The Importance of Implied Contractual Duties in Joint Venture Agreements

September 7, 2024 Sareesh Rawat, Esq.

The Small Business Administration (SBA) mentor-protégé program allows experienced firms to pair with smaller firms to form separate joint venture (JV) entities to pursue federal government contracts. The mentor and protégé firms enter into a JV agreement to meet the program’s regulatory requirements. The JV agreement typically divides the work and the responsibilities of contract performance between the member firms. The JV entities are usually “unpopulated,” meaning they do not have their own employees. Thus, instead of performing the work itself, the JV entity subcontracts the performance to member firms per the JV agreement and any subsequent addendums. Additionally, the JV entity is managed by the protégé firm and requires that the protégé firm hold at least 51% of the ownership interest. The SBA’s mentor-protégé program is designed to be mutually beneficial for participating firms, allowing the protégé to benefit from the mentor’s business development assistance and simultaneously affording the mentor firm access to certain contracts it could not otherwise compete for. Despite the arrangement’s “win-win” nature, disputes between participating firms can and often do arise. In case of such disputes, the JV member firms should be mindful that they are not only bound by the terms of the JV agreement but also by any contractually implied duties and covenants, such as the duties of loyalty, care, and good faith and fair dealing.

In a decision issued on July 19, 2024, the Court of Appeals for the Eleventh Circuit again confirmed the existence of such implied duties between the member firms of an unpopulated JV limited liability company (LLC) formed under the SBA’s mentor-protégé program. In the unpopulated JV at issue, the protégé firm was the designated JV manager per the program regulations and held 51% of the ownership interest. Meanwhile, the mentor firm owned the remaining 49% interest in the JV. Notably, Delaware law governed the underlying JV agreement, which, in giving maximum effect to the principle of freedom of contract, permits parties to an LLC agreement to expand, restrict, or even eliminate the fiduciary duties the parties owe each other. The JV bid for and was awarded the Army’s Training and Doctrine Command G-2 (TRADOC) contract valued at approximately $165 M. As the prime contractor, the unpopulated JV entered into subcontracts with its member firms, allocating 50.6% of the workshare to the protégé firm and the remaining 49.4% to the mentor firm. This workshare allocation was consistent with the program regulations, which require the protégé firm to perform at least 40% of the work.

The performance period for the subcontracts was one base year, followed by four one-year options. The JV held a unilateral right to exercise the options. Additionally, the subcontracts contained a termination for convenience provision, allowing the JV to terminate the subcontract for its convenience. The JV LLC, with the protégé firm as the designated manager at its helm, exercised the first option period of its subcontract with the mentor firm. However, before the first option period could conclude, the relationship between the JV member firms deteriorated, and the mentor firm filed a lawsuit against the protégé firm at the United States District Court for the Northern District of Alabama. In response, the protégé firm’s CEO, acting as the manager of the JV, terminated the mentor firm’s subcontract under the termination for convenience provision in the subcontract. The termination letter directed the mentor firm to stop all work on the subcontract effective the very next day. The mentor firm rushed to file an emergency motion for a temporary restraining order (TRO) with the District Court, requesting that the protégé firm be enjoined from terminating its TRADOC subcontract. The District Court granted the TRO, noting that the protégé’s unexpected termination maneuver gave the mentor virtually no time to obtain relief. After obtaining the TRO, the mentor firm amended its complaint at the District Court, this time including claims for the protégé’s breach of the JV agreement and fiduciary duty. Additionally, the mentor firm sought specific enforcement of the JV agreement and an injunction to prevent the protégé firm from terminating its TRADOC subcontract and taking its workshare. After an evidentiary hearing, the District Court found in favor of the mentor firm and entered a preliminary injunction. The protégé filed an interlocutory appeal with the 11th Circuit.

At the start of its analysis, the 11th Circuit first stated that its review of the District Court’s decision to grant a preliminary injunction is narrow in scope, and a reversal is typically only granted in cases where the District Court had clearly abused its discretion. The Court then ruled that the District Court acted well within its discretion in determining that the mentor was likely to succeed on its breach of fiduciary duty claim. Even when acting as the JV’s manager, the protégé firm’s CEO owed the mentor firm the traditional duties of loyalty and care as a fellow member of the JV LLC. Additionally, while Delaware law permitted parties to expand, restrict, or eliminate these duties by including relevant provisions in the LLC agreement, the LLC agreement did not contain such a provision. Furthermore, based on the evidence presented at the preliminary injunction hearing, the District Court did not abuse its discretion in finding that the protégé firm’s CEO’s actions were designed to advance the protégé firm’s interests, not the interests of the mentor firm, or the interests of the JV itself. Therefore, the protégé firm’s attempts to use the termination provision in the subcontract to subvert any duty of loyalty and care it owed to the mentor firm as its fellow member in the JV was far from justified. In fact, the District Court described the protégé firm’s attempts to cut its mentor out of the very contract the mentor helped it secure as the “epitome of disloyalty.”

