## Facts

- Instruments for Industry, Inc. (IFI), a defense contractor, entered a Navy contract to supply twenty units of electronic countermeasure equipment.
- The contract included standard Disputes, Guaranty, and Inspection clauses.
- The government inspected and accepted the equipment at IFI’s plant; under the contract, acceptance was finalized at the plant.
- Within one year after delivery, the contracting officer notified IFI that the equipment was allegedly defective at delivery and that IFI owed over $390,000 under the Guaranty clause; no final contracting officer decision issued until 1972.
- The Guaranty clause required notice of defects within one year of delivery and allowed the government to require correction/replacement or, if not required, repayment of an equitable portion of the contract price; it also stated it did not limit government rights under the Inspection clause.
- The Inspection clause provided that acceptance was conclusive except for latent defects, fraud, or gross mistakes amounting to fraud.
- The government did not claim latent defects, fraud, or gross mistake amounting to fraud, and did not claim defects arose after delivery.
- IFI filed a Chapter XI arrangement; the United States filed a proof of claim including the defect-based amount and an uncontested balance under another contract.
- The bankruptcy judge denied IFI’s request to expunge the defect-based claim and designated the Armed Services Board of Contract Appeals to liquidate it.
- The district court reversed and expunged the defect-based claim, holding the Inspection clause cut off the Navy’s rights; the United States appealed.

## Issues

1. Whether a broad Guaranty clause preserves the government’s right to recover for defects existing at delivery after “conclusive” acceptance under an Inspection clause, when the alleged defects are not latent and no fraud-type exception is asserted.
2. Whether, given the contract’s effect, the government’s defect-based proof of claim in the Chapter XI proceeding was enforceable or had to be expunged.

## Decision

- The Second Circuit affirmed the district court’s order expunging the government’s defect-based claim.
- The Inspection clause’s “conclusive” acceptance barred post-acceptance recovery for non-latent defects absent latent defect, fraud, or gross mistake amounting to fraud.
- Any ambiguity created by the coexistence of the Guaranty and Inspection clauses was construed against the government as drafter.
- The Guaranty clause’s statement that it did not limit Inspection-clause rights did not create affirmative rights inconsistent with conclusive acceptance.

## Legal Principles

- Where an Inspection clause makes acceptance conclusive except for latent defects, fraud, or gross mistakes amounting to fraud, the government may not recover after acceptance for non-latent defects existing at delivery unless the contract clearly provides otherwise.
- When standard-form contract provisions conflict or create ambiguity, the ambiguity is construed against the drafter (contra proferentem), including when the drafter is the government.
- A clause stating it does not limit another clause preserves the other clause’s operation; it does not expand rights in a way that negates explicit finality language.

## Conclusion

Because the government alleged only non-latent defects existing at delivery and did not assert any exception to conclusive acceptance, the Inspection clause barred the Navy’s post-acceptance defect claim, and the defect-based proof of claim was properly expunged in the Chapter XI proceeding.


In re Instruments for Indus., Inc., 496 F.2d 1157 (2d Cir. 1974)