B-145104, JULY 20, 1961, 41 COMP. GEN. 34

B-145104: Jul 20, 1961

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CONTRACTS - MODIFICATION - FIXED-PRICE - CONTRACTS - EVENTS PRIOR TO CONTRACT EXECUTION - MISTAKES A FIXED-PRICE CONTRACT WHICH WAS NEGOTIATED ON THE BASIS THAT AN ELEMENT OF COST TO THE CONTRACTOR WAS ROYALTY PAYMENTS REQUIRED UNDER CERTAIN EXISTING LICENSE AGREEMENTS. IS REGARDED AS A CONTRACT NEGOTIATED AND EXECUTED ON THE BASIS OF A MISTAKE ON THE PART OF BOTH PARTIES THAT A LIABILITY EXISTED TO PAY ROYALTIES AND. REFORMATION IS PROPER TO PERMIT THE GOVERNMENT TO RETAIN THE AMOUNT OVERSTATED FOR ROYALTY FEES NOT LEGALLY REQUIRED TO BE PAID. RECONSIDERATION WAS REQUESTED OF OUR DISALLOWANCE OF DECEMBER 6. WERE BELIEVED TO BE PAYABLE BY ITT FEDERAL AS PART OF THE COST OF PERFORMING THE CONTRACT.

B-145104, JULY 20, 1961, 41 COMP. GEN. 34

CONTRACTS - MODIFICATION - FIXED-PRICE - CONTRACTS - EVENTS PRIOR TO CONTRACT EXECUTION - MISTAKES A FIXED-PRICE CONTRACT WHICH WAS NEGOTIATED ON THE BASIS THAT AN ELEMENT OF COST TO THE CONTRACTOR WAS ROYALTY PAYMENTS REQUIRED UNDER CERTAIN EXISTING LICENSE AGREEMENTS, ALTHOUGH SHORTLY BEFORE THE EXECUTION OF THE CONTRACT BUT WITHOUT THE KNOWLEDGE OF EITHER PARTY, A FEDERAL COURT RELIEVED THE CONTRACTOR OF LIABILITY FOR THE ROYALTY PAYMENTS, IS REGARDED AS A CONTRACT NEGOTIATED AND EXECUTED ON THE BASIS OF A MISTAKE ON THE PART OF BOTH PARTIES THAT A LIABILITY EXISTED TO PAY ROYALTIES AND, THEREFORE, REFORMATION IS PROPER TO PERMIT THE GOVERNMENT TO RETAIN THE AMOUNT OVERSTATED FOR ROYALTY FEES NOT LEGALLY REQUIRED TO BE PAID.

TO THE INTERNATIONAL TELEPHONE AND TELEGRAPH CORP., JULY 30, 1961:

BY YOUR LETTERS DATED FEBRUARY 13 AND APRIL 28, 1961, WITH ENCLOSURES, RECONSIDERATION WAS REQUESTED OF OUR DISALLOWANCE OF DECEMBER 6, 1960, WHEREIN ITT FEDERAL'S CLAIM FOR $11,950.50, REPRESENTING AN AMOUNT WITHHELD BY THE DEPARTMENT OF THE ARMY TO RECOVER ROYALTIES WHICH, PRIOR TO AWARD OF CONTRACT NO. DA-36-039-SC 71467 DATED FEBRUARY 14, 1956, WERE BELIEVED TO BE PAYABLE BY ITT FEDERAL AS PART OF THE COST OF PERFORMING THE CONTRACT, WHEN IN FACT NONE WERE PAYABLE.

