Is Your City Contract Safe?

Until recently, contractors have been able to safely assume that if they contracted with a city or other local government, the city could be sued if it breached the contract, but also faced potential liability for the full amount of the contract. That assumption may no longer be accurate.

Take, for example, this hypothetical: John Smith is the general manager of ABC Road Construction, Inc.'s Texas office. One year ago today Smith obtained an exclusive contract for ABC to provide road expansion and construction work for a major city around the city's new NFL stadium. The contract was for a period of three years. As a result, he hired 50 additional employees. The contract generated almost $3 million in revenue last year and netted Smith's office a profit of $750,000. The city never complained about ABC employees' work. Today, however, Smith received a call from the city manager, who informed Smith that the city was terminating the contract immediately with no explanation whatsoever.

Before Smith called his boss with the bad news, he thought, "But we had a three-year contract. Even though the city terminated the agreement, it will still have to pay us for the profit we would have made for the final two years, right?" Until a couple of years ago the answer to that question would probably have been yes. But two recent events completely changed the landscape of the rights of private parties, including contractors, to sue cities, school districts and other local governments for breach of contract.

For centuries, a public policy doctrine has existed known as "sovereign immunity." In the past this phrase was translated to mean "the king can do no wrong." The effect of this doctrine was to provide limited, if any, instances in which private persons could sue the government. For nearly 50 years, Texas law provided an exception to sovereign immunity that allowed private parties to sue cities and other local governments for breach of contract based on language in the cities' charters.

In 2006, however, the Texas Supreme Court held in Tooke v. City of Mexia that that language does not, by itself, waive the city's immunity from suit on breach of contract claims. The Tooke case appears to stand for the proposition that a contractor cannot sue a city or local governmental entity without some other express waiver of sovereign immunity beyond what is contained in the city charter.

While Tooke was pending before the Texas Supreme Court, the Texas Legislature passed a law that waived cities' immunity from suit for breach of contract claims. This waiver applies only if the city does not expressly waive immunity in another fashion. However, the new law limits recovery to the amount owed for work actually performed, and prohibits a contractor from recovering "consequential damages," which courts have identified as including lost profits.

It is important to emphasize that these new laws apply across the board — they are not limited to any specific contracting profession. For example, cities and other local governments have successfully claimed sovereign immunity in cases involving construction on a convention center, expansion of a commercial airport, and removing sludge from a city's waste treatment plant.

So, is ABC Road Construction Contractors' contract safe? Unfortunately, ABC will probably not be able to recover the profits it would reasonably expect for the final two years of the contract. Rather, the city is probably only responsible for the amounts it owed to ABC at the time that it terminated the contract. The practical effect of these recent changes in the law is that cities and other local governments have the ability to cancel a contract at any time, for any reason or no reason whatsoever, knowing there is limited liability exposure.

It may be possible, however, to get cities and other local governments to expressly waive any limitations provided by Tooke and the legislation in the parties' contract. For example, a city could expressly waive any damage limitations, thus potentially allowing a contractor to recover lost profits for the remainder of the contract. Alternatively, contractors can lobby the Legislature, either individually or through political action committees, to change the law to allow contractors to recover a portion of the profits they would have received had the city fully performed its end of the bargain.