A Lesson for ‘Disadvantaged’ Subcontractors

By John S. Mrowiec

Public procurements often require the bidder or offeror to list disadvantaged business subcontractors and intended subcontract amount in the bid or proposal submission. Bidders often also must provide letters of intent with proposed DBE subcontractors.

If the bidder subcontracts with the listed subcontractor, may the subcontractor enforce the full listed amount as subcontract compensation? Might the answer depend on whether the later signed subcontract does not expressly obligate the contractor to pay that much?

Those were some of the questions decided in Business Systems Engineering Inc. v. International Business Machines Corp., 2008 U.S. App. LEXIS 23682 (7th Cir., Nov. 10, 2008). Although the IBM case involved a computer-system procurement, its reasoning applies equally to design and construction contracts.

Contract Has Construction Implications

In IBM, IBM proposed a contract to implement a new computer system for the Chicago Transit Authority. A requirement was that IBM subcontract not less than 30% of the $42-million contract value to disadvantaged business enterprises.

As part of the proposal process, offerors were required to submit to the CTA a “Schedule C: Letter of Intent from DBE to Perform as Subcontractor, Supplier and/or Consultant” signed by each disadvantaged business entity that was contemplated to provide work as a subcontractor. The bidders also had to submit a “Schedule D: DBE Utilization Plan” signed by the bidder.

Initially, IBM submitted a number of Letters of Intent, including one signed by Business Systems as being “prepared to provide” the sum of $8,560,000 in “quantity/unit price” of “services.” IBM submitted a revised Schedule C listing Business Systems as being “prepared to provide” $2,124,550 in “services” and $1,500,000 as “software.”

IBM’s Schedule D listed Business Systems with $3.6 million under the heading “Contract Amount.” All of IBM’s Schedules stated that after CTA executed the contract with IBM, it and the listed subcontractors would “enter into a formal written agreement for the above work.”

For subcontractors, IBM had standard “Customer Solutions Agreements.” The CSA was a “base agreement” with detailed terms not specific to an individual project. Instead, the CSA stated that the subcontractor was to provide “deliverables and services” according to the specifications in separate, project-specific “Statements of Work.” IBM’s CSA defined a Statement of Work as “any document which described the Deliverables and Services, including any requirements, specifications or schedules.”

A subcontractor could not begin the tasks described in a Statement of Work, however, without a corresponding “Work Authorization.” The CSA defined a Work Authorization as “a purchase order, bill of lading or other designated document.”

Regarding what IBM would pay a subcontractor, the CSA stated that “the only amount due” was the “pre-approved expenses specified in the relevant” Statements of Work.

When IBM needed a specific task performed on the project by an outside technical consultant, IBM advertised the position to one of the approved disadvantaged business enterprises, including Business Systems. CTA approved the right to reject candidates. If Business Systems presented a suitable candidate, IBM would send Business Systems a Statement of Work and would issue a Work Authorization in the form of a purchase order authorizing payment of funds.

IBM issued 38 separate Statements of Work to Business Systems for the project. Together with the corresponding purchase orders, the Statements of Work authorized approximately $2.2 million in work to Business Systems. Sometimes Business Systems failed to submit candidates to fill an open position. Business Systems also was tardy in paying some of its own subcontractors. Those sub-subcontractors threatened to leave the project.

DBE Requirements Exceeded

By conclusion of the project, IBM had provided 42% of the total contract value to disadvantaged business enterprises. IBM had approved 10 such businesses to participate. Eight exceeded the dollar amounts listed in IBM’s Schedules C and D. Business Systems and another vendor did not achieve the listed amounts. IBM paid Business Systems in full the approximately $2.2 million IBM ordered from Business Systems.

Seeking the $1.4 million that Business Systems contended IBM should have awarded above the actual $2.2 million awarded, Business Systems sued IBM. Initially, Business Systems alleged that the Schedule C: Letter of Intent signed by Business Systems constituted a written contract breached by IBM. The federal District Court rejected that argument and dismissed Business Systems’ original complaint with leave to amend.

Business Systems filed an amended complaint that alleged that the Schedule C: Letter of Intent, and Schedule D: DBE Listing, along with other documents, constituted a written agreement breached by IBM. Among the “other documents” was an e-mail from IBM’s Client Director to the CTA explaining that Business Systems’ participation in the project was set at $3.6 million “by mutual agreement.” That e-mail attached a spreadsheet that provided detail about how IBM and Business Systems planned to achieve the $3.6 million objective.

IBM moved to dismiss Business Systems’ amended complaint. The District Court denied the motion. Discovery proceeded.

Vague Documents Affect Ruling

IBM moved for summary judgment. The District Court granted IBM’s motion finding that there was no evidence of a written contract for $3.6 million.

The Letter of Intent, DBE Listing and other documents relied upon by Business Systems were “too vague and incomplete to establish a legally enforceable agreement by which [Business Systems] could hold IBM accountable for the alleged breach” Business Systems Engineering Inc. v. IBM Corp., 520 F. Supp. 2d 1012, 1019 (N.D. Ill. 2007). The District Court also held that there was no evidence of IBM agreeing to an oral contract for $3.6 million of work, Id. at 1019.

Business Systems appealed. The IBM appellate court compared the Letter of Intent, DBE Listing and e-mail, on the one hand, with IBM’s CSA, Statements of Work and purchase orders, on the other. The appellate court framed the question as “$3.6 million for what?” IBM, 2008 U.S. App. LEXIS 23682, *20-21.

The IBM appellate court concluded the evidence in the record, “at best” showed that IBM “intended” to offer Business Systems $3.6 million in subcontracting work. Legally, though, “a manifestation of an intent to be bound, by itself, is not enough to form a contract,” IBM, 2008 U.S. App. LEXIS 23682 at 20 citing Academy Chicago Publishers v. Cheever, 578 N.E.2d 981, 983 (Ill. 1991). Importantly, there have to be understandable terms: “Even though a manifestation of intention is intended to be understood as an offer, it cannot be accepted so as to form a contract unless the terms of the contract are reasonably certain,” IBM, 2008 U.S. App. LEXIS 23682, *20 citing Village of South Elgin v. Waste Management of Illinois, Inc., 810 N.E.2d 658 (Ill. App. Ct. 2004) (quoting Restatement (Second) of Contracts, Section 33 (1) (1981)).

The IBM appellate court stated that “the terms of a contract are reasonably certain only if ‘they provide a basis for determining the existence of a breach and for giving an appropriate remedy,’” IBM, 2008 U.S. App. LEXIS 23682, *20. Because the court had no way to determine what Business Systems was supposed to do in exchange for the additional $1.4 million, Business Systems’ claim for breach of contract failed.

Whenever a “letter of intent” is involved, the possibility of a finding of a contract looms. In IBM, the key point was that the parties signed a subsequent detailed contract that governed the relationship.