PURSUANT TO REQUEST FOR PROPOSALS NO. SC-36-039-10311-55 DATED DECEMBER 12, 1955, ITT FEDERAL SUBMITTED A PROPOSAL DATED JANUARY 2, 1956, TO FURNISH, AMONG OTHER ITEMS, CERTAIN RADIO SETS TO THE SIGNAL SUPPLY AGENCY. ITT FEDERAL'S QUOTATION ON THE RADIO SETS OF $7,399 PER UNIT FOR FURNISHING 120 TO 180 UNITS WERE CONSIDERED FOR NEGOTIATION AND ON JANUARY 16, 1956, ITT FEDERAL SUBMITTED A REVISED PROPOSAL TO REDUCE THE UNIT PRICE FROM $7,399 TO $5,500. A PRICE ANALYSIS WAS ATTACHED TO THIS REVISED QUOTATION AND SHOWED AN ITEM OF COST OF 1.75 PERCENT OF SELLING PRICE FOR SALES ROYALTY OR $96.25 PER UNIT. A GOVERNMENT PRICING REPORT DATED JANUARY 18, 1956, RECOMMENDED THAT NO PROVISION FOR PRICE REDETERMINATION BE INCORPORATED IN THE CONTRACT "BECAUSE OF CONTRACTOR'S LONG EXPERIENCE IN THE MANUFACTURE OF SUBJECT ITEM, REALISTICALLY PRICED ELEMENTS OF COST AS COMPARED TO HISTORICAL MANUFACTURING INFORMATION; TOGETHER WITH ADEQUATE COMPETITION OBTAINED ON ALL ITEMS.' CONCERNING THE ESTIMATED UNIT COST OF $96.25 FOR ROYALTY PAYMENTS, THE PRICING REPORT STATED:

THE CONTRACTOR HAS INCLUDED 1.75 PERCENT OF SELLING PRICE IN HIS BID TO COVER THE COST OF A 1 PERCENT OF SALES ROYALTY PAYABLE TO WESTERN ELECTRIC COMPANY AND .75 PERCENT OF SALES ROYALTY PAYABLE TO RADIO CORPORATION OF AMERICA. PAYMENT TO EACH COMPANY IS BASED ON EXISTING ROYALTY AGREEMENTS WHICH PROVIDE FOR PAYMENT AT THAT RATE FOR "POINT TO POINT EQUIPMENT.' THE PROVISION FOR ROYALTY PAYMENTS IS CONSIDERED ACCEPTABLE, SUBJECT TO THE CONTRACTOR'S SUBMISSION OF REPORT OF ROYALTIES, IN ACCORDANCE WITH ASPR 9-103.

ON JANUARY 26, 1956, ITT FEDERAL SUBMITTED A FINAL WRITTEN PROPOSAL SETTING FORTH THE PRICE DETAILS, INCLUDING A UNIT PRICE OF $5,500 FOR 120 RADIO SETS. ATTACHED TO THIS FINAL PROPOSAL WAS YOUR PRICE ANALYSIS WHICH SHOWED THAT A ROYALTY OF 1.75 PERCENT OF THE SELLING PRICE OF THE RADIO SET, OR $96.25 PER SET, WAS INCLUDED AS AN ITEM OF COST MAKING UP THE UNIT PRICE OF $5,500.

A NOTICE OF AWARD WAS ISSUED TO ITT FEDERAL ON FEBRUARY 14, 1956, IN THE TOTAL AMOUNT OF $694,069.57, THE MAJOR PORTION OF WHICH ($600,000) COVERED 120 RADIO SETS. BY SUBSEQUENT CONTRACT AMENDMENT, THE UNIT PRICE OF THE RADIO SETS WAS INCREASED TO $5,690.72, MAKING THE TOTAL REVISED PRICE FOR THE RADIO SETS AMOUNT TO $682,886.40. HOWEVER, ON JANUARY 24, 1956, BEFORE THE FINAL PROPOSAL AND AWARD OF THE CONTRACT, THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY, IN THE CASE OF UNITED STATES V. WESTERN ELECTRIC, INCORPORATED, AND AMERICAN TELEPHONE AND TELEGRAPH COMPANY, CIVIL ACTION NO. 17-49, ENTERED A CONSENT DECREE, DENOMINATED AS A " FINAL JUDGMENT," AGAINST THE DEFENDANTS WHICH HAD THE EFFECT OF RELIEVING ITT FEDERAL OF LIABILITY FOR THE ROYALTY PAYMENTS INCLUDED AS AN ITEM OF COST IN THE CONTRACT. BY LETTER DATED OCTOBER 28, 1957, ITT FEDERAL COMMENTED ON THE EFFECTS OF THE FINAL JUDGMENT AS FOLLOWS:

CONTRACTOR IS LICENSED UNDER THE TERMS OF TWO LICENSE AGREEMENTS, THEREBY NECESSITATING TWO SEPARATE REPORTS AS FOLLOWS.

1. UNDER THE TERMS OF A LICENSE AGREEMENT BETWEEN INTERNATIONAL TELEPHONE AND TELEGRAPH CORPORATION AND THE WESTERN ELECTRIC COMPANY, EFFECTIVE AS OF JANUARY 1, 1951, FEDERAL TELEPHONE AND RADIO COMPANY, AS A MANUFACTURING DIVISION OF INTERNATIONAL, IS REQUIRED TO PAY ROYALTIES TO WESTERN (THROUGH INTERNATIONAL) ON LICENSED EQUIPMENT AND SPARE PARTS THEREFOR.

NOTWITHSTANDING THE AGREEMENT, UNDER THE TERMS OF THE FINAL JUDGMENT IN CIVIL ACTION NO. 17-49 BETWEEN THE UNITED STATES OF AMERICA, AS PLAINTIFF, AND WESTERN ELECTRIC COMPANY, INC. AND AMERICAN TELEPHONE AND TELEGRAPH COMPANY, AS DEFENDANTS, NO ROYALTIES ARE PAYABLE TO THE WESTERN ELECTRIC COMPANY ON SALES OF EQUIPMENT MANUFACTURED ON OR AFTER JANUARY 24, 1956 UNLESS THE EQUIPMENT RESULTING FROM SAID MANUFACTURE EMPLOYS THE INVENTION OF A WESTERN PATENT WHICH ISSUED ON OR SUBSEQUENT TO THE DATE OF THE FINAL JUDGMENT. SINCE THE SUBJECT CONTRACT WAS ENTERED INTO AS OF FEBRUARY 14, 1956 SUBSEQUENT TO THE DATE OF THE FINAL JUDGMENT AND THE APPARATUS TO BE MANUFACTURED THEREUNDER PRESENTLY EMPLOYS NO INVENTION OF A WESTERN PATENT ISSUED SUBSEQUENT TO THE DATE OF THE FINAL JUDGMENT, IT APPEARS UNLIKELY THAT ROYALTIES WILL BE PAYABLE TO THE WESTERN ELECTRIC COMPANY. ROYALTIES WILL BE PAYABLE UNLESS A WESTERN PATENT COVERING AN INVENTION EMPLOYED BY THE LICENSED APPARATUS ISSUES BEFORE THE APPARATUS HAS BEEN MANUFACTURED.

2. PURSUANT TO THE TERMS OF A LICENSE AGREEMENT BETWEEN THE INTERNATIONAL TELEPHONE AND TELEGRAPH CORPORATION AND THE RADIO CORPORATION OF AMERICA, EFFECTIVE AS OF JANUARY 1, 1955, FEDERAL TELEPHONE AND RADIO COMPANY, AS A MANUFACTURING DIVISION OF IT AND T, IS LICENSED TO SELL RADIO APPARATUS AND ACCESSORIES THEREFOR. ROYALTIES ARE PAYABLE ON SALES OF SAID LICENSED APPARATUS AND ACCESSORIES PROVIDED THEY EMPLOY THE INVENTION OF ANY PATENT UNDER WHICH IT AND T IS LICENSED BY RCA.

THE ROYALTY RATE ON SALES TO THE UNITED STATES GOVERNMENT IS ONE PERCENT OF THE NET SELLING PRICE OF THE APPARATUS. THE NET SELLING PRICE DIFFERS FROM THE GENUINE OR GROSS SELLING PRICE BY CERTAIN ALLOWABLE DEDUCTIONS, E.G., ALL VACUUM TUBE COMPONENTS, ANTENNAS, REPAIR PARTS, PACKING MATERIAL, INSTRUCTION BOOKS, DRAWINGS, ETC.

