Taking Risks with Numbers: How Far Can You Go?

By Susan L. McGreevy & Kathryn I. Landrum

In construction, a contractor walks a fine line in the bidding and billing process in attempting to increase profits. Whether the work is competitively bid or cost-reimbursement, some contractors view this practice as a matter of economic survival.

Contractors often rely on the fact that they know a lot more about what a proposed project will cost than the owner (which they often do). And since “everybody does it,” contractors assume that it must be okay to take risks on bidding actual quantities or try to recoup costs as quickly as possible. But, where public money is involved, there are always rules that restrict a contractor’s right to do what it might otherwise want to do.

The purpose of this article is to provide helpful guidance to contractors regarding two risky bidding and billing techniques, commonly referred to as “unbalanced bidding” and “front-end loading.” While common in the field, such tactics may result in real harm to a contractor’s bottom line.

Unbalanced Bidding

When an owner intends to award one contract with multiple unit prices, it can be hard to determine the low bidder. To arrive at a means of evaluating bids, most owners tell the bidders to assume that there will be certain quantities of each item – one cubic yard of X, 100 lineal feet of Y, and a lump sum of Z. The calculations are made by multiplying the number of units by unit prices, and then all of the extended numbers are added to get a total bid. While these hypothetical bid units are used to determine the low bidder, the eventual contractor is paid based on the actual quantities installed or furnished – which are frequently different that the bid quantities.

Unbalanced bidding refers to the practice of pricing individual line items on a bid sheet at more (or less) than what the bidder would normally offer. The bidder believes that the owner will actually use more or less of the item than is provided in the bidding documents. In doing so, the bidder attempts to take advantage of an owner’s over or under-estimation.

What’s Wrong with That?

If the project being bid is private, unbalanced bidding is not illegal. But if the project is public, unbalanced bidding comes with a substantial risk to contractors. In fact, if the project is federally owned, an unbalanced bid can result in the outright rejection of the bid as a result of a bid protest or official action.

Alternatively, an unbalanced bid can result in the deletion of some items of work – namely, the items that the contractor was counting on for its extra profit. As the Interior Board of Contract Appeals stated in Appeal of Manis Drilling, IBCA No. 2658, 93-3 B.C.A. (CCH) at 115187 (1993):

We recognize that the practice of submitting unbalanced bids in the construction industry is not uncommon. While a contractor may legitimately unbalance its bid as a bidding technique, it does so at its own peril and must accept the consequence that the deletion of separately priced items may affect its profit or loss structure.

From the government’s perspective, unbalanced bids carry the risk of increased cost to the owner. If the government overpays in the first half of the project, a later contractor default could leave the government without enough funds to complete the project. And, as recently noted by the U.S. Government Accountability Office in Matter of Gulf Master General Trading LLC, Comp. Gen. Dec. No. B-407941.2 (July 15, 2013), it does not matter if the actual project costs support the total price of an unbalanced bid. What matters is that the structure of such bids creates a financial risk to the government. The U.S. government is not in the business of taking chances.

Federal Law

The Federal Acquisition Regulation (FAR) § 52.214-10(e) addresses federal government concerns regarding unbalanced bids. This regulation provides:

The Government may reject a bid as nonresponsive if the prices bid are materially unbalanced between line items or subline items. A bid is materially unbalanced when it is based on prices significantly less than cost for some work and prices which are significantly overstated in relation to cost for other work, and if there is a reasonable doubt that the bid will result in the lowest overall cost to the Government even though it may be the low evaluated bid, or if it is so unbalanced as to be tantamount to allowing an advance payment.

As this regulation points out, just because a bid appears unbalanced does not mean that a contractor is in trouble. Rather, the bid must be materially unbalanced – that is, the imbalance must be detrimental to the government buyer, as noted in the Matter of Ultra Technology Corporation, Comp. Gen. Dec. No. B-230309.6 (Jan 18, 1989). In Ultra Technology, the Comptroller General noted that “very small difference[s]” between all of the awardee’s prices were simply too insignificant to find the bid to be “mathematically or materially unbalanced.” Accordingly, small price differences will not result in a finding of an unbalanced bid.

State Law

Many states also have rules addressing the issue of unbalanced bids. For example, the Missouri Department of Transportation (MoDOT) has similar rules to those of the federal government. Accordingly, a bid may be rejected if it is deemed unbalanced. As stated in MoDOT Bidding Requirements and Conditions § 102.8.1, “A bid will be considered irregular and may be rejected as non-responsive if any of the unit bid prices are mathematically or materially unbalanced to the detriment of the Commission.”

The Minnesota Department of Transportation (MnDOT) also provides similar regulations regarding unbalanced bids. MnDOT Standard Specification § 1207 states, “Proposals will be considered irregular and may be rejected for any of the following reasons . . . (5) If any unit prices are obviously unbalanced, either in excess of or below the reasonable cost analysis values.”

In states that lack regulations, it is up to the courts to decide how to handle the situation. Accordingly, a contractor should review state regulations that address unbalanced bids before bidding on a state-owned project.

What Can the Public Owner Do?

Before an award is made on a public project, the issue of unbalanced bids can be raised by the awarding agency (or by the protest of another bidder). The regulations generally require the agency to perform a mathematical analysis to determine if there is a problem regarding the balance of the bid, and if so, to determine the extent to which the bid is unbalanced (i.e., to determine if the difference is material). The bidder in question is generally (but not always) given the opportunity to explain why the discrepancy in the bid is justified. Then, a determination is made regarding whether to disqualify the bidder.

After a contract is awarded, the owner has fewer options to address an unbalanced bid. The owner may issue a partial termination for convenience for the overpriced items, as was approved by the Federal Circuit Court in Krygoski Construction Company v. United States, 94 F.3d 1537 (Fed. Cir. 1996), but this is not practical in most situations. (Who wants one contractor to remove the rock while another contractor removes the dirt?)

Almost always, the owner may refuse any later claim by the contractor for an increase in price for work that exceeds or falls below the quantity listed in the original bid documents. Once the contract is awarded, however, the government generally cannot make the contractor change the prices to what would be considered “fair” under the circumstances.

Federal construction contracts often include a Variation in Estimated Quantity (VEQ) clause.1 Most of the time, the VEQ clause is invoked by contractors seeking additional time or money because work has been added to their scope on a project. In theory, the government could use a VEQ clause to seek a downward adjustment in price when there is an unbalanced bid. Courts that have heard this argument have decided, however, that a party can only use a VEQ clause to seek an adjustment if the reason the price went up or down is solely attributable to a change in quantities.2

Front-End Loading

Front-end loading generally takes place after a project is awarded, when the contractor prepares a schedule of values (SOV) allocating all the dollars in the contract amongst the various items of work. If a contractor disproportionately allocates more dollars to earlier-performed work, then more funds are disproportionately paid early in the job.

How Does Front-End Loading Occur?

Most contractors are paid incrementally, with payments based on the percentage of the work that has been completed in the most recent payment period. In order to determine how much work has been completed – and therefore how much money should be paid – the contractor prepares, and the owner accepts, a SOV at the beginning of a job. The SOV distributes the whole contract amount over various parts of the work so that the person inspecting for purposes of approving a payment application can judge how far the project has progressed and approve payment for the appropriate percentage of the work completed.

Front-end loading arises when a contractor shifts costs that will probably not be incurred until later in a job to a line item that will be paid earlier in the job. This creates a risk of running out of money before the end of the project. Front-end loading occurs because contractors cannot afford to finance projects during the beginning stages of the work, which often takes place before any payment is made to the contractor. As a result, many contractors view front-end loading as a way for them to “level the playing field” and get paid the funds they need to complete the project.

What Is the Law on Front-End Loading? 

Front-end loading triggers laws relating to overpayment and uncompetitive bidding. The leading federal decision in this area is Matter of Riverport Industries, Incorporated, Comp. Gen. Dec. No. B-216707, 64 Comp. Gen. 441 (Apr. 1, 1985). In Riverport Industries, the Comptroller General held that if a bid is front-end loaded, regardless of whether it may be the lowest price, it “should be viewed as materially unbalanced since acceptance of the bid would be tantamount to allowing an advance payment.”

To be a violation of law, front-end loading generally has to be “gross.” For example, a price difference of 2.6% is not enough to find front-end loading.3 In contrast, pricing an initial line item at 36 times greater than its actual value is considered to be “gross.”4

It is not always easy to determine how funds have been shifted on a SOV. Indeed, an owner would be required to perform a significant amount of accounting work and obtain access to the contractor’s bidding and accounting systems to confirm the use of front-end loading. Because most owners are not in a position to do this, there is not much owners can do when they merely suspect front-end loading. But, there are still plenty of laws and regulations that can be invoked to address this issue.

How Governments Combat Front-End Loading: Constraints on Payment for Mobilization

Public owners have tackled the issue of front-end loading by specifically limiting reimbursement for mobilization – costs that are incurred at the beginning of a job that usually can’t be recouped until the contractor has actually completed some installation of contract work. If the contract has to equitably spread mobilization costs over all line items, then it could be a long time before the contractor is reimbursed for these costs.

To help remedy this type of situation, the Federal Highway Administration Regulation § 151.03, for example, allows for reimbursement for mobilization as a separate line item, but it may not exceed 10% of the contract price and still is paid only as work is actually completed.

FAR § 252.236-7003, however, allows a federal purchasing agency to pay for mobilization, but it requires a significant amount of documentation and there are limits on how much the government will pay for mobilization. And, despite this regulation, a bid can still be rejected if the government reasonably finds that the excessive mobilization costs would result in the recovery of sums prior to the actual commencement of construction, as noted by the Comptroller General in Matter of Dement Construction Company, Comp. Gen. Dec. B-192794, 78-2 CPD at 399 (Dec. 8, 1978).

Many states have also passed regulations to curtail the practice of front-end loading. MoDOT’s regulations, for example, are more strict than the federal rules and specifically limit when mobilization costs may be paid. (See MoDOT Standard Specifications § 618.2.1.) In contrast, MnDOT has particularly complex regulations on how it will pay for mobilization. (See MnDOT Standard Specifications § 2021.5.) And, the Kansas Department of Transportation (KDOT) does not permit billing for mobilization at all unless specific circumstances are present. (See KDOT Standard Specifications § 801.)

