Implied Covenant Does Not Add to the Terms of a Contract under Virginia Law

Terms of contract
In a July 28th opinion, the Eastern District provided some much-needed clarity on whether an implied covenant of good faith and fair dealing alters or adds terms in a written contract.  Judge Gerald Bruce Lee held that “Virginia law does not recognize an independent cause of action” for a breach of the implied covenant and granted summary judgment against the party asserting the claim. In Middle East Broadcasting Networks, Inc. v. MBI Global, LLC, No. 1:14-cv-01207, 2015 WL 4571178 (E.D. Va. July 28, 2015), the Plaintiff was a news broadcaster that had operated a bureau in Baghdad, Iraq, since 2004.  In 2013, the Plaintiff solicited proposals to build a special Blast Resistant Building (“BRB”), with a delivery of no later than December 31, 2013.  The Defendant, billing itself as “an expert ‘in the construction of BRBs’ and an ‘expert in the delivery of BRBs to locations in the Middle East,’” accepted the challenge, and the parties entered into a contract.  The delivery date, however, slipped several times to the following summer due to the Defendant’s difficulty in paying a subcontractor.  The parties finally agreed to a contract amendment that required delivery by August 3, 2014, and that this deadline “‘would not be waived or excused for any reason whatsoever.’”  The Defendant then missed the August 3rd deadline and never delivered the BRB.  After the Plaintiff filed suit for breach of contract, the Defendant counterclaimed for breach of the contract’s implied covenant of good faith and fair dealing.  After discovery, the Plaintiff moved for Summary Judgment on the implied covenant counterclaim. Judge Lee granted the Plaintiff’s Summary Judgment motion on the breach of the implied covenant of good faith and fair dealing claim “because Virginia law does not recognize an independent cause of action for this claim.”  Judge Lee went on to cite prior Eastern District case law that recognized that while such an implied covenant does exist in every contract under Virginia law, the covenant “simply bars a party from acting in such a manner as to prevent the other party from performing his obligations under the contract.” Judge Lee then used this analysis to determine that the Defendant had failed to demonstrate a genuine issue of material fact as to whether the Plaintiff had done something to prevent the Defendant from performing under the contract.  Notably, Judge Lee implicitly rejected the Defendant’s argument that the implied covenant somehow adds obligations to the contract. This decision is useful guidance for practitioners who often see breach of contract claims paralleled with breach of implied covenant claims in commercial litigation.  Prior to this opinion, different Virginia courts had gone in different ways when facing the question of whether an implied covenant added to the express terms of a contract.  Judge Lee’s opinion adds much-needed clarity to the subject and essentially answers that question in the negative.  Business litigators can rest (somewhat) more easily by knowing that the four-corners of the contract will not be expanded by a nebulous, undefined, implied covenant.

EDVA Provides Road Map to Enforce a Contractual Waiver of the Statute of Limitations Defense

limits of waivers
Business attorneys frequently agonize over the statute of limitations. After a debt has gone unpaid, attorneys often seek an alternative to filing suit to provide more time to collect the debt before the running of the statute of limitations. Many attorneys demand a debtor execute a waiver of a statute of limitations defense in return for refraining from filing suit. Such waivers, however, contain hidden landmines due to a little-known Virginia statute. The Eastern District of Virginia recently relied upon that statute to allow a debtor to escape repayment of a $235,000 loan despite signing such a waiver. This case is a warning to corporate practitioners and creditors’ counsel, but it also provides a road map to successfully navigate this statutory minefield. In Slaey v. Harrington, 1:14-cv-1210, 2015 WL 5139317 (E.D. Va. Sept. 1, 2015), Judge T.S. Ellis reversed the EDVA bankruptcy court which initially ruled in favor of the creditor. The facts of the case are straight-forward. Harrington (an attorney) loaned $235,000 to Slaey (a client of Harrington’s) in 2002 in return for a signed promissory note requiring repayment in 30 days. Slaey, however, failed to repay the loan. Approximately three days prior to the expiration of Virginia’s statute of limitations, Harrington had Slaey sign a written agreement that purported to waive any defense of the statute of limitations in a subsequent lawsuit. Based upon this new agreement, Harrington did not file suit until five years later during Slaey’s Chapter 11 bankruptcy proceeding. Slaey opposed, arguing that Harrington’s claim was time-barred under Virginia law and that the waiver signed five years earlier was unenforceable under Section 8.01-232(A) of the Virginia Code. Normally, most defenses to a breach of contract action are waivable by a defendant, and this general rule has led many attorneys to mistakenly assume that they can easily contract around a looming statute of limitations defense. But little-known Va. Code § 8.01-232(A) restricts the enforceability of such waivers, and unfortunately, the statute is not a model of clarity: Whenever the failure to enforce a promise, written or unwritten, not to plead the statute of limitations would operate as a fraud on the promisee, the promisor shall be estopped to plead the statute. In all other cases, an unwritten promise not to plead the statute shall be void, and a written promise not to plead the statute shall be valid when (i) it is made to avoid or defer litigation pending settlement of any case, (ii) it is not made contemporaneously with any other contract, and (iii) it is made for an additional term no longer than the applicable limitations period. The bankruptcy court initially agreed with Harrington’s argument that to ignore Slaey’s waiver would operate as a “fraud” on Harrington, and thus, the first sentence of the statute should apply. In doing so, the bankruptcy court relied upon a 1938 Fourth Circuit case that broadly interpreted the term “fraud” in this context. In Tucker v. Owen, 94 F.2d 49 (4th Cir. 1938), the Fourth Circuit focused on the apparent purpose of the statue to protect creditors and noted that the “[Virginia] Legislature intended to stigmatize as fraudulent the failure of a debtor to keep a promise of this sort upon which his creditor has relied, and to estop the debtor from pleading the defense when at his request the suit has been delayed.” Based upon this, the bankruptcy court sided with Harrington and enforced the waiver of the statute of limitations defense. After Slaey appealed to the U.S. District Court, Judge Ellis reversed. The judge noted that two years after the Tucker case, the Supreme Court of Virginia handed down a contrary ruling in Soble v. Herman, 9 S.E.2d 459 (Va. 1940). In that case, the Supreme Court rejected the Fourth Circuit’s reasoning and held that the “fraud” exception must be interpreted narrowly. Looking to the elements of common law fraud, the Virginia high court stated that the exception only applied if the debtor misrepresented a present fact at the time of execution of the waiver. Judge Ellis noted that the bankruptcy court should have followed the Virginia Supreme Court’s Soble decision and not the Fourth Circuit’s Tucker opinion since the question turned on interpretation of a Virginia statute. Judge Ellis found no evidence in the record of Slaey’s intentions at the time she executed the waiver, let alone “clear and convincing evidence” that she never intended to comply with the agreement. This was fatal to Harrington’s claim. According to Judge Ellis, “[s]imply put, therefore, the circumstances presented here involve merely an unfulfilled written promise on Slaey’s part not to assert a statute of limitations defense in a future suit brought by Harrington. Such a naked, unfulfilled promise is precisely what the Soble court made clear would not satisfy the limited fraud exception set forth in Va. Code § 8.01-232(A).” While this case stands as a warning to corporate practitioners, the most useful part of this opinion is the road map through section 8.01-232(A) provided by Judge Ellis. After noting that unwritten waivers are flatly barred under the statute, the judge turned to written waivers: [A] written promise not to plead the statute is generally valid and enforceable only if three specified requirements are met, namely, if the written promise (i) is made to avoid or defer litigation pending settlement of a case, (ii) is not made contemporaneously with any other contract, and (iii) is made for an additional term not longer than the applicable limitations period. The only exception to this rule, according to Judge Ellis, is the “limited” fraud exception. To trigger this exception, a creditor must meet the heavy burden of showing the debtor misrepresented a present fact at the time of the waiver (as opposed to merely failing to fulfill a future promise such as payment). As a practical matter, most creditors will not successfully meet this burden. Thus, Judge Ellis’s opinion essentially means that creditors must strictly follow the road map to enforce a limited, written waiver of a statute of limitations defense. For example, such a waiver must come after a promissory note has been signed (and cannot be included in the promissory note itself), must be contained in a separate document, and can only extend the time to file suit to a date that is twice the amount of time under the applicable statute of limitations (meaning that if the applicable statute of limitations is three years, the waiver can only extend the time to file suit another three years). The practical effect is that general, open-ended waivers of the defense are unenforceable under the statute. Judge Ellis’s ruling makes sense as a matter of statutory interpretation. To otherwise apply a broad reading of the “fraud” exception would allow the exception to swallow the rest of the statute, encouraging a creditor to draft an open-ended waiver and then claim that the failure of a debtor to pay the legitimate obligations operated as a fraud on the creditor. The Fourth Circuit, however, may have the final say as Harrington has already filed a Notice of Appeal with the district court. Assuming that Harrington follows through on the appeal, a decision from the appellate court can be expected in the fall or winter of 2016. But regardless of the outcome, this case stands as a warning and a road map for Virginia corporate practitioners and creditors’ counsel.

Federal Officer Jurisdiction: Defense Contractor Successfully Removes Case under Federal Officer Jurisdiction Statute

provisions for contractors
In Stephenson v. Nassif et al., Case 1:15-cv-1409, 2015 WL 945614 (EDVa Dec. 21, 2015), Judge T.S. Ellis ruled in favor of the Defendant (a government contractor) on whether the contractor properly removed state law claims to federal court based on the Federal Officer jurisdiction in 28 USC § 1442(a)(1). The challenge for the EDVa Court was to keep this case in the federal court while not opening the door to the more common effort to remove contractor/subcontractor disputes under government contracts based on the argument that that compliance with FAR provisions and flow-down clauses meets the removal test. As explained below, the EDVa Court navigated this challenge by extracting and applying the “the principles of Watson.” Issue Focuses on NISPOM Mandatory Reporting Regulations Plaintiff, a former employee of Contractor, filed in the Alexandria Circuit Court defamation and other state law tort claims against the Contractor.   The Contractor removed the case to federal court asserting federal jurisdiction under 28 USC § 1442(a)(1). Plaintiff then moved for remand back to the state court. The Contractor contended that in making a required report to the Defense Security Service (“DSS”), it was “acting under” a federal officer when it complied with the NISPOM regulations (the federal regulations regarding security clearances). The argument continued that the remaining state court claims were covered by the ancillary jurisdiction provision of this jurisdiction statute. The EDVa Court, citing Mesa v. California, 489 U.S. 232 (1987) recognized first that § 1442(a)(1) creates an exception to the “well-pleaded complaint” rule.   Under this rule, federal defenses to state law claims typically do not create a federal question for purposes of federal court jurisdiction. The EDVa Court then turned to the specifics of 1442(a)(1) and the facts of the case. 28 USC § 1442(a)(1)’s Broad “Acting Under” Language 28 USC § 1442(a)(1) provides that “[a] civil action . . . that is commenced in a state court” may be removed to federal court if the action is against “any officer (or any person acting under that officer) of the United States . . . for or relating to any act under color of such office.”   Mesa establishes a 4-part test for removal under § 1442(a)(1):
  1. that the defendant is a “person” as used in the statute,
  2. that the defendant acted pursuant to a federal officer’s directions,
  3. a causal nexus between the defendant’s actions under color of a federal office and the plaintiff’s claims, and
  4. the existence of a colorable federal defense.
Key in the EDVa Court’s ruling is that the Court was persuaded that the Contractor’s reporting was dictated by NISPOM § 1-302(a).   The Court then found that the DSS reporting fell within the statute’s boundaries: . . . because compliance with NISPOM § 1-302(a) is mandatory, assists with the important federal task of protecting classified information, and invites the risk of state tort litigation that might disable the exercise of federal functions (as this lawsuit aptly illustrates), defendants’ [DSS] incident report falls within § 1442(a)(1)’s broad ‘acting under’ language. The “Principles of Watson The Court did not hesitate in making its finding on part (ii) of the Mesa test: “The first statutory requirement in issue—that a defendant acted pursuant to a federal officer’s directions—is plainly met.”   In the case, the Contractor was complying with the NISPOM regulations, and not acting pursuant to explicit directives from a federal officer (although the Contractor sought and received directions from its DSS contacts, the Court stayed focused on the NISPOM regulations).   The Supreme Court, in Watson v. Philip Morris Cos., Inc., 551 U.S. 142, 147 (2007), has held that “mere compliance” does not give rise to federal officer jurisdiction.   This is so, the Supreme Court reasoned, because “acting under” must involve “an effort to assist, or to help carry out, the duties or tasks of the federal superior.” To elevate the Contractor’s NISPOM report above “mere compliance,” the EDVa Court extracted “the principles of Watson.” The EDVa Court noted that the Contractor had “no discretion not to report” and that a “failure to report something that falls within the broad reach of ‘adverse information’ is not an exercise of discretion but a breach of the mandatory reporting obligation.”  The Court concluded that the Watson principles “point persuasively to the conclusion that defendant [Contractor] was ‘acting under’ a federal officer when it submitted the [DSS] incident report concerning plaintiff.” The Court’s Memorandum Opinion relegates discussion of other federal officer jurisdiction cases to a footnote. While the Opinion acknowledges “§ 1442(a)(1)’s broad ‘acting under’ language,” the ruling seems to navigate carefully so as not to expand what has been held to be a narrow jurisdictional statute.  In L-3 Commc’ns Corp. v. Serco Inc., 39 F. Supp. 3d 740 (EDVa 2014), the Court nixed the argument that reliance on alleged FAR violations necessarily creates federal question jurisdiction. The Court added that “removal under § 1442(a)(1) [was] not proper when Defendant had near full discretion over sub-contract award decisions and was therefore not ‘acting under’ color of a federal officer.” In other cases where removal has been upheld, courts have relied on facts showing “direct and detailed” control by a federal officer. For example, in CRGT, Inc. v. Northrop Grumman Sys. Corp., No. 1:12-CV-554, 2012 WL 3776369 (E.D. Va. Aug. 28, 2012), the court found that the challenged conduct was under direct and detailed control of a federal contracting officer because the officer expressly instructed the prime contractor to halt the provision of services that were the object of the subcontract.   Similarly, in an asbestos case involving Navy ships, the court found the defendant contractors were acting under the control of the Navy and its officers when constructing or repairing Navy ships.   Epperson v. Northrop Grumman Sys. Corp., No. 4:05CV2953, 2006 WL 90070, (E.D. Va. Jan. 11, 2006). Ancillary Jurisdiction for other State Court Claims Under 28 USC § 1442(a)(1) Plaintiff’s state court complaint asserted seven counts.   The EDVa Court’s ruling denied remand and kept all counts in the federal court.   After the Court ruled that the lead count would stay in federal court, the remaining part of the order was straightforward. By its plain language, § 1442(a)(1) provides for the removal of an entire “civil action,” so removal was not limited only to specific qualifying claims. The EDVa Court’s consistent skepticism on allowing removal under 28 USC § 1441(a)(1) remains in place.   While arguably the Court’s ruling that a Contractor’s compliance with the NISPOM regulations satisfies Mesa’s “acting under” requirement, the ruling is constrained by the facts, and perhaps limited the world of NISPOM regulations and security clearances, and it should not be read as opening a new path for federal jurisdiction on common government contracts litigation.
Disclosure:  Redmon, Peyton & Braswell, LLP, served as counsel of record for the Defendant in this case.