Teaming Agreements, Latham

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TEAMING AGREEMENTS / EDITION II

Thomas L. Patten, Michael J. Shockro, Robert S. Metzger

Latham & Watkins

Basic Principles and Guidelines

A teaming agreement is an arrangement whereby two or more firms join together--usually in a prime contractor-subcontractor relationship--to perform certain tasks under a specified Government contract or program.1 Use of these arrangements has increased significantly over the past decade, particularly on contracts to supply sophisticated weapons systems, where no single company possesses the entire technical resources to perform the effort involved.2 For this reason, the Department of Defense (DOD) has in recent years actively or tacitly encouraged teaming agreements on some major weapon system programs.

Although teaming agreements present contractors and subs with many opportunities, they can also be fertile ground for disputes. Moreover, since there are very few cases dealing with the legal issues surrounding teaming agreements, the ramifications of even the most carefully drafted agreement are to some extent unknown.

This Briefing Paper discusses (a) the regulations governing teaming agreements, (b) the nature of the relationship between the team members, (c) antitrust problems which can arise, (d) grounds for legal actions between members, and (e) forms of relief available to members. Since most teaming agreements occur on DOD procurements, this Paper focuses primarily on DOD contracts.

BASIC PRINCIPLES

Regulations. DOD first formally recognized teaming arrangements in 1966.3 The substance of the 1966 policy--as contained in the Defense Acquisition Regulation (DAR)4--is now incorporated in the Federal Acquisition Regulation (FAR) as follows:5

(a) Contractor team arrangements may be desirable from both a Govt and industry standpoint in order to enable the companies involved to (1) complement each other’s unique capabilities and (2) offer the Govt the best combination of performance, cost, and delivery for the system or product being acquired.

(b) Contractor team arrangements may be particularly appropriate in complex research and development acquisitions, but may be used in other appropriate acquisitions, including production.

□ Time Of Creation

One difference between the DAR and FAR provisions regarding teaming agreements is that DAR required bidders to disclose the existence of the agreement in the proposal. Although the DAR provision seemed to allow formation of a teaming arrangement after award, it was difficult to reconcile that possibility with the disclosure requirement. FAR clarifies this issue by recognizing that a team may be created after award. In such instances, the agreement must be disclosed before the arrangement becomes effective.6

□ Govt Relationship To Prime & Subs

The Govt holds the prime contractor fully responsible for contract performance regardless of any team arrangement the prime contractor has with his subs.7 This is so because there is no contractual relationship between the Govt and team subs.

2 The Govt also has the right to (1) approve subcontracts,8 (2) determine the responsibility of a prime contractor on the basis of the stated team arrangement,9 and (3) pursue policies intended to foster competition at the subcontract level, after initial production or at any other time.10 Hence, although the Govt evaluates the responsibility of the prime on the basis of the teaming arrangement--and although important proposal content is usually generated by the intended sub--every teaming agreement risks disapproval of the subcontract after award of the prime.

□ No Antitrust Exemption

The regulations specifically state that teaming arrangements are not exempt from the antitrust laws.11 This is a particularly troublesome area, and contractors concerned about antitrust exposure are wise to establish--in their bidding documents and in the teaming agreement itself--any facts which make their arrangement beneficial to the Govt. Such a record can help in defending the “reasonableness” of the arrangement if it is subjected to antitrust scrutiny, particularly where the agreement is among companies who could be viewed as potential competitors. This subject is discussed in greater detail in a later section of this Paper entitled Antitrust Issues.

Nature Of Relationship

The few cases which specifically address teaming agreements do not clearly define the legal relationship between team members. Nevertheless, when disputes arise, it can be very important to determine the precise legal nature of the relationship between team members--specifically, whether or not the relationship constitutes a joint venture. This is an important consideration because true joint ventures usually include elements--e.g., the risk of being found liable for the debts of the other--which team members prefer to avoid. The determination of whether the arrangement is (or is similar to) a joint venture--and thus is subject to the legal principles applicable to joint ventures--is decided under State law. As a result, the rights and obligations of team members may--under State law--be those of joint ventures, even if you had no intention of forming a joint venture.

