Contract Administration, Part 3: Contract Interpretation Guidelines and Best Practices

Contract Administration, Part 3: Contract Interpretation Guidelines and Best Practices 58 Contract Management April 2010

Successful contract administration involves an understanding of the guidelines typically used in contract interpretation and some of the proven-effective best practices to mitigate potential contract misinterpretations. BY Gregory A. Garrett Contract Management April 2010 59

Human communications, both verbal and nonverbal, are imperfect, thus subject to misinterpretation. As a result of our imperfect communications, people are often unable to obtain the on-time delivery of quality products, services, systems, and/or solutions they require at the price they consider to be both fair and reasonable. Simply put, contract interpretation is the process of determining what the parties agreed to in their bargain. This process typically involves determining what the original intent of the parties was at the time they negotiated the deal, which often requires determining the meaning of words, supplying missing words, and resolving ambiguities and/or contradictions which may appear in the contract. In U.S. federal government contracting, numerous contract performance problems and controversies stem from misunderstandings or disagreements about contract requirements. Clearly, it is important for U.S. government agencies, government prime contractors, and subcontractors to understand the guidelines typically used in contract interpretation and some of the proveneffective best practices to mitigate potential contract misinterpretations between the parties of the contract or subcontract. The Seven Guidelines of Contract Interpretation The cardinal rule of contract interpretation is to seek to ascertain a single interpretation of the contract that reflects the parties intent. U.S. courts and boards of contract appeals usually seek to determine the right interpretation based upon the intent of the parties by examining two sources of information: 1) the language in the contract, and 2) extrinsic evidence pertaining to facts and circumstances surrounding contract formation and post-award performance. 1 Indeed, it can prove very difficult to discern what was in the minds of the parties, buyer and seller, unless their intent was well stated in the contract, in post-contract negotiation memorandums, or by their subsequent actions. U.S. courts and boards of contract appeals usually strive to determine the intent of contract parties when a contract dispute/claim arises by using the objective test. 2 The objective test is the understanding that U.S. courts and boards of contract appeals interpret a contract in a way that would be consistent with a reasonably intelligent person familiar with all of the facts and circumstances surrounding contract formation. 3 FIGURE 1 on page 62 illustrates the seven most common contract interpretation guidelines which are often used by U.S. government contracting officers, courts, and boards of contract appeals when resolving a contract dispute or claim which arises due to a contract interpretation issue. 1. Read the Contract as a Whole This may sound silly, but, one should actually read the contract before signing it and again before performing the work required by the contract. When a contract is formed, it is the entire document that embodies the agreement of the parties, buyer and seller, not just the scope of work, statement of work, delivery schedule, individual sections, or certain contract clauses. Clearly, the meaning of our selected language is often derived from the context in which it appears. Thus, an attempt to interpret a word, term, phrase, or clause independent of the context of the remaining contract document may distort its intended meaning. In numerous U.S. court cases where the contract interpretation guideline read the contract as a whole has been used, the courts chiefly rely upon two key principles: 1) parts of a contract must be read together and harmonized if at all possible, and 2) preference is given to an interpretation which gives effect to all terms and leaves no clause meaningless. 4 2. Understand the Definitions of Key Contract Terms Contracts are composed of words, numbers, and symbols that result in key terms and conditions between the parties, which in turn give rise to specific obligations for the buyer and the seller. In U.S. federal government contracting, U.S. courts and boards of contract appeals generally use three sources to define key contract terms. First, the courts and boards shall apply any definitions which the parties have incorporated into the contract document. Often, specific definitions for key words and terms in government contracting are referenced via Federal Acquisition Regulation (FAR) 2.1. Second, if the key contract term is not defined within the contract and/or referenced in the FAR, then the courts and boards will use dictionaries or common usage to provide an appropriate definition. Third, if the key contract term is not defined in the contract and circumstances indicate that the intent of the parties was a technical term, not a common usage term, then an appropriate technical definition shall be selected. These latter two definitions are described by the Restatement (Second) of Contracts, section 202(3), which states: Unless a different intention is manifested, a. b. where language has a general meaning it is interpreted in accordance with that meaning; technical terms and words of art are given their technical meaning when used in a transaction within their technical field. 60 Contract Management April 2010

It is important to remember that contracts often contain definitions of key terms in numerous places, including: the statement of work, performance work statement, performance standards and/or specifications, specific contract clauses, general contract clauses, incorporated by reference, and other contract sections. 3. Apply the Order of Precedence Clause Given the length and complexity of most government contract documents, it is quite possible conflicting statements and/ or vague requirements may be drafted independently of each other. Thus, it may be quite difficult to arrive at an interpretation that gives a reasonable effect to all sections of a contract. When such contradictions, conflicts, and or ambiguities exist, they may be resolved by use of contract interpretation guidelines via an Order of Precedence clause contained within the contract. In order for an Order of Precedence clause to be applied, there must be a conflict between the terms and conditions in question. 5 The basic Order of Precedence clause used in sealed bid and negotiated procurements (in FAR 52.214-29 and 52.215-33, respectively) provides: Any inconsistency in this solicitation shall be resolved by giving precedence in the following order: a. b. c. d. e. The Schedule; Representations and other instructions; Contract clauses; Other documents, exhibits, and attachments; and The specification. These FAR clauses may also be supplemented by agency clauses. The Order of Precedence clause guideline to contract interpretation is- Contract Management April 2010 61

FIGURE 1. Contract Interpretation Guidelines Discussions and concurrent actions, Interpretation Against the Drafter Parol Evidence Rule Extrinsic Evidence Duty to Seek Clarification Intent of the Parties Read the Contract as a Whole Order of Precedence Clause Definition of Key Contract Terms Prior course of dealing between the parties, and 7 Custom and trade usage. Evidence of discussions, meetings, teleconferences, e-mails, or conduct prior to the submission of bids, quotes, or proposals may serve as proof of the intent of the parties pertaining to terms in conflict. Further, the conduct of the parties after contract award, but before the controversy, may provide valuable insight into the interpretation of the terms of the contract in question. sues provides an objective and relatively quick resolution of a contractual conflict. However, there is no real assurance that the decision reached will reflect the true intent of the parties. 6 If possible, it is always best to try to determine what the intent of the parties really was at the time they negotiated the contract. 4. Understand the Extrinsic Evidence There are three types of extrinsic evidence or surrounding circumstances frequently used to assist in the resolution of contract interpretation conflicts: Evidence of prior course of dealings between the parties is an important type of extrinsic evidence to help resolve the meaning of ambiguous language or conflicts. Prior course of dealings can establish precedence based upon past actions, thus it can be used to establish the intent of the parties. The cardinal rule of contract interpretation is to seek to ascertain a single interpretation of the contract that reflects the parties intent. 62 Contract Management April 2010

