Request By:
Mr. Jody Richards, Speaker of the House
Opinion
Opinion By: Gregory D. Stumbo, Attorney General; Robert S. Jones, Assistant Attorney General
Opinion of the Attorney General
On October 6, 2004 the Speaker of the House, Mr. Jody Richards, submitted two opinion requests which inquire into the contractual relations between the Commonwealth of Kentucky and several health insurance providers. The terms of those contracts are set forth in the "Request for Proposal (RFP) to Insure or Administer the Commonwealth's Public Employee Health Insurance Program", solicitation No. S-04130610, issued April 2004 by the Finance and Administration Cabinet on behalf of the Department of Personnel, Office of Public Employee Health Insurance.
The initial question asked by Mr. Richards is: "To what extent can the General Assembly modify, amend, alter or terminate the contracts and what would be the consequences in terms of remedies available to the parties for such action by the General Assembly."
As to the ability of the General Assembly to "modify, amend or alter" the contracts, any proposed changes should be "processed through the Division of Material and Procurement Services and approved by the Finance and Administration Cabinet prior to the effective date of such modification or change pursuant to KRS 45A.210(1) and 200 KAR 5:311,"as is stated in the RFP at Section 40.05, "Changes and Modifications to the Contract." In discussing the modification or amendment of the contracts, it is assumed that the Executive Branch will be directed by the General Assembly to take the steps identified in the RFP to accomplish the modification or amendment. Amendments or modifications to competitively bid contracts are permitted as long as they are not material to the central purpose of the contract. The underlying issue is whether the proposed changes tend to subvert the purpose of competitive bidding. Factors considered by courts generally in answering this question include the following:
1. The legitimacy of the reasons for the change;
2. Whether the reasons for the change were unforeseen at the time the contract was made;
3. The timing of the change;
4. Whether the contract contains clauses authorizing modifications;
5. The extent of the change, relative to the original contract.
See generally:
Kenai Lumber Co., Inc. v. LeResche, 646 P2d 215 (Alaska, 1982), collecting national case law. Any attempted modifications of the contract should therefore be made with the above factors in mind.
Amendments or modifications to the contracts may be affected by the General Assembly's power to suspend KRS Chapter 45A, which may remove certain requirements related to competitive bidding. Similarly, the Governor's declaration of a state of emergency under Chapter 39A may also permit the expedited procurement of "services essential for protection of public health and safety", (KRS 39A.100), thus avoiding some limitations ordinarily applicable to the competitive bidding process. Analysis of these issues is beyond the scope of the present opinion request.
Generally, the Commonwealth may seek to cancel a competitively bid contract for convenience, (discussed infra. ), or may cancel such a contract for cause. The Office of the Attorney General has previously opined that the Commonwealth is required to "provide . . . health insurance coverage equal to or greater than the level provided by the Kentucky Kare Standard as of January 1, 1994." See: OAG 98-4. To the extent that the present health insurance contracts fail to provide this level of coverage, and in light of the fact that the General Assembly has not acted to suspend the application of KRS 18A.225(2) requiring this level of coverage, the contracts may be subject to cancellation for cause. As noted in OAG 98-4, this office cannot adjudicate any factual dispute as to whether the present contracts meet the statutory standard, which is a determination appropriately made by qualified industry experts.
The second question posed by Mr. Richards is whether "lost profits" are properly recoverable where the contracts are terminated for convenience.
Provision 40.46 of the RFP states:
KRS 45A.210(2) and 200 KAR 5:312 Section 2 set out the provisions for termination of the Contract for convenience.
The Commonwealth may terminate the Contract for its own convenience upon thirty (30) days prior written notice when the Finance and Administration Cabinet has determined that such terminations will be in the Commonwealth's best interests. When it has been determined that the Contract should be terminated for the convenience of the Commonwealth, the Commonwealth shall negotiate a settlement with the Contractor according to terms deemed just and equitable by the Commonwealth. Compensation to the Contractor for lost profits on the Contract terminated for convenience of the Commonwealth shall not exceed an amount proportionate to the sum that the Contractor's total expected margin of profit on the Contract bore to the Contract price, based on the total out of pocket expense incurred by the Contractor as of the date of termination of the Contract. If the Contract is terminated for the convenience of the Commonwealth, the Contractor shall have the burden of establishing the amount of compensation to which it believes itself to be entitled by submission of complete and accurate cost data employed in submitting its proposal for the Contract and evidence of expenses paid or incurred in performance of the Contract from the date of award through the date of termination. (Emphasis added)
It is crucial to note, however, that the overriding purpose of the doctrine of termination for convenience is expressly to protect the Commonwealth from the payment of future profits as an element of damages. See: District of
Columbia v Organization for Environmental Growth, Inc. 700 A2d 185 (D.C. 1997), holding:
The major impact of the termination for convenience procedure is that it relieves the government from the obligation of paying anticipated profits for unperformed work when it terminates the contractor's performance under the contract.
