. Given these facts, the proposal in Centech could be read one of two ways: On the one hand, the proposal could be interpreted as being a unilateral reservation of the offeror’s right to use a mixed labor force. Alternatively, because the Agency had already informed the bidders on how it would construe the terms of the solicitation, the offeror’s decision to draft its proposal the way it did was by no means unilateral—since it was simply adhering to the Agency’s directives.
Although Centech is procedurally distinguishable from the facts of IBM Corp., the same fundamental tension exists: at what point does a contractor’s reservation of rights with respect to a material solicitation requirement cross the line and render a proposal nonresponsive? The Federal Circuit’s analysis in Centech gave little weight to the Agency’s determination on how it would interpret its own LOS clause and imposed the risk of noncompliance upon the contractor—who ultimately lost the award. As discussed here, the Court of Federal Claims in IBM Corp. afforded the Agency considerably more deference in its flexible application of the PWS requirements.
What is the takeaway from all this? Although EY prevailed in IBM Corp., contractors should be very careful about including reservations in their proposals given the surrounding case law. The level of deference afforded to the Agency’s judgment in IBM Corp. was particularly high and, as a general rule, including a “reservation,” “condition” or “contingency” in an offer can be a red flag that indicates a departure from solicitation requirements or, more broadly, an unknown or unspecified term in the offer that the Agency is simply unwilling to accept.
Perhaps more troubling about IBM Corp. is that two fundamental tenets of Government contracting appear to have been overlooked. First, contractors are entitled to have their proposals fairly evaluated, subject to the same ground rules. Although the Court found that “nothing . . . suggests that EY’s rate discounts were based on any expectation that it would be able to exceed the hours allocated to each labor category as specified in the PWS,” the record establishes that EY’s reservation imposed a contingency, or condition, upon its offer arguably not provided for in the PWS. It is also clear that the CO acknowledged that the Q&A created an “inconsistency,” which, here, led EY and IBM to come to very different understandings regarding material solicitation requirements. Once the Agency decided to overlook this inconsistency to the benefit of EY, and in view of the $30 million delta between offerors ranked 1 and 2, IBM was entitled to a “clarification” to ensure that the basis of its pricing was consistent with Solicitation requirements. In contrast, the offeror in Centech was not given the opportunity to clarify its proposal and the Federal Circuit employed a much stricter reading of the governing law.
Second, when the Government evaluates offers on a best value basis, the evaluation should proceed in a manner consistent with the solicitation requirements that will, in fact, lead to the selection of the contractor that offers best value to the Government. Here, the record established that IBM could have discounted its rates more deeply, resulting in a $23 million reduction in price, if it had the flexibility to reallocate hours and exceed the contract maximums for particular labor categories. Had the Agency properly clarified its position on pricing, not only would it have ensured that each offeror’s pricing was evaluated “apples to apples,” it also undoubtedly would have received more competitive offers that could have led to a different best value determination.