IV. Liability of the United States for Breach of Contract

53

9. General. When acting in its contractual capacity, the United States is liable to private contractors for damages caused by a breach of contract. If, however, the breach is caused by an act of the United States in its sovereign capacity, there is no liablity for damages. The reason for this rule is that the United States, as a sovereign, should not be burdened by claims for damages arising from the performance of general acts for the public good.

10. The defense of sovereign capacity. The problem commonly arises in the following situation. After the contractor and Agency X have entered into a contract, Agency Y takes some action which causes Agency X to breach the contract. The contractor then seeks damages and the defense of sovereign capacity is raised by the United States. Initially, the contractor cannot recover damages if the act of Agency Y was foreseeable.55 Similarly, the defense of sovereign capacity cannot be raised if the act of Agency Y exceeded its authority or was arbitrary and capricious.56 But if these conditions are satisfied, the defense of sovereign capacity will succeed if the act originated in an agency other than the contracting agency, was for the public good and was general in application." The test is this: if a private party were substituted for Agency X, would the act of Agency Y afford this substituted private party a defense to a breach of contract action under general contract law.58 Quite

53 See, e.g., Perry v. United States, 294 U.S. 330 (1935); United States v. Peck, 102 U.S. 64 (1880). Of. Lynch v. United States, 292 U.S. 571 (1934) (while United States may not repudiate obligations in contractual capacity, may withdraw consent to be sued on that obligation).

54 Horowitz v. United States, 267 U.S. 458 (1924). The Court approved the statement in Jones v. United States, 1 Ct. Cl. 383, 385 (1865) "that the United States as a contractor cannot be held liable directly or indirectly for the public acts of the United States as a sovereign."

55 Randall v. United States, 90 Ct. Cl. 325 (1940) (if contractor on notice impliedly assumes risk). Cf. Frank v. United States, 79 Ct. Cl. 516 (1934).

See Ottinger v. United States, 88 F. Supp. 881 (Ct. Cl. 1952), where the Government's determination of a labor dispute was, in view of applicable regulations so arbitrary and unreasonable as to remove it from the category of sovereign acts which do not constitute breaches of implied terms in the contracts of the United States. 57 Horowitz v. United States, 267 U.S. 458 (1924). Accord: Borg-Warner Co. v. United States, 89 F. Supp. 1013 (Ct. Cl. 1950); Froeming v. United States, 70 F. Supp. 126 (Ct. Cl. 1947); Babour & Sons v. United States, 102 Ct. Cl. 400 (1934); United States v. Warren Transportation Co., 7 F. 2d 161 (D. Mass. 1925); Jones v. United States, 1 Ct. Cl. 383 (1865).

58 See Jones v. United States, 1 Ct. Cl. 383, 384-385 (1865):

In this court the United States appear simply as contractors; and they are to
be held liable only within the same limits that any other defendant would be in
any other court. Though their sovereign acts performed for the general good
may work injury to some private contractors, such parties gain nothing by
having the United States as their defendants (W)hen ever the public and
private acts of the government seem to commingle. a citizen or corporate
body must by supposition be substituted in
(the Government's) place,
and then the question be determined whether the action will lie against the
supposed defendant.
If the removal of troops from a district liable to
invasion will give the claimant damages for unforeseen expenses, when the
other party is a corporate body, then it will when the United States form
the other party, but not otherwise. This distinction between the public
we now desire to make

acts and private contracts of the Government
so broad and distinct that hereafter the two cannot be confounded; ...

clearly, no liability for breach of contract would arise if the cause were an unforeseeable act of a governmental agency over which the private contractor had no control.59

61

11. Executive discretion and probable cause. An apparent limitation upon the defense of sovereign capacity has been that the governmental act may not be directed at a specific contract or group of contracts. This may still be true if the act originates with the contracting agency. In Derector v. United States,62 however, the State Department directed the Maritime Commission to delay a promised registry transfer on a vessel that the Commission had sold to the plaintiff when it appeared that the vessel would be used to violate British immigration policy in Palestine. The court denied the plaintiff's claim for damages on the theory that the United States acted in its sovereign capacity: there was a moral obligation not to permit a vessel under United States control to be used in a manner which might prejudice the policies of a friendly foreign government. The fact that the State Department's act was directed at a single contract and effectuated through the contracting agency was not material. The real question was whether the State Department's belief that the immediate transfer of the vessel's registry would prejudice the foreign relations of the United States was based upon probable cause.63 Quite clearly, if the executive discretion involved is not based upon probable cause, it is an act of the United States in its contractual capacity which entitles the plaintiff to damages for breach of contract.64

12. Summary. In summary, the United States has acted in its sovereign capacity if a private party, substituted for the contracting agency, would not be liable for damages under general commercial law. The defense does not fail simply because the act is directed at

See 6 Corbin, Contracts §§ 1343-1352 (1952).

60 Perry v. United States, 294 U.S. 330 (1935); Lynch v. United States, 292 U.S. 571 (1934); Sunswick Corp. v. United States, 75 F. Supp. 221 (Ct. Cl. 1948), cert. denied, 334 U.S. 827 (1948). In Horowitz v. United States, 267 U.S. 458, 461 (1924), the Court quoted with approval a statement made in Jones v. United States, 1 Ct. Cl. 383, 385 (1865):

Whatever acts the Government may do, be they legislative or executive, so long as they be public and general, cannot be deemed specially to alter, modify, obstruct or violate the particular contracts into which it enters with private persons.

The Termination for Convenience Clause, ASPR 8-701, is designed to cover this situation. See infra Chapter 17.

128 F. Supp. 136 (Ct. Cl. 1954), cert. granted, 348 U.S. 926 (1955), case dismissed, 350 U.S. 802 (1955).

Probable cause in the Derector case was found in the plaintiff's prior involvement with illegal immigrations to Palestine, his current association with an agent of the movement and the fact that after a transfer was made, the ship was actually used in violation of British policy.

In Miller v. United States, 135 Ct. Cl. 1 (1956), the State Department's repudiation of a sale of surplus airplanes to the plaintiff was not based upon probable cause that the planes would be used to jeopardize the foreign relations of the United States. The action was based upon hearsay evidence. Further, the plaintiff offered to permit the State Department to approve any resale of the planes and thus placed the power to avoid the illegal acts in the Government's hands.

specific contracts.65 But if the act is based upon executive discretion rather than a statute or regulation, there must be an important public interest to protect and probable cause that performance of the contract will impair that interest. Given these conditions, the power of the United States to act with impunity is assured."

V. Choice of Law in Government Contracts

67

13. Federal law governs Government contracts. As a general rule, the legal effect of a Government contract is governed by federal rather than state law. This body of law is fashioned from federal statutes and regulations and from selected state court decisions, giving due regard to local interests and institutions.68 The departure from Erie R.R. Co. v. Tompkins " is justified by the necessity of protecting important federal interests from the varieties and uncertainty of state law through the uniform application of an independent, "federal common law." As stated by the Court in United States v. County of Allegheny: 70

Procurement policies so settled under federal authority may not be defeated or limited by state law. The purpose of the supremacy clause was to avoid the introduction of disparities, confusions and conflicts which would follow if the Government's general authority were subject to local controls. The validity and construction of contracts through which the United States is exercising its constitutional functions, their consequences on the rights and obligations of the parties, the titles or liens which they create or permit, all present questions of federal law not controlled by the law of any state.

14. Exceptions. If the federal interest involved in a particular controversy does not require protection, state law may be applied.

In Wah Chang Corp. v. United States, 282 F. 2d 728 (Ct. Cl. 1960), the Court of Claims rejected an argument that the defense of sovereign capacity was not applicable to "isolated and non-general acts of sovereignty" and held that the Horowitz doctrine, supra note 57, covered the condemnation by the War Department of premises leased by the plaintiff to perform a contract with the Reconstruction Finance Corporation. The purpose of the condemnation was to guard the secrecy of wartime troop movements and was therefore a "public and general" act of sovereignty even though affecting a specific lease.

68 For the view that the defense of sovereign capacity should not prevent a private contractor's recovery of "out of pocket" damages as opposed to anticipatory profits, see Stack, The Liability of the United States for Breach of Contract, 44 Georgetown L.J. 77 (1955).

07 S.R.A., Inc. v. Minnesota, 327 U.S. 558 (1946) (contract for sale of land); Clearfield Trust Co. v. United States, 318 U.S. 363 (1942) (rights and duties of United States on commercial paper issued pursuant to Constitution and statutes are governed by federal law). Cf. United States v. County of Allegheny, 322 U.S. 174 (1944) (operation of state tax upon federal property in the hands of Government contractor presents question of federal law).

68 See United States v. Standard Oil Co., 332 U.S. 301 (1947). This power is exercised in the absence of congressional action. Cf. D'oench Duhme & Co. v. F.D.I.C., 315 U.S. 447 (1942) (Congress specifically provided that suits to which F.D.I.C. is party "shall be deemed to arise under the laws of the United States").

69 304 U.S. 172 (1938) (litigation between private parties of diverse citizenship in federal courts is governed by law of state in which court sits unless controversy arose under federal law).