Evidence of related documents, such as request for quotation, request for proposal, bids, quotes, proposals, or post-negotiation memorandums may provide meaning via the custom and trade usage of the language in question. Clearly, understanding the facts surrounding a contract interpretation issue and the actions the parties have taken before, during, and after the contract interpretation issue can add context and provide valuable insights to help develop an appropriate resolution. 5. Apply the Parol Evidence Rule According to the Restatement (Second) of Contracts, Section 213, the Parol Evidence Rule renders inoperative prior written or oral agreements that contradict an integrated agreement. In this case, when there is no fraud, duress, or mutual mistake, the parol evidence rule will prohibit a party from presenting such prior agreements to prove the meaning or intent that the words in dispute may or may not mean. Said simply, the parol evidence rule states that only what is written in the contract really matters and all previous verbal and/or written statements are null and void. 6. Apply the Interpretation against the Drafter In accordance with Restatement (Second) of Contracts, Section 206: In choosing among the reasonable meanings of a promise or agreement or a term thereof, that meaning is generally preferred which operates against the party who supplies the words or from whom a writing otherwise proceeds. The Latin phrase for interpretation against the drafter is contra proferentem. Simply put, the contract interpretation guideline Interpretation against the Drafter says whoever wrote this confusing mess of a contract deserves to lose any argument over what the contract means. For example, if the buyer wrote the confusing contract, then the seller s interpretation should be considered the valid interpretation. While this contract interpretation guideline does allow for a prompt resolution, it does not always provide the best solution. 7. Understand and Practice the Duty to Seek Clarification If an item or items of contract interpretation come to light, then the party that identifies said contract interpretation issue(s) must bring these issues to the attention of the other party or parties in a timely fashion. Contra proferentem shall not be applied if the non-drafting party fails before bidding to seek clarification of an ambiguity of which it was or should have been aware. 8 If a contractor fails to inquire about an ambiguous term or conflicting requirements prior to the contract award, it forfeits the opportunity to rely on its interpretation and thus bears the risk of misinterpretation. NCMA s Newest Book! FOR COMPLEX U.S. GOVERNMENT CONTRACTS AND PROJECTS A must-read for everyone in the business of buying or selling complex products, systems, services, or integrated solutions for or to the U.S. government. Available from the National Contract Management Association (NCMA) $65 for NCMA members $80 for Nonmembers Visit www.ncmahq.org/publications/rm to order or call 800-344-8096. Contract Management April 2010 63

Application of the Seven Guidelines of Contract Interpretation The aforementioned seven guidelines of contract interpretation can prove very useful to help U.S. government agencies, prime contractors, and/or subcontractors to resolve potential vague, ambiguous, or contradictory contract requirements. Of course, the preferred approach is to prevent or mitigate the potential for poorly written, confusing, misleading, contradictory, and vague contracts by implementing some proven-effective best practices to ensure the government contracts and related subcontracts are clear, more concise, and mutually understood. Best Practices to Mitigate Contract Interpretation Issues The following are proven-effective best practices to mitigate contract interpretation issues, which have been successfully applied to both U.S. government and commercial contracts and subcontracts. Further, the following best practices to mitigate contract interpretation issues are no more or less than the application of common sense, which today is far too uncommon in many businesses, especially government contracting. Select and Define the Key Words and Terms of the Contract It is critical to carefully select and use the most appropriate key words and terms in government contracts because different words and phrases have various meanings. In addition, it has often proven very effective to include the definition of key words and terms in the contract. Some organizations have created a specific contract glossary or mini-dictionary of key words and terms with their appropriate definitions. Other organizations often reference specific documents for the precise definition of words and terms, including: the FAR, agency FAR supplements, the Project Management Body of Knowledge, technical dictionaries, U.S. Military Standards, professional industry standards, etc. Tailor the Terms and Conditions to the Contract Situation In government contracting, the terms and conditions are often overwhelming. Most government contracts for noncommercial item acquisitions exceeding the simplified acquisition threshold typically contain more than 100 mandatory contract clauses, most of which are incorporated by reference and are very seldom tailored for the specific contract situation. Quite frankly, many government contractors never read nor fully understand and appreciate the full impact of these mandatory terms and conditions unless a problem arises in which one or more of the clauses are affected. Government agencies should seek to always select and tailor as needed the appropriate contract clauses for the specific contract situation given the type of contract, the nature of the products and services, the complexity of the deal, the urgency of the requirements, and the level of contract administration and surveillance required to ensure quality and on-time performance results. Contractors should read the contract provisions before the contract is awarded and identify and seek to negotiate appropriate terms and conditions. Likewise, after contract award the prime contractor should negotiate appropriate contract terms and conditions for all contract modifications. 64 Contract Management April 2010