Other Legal Issues

Front-end loading also presents other significant legal risks to both owners and contractors. First, a contractor should be aware that just because an owner signs off on a SOV that disproportionately shifts payments forward, the contractor will not have a defense to a claim that the contractor has overbilled. The government is not privy to all of a contractor’s cost data, nor is it in a good position to know if it is being billed in advance of costs.5 Additionally, billing for work before it is completed could result in the violation of the False Claims Act, 31 U.S.C. § 3729 et seq.

Front-end loading may also provide a convenient legal defense to a surety. If an owner or a contractor makes a claim on a surety bond, the surety can defend itself by arguing that the owner was negligent in paying out more of the contract balance than the contractor had earned, as was done in Continental Insurance Company v. City of Virginia Beach, 908 F. Supp. 341 (E.D. Va. 1995). Although this defense will only work in egregious cases where the surety can prove that it was prejudiced, it is another reason why public agencies have such strong policies against front-end loading.

Could an Owner Retain Funds If a Contractor Is Caught Front-End Loading?

If there is no applicable statute or regulation, the only basis on which an owner could pursue a contractor for front-end loading, after payment is made, would be if the contract allowed for an adjustment of payment amounts based on subsequently discovered information. Indeed, such language is contained in the standard American Institute of Architects (AIA) A201-2007, General Conditions of the Contract for Construction § 9.5.1.

So, if an owner learns that the SOV was front-end loaded, it would have a contractual basis under the A201 for withholding money until the amount paid is more in line with the percentage of completion.


Summary

When working on a government project, unbalanced bids and front-end loading come with significant risk. A contractor could lose its bid, and in some cases, these practices can result in the violation of law or regulation. Some preventative best practices include:

  • Make sure someone reviews the contract terms and regulations “incorporated by reference” to know what
    is acceptable on line-item bids.
  • Be aware of bid protest procedures and rights for your public agencies.
  • After bid opening, review the pricing of the apparent low bidder to see if there is a basis for a bid protest.
  • Review SOVs before they are submitted to the owner for accuracy. Review subcontractor-submitted SOVs
    to assure they are not front-end loaded.

While unbalanced bids and front-end loading often go undetected, both public and private owners are beginning to take action to curb these practices. It is important to be aware of the risk of skewed numbers, as they might end up being risks not worth taking.


Endnotes

  1. FAR § 52.211-18: “If the quantity of a unit-priced item in this contract is an estimated quantity and the actual quantity of the unit-priced item varies more than 15 percent above or below the estimated quantity, an equitable adjustment in the contract price shall be made upon demand of either party.”
  2. Foley Company v. United States, 26 Cl. Ct. 936 (1992).
  3. Matter of Kidde, Inc., Weber Aircraft Division, Comp. Gen. Dec. No. B-223935; B-223935.2 (Nov. 19, 1986).
  4. Matter of Islip Transformer & Metal Co., Comp. Gen. Dec. No. B-225257 (Mar. 23, 1987).
  5. See Gen. Ry. Signal Co. v. Washington Metro. Area Transit Auth., 875 F.2d 320, 326 (D.C. Cir. 1989) (holding that prices in the unit price schedule did not presumptively reflect a reasonable cost of the work).


SUSAN L. McGREEVY is Partner at Stinson Leonard Street, LLP in Kansas City, MO, where she advises construction companies, sureties, design professionals, and owners in their day-to-day business ventures. She specializes in drafting and negotiating of all types of agreements, dispute resolution, strategic and succession planning, and representing sureties in bond claims and litigation.

Previously, Susan was a former trial attorney for the U.S. Department of Justice. She has presented at numerous industry events, including those of CFMA, AGC, the International Municipal Lawyers Association, Kansas Contractors Association, American Society of Professional Estimators, and NAWIC.

A longtime author for CFMA Building Profits, Susan has been a member of CFMA’s Kansas City Chapter for more than 10 years.

Phone: 816-691-3480
E-Mail: susan.mcgreevy@stinsonleonard.com
Website: www.stinsonleonard.com 


KATHRYN I. LANDRUM is an Associate Attorney at Stinson Leonard Street, LLP in Minneapolis, MN, where she practices Construction Law and Business and Commercial Litigation.

Prior to joining Stinson Leonard Street, Kathryn worked as an honors attorney for the Federal Deposit Insurance Corporation. In addition, she held two clerkships – for the Honorable Richard A. Griffin, U.S. Court of Appeals for the Sixth Circuit and for the Honorable Richard H. Kyle, U.S. District Court for the District of Minnesota.

Kathryn earned a BA from Macalester College and JD from Hamline University School of Law in St. Paul, MN. She belongs to the ABA, Minnesota Women Lawyers, and NAWIC.

Phone: 612-335-7050
E-Mail: kathryn.landrum@stinsonleonard.com
Website: www.stinsonleonard.com


Copyright © 2014 by the Construction Financial Management Association. All rights reserved. This article first appeared in CFMA Building Profits. Reprinted with permission.
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