AT THE PRESENT TIME IT IS IMPOSSIBLE TO SAY JUST WHAT ROYALTIES, IF ANY, WILL BE PAYABLE TO THE RADIO CORPORATION OF AMERICA UNDER OUR AGREEMENT WITH THEM. ROYALTIES ARE PAYABLE ONLY UPON DELIVERY AND BILLING OF EQUIPMENT MANUFACTURED UNDER THE CONTRACT. NO DELIVERIES HAVE AS YET BEEN MADE AND IT IS IMPOSSIBLE TO PREDICT AT THIS TIME WHETHER OR NOT THE EQUIPMENT WHEN DELIVERED WILL EMPLOY THE INVENTION OF ANY UNEXPIRED PATENT UNDER WHICH IT AND T IS LICENSED BY RCA.

A FUTURE REPORT WILL BE PREPARED WHEN ALL OF THE EQUIPMENT SPECIFIED TO BE DELIVERED UNDER THIS CONTRACT HAS BEEN DELIVERED.

ON APRIL 21, 1959, ITT FEDERAL ADVISED THE CONTRACTING OFFICER THAT NO ROYALTIES IN EXCESS OF $250 WOULD BE PAID TO ANY ONE LICENSOR UNDER THE CONTRACT. AS REQUIRED BY THE CONTRACT REPORTING OF ROYALTIES CLAUSE, ITT FEDERAL CERTIFIED ON THAT DATE "THAT ROYALTIES IN EXCESS OF $250 HAVE NOT BEEN PAID AND ARE NOT TO BE PAID TO ANY ONE LICENSOR IN CONNECTION WITH THE PERFORMANCE OF THE ABOVE IDENTIFIED CONTRACT.' IN VIEW THEREOF, THE CONTRACTING OFFICER WITHHELD $11,950.50--- APPROXIMATELY 1.75 PERCENT OF THE CONTRACT PRICE FOR THE RADIO SETS DELIVERED--- FROM AMOUNTS OTHERWISE DUE UNDER THE CONTRACT ON THE BASIS THAT SUCH AMOUNT REPRESENTED AN ERRONEOUS PAYMENT TO ITT FEDERAL FOR A CONTRACT COST WHICH HAD NOT BEEN INCURRED IN CONNECTION WITH CONTRACT PERFORMANCE.

YOUR COMPANY CONTENDS THAT THE ACTION TAKEN IN WITHHOLDING THE $11,950.50 OTHERWISE DUE UNDER THE SUBJECT CONTRACT WAS IMPROPER FOR THE FOLLOWING REASONS:

1. THAT THE CONTRACT WAS A FIRM FIXED-PRICE CONTRACT AND THAT ANY PARTICULAR ELEMENT OF COST IS NOT SUBJECT TO ADJUSTMENT BECAUSE OF CHANGES IN ACTUAL COST;

2. THAT YOUR COMPANY WAS OBLIGATED TO PAY ROYALTIES ON THE DATE OF AWARD AND THEREAFTER TO MARCH 14, 1956, WHEN ADVICE WAS FIRST RECEIVED FROM WESTERN ELECTRIC THAT THE OBLIGATION CEASED;

3. THAT THERE WAS NO MISTAKE OF FACT OR LAW SINCE THE EXEMPTION FROM ROYALTY PAYMENTS DID NOT ARISE UNTIL MARCH 14, 1956;

