September 1, 2020
When Ambiguity Changes Your Contract: Avoiding a Misunderstanding that Could Cost You
When you believe a provision in your contract means one thing, but the other side disagrees, what do you do? And, just as importantly, who pays for any additional cost associated with these differing meanings? One phrase lawyers say often, but it truly applies here: “it depends.”
It depends on a lot of things, including:
- Are both interpretations reasonable?
- When did each side discover that the other side interpreted the contract differently?
- Whether one party’s interpretation relies on an industry-specific term that everyone in the industry knows carries a specific meaning?
- How have the parties performed under this contract so far?
- How have the parties performed under previous contracts?
A Case Study of What Went Wrong: Unseen Drywall.
A recent case involving drywall illustrates how both sides to the contract might have a different, but reasonable, understanding (an ambiguity in the terms). The case also illustrates how those understandings may result in materially different meanings of the contract, in terms of performance liabilities.
The case illustrates the general legal principal in United States law in private as well as state and local public contracting. The case also illustrates how the ultimate outcome of a dispute is extremely fact dependent – the details and circumstances matter a lot. The legal principle may be fairly straightforward. The hard part is applying that legal principle to the many and changing facts and circumstances over the life of a project.
Appeal of KiewitPhelps is a Federal Government Contract case involving a dispute over drywall installation. According to the expert witnesses there are various levels of drywall finishing – Level 1 (“fire-taping”) up to Level 5, “which is the highest level with the most applications of joint compound.” Pre-award, a bid inquiry addressed the drywall finish levels to be applied – specifically asking the government to ‘identify where each finish level is to be applied.” In response, the architect’s response referred to paint level finishes, rather than drywall finish levels, which also involved levels of possible finishes.
All bids submitted interpreted the drywall specifications to require higher level finishes for exposed walls and only Level 1 or 2 for areas above ceilings.
The bid was awarded to KiewitPhelps, work began, and drywall in visible areas was finished to Level 4/5. The unseen drywall – above ceilings and elsewhere – was finished to coincide with “Level 1.” Inspections began in April 2015 and all was well through 14 months of performance. And then came the dispute and ambiguity was revealed. In June 2016, a new Government inspector insisted that all drywall – both seen and unseen – should be finished to at least a Level 4.
In deciding the case, the court astutely noted that, despite nearly 20 pages in its decision summarizing evidence on specifications, inspections, and testimony by various witnesses, what the court termed “a lot of moving parts” to the case, the dispute essentially turned on the interpretation of a single sentence: “All remaining locations, unless noted otherwise” should be completed with Level 4 finish.
Following the June 2016 inspection, the Government required the contractor to complete nearly all finishes to at least Level 4. The contractor provided notice that there would be substantial increased cost and that it would seek reimbursement if it was required to take on that cost. The court ultimately decided that the contractor’s interpretation should be applied and enforced and that the contractor was entitled to recover its additional costs. The court’s decision turned on multiple facts, including several that were of particular importance:
- There was a “course of performance” between the parties indicating what both sides thought the contract meant. For quite some time, the parties operated as if Level 4 was only required in visible areas.
- The contractor did not know about the Government’s interpretation when it signed the contract. This is also part of the parties’ course of performance.
- The parties agreed to a cost reduction when the ceiling height was changed and required less visible drywall area over the course of the project (indicating that the more expensive Level 4/5 finish would cover less area). Again, part of the parties’ course of performance.
- Other bids submitted also assumed higher level finishes only where visible, indicating a general trade usage and understanding.
Contract Interpretation 101.
When interpreting a contract, a court looks to plain language of the written agreement, without reference to outside sources. Unless a court determines the contract is “ambiguous”, meaning the terms are subject to more than one reasonable interpretation. That means, both interpretations (e.g., the argument made by both parties) have to fall within a “zone of reasonableness.” If one of the interpretations is off the wall or nonsensical, the contract is not ambiguous. If the contract is not ambiguous, the court will apply the only reasonable interpretation. And, the party with the only reasonable interpretation wins.
If both sides have reasonable interpretations of the same term, then the contract is ambiguous, and the court may look outside of the contract to interpret the contract’s meaning.
Generally, a contract is construed against the drafter where the ambiguity is latent (hidden) and the non-drafting party relied on its interpretation during bidding. This will generally be the case in competitive bidding, especially in public construction. Note that this general rule may be changed by a contract provision to the contrary or if both sides were in fact involved in drafting. Further, if an ambiguity is patent (obvious), the party that did not draft the contract has a duty to inquire.
As warned in the first paragraph of this article, what is reasonable always “depends.” It depends on the circumstances, the intent of the contract, and many other variables.
Who pays for the change will depend in large part on when the ambiguity is discovered. For example, was it discovered early during bidding? And, did the bidding party know about the ambiguity? Are both sides’ interpretations reasonable? Or, alternatively, is one side coming up with a nonsensical reading of the contract? Did the owner rely on its interpretation when accepting bids? Does the misinterpretation rely on an industry term that the parties knew had a specific meaning?
What everyone wants to know is – what is the cost to me for this “ambiguity”?
A few big picture points from the KiewitPhelps case help explain why the court sided with the contractor.
You cannot know that there is a misunderstanding and then rely on an ambiguity to the other side’s detriment. The court found that there was no evidence the contractor entered into the contract knowing that the Government’s interpretation differed from the contractor’s. That is important because, if the drywall contractor had known, it would be bound by the Government’s interpretation.
Responses to bid inquiries can be very important in determining the correct interpretation when there is an ambiguity. In the KiewitPhelps, responses to bid inquiries were confusing and neither side considered the responses particularly important, so they were not helpful to the court in interpreting the ambiguity.
The court in KiewitPhelps also looked to trade practice (industry-wide) and course of performance (these two parties).
In that case, trade practice was evidenced by the subcontract bids that priced lower level drywall above walls and below floors and only the higher Level 4/5 where it would be visible. The parties’ course of performance was evidenced by the lengthy performance by the contractor in placing only higher Level 4/5 finishes in visible areas.
Because of the various evidence in support of the contractor’s interpretation, the court found that the contractor’s interpretation was certainly reasonable.
The case is just an illustration. Each case will depend on the facts and especially the contract language, parties’ actions, bid inquiries/documents, among other items. All parties should be careful to clarify any terms that appear obviously ambiguous and understand they cannot play “gotcha” games with misunderstandings they know about at the time of contracting.
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice.