What is the doctrine of substantial performance?

The following topic was raised by a government official: When a government contractor fails to perform completely as required by the contract, in many cases the government is still required to pay for work that was performed under the "substantial performance" rules. Is this consistent with commercial practices? Shouldn't the government be entitled to performance that fully complies with the contract?

The substantial performance rules applicable to government contracting are very similar to the analogous rules that are applicable in commercial contracting. Under the various doctrines, a contractor may be excused from relatively minor deviations from a contract's terms, subject to a monetary adjustment where necessary, to give the parties the benefit of their bargains. Further, the more discretion a contract places with a party to determine for itself the manner of performance, the harder it will be for the other party to insist on performance of a particular type.

This is equally true in both commercial and government business. Thus, the current move toward greater use of performance-based contracting, under which the government focuses on results and leaves to contractor discretion the details of performance, makes the substantial performance doctrine more important than ever.

In the commercial world, the parties to a contract are generally expected to comply with the principal terms of the contract. Thus, for example, a seller of goods must comply specifically with the provisions of its contract or face the possibility of rejection by the purchaser. Accordingly, the Uniform Commercial Code includes a "perfect tender rule" under which a buyer may reject tendered goods unless they comply perfectly with the contractual requirements.

However, the requirement to comply exactly with the terms of a contract is subject to certain limitations. For example, a contracting party's de minimum failures will be excused if they have no real impact on the contract's value. Furthermore, for many contracts, particularly those involving construction and similar services, a doctrine of substantial performance has developed. Under this doctrine, a party must pay for work that is performed substantially in compliance with the contract's terms, subject to adjustments intended to compensate for any omissions or defects. See Williston, S., A Treatise on the Law of Contracts, Section 805.

In government contracting, similar rules apply. Thus, under the general rule of "strict compliance," the government "has the right to insist on performance in strict compliance with the contract specifications and may require a contractor to correct nonconforming work."

However, the doctrine of strict compliance is applicable only when the contract includes "design specifications" that set forth a detailed explanation of the government's ultimate design. The doctrine has no applicability when the contract incorporates "performance" rather than design specifications. Performance specifications specify a goal to be achieved but leave to the contractor discretion to determine how that goal will be achieved.

In any event, the government may not insist on strict compliance if the result would be inequitable. Accordingly, the government may not require strict compliance when doing so would be an abuse of discretion, arbitrary, irrational or unjustified. Thus, in government contracting, substantial performance is defined as "the equitable doctrine that guards against forfeiture in situations where a party's contract performance departs in minor respects from that which had been promised." Franklin E. Penny Co. v. United States, 524 F.2d 668, 676 (Ct. Cl. 1975).

When substantial performance is applied to excuse a failure to comply strictly with a contract's terms, the government ordinarily will be entitled to an equitable adjustment in the contract price. In general, the adjustment is measured by the difference between the value of the product as finished and the value if it had been completed properly.

When the doctrine of substantial performance is applicable, the government may not refuse to pay for the work, subject to an appropriate adjustment.

Recently, a staff member at the Office of Management and Budget told me that OMB hoped to do away with the doctrine of substantial performance in government contracting. However, as discussed above, the doctrine is rooted in issues of equity and fairness, and it is entirely consistent with commercial practices.

Furthermore, as the government moves even further from government-unique design specifications, the doctrine of substantial performance will be applicable in more cases than ever.

Clearly, this is a doctrine that cannot be wished away so simply by a few government functionaries.

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Peckinpaugh is a member of the government contracts section of the law firm of Winston & Strawn, Washington, D.C. His column can be read on FCW's Web page at http://www.fcw.com. For more information, contact him at carl@carl.com. Should you have a specific question or legal problem, consult an attorney.