For example, under California law, a joint venture is defined as an agreement between parties for a common business undertaking, with joint (a) control, (b) property, (c) liability for losses, and (d) participation in profit. Such an arrangement may be informal or oral.12 Using this definition, some Courts have found that arrangements with relationships similar to those involved in teaming agreements are quasi-joint ventures.

In one such case, a party agreed to help a second party develop a new machine in return for a share of the sales profit. But because the model actually perfected was slightly different from the one that was the subject of the agreement, the second party refused to share the profits with the first party. The Court found that (1) the relationship between the parties was “akin to that of joint adventures,” and (2) the second party breached an implied covenant that neither party would deny the other “the fruits of the contract.”13

Obligations resulting from characterizing the relationship as a joint endeavor are discussed below.

□ Existence Of Legal Obligations

In one early case, after receiving the contract, the contractor refused to negotiate with the expectant sub. Rather, the contractor offered that sub and others an opportunity to bid on the work. The Court held that this was a breach of an informal (oral) contract for a “joint undertaking,” finding the measure of damages to be the reasonable value of the lost opportunity.14 In a more recent decision, a Court agreed that the sub could proceed on claims for wrongful authorization of initial subcontract work, and that the prime improperly used the “Termination For Convenience” clause to discard the sub. By describing the sub as a “team” member in his proposal, the prime indicated an intent to deliver a full subcontract.15

A 1983 case failed to resolve the issue but contained some interesting observations. The teaming agreement at issue contained a disclaimer that the arrangement did not, in any manner, create a joint venture or otherwise imply joint or several liability. Nevertheless, the Court raised a question of whether a teaming arrangement is analogous to partnerships or *3 other joint arrangements pursuant to which parties who would otherwise be competitors pool their capital and share the risks of loss as well as opportunities for profit. The Court left these questions concerning the nature of the relationship to be answered by the Trial Court on remand.16

□ Implied Obligations

The existence of implied obligations associated with joint ventures can be crucial to the operation of a teaming agreement. Should one or the other team member seek to pull out and pursue his own opportunities--over the objections of the other--arguments can be made that a fiduciary relationship (i.e., a relationship of trust where the parties are obligated to treat each other with fairness and good faith) was created by the agreement.

The law imposes a variety of fiduciary relationships upon true joint venturers, including: (1) vicarious liability for acts of the other,17 (2) liability as a so-called constructive trustee for joint property,18 and (3) liability for an accounting.19 This is not an exhaustive list of the obligations that exist between parties found to be joint venturers. In fact, as a general rule, their obligations to each other resemble those of general partners.

□ Avoiding A Joint Venture Label

To avoid the implications of being labeled a joint venture, team agreements should exclude the ingredients of a joint venture--e.g., joint control, joint property, joint liability for losses and expenses, and joint participation in profits. Excluding these elements is preferable to a mere disclaimer of the label since the relationship may be held to be a joint venture if those circumstances and obligations exist, regardless of how the arrangement is labeled.20 Other safeguards might include: a “Termination” clause and exclusion of all obligations other than those stated in the agreement.

The Obligation To Subcontract

Once the team has succeeded in gaining award to the prime, all too frequently disputes arise concerning whether the prime is required to award a subcontract to the junior member. Since there is no definitive Federal law governing this area, disputes such as these will turn on applicable State law.

□ Terms Of Agreement

Often disputes arise in the absence of a formal agreement, or in the presence of a poorly drafted agreement. In a case involving an oral agreement, although the Court was unable to arrive at a precise definition of the legal relationship between the parties, it readily concluded that the prime was subject to an implied contract to award a subcontract.21

Nevertheless, if no written agreement exists, or if virtually all material terms are “left to future agreement,” a Court is likely to find that the terms of the contract are too uncertain to make it enforceable.22 The less specific the terms of the teaming agreement, the more inclined a Court will be to conclude that there was no “meeting of the minds”--the essential prerequisite to the formation of a contract.