The 11th Circuit also ruled that the protégé firm’s attempted termination was also likely not in compliance with the terms of the subcontract itself, which remained subject to SBA regulations, the mentor-protégé agreement, and the JV agreement. For instance, the pertinent SBA regulations require at least 30 days of advance notice to the other party and the SBA before either party may terminate a mentor-protégé relationship. Here the protégé firm provided mere hours’ notice before terminating the mentor firm’s subcontract. Consequently, the 11th Circuit affirmed the District Court’s decision in the most important preliminary-injunction criterion – the mentor firm’s likelihood of success on the merits.

The Court also noted that the mentor firm had likely sufficiently demonstrated that it would suffer irreparable harm that could not be undone through monetary remedies if the injunction was not granted. The Court noted that the day after the protégé firm’s CEO attempted to terminate the mentor firm’s subcontract, government employees on the TRADOC contract approached the mentor firm’s employees and asked them to apply for jobs on the protégé firm’s website. The Court emphasized that performance on the TRADOC contract required highly skilled and experienced employees with institutional knowledge that could not be easily replaced. If the mentor firm were to lose these employees due to the termination of the TRADOC subcontract, its damages would be complicated, if not entirely impossible, to quantify. Additionally, an abrupt termination of the TRADOC subcontract could also impact the mentor firm’s past performance assessment, harm its reputation, and impede its ability to compete for and obtain other federal contracts in the future. Since quantifying such future losses was again extremely difficult, if not impossible, the 11th Circuit ruled that the District Court did not abuse its discretion in finding that the mentor firm had sufficiently demonstrated that it would suffer irreparable injury from the termination of the TRADOC subcontract, that monetary damages could not remedy. In conclusion, in affirming the lower court’s decision, the 11th Circuit ruled that the Alabama District Court did not exceed the scope of its equitable authority when it ordered the protégé firm to refrain from using its position as managing member of the JV to push the mentor firm out of its workshare on the TRADOC contract.

When entering JV agreements for SBA programs or otherwise pursuing federal contracts, contractors should be mindful of governing federal regulations, along with their duties and responsibilities toward the other JV member firms. This not only means having a comprehensive understanding of the terms of the JV agreement itself but also of any subsequent addendums that may allocate the parties’ workshare on specific contracts. Additionally, JV member firms should understand their roles on the contract along with any implied contractual duties they may owe to other JV members, such as the covenants of good faith and fair dealing, the implied duties of loyalty and care, and any fiduciary responsibilities. Depending on the member firms’ intentions and the specific state laws governing the JV agreement, parties to a JV may be able to expand, limit, or even eliminate such implied duties. However, it is essential that the member firms thoroughly discuss, understand, and, if necessary, obtain counsel on the implications of such actions before including pertinent provisions in their JV agreements. An adequate meeting of the minds of the JV members at the preliminary negotiation stages may prove critical down the road in avoiding costly litigation and outlay of resources that could be better utilized in pursuing future opportunities.

This Federal Procurement Insight is provided as a general summary of the applicable law in the practice area and does not constitute legal advice. Contractors wishing to learn more are encouraged to consult the TILLIT LAW PLLC Client Portal or Contact Us to determine how the law would apply in a specific situation.

Related Insights

Protesting Competition Restrictions on Procurements Lacking Advanced Acquisition Planning

February 28, 2024 Sareesh Rawat, Esq.

Acquisition planning on U.S. federal contracts requires the contracting activity to coordinate and integrate the efforts of all personnel responsible for the acquisition via a comprehensive plan that fulfills the government’s requirements in a timely manner and at reasonable cost. The Competition in Contracting Act (CICA) of 1984, implemented by Federal Acquisition Regulation (FAR) Part 6, mandates full and open competition in federal procurement. Consequently, while there are limited exceptions enumerated in FAR § 6.3, federal agencies must generally use competitive procedures in procuring products and services. Furthermore, federal agencies are expressly prohibited from entering contracts for property or services by utilizing non-competitive procedures when they have failed to properly plan the procurement in advance.

Contractors looking to challenge the Government’s use of non-competitive procedures in such improperly planned procurements must be prepared to demonstrate that the agency’s decision was unreasonable under the particular circumstances of that procurement. In 2014, the Bureau of Indian Affairs (BIA), an agency under the Department of Interior (DOI), was involved in a procurement contract for technology services. The procurement at issue was a Buy Indian Set-Aside conducted under the Buy Indian Act of 1910, and the eventual contract was awarded to an eligible non-incumbent contractor. However, a week before the conclusion of the predecessor contract, the incumbent contractor timely protested the award at the Government Accountability Office (GAO). In response, the BIA informed the GAO that it intended to take corrective action and requested that the GAO dismiss the incumbent’s protest.

