Arbitrary Denial of Claims subjects DGS to Penalty and Interest and Attorney Fees under the Commonwealth Procurement Code

In a case of first impression, the Commonwealth of Pennsylvania held that the Commonwealth Procurement Code’s penalty, interest and attorney fees provisions applies not only to arbitrary refusal to pay contract balances but also to a claim that was arbitrarily denied by DGS during the project. 

The factual background for this decision involved difficulties in the placement of fill for the construction of a building.  The project documents represented that the site was balanced and although some soil contained clay, all site material was suitable for fill.  After several weeks of excavation, the contractor encountered excess moisture content that rendered the site material unsuitable for fill.  DGS, in an attempt to accommodate the wet soil conditions ordered a suspension of the work under 12.1 allowing DGS to suspend the work if the contractor is taking undue risk of damage to any part of the structure or installation during unfavorable weather conditions.  Under this clause, the contractor was not entitled to compensation for any expense resulting from the suspension.  The contractor timely notified DGS that it believed the suspension was for convenience entitling it to compensation.

In the spring of the following year, DGS lifted the suspension.  Because the soil conditions did not improve, the contractor attempted to utilize soil from an adjacent parking lot, but discovered large amounts of highly plastic clay which was unsuitable for fill material.  Of note the project specifications represented that all soil on site could be used for fill although it may require air-drying.  To resolve the issue, DGS directed the contractor to utilize material from an adjacent hillside and move the unacceptable material to the excavated area.  The contractor performed the work under protest and later submitted a claim for additional costs.

At the Board of Claims level, the Court found that DGS engaged in constructive fraud and actively interfered with the contractor’s performance regarding the representations made of existing site conditions.  Although DGS provided a geotechnical investigative report as part of the bidding documents, the Board found that the report standing alone did not accurately reveal the extent of clayed soils.  This holding was based on the fact that an internal DGS memorandum provided a site assessment stating the site was unsuitable for earthwork in the winter and early spring.  Even though these findings were made, the Board declined to award penalty, interest and attorney fees holding that these damages only apply to a withholding of progress payments which was not the current dispute.

The Commonwealth Court in upholding the Board’s determinations that the suspension was compensable and that DGS engaged in constructive fraud as a result of its withholding of the internal memorandum on the difficulties of earthwork while making assurances to the contrary, reversed the Board and awarded penalty, interest and attorneys’ fees.  The Commonwealth Court (in a footnote) determined that Section 3935 of the Commonwealth procurement Code is not limited strictly to progress payments because no such limiting language is present in the statute.  It held that penalty, interest and attorney fees are recoverable for any payments that are wrongfully withheld.

The Commonwealth further found that DGS engaged in vexations conduct when it withheld payment for costs associated with the five –month suspension and the unsuitable soil conditions, when it knew of the unsuitable soil conditions as articulated in its internal memorandum and yet directed the contractor to work on the project.  DGS did not have sufficient grounds in either law or fact in withholding payment for costs related to the suspension and unsuitable soil condition.  Reaching these determinations the case was sent back to the Board of Claims for a determination of penalty, interest and attorney fees due to the contractor.

Although the case may clarify that penalty, interest and attorney fees are recoverable in instances where a governmental agency denies a claim when it has no reasonable basis to do so, the facts of this case are extreme and do not provide guidance to construction participants as to the recovery of penalties and attorney fees when there is no finding of constructive fraud.  The case does provide caution to construction participants to have at least a good faith basis for denying a claim.

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