Although more detail is better than less, it is not necessary to agree to more than the general outlines of the contemplated subcontract. One case held that an agreement no more precise than to build a “parking garage” was sufficient to create a binding contract--despite the absence of plans or specifications.23 In another case, a contract to build a “first class theater” was upheld.24 As one Court explained, the “enforceability of a contract containing a promise to agree depends upon the relative importance and the severability of the matter left to the future….”25

Each case turns on its own facts, of course, but a sub’s ability to force the prime to award him the subcontract is greatly improved if the sub has a reasonably detailed teaming agreement which spells out the respective obligations of the parties.

□ Avoiding A Commitment To Subcontract

There are devices which a prime can employ to maintain his flexibility and reduce the likelihood he will be forced to make an award to an insistent sub. This can be done by: (a) reserving specific material issues for later agreement, (b) conditioning obligations on entire agreement, (c) clearly indicating that the teaming agreement represents only the results of preliminary negotiations, and--most importantly--(d) expressing an intention not to be bound. Although a contract can be binding without an expression of an intention to be bound, manifestation of an intent not to be bound will prevent the formation of a contract.26

□ Sub’s Obligation To Accept

Sometimes the reverse issue will arise--namely, after the prime has received the contract, is the sub obliged to accept award? The prime can successfully *4 argue, among other things, that his reliance on the sub’s quote binds the sub, and thus makes the sub’s quote an irrevocable offer.27 Even if the sub’s quote omitted material terms, a Court can find an implied obligation for the parties to attempt in good faith to agree on other material terms.28 These rules do not create a contract between the parties or obligate the prime to accept the sub’s bid. Only the sub is bound.

Antitrust Issues

Despite the importance of teaming agreements to Govt procurement, there are only three reported decisions that contain any meaningful discussion of their legal consequences. Two of these decisions were handed down in the last four years by the U.S. Court of Appeals for the Ninth Circuit. Although both cases gave the Court an opportunity to clarify the nature of the relationship created by a teaming agreement--and the antitrust consequences of such agreements--the Court failed to do either.

Aside from these cases, no Court has focused on the antitrust implications of teaming arrangements. Instead, those issues can best be addressed by reference to analogous questions in joint venture agreements. In the context of joint ventures, four issues are considered:29

(1) Does the creation of the venture itself offend the antitrust laws?

(2) Does the venture impose ancillary restrictions on the parties which raise questions under the antitrust laws?

(3) Is there a danger that discussions among the venturers will “spill over” into areas where they are actual or potential competitors?

(4) Does the venture constitute an “essential facility” to which others must be given access on reasonable terms?

These issues are discussed in the next three sections of this Paper.

Creation

The Department of Justice has indicated that formation of a joint venture should not present significant antitrust concerns unless the venture is between actual or potential competitors.30 By analogy, if team members are not at least potential competitors, the creation of their teaming arrangement should be relatively free from antitrust consequences.

However, where a teaming agreement involves companies that are potential or actual competitors, significant antitrust concerns could be present. Cases where joint ventures have been struck down have commonly involved circumstances where (1) the joint arrangement was, in reality, only an allocation of markets, involving no joint development or other common effort between the parties, or (2) the primary purpose for the joint effort was to facilitate the formation or operation of a broader cartel.31 Since teaming arrangements are usually formed to develop a new product in the face of uncertain funds and unknown technological obstacles, the creation of most teaming agreements is likely to survive antitrust scrutiny.

On the other hand, if the joint venture (and, presumably, the teaming agreement) is (a) among competitors, and (b) entered into for the purpose of fixing prices or allocating territories or customers in order to avoid competition between the partners, it may be condemned as a per se (automatic) violation of the antitrust laws. Even if the venture escapes classification as an automatic violation, it is still subject to antitrust scrutiny under the merger laws and the so-called “rule of reason”--a doctrine created under the Sherman Act which assesses whether arrangements that have a restraining impact on trade can be justified as reasonable in light of their legitimate purposes or effects.32

Restrictions On Member Conduct

Even if the creation of a teaming agreement passes muster under the antitrust laws, questions remain regarding the validity of restrictions imposed by the agreement on the team members. This was the primary issue in a case which arose out of a series of teaming agreements entered into for the development of a military aircraft.33 As part of the lightweight fighter competition in the mid-1970’s, the Navy was directed by Congress to evaluate proposals from two companies, neither of which possessed significant experience in producing carrier-suitable aircraft. To overcome this limitation, both contractors were urged by the Navy to “team” with companies having greater pertinent experience.