70 322 U.S. 174, 183 (1944).

In Bank of America v. Parnell," the United States was the guarantor of bearer bonds, the ownership of which was being litigated in a federal court by private parties of diverse citizenship. State law was applied on the theory that the controversy was essentially private even though the United States had some interest in which of the two litigants could ultimately demand payment. The interest, however, was not so immediate as to require the protection of federal law." Therefore, in controversies between private parties over the meaning of Government contracts, the trend is to apply state law unless a compelling federal interest is present.73

352 U.S. 29 (1956).

T2 Compelling and immediate federal interests have been found in the following cases: United States v. 93.970 Acres, 360 U.S. 328 (1959) (Government's right to either revoke lease or condemn land not affected by state election of remedies doctrine); Holmberg v. Armbrect, 327 U.S. 392 (1946) (state statute of limitations does not bar federal statutory cause of action in private litigation); Clearfield Trust Co. v. United States, 318 U.S. 363 (1942) (right of United States to recover payments on forged indorsement governed by federal law).

See generally, Steele, Choice of Law, State or Federal in Government Subcontracts, 16 Fed. B.J. 202 (1956). For the application of state law to controversies between materialmen and Government construction contractors under the Miller Act, 40 U.S.C. § 270a, see Ascher Corp. v. Bradley-Dodson Co., 281 F. 2d 676 (8th Cir. 1960); Socony. Vacuum Oil Co. v. Continental Gas Co., 219 F. 2d 645 (2d Cir. 1955). In United States v. Tholen, 186 F. Supp. 346 (N.D. Iowa 1960), State law governed the rights of the United States in a note assigned to it as security for insurance indemnification under the National Housing Act.

CHAPTER 2

LEGAL PRINCIPLES PERTAINING TO APPROPRIATED FUNDS*

1. Introduction. This chapter discusses the fiscal problems that arise in connection with the procurement of property and services for the Navy † and the legal position of the United States as a creditor in matters involving debt collection. The fiscal problems, as the term suggests, relate to the appropriation of funds by the Congress for Navy use, the obligation by contract of funds so appropriated, the subsequent expenditure of these obligated funds for all of the property and services which are required for the support of the Navy, and indeed, to the entire subject of financial management in the Navy. The fiscal process is a specialized and technical subject, circumscribed by both statutory and administrative controls that place many restrictions, both procedural and substantive, on the conduct of the Navy's business. This chapter will outline the subject in a general way in order to afford the student as well as the practitioner new to the ways of Government a background for dealing with any fiscal or debt collection problem relating to Navy procurement. In approaching any specific problem, however, reference should be made to current reference material since the statutes, regulations, and other authorities cited in the text are constantly shifting and changing.1

This chapter was adopted from Parts I, II and V of Chapter 4, Navy Contract Law, Second Edition, 1959. The Navy Chapter was prepared by Lawrence E. Chermak, Counsel for the Comptroller of the Navy, and by Benjamin Lee Bird, Assistant Counsel, Bureau of Ordnance, with the assistance of Paul L. Laskin, Assistant Counsel, Bureau of Ships. The text has been taken verbatim from Navy Contract Law, except for references to other text chapters and footnote numbers. Footnotes have been amended or added, where appropriate, to indicate significant changes in the law since publication of Navy Contract Law and statutes and regulations applicable to the Army.

† All references to the Navy in this paragraph are equally applicable to the Army. 1 The need for current legal reference material is well illustrated by the many changes made in fiscal statutes and regulations during the last few years. Since 1949, for example, the following significant statutory changes have been made in this field: The Budget and Accounting Procedures Act of 1950, 64 Stat. 832, codified in scattered sections of Title 31 of the United States Code; Title IV of the National Security Act 1947, as amended, 63 Stat. 585 (1949), 5 U.S.C. § 172 (1958), providing for an up-todate system of financial management in the Department of Defense; the so-called AntiDeficiency Act, 64 Stat. 765 (1950), 31 U.S.C. § 665 (1958), establishing administrative controls on the use of public funds; section 1311 of the Act of August 26, 1954, 68 Stat. 830, 31 U.S.C. § 200 (1958), defining the criteria for recording obligations; the Act of July 25, 1956, 70 Stat. 647, 31 U.S.C. §§ 701-708 (1958), simplifying accounting and facilitating the payment of obligations; the Act of August 1, 1956, 70 Stat. 782, 31 U.S.C. §§ 24, 66a (c) (1958), establishing accrual accounting and cost-based budgets; and the Act of August 25, 1958, 72 Stat. 852, 31 U.S.C. § 11(b)-(f) (1958), authorizing limitations on annual accrued expenditures.