4. THAT THERE WAS NO MISREPRESENTATION CONCERNING THE OBLIGATION TO PAY ROYALTIES.

WE AGREE THAT THE SUBJECT CONTRACT WAS A FIRM FIXED-PRICE AGREEMENT AND THAT NO DELIBERATE MISREPRESENTATION WAS MADE RESPECTING ROYALTY PAYMENT LIABILITY. HOWEVER, WE ARE OF THE OPINION THAT THE COST OF THE RADIO SETS WAS OVERSTATED TO THE EXTENT OF ROYALTY COSTS WHICH ITT FEDERAL WAS NOT LEGALLY REQUIRED TO PAY, AND DID NOT PAY, ON AND AFTER JANUARY 24, 1956, IN CONNECTION WITH PERFORMANCE OF THE CONTRACT. WE ARE OF THIS OPINION BECAUSE THE CONTRACT WAS NEGOTIATED AND EXECUTED UNDER THE MISTAKEN BELIEF THAT ROYALTY PAYMENTS WERE REQUIRED TO BE PAID BY ITT FEDERAL TO WESTERN ELECTRIC UNDER EXISTING LICENSE AGREEMENTS WHICH WERE EFFECTIVELY AVOIDED BY THE FEDERAL COURT BY ITS FINAL JUDGMENT OF JANUARY 24, 1956. IT IS CLEAR FROM THE RECORD BEFORE US THAT THE PARTIES CONDUCTING THE NEGOTIATIONS LEADING UP TO THE EXECUTION OF THE CONTRACT WERE UNDER THE IMPRESSION THAT A LIABILITY EXISTED TO PAY ROYALTIES. MOREOVER, IT IS CLEAR THAT HAD THE GOVERNMENT, OR FOR THAT MATTER ITT FEDERAL, BEEN AWARE OF THE FINAL JUDGMENT, AN ITEM OF COST FOR ROYALTY PAYMENTS WOULD NOT HAVE BEEN INCLUDED AS PART OF THE NEGOTIATED PRICE OF THE RADIO SETS. THUS, ABSENT THE NECESSARY KNOWLEDGE OF THE EXISTING FACTS RESPECTING ROYALTY PAYMENTS ON THE PART OF BOTH NEGOTIATING PARTIES, WE ARE OF THE VIEW SUCH CIRCUMSTANCES CONSTITUTE A BASIS FOR CONTRACT REFORMATION. 76 C.J.S., REFORMATION OF INSTRUMENTS, SECTION 29; LEATHEM SMITH-PUTNAM NAV. CO. V. NATL. U. F. INS. CO., 96 F.2D 923.

THE PRINCIPLE OF LAW APPLICABLE HERE IS THAT MISTAKE ON ONE SIDE AND MISREPRESENTATION ON THE OTHER SIDE, WHETHER WILLFUL OR ACCIDENTAL, CONSTITUTES A GROUND FOR REFORMATION WHEN THE PARTY DECEIVED HAS RELIED ON THE MISREPRESENTATION OF THE OTHER PARTY. RESTITUTION MAY BE OBTAINED FOR MISREPRESENTATIONS OF MATERIAL FACTS ON THE PREMISE THAT IT WOULD BE UNJUST TO ALLOW ONE WHO MADE THE MISREPRESENTATION, THOUGH INNOCENTLY, TO RETAIN THE FRUITS OF A BARGAIN INDUCED, IN ALL OR PART, BY SUCH MISREPRESENTATIONS. SEE WILLISTON ON CONTRACTS, REV. USED., SECTIONS 1500 AND 1509, AND THE CASES THEREIN CITED; RESTATEMENT, CONTRACTS, SECTION 476, COMMENT B. IN GRAND TRUNK WESTERN R. CO. V. H. W. NELSON CO., INC., 116 F.2D 823, 832, THE COURT STATED:

* * * A PARTY IS GUILTY OF FRAUD IN NEGOTIATING A CONTRACT WHEN HE MAKES A FALSE REPRESENTATION CONCERNING THE SUBJECT MATTER BY MEANS OF WHICH HE PUTS THE OPPOSITE PARTY UNDER MISTAKE AS TO THE TERMS OF THE BARGAIN AND WHETHER A PARTY MISREPRESENTING A MATERIAL FACT KNOWS IT TO BE FALSE OR MAKES THE ASSERTION WITHOUT KNOWING WHETHER IT IS TRUE OR FALSE IS WHOLLY IMMATERIAL, FOR THE AFFIRMATION OF WHAT ONE DOES NOT KNOW OR BELIEVE TO BE TRUE IS EQUALLY IN MORALS AND LAW AS UNJUSTIFIABLE AS THE AFFIRMATION OF WHAT IS KNOWN POSITIVELY TO BE FALSE AND EVEN IF A PARTY INNOCENTLY MISREPRESENTS A MATERIAL FACT BY MISTAKE, IT IS EQUALLY CONCLUSIVE FOR ITS OPERATES AS A SURPRISE AND MISREPRESENTATION ON THE OTHER PARTY. * * *