In response, the two contractors entered into a teaming agreement with each other to develop a new airplane (the F-18). The agreement provided that *5 the first contractor would be the prime contractor for the F-18 or derivative aircraft of basically the same configuration. The second contractor contended that this agreement restricted the first contractor to providing only carrier-suitable aircraft, while allowing the second contractor to sell derivatives designed only for land-based operations. As part of the agreement, the parties agreed to exchange technical data related to the aircraft. The issues raised by this case are (a) whether the agreement constituted a per se (automatic) violation of the antitrust laws, (b) the definition of “market” accepted by the Court, and (c) whether the restraint was justified by the disclosure of technical data.

□ Automatic Violations

In a suit arising from a violation of this agreement, the violating contractor argued that the teaming agreement was a per se violation of the antitrust laws because it limited his ability to market F-18 derivatives. The Court held that the validity of the restraints are to be judged under the “rule of reason,” rather than the per se rule.

Although the Sherman Act prohibits all agreements “in restraint of trade,”34 judicial decisions have made it clear that only those agreements which unreasonably restrain competition are violative of the antitrust laws.35 There are certain categories of agreements, however, which Courts, over the years, have found to be so lacking in justification and so inimical to competition that they have been categorized and condemned as unreasonable per se. The division of markets between competitors--so called horizontal restraints--is one of the four main categories of competitive restraints that have been held to be per se violations.36

The non-violating contractor argued that the agreement’s restrictions should not be categorized as a per se illegal horizontal market allocation for three reasons: (1) Courts have insufficient experience with this type of teaming agreement, or with the military aircraft industry in general, to warrant out-of-hand condemnation, (2) the agreement actually enhanced competition by creating an opportunity to enter a market from which the contractor would otherwise have been foreclosed, and (3) the limitation on sales was ancillary to and a reasonable limitation upon the use of technical data which was exchanged. Although the Court agreed with these arguments, its decision left open a number of questions concerning the validity of teaming agreements which restrict either party’s ability to freely market products developed by the team’s efforts.

□ Definition Of Market

The effect of a marketing restraint can only be measured after the relevant market is defined. In this case, the Court accepted the parties’ characterization of the “market” as that for F-18 aircraft and its derivatives--rather than a broader market consisting of fighter aircraft or military aircraft generally. Should this precedent be followed, it could have important implications. If markets are so narrowly defined, it will be relatively easy to demonstrate that the parties have the requisite market power to invoke the antitrust laws. This is particularly true in the case of sophisticated military equipment, where there are usually only a few suppliers.

□ Disclosure Of Data

Many cases have concluded that a party who discloses proprietary information is entitled to restrict the receiving party from using that information in competition with the disclosing party.37 In the case discussed above, the Court observed that even though the data had been disclosed to the Govt with unlimited rights, the parties to the teaming agreement could impose restrictions on each other’s use of the data. As a result, use of the data by one party contrary to the restriction would give rise to a breach of contract claim. On the other hand, the Court commented that disclosure of proprietary data--by itself--probably would not have been sufficient to avoid per se condemnation of the restrictions imposed by this agreement. Although the Court’s reasoning is not well explained, its decision suggests that contractors should not automatically assume that disclosure of proprietary data in the course of a teaming arrangement is sufficient in itself to justify a restriction on the marketing activities of the other team member.

Again, joint venture cases offer further guidance. The usual analysis asks whether (a) there is a legitimate justification for the restraint, (b) the restraint is reasonably necessary to accomplish that objective, and (c) the restraint is no broader than that necessary to achieve the objective.38 Under these cases and other authority, it appears that the prudent course is to limit the scope of restraints that accompany the disclosure of data. For example, the party receiving the data might be prohibited from using the data, rather than being subjected to a prohibition on marketing.

6 Spill-Over & Essential Facility Problems

There has been little judicial discussion of the third and fourth issues mentioned above--i.e., the problem of teaming agreements spilling over into areas where the team members are actual or potential competitors, and the question of whether the agreement constitutes an “essential facility” to which others must be given access. In fact, only one Court has alluded to “spill-over” as a concern.39 In a teaming arrangement, the risk of an impermissible “spill-over” can be avoided (or at least minimized) by limiting the information communicated between team members to that which is necessary to accomplish the objective of the team agreement. The risk is also minimized where--as is the usual case--the teaming agreement is a one-shot arrangement.40

Team members also need not be too concerned with the issue of providing access to what becomes an “essential facility.” In the joint venture context, where the venture generates advantages that are essential to competition in the relevant market, competitors must be given a fair opportunity to share in those advantages on reasonable terms.41 In view of the limited nature of the relationship contemplated by most teaming arrangements, however, it is difficult to imagine how an essential facility can be created. Moreover, even if a teaming arrangement should ripen into such a facility, the team members can deal with the problem when the time arises.

Disputes Between Team Members

As is illustrated by the case discussed above, teaming agreements can be fertile ground for disputes after formation--especially where one team member attempts to circumvent restraints imposed by the agreement. The two bases for such suits--breach of contract and breach of an implied covenant of good faith--are discussed below. Again, since there is very little Federal law directly assessing disputes among members of a teaming agreement, principles derived from State law are applied.

□ Breach Of Contract

If the teaming agreement is express and contains terms governing the activity in dispute, then the aggrieved team member can pursue a claim of breach of contract. The available defenses include the assertion that the operative agreement should not be enforced on the grounds of antitrust violation.

□ Implied Covenant Of Good Faith

Apart from breach of contract--and especially where the terms of the agreement are unclear or do not cover the disputed practice--there are several other theories available to team members. One is the implied covenant of good faith and fair dealing. One State Court, expressed the general rule as follows:42

There is implied in every contract a covenant by each party not to do anything which will deprive the other parties thereto of the benefits of the contract … [T]his covenant not only imposes on each contracting party the duty to refrain from doing anything which would render performance impossible by any act of his own, but also the duty to do everything that the contract presupposes … to accomplish its purpose.

This duty of good faith and fair dealing exists except where the parties have expressly disclaimed it.43 Hence, team members should expressly disavow unwanted consequences of the implied covenant when they draft their agreement--if that is their intent.

This implied covenant has many potential applications--e.g., where a sub believes he has been improperly terminated for cause. Several cases have held that the right of one party to terminate another for cause is tempered by the implied obligation of good faith. One Court stated that a termination for cause “must be a fair and honest cause or reason, regulated by good faith on the part of the party exercising the power.”44 Other doctrines also may constrain the right to terminate. For example, a variation of the obligation of good faith is that termination cannot be accomplished until a contract has been in effect for a reasonable time.45

The implied covenant doctrine can be applied in many other situations. For example, if a prime was confronted with a sub’s attempt to contract directly for the work that had been the prime’s responsibility, the prime might argue that the sub’s initiative--apart from being a breach of the teaming agreement-- was also in violation of the implied covenant. In such a case, equitable remedies may be available--apart from remedies “at law” which are in the nature of money damages.

Equitable Remedies

□ Injunctive Relief

In the example given above, the prime contractor might seek to obtain a preliminary injunction requiring the sub to withdraw his bid. When considering a petition for a preliminary injunction, Courts look to four factors in exercising their discretion:

7 (1) A likelihood of success on the merits;

(2) A risk of irreparable injury to the plaintiff if the injunction is denied;

(3) A balancing of hardships, indicating that the harm to the defendant if the injunction is granted does not exceed the harm to plaintiff if it is denied; and

(4) A determination that interests of the public will not be adversely affected by the injunction.

The application of these principles--each of which is discussed below--to teaming agreements raises some unusual issues, especially where the object of the arrangement is a contract with the Govt to supply military equipment.

(1) Likelihood Of Success--Whether a party can satisfy the first factor-- likelihood of success on the merits--depends on the facts and circumstances of each case.