Well-written contracts that are easily understood, effectively managed, and successfully executed do not occur by accident. Conduct Solicitation, Proposals, and Contract Reviews before Execution While it may seem very obvious to most people, in practice many organizations are in such a zeal for the deal that they rush to quickly issue solicitation documents (request for proposals, request for quotations, invitations for bid, etc.), proposals, quotes, bids, and contracts without conducting an appropriate multifunctional review of the entire document. Proven best practices include procurement organizations conducting solicitation review boards composed of government contracting, technical, and legal experts who are tasked to read the entire solicitation to ensure that it makes sense and to identify and correct any unclear, vague, inaccurate, or contradictory language which may exist in the draft solicitation. Likewise, prime contractors and subcontractors should conduct appropriate contractual, technical, financial, and legal reviews of their bids, quotes, and proposals before submission. Typically, contractors conduct bid/ proposal reviews to ensure compliance with the solicitation requirements, these bid/ proposal reviews are usually referred to as Pink Team Reviews (initial internal review), Red Team Reviews (intermediate internal or external reviews), or Gold Team Review (final executive review). Conduct a Post-Award Contract Review before the Start of Work Project managers who are trained and certified by the Project Management Institute would typically refer to such a postaward contract review before the start of work at a project kick-off meeting. Many government agencies would typically refer to such a meeting as a post-award conference between the government agency (buyer) and the prime contractor (seller), and possibly some of their subcontractors (vendors). It really does not matter what you call the meeting, what counts is what is discussed and agreed to during the meeting and how you create communication channels, business processes, and hold each other accountable for the performance of the work and agree to methods to quickly and promptly resolve Contract Management April 2010 65

any contract interpretation issues before they result in significant project impacts. Provide Education and Training on Contract Writing Skills It is vital that government agencies, prime contractors, and subcontractors invest in providing timely and appropriate professional continuing education and training for their employees engaged in contract-related writing, including: Preparing solicitations, Developing bids, Preparing quotes, Writing proposals, and Drafting/tailoring contracts terms and conditions. Well-written contracts which are easily understood, effectively managed, and successfully executed do not occur by accident. Well-written and successfully executed contracts and projects are the result of highly skilled, experienced, and dedicated business professionals working together to achieve mutual goals. Understand and Be Able to Apply the Contract Interpretation Guidelines As briefly discussed in this article, it is important for contract managers and project managers from both government and industry to be able to understand and successfully apply the appropriate contract interpretation guidelines when such issues arise. Summary To achieve success as a government prime contractor and/or subcontractor, you must know the rules of the game, be fully compliant with the government s laws and regulations, and know how to maximize your contract opportunity while mitigating the risk of doing business with the government. Further, government agencies, prime contractors, and subcontractors should understand and apply the proven-effective best practices to mitigate contract interpretation issues from ever occurring on their respective contracts and projects. CM About the Author GREGORY A. GARRETT, CPCM, NCMA Fellow, C.P.M., PMP, is the managing director and practice leader of Navigant Consulting, Inc. s Government Contractor Services practice, headquartered in Vienna, Virginia. He is an international educator, best-selling author, highly respected consultant, and is the recipient of numerous national and international business awards. He has authored 16 books and more than 90 published articles. He is also a member of the NCMA Executive Advisory Council. This article is a modified excerpt from the new book entitled Contract Administration: Tools, Techniques, and Best Practices, by Gregory A. Garrett (CCH Wolters Kluwer Law & Business: Chicago, IL: 2009). Send comments about this article to cm@ncmahq.org. To discuss this article with your peers online, go to www.ncmahq.org/cm0410/garrett and click on Join Discussion. Endnotes 1. John Cibinic and Ralph C. Nash, Administration of Government Contracts, fourth ed. (CCH, Chicago, IL: 2004). 2. Ibid. 3. Restatement of Contracts, 2nd ed. 4. Cibinic and Nash, see note 1. 5. Ibid. 6. Ibid. 7. John Cibinic and Ralph C. Nash, Formation of Government Contracts, fourth ed. (CCH, Chicago, IL: 2004). 8. Ibid. 66 Contract Management April 2010