SEE, ALSO, VAN METER V. BENT CONSTRUCTION CO. 297 P.2D 644, INVOLVING AN ACTION BY A SUBCONTRACTOR AGAINST A GENERAL CONTRACTOR FOR REFORMATION OF A CONTRACT, WHERE IT WAS HELD THAT EVEN IN THE ABSENCE OF ANY MISREPRESENTATIONS, NEGLIGENT FAILURE OF A PARTY TO KNOW OR DISCOVER FACTS AS TO WHICH BOTH PARTIES ARE UNDER MISTAKE DOES NOT PRECLUDE REFORMATION BECAUSE OF SUCH MISTAKE. THE COURT STATED ON PAGE 648: " THERE IS EVEN MORE REASON FOR NOT BARRING A PLAINTIFF FROM EQUITABLE RELIEF WHERE NEGLIGENCE IS DUE IN PART TO HIS RELIANCE IN GOOD FAITH UPON THE FALSE REPRESENTATIONS OF A DEFENDANT, ALTHOUGH THE STATEMENTS WERE NOT MADE WITH THE INTENT TO DECEIVE.'

THE SUPREME COURT POINTED OUT IN THE CASE OF UNITED STATES V. BARLOW, 132 U.S. 271, THAT IT WOULD INDEED BE A MISCHIEVOUS DOCTRINE IF ACTIONS BY PUBLIC OFFICIALS BASED UPON GUESSES ONLY AND WITHOUT REGARD TO THE TRUE FACTS COULD PRECLUDE THE GOVERNMENT FROM RECOVERING ITS MONEY PAID FOR ITEMS NOT REQUIRED OR EMPLOYED IN PERFORMING THE CONTRACT IN QUESTION. THE COURT ALSO REFERRED TO THE RULE OF LAW THAT WHERE MONEY IS PAID TO ANOTHER UNDER THE INFLUENCE OF A MISTAKE, THAT IS, UPON THE SUPPOSITION THAT A SPECIFIC FACT IS TRUE, AND THE MONEY WOULD NOT HAVE BEEN PAID IF IT HAD BEEN KNOWN TO THE PAYER THAT THE FACT WAS UNTRUE, AN ACTION WILL LIE TO RECOVER IT BACK, AND IT IS AGAINST GOOD CONSCIENCE TO RETAIN IT. CF. KOSTELAC V. UNITED STATES, 247 F.2D 723.

THE GOVERNMENT WAS ENTITLED TO RELY ON THE REPRESENTATION THAT ROYALTY PAYMENTS WERE A PROPER ITEM OF COST OF PRODUCING THE RADIO SETS NOT ONLY BECAUSE IT WAS A MATTER IN WHICH ITT FEDERAL SHOULD HAVE HAD SPECIAL KNOWLEDGE BUT ALSO BECAUSE THE GOVERNMENT COULD NOT HAVE REASONABLE DISCOVERED THE TRUE FACTS DURING THE COURSE OF NEGOTIATIONS IN THE ABSENCE OF SOME INDICATION THAT THE ROYALTY COST FIGURES WERE QUESTIONABLE.

IN CONCLUSION, WE POINT OUT THAT THE REMEDY OF CONTRACT REFORMATION TO CORRECT MUTUAL MISTAKES HAS BEEN APPLIED CONSISTENTLY BY OUR OFFICE AND THE COURTS IN PROPER CASES WITHOUT REGARD TO WHETHER THE CONTRACT BE FIXED PRICE OR OTHERWISE. 20 COMP. GEN. 533; ID. 782; 30 ID. 220; UNITED STATES V. HURWITZ, 174 F. SUPP. 925; EASTERN FREIGHT WAYS, INC. V. UNITED STATES, 257 F.2D 703; HELD V. UNITED STATES, 63 CT. CL. 392; PACIFIC MARITIME ASSOCIATION V. UNITED STATES, 125 CT. CL. 216.