Id., at p. 199, citation to authority deleted. See also: Petrillo and Conner, "From Torncello to Krygoski: 25 Years of the Government's Termination for Convenience Power", 7 Fed. Circuit B.J. 337 (1997). In light of this undeniable purpose underlying the termination for convenience doctrine, any attempt to claim future anticipated profits as a result of a valid termination for convenience is highly suspect.
Analysis of the remedy available under the termination for convenience clause requires initial consideration of the nature of the government's right to terminate a contract for convenience under the Model Procurement Code, KRS 45A.010, et. seq. The Kentucky Supreme Court recently took up this precise issue in
RAM Engineering & Construction, Inc. v. University of Louisville, Ky., 127 S.W.3d 579 (2003). Therein the Court found:
The Kentucky Model Procurement Code holds the government to the same standard of good faith and fair dealing as private parties. KRS 45A.015. Although the government may terminate contracts for convenience, that cannot supersede the good faith duty to do "everything necessary" to carry out the contract. Kentucky's recognition of good faith as "a duty to do everything necessary to carry [the contract] out," Kentucky Utilities, supra, limits the contracting officer's discretion to terminate a contract for convenience and indicates that a change of circumstances standard is best for Kentucky. Interpreting termination for convenience clauses required by the Code in the light of the duty of good faith and fair dealing obligations of that same Code is reasonable. And if we must presume that government officials act in good faith to contract in their best interest at the time of the agreement, Linan-Faye, supra, then a change in circumstances is necessary for the contract to no longer be in the government's best interest when terminating for convenience.
Hence, the Commonwealth does not have unfettered discretion to terminate the contract for convenience. A change of circumstance must first be identified. Moreover, the nature of that change could seriously affect the Contractor's ability to even meet its burden to prove the amount of compensation to which it is entitled under the terms of the contract. Nevertheless, if it is assumed a change in circumstances has occurred since the contract was executed which justifies termination for convenience, and if it is also assumed the nature of the changed circumstances would not prevent the Contractor from proving it sustained lost profits due to the termination, damages would be limited by statute.
The Kentucky Supreme Court addressed the limits to which a public official may contractually bind the
Commonwealth in Commonwealth v. Whitworth, Ky., 74 S.W.3d 695 (2002). The opinion cites favorably the following language from
Clark County Construction Company v. State Highway Commission, Ky., 248 Ky. 158, 58 S.W.2d 388 (1933):
? anyone who deals or contracts with public officials or with public bodies must at his own peril take notice of their authority since they can only act within the limits of express or necessarily implied powers conferred upon them by law.
Commonwealth v. Whitworth, at p. 699.
Also, reiterating well established legal principles in this area the Court held:
Suit cannot be instituted against the Commonwealth on a claim unless sovereign immunity has been specifically waived, as it has been on a lawfully authorized written contract. All-American Movers, supra. KRS 45A.245(1) provides that any person having a lawfully authorized written contract with the Commonwealth may bring an action against the Commonwealth on the contract . . . .
Commonwealth v. Whitworth, at p. 700.
KRS 45A.245(2) proceeds to then limit the waiver of sovereign immunity as to damages which may be awarded on a contract claim against the Commonwealth. If an award exceeds the amount of the original contract, "such excess shall be limited to an amount which is equal to the amount of the original contract. " The nature of damages which may be awarded on a contract claim is not addressed with specificity; only the amount. Interpretation of which elements may be considered in the calculation of damages owed a contractor due to termination of a contract for the convenience of the Commonwealth is provided by the Secretary of the Finance and Administration Cabinet in 200 KAR 5:312 Section 3. The regulation allows a purchasing agent to negotiate a settlement with the contractor based upon the contractor's proof of "revenues resulting from the contract, expenditures associated with the contract, and all profit and loss attributable to the contract."
Regulations which are duly promulgated and are consistent with the enabling legislation have the force and effect of law.
Centre College v. Trzop, Ky., 127 S.W.3d 562(2003);
Flying J Travel Plaza v. Commonwealth, Ky., 928 S.W.2d 344 (1996). To the extent 200 KAR 5:312 Section 3 provides for a calculation of damages not exceeding the amount allowed by KRS 45A.245 it is controlling as to the elements of damage which may be claimed by a contractor as resulting from the Commonwealth's decision to terminate a contract for convenience, and profits "attributed to the contract" are provided for. Unfortunately, there is not presently available sufficient information to calculate whether, either under the contract or the regulation, lost profits would exceed the amount allowed by KRS 45A.245(2). Therefore, issuing a definitive opinion as to the enforceability of the lost profits portion of provision 40.46 is not currently possible.
In drafting this opinion the Office of the Attorney General is limited by the wording of the opinion request. Excluded from review are other options for termination of the contract which may be available to the Commonwealth. For example the opinion does not address termination under 200 KAR 5:312 Section 4 which allows for termination of the contract if necessary funds are not appropriated to the contracting agency. Further, under KRS 45A.245 the Commonwealth retains all contractual defenses in law or equity except for governmental immunity. This opinion addresses none of the common law defenses which may be available to the Commonwealth as a basis for cancellation or reformation of the contract in question.