Implied Duties of Cooperation, Good Faith, and Fair Dealing in Federal Contracts

May 2, 2024 Sareesh Rawat, Esq.

Due to the highly regulated nature of federal government contracts, their formation and administration are governed by a well-defined set of rules. Despite this, government contracts rely on a foundation of mutual trust and cooperation between the government and its contractors. Parts of this invisible layer of obligation are embedded in the implied duties of cooperation, good faith, and fair dealing. Therefore, while related and somewhat interchangeable concepts, these implied duties are inherent to all government contracts and help ensure a successful, productive, and professional relationship between the contracting parties. However, from time to time, the Government may violate these implied duties, giving rise to contractor claims. Understanding these duties empowers contractors to navigate potential issues by identifying causes of action for Government breaches that result in disruption in performance or monetary damages. Therefore, a general discussion distinctly describing these obligations may be helpful to contractors alleging Government violations during contract performance.

o Duty of Cooperation

The Government’s duty to cooperate during the performance phase is as inherent to a government contract as the Government’s right to expect performance in accordance with specifications. Since both parties are required to work together as partners to achieve common contractual objectives, a lack of cooperation during performance by the Government may, and often does, become a source of disputes. When facing scenarios where contractors suspect a lack of adequate cooperation by the Government, they should evaluate the Government’s conduct in the context of the contract’s overall objectives. If the conduct at issue is inconsistent with the Government’s stated mission needs or hinders the contractor’s performance, the Government may be in breach of its duty of cooperation. The Government’s duty to cooperate during performance may be viewed independently by adjudicative forums in accordance with the facts at issue or in contrast with its treatment of other similarly situated contractors. Understanding the government's duty to cooperate empowers contractors to identify potential roadblocks and seek redress for hindered performance.

Subcontractor Settlements Post Termination for Convenience

June 15, 2024 Sareesh Rawat, Esq.

As a sovereign and a contracting party, the government holds the prerogative to terminate a government contract, either partially or completely, whenever it is in its best interest. While a contractor may pose certain challenges to the CO’s decision to terminate a contract, it is generally accepted that the government’s rights in this regard are practically limitless. The Federal Acquisition Regulation (FAR) outlines the methods through which the government may settle contracts it terminates for its convenience. Specifically, under FAR § 49.103, the government may settle contracts terminated for convenience through negotiated agreement, CO’s determination, costing-out under vouchers for cost-reimbursable contracts, or through a combination of these methods. Typically, when the government exercises its right to terminate a contract for convenience, it enters into a settlement agreement with the prime contractor. In turn, prime contractors are required to settle any subcontractor termination settlement proposals.

Once the government issues a notice terminating a contract for convenience, the prime contractor must terminate all subcontracts related to the terminated portion of the prime contract. Under FAR § 49.104, prime contractors are required to settle all outstanding liabilities that arise out of the termination of subcontracts and promptly notify the CO of any legal proceedings that may be instituted by a subcontractor. Additionally, FAR § 49.108 generally outlines the parties’ rights, obligations, and procedures pertaining to subcontractor settlement proposals. Notably, FAR § 49.108-2(b) makes it abundantly clear that the government’s rights to terminate the contract for convenience are unaffected by a prime contractor’s failure to include an appropriate termination clause in a subcontract. Therefore, contractors should review the termination clause of their subcontract agreements to ensure their rights are adequately protected in case of a termination for the government’s convenience.

Prequalification Issues in Relying on De Facto Joint Ventures in Security Act Procurements

August 2, 2024 Sareesh Rawat, Esq.

Government contractors often rely on joint venture (JV) arrangements to meet the requirements of a solicitation. One such arrangement is the "de facto joint venture," where no formal agreement is reached, but the offering entity relies upon the experience of a related U.S. firm that guarantees the offering entity's performance. De facto joint ventures are commonly used in the context of procurements conducted under the Omnibus Diplomatic Security and Antiterrorism Act (Security Act) of 1986, which sets forth the requirements for companies seeking to compete for the construction of U.S. diplomatic facilities. Notably, where adequate competition exists for contracts involving diplomatic construction or design, the Security Act requires that only U.S. persons and “qualified joint venture persons” may submit a bid. Additionally, in its Security Act implementing regulations, the DOS permits offerors to rely on de facto JVs to meet the requirements of the Security Act. Therefore, depending on the terms of the solicitation, the de facto JV may provide potential contractors an additional avenue to demonstrate responsibility or meet past performance requirements by leveraging the resources and experience of related U.S. entities. However, since the de facto JV is not a separately registered entity, issues may arise when the de facto JV must meet specific qualification requirements, such as having an active registration in the System of Award Management (SAM).

The Importance of Implied Contractual Duties in Joint Venture Agreements

TILLIT LAW Federal Procurement Insights