(2) Irreparable Injury--To demonstrate irreparable injury, the party seeking the relief must show that there is no adequate remedy at law--i.e., that it is difficult or impossible to accurately ascertain the amount of the damages.46 Regarding the loss of prospective business, the prime can argue that damages are difficult to ascertain accurately, and, therefore, that injunctive relief is appropriate.47 Moreover, the prime might even seek a temporary restraining order (TRO) to prevent the sub from starting work on the contract on the grounds that--once the sub starts work--the Govt’s interest in timely completion will make it very unlikely that the award would then be overturned.48

(3) Balancing Of Hardships--If a Court compels a sub to withdraw his proposal, or enjoins him from starting work, the sub can argue that his loss of a potentially important Govt contract is a greater harm than the possibility that money damages might not be adequate to compensate the prime for the injury the prime suffered.

(4) Public Interest--Where a sub’s unsolicited proposal offers the same product to the Govt at a lower price, the sub has a powerful argument that an injunction should be denied in order to preserve the public’s interest in having the contract performed at a better price. One Court refused to issue injunctive relief to stop negotiations between a sub and the Govt from taking place because it was concerned that an injunction would delay completion of an important project for the Govt.49

□ Constructive Trusts

If it appears that an injunction would be difficult to obtain, an unhappy team member should consider seeking a constructive trust as a way of having the fruits of the other’s violation held for his benefit. One State describes the constructive trust principle as follows:50

One who gains a thing by fraud, accident, mistake, undue influence, the violation of a trust, or other wrongful act is, unless he has some other and better right thereto, an involuntary trustee of the thing gained, for the benefit of the person who would otherwise have used it.

To succeed in establishing a constructive trust, one of two facts must be present: (a) the existence of and validity of a fiduciary duty between the team members; or (b) the existence and validity of some other confidential relationship.51 As explained previously, the existence of a fiduciary duty is more likely to be found if the teaming arrangement itself can be characterized as a joint venture. Even if the agreement contains a disclaimer on this score, the disgruntled team member could assert the existence of a joint venture nevertheless, explaining away the disclaimer as being inapplicable to the determination of the rights of the parties between one another.52

If a joint venture can be established, or if the arrangement can be characterized as a “joint enterprise,” a constructive trust can be established if one of the teammates converts a business opportunity of the joint venture to his sole benefit53--assuming that the antitrust laws do not interpose a barrier to this premise.

GUIDELINES

These Guidelines are intended to alert you to the regulations and legal principles governing teaming agreements. They are not, however, a substitute for professional representation in any specific situation.

1. Teaming agreements may be a useful method of pooling your resources with those of other (perhaps specialized) companies in order to compete for Govt contracts requiring sophisticated technology.

2. There are a number of differences between teaming agreements and joint ventures--the relationship *8 of joint venturers to each other has been compared to that of general partners. To avoid the kind of obligations and liabilities that are associated with joint ventures, be careful to draft your agreement as precisely as possible.

3. As the prime contractor in a teaming agreement, you may be obligated to award the subcontract to the sub you have designated as a team member. Even if the agreement with your sub is oral, Courts have shown a willingness to find an enforceable agreement.

4. Your sub may also be bound to accept the subcontract once you have been awarded the prime contract. If the sub is unwilling, you can enforce the agreement by arguing that you relied on the sub’s quote.

5. Keep in mind that teaming agreements are not exempt from the antitrust laws. In particular, care should be taken in formulating restrictions on team members so that they are not deemed overbroad by Courts.

6. The antitrust statutes may also provide a defense to violating the agreement--i.e., when the other party attempts to enforce it, you may be able to argue that it cannot be enforced because it constitutes an antitrust violation. In doing so, remember that it has been held that teaming agreements are not automatic violations, and thus can have valid pro-competitive elements which justify their existence.

7. In the event your sub attempts to negotiate directly with the Govt for the contract you and the sub agreed to “team” on, you should consider filing for injunctive relief or a constructive trust to prevent award or stop the sub from benefitting from his action.

Footnotes

FAR 9.601.

Briefing Papers #69-2 (Van Gemert, “Teaming Agreements”), 1 BPC 371.

Defense Procurement Circular #41 (29 Apr. 1966).

DAR 4-117.

FAR 9.6.

FAR 9.602(c); FAR 9.603.

FAR 9.604(e).

FAR 9.604(a).

FAR 9.604(b).

FAR 9.604(d).

FAR 9.604.