## Facts

- The United States Navy entered into a fixed-price construction contract with All-State Construction, Inc. to build a hazardous waste storage facility at Naval Weapons Station Earle in New Jersey.
- All-State fell behind schedule, and the Navy began taking steps associated with possible default.
- On October 4, 1996, the Navy issued a show-cause notice stating that, because All-State had not made adequate progress toward timely completion, the Navy was considering terminating the contract for default and seeking about $180,000 in liquidated damages.
- On October 9, 1996, All-State submitted a progress-payment invoice for approximately $120,000 (about $120,878.67) for work already performed.
- The Navy refused to pay the invoice, invoking setoff on the ground that All-State’s debt to the government for liquidated damages exceeded the amount the government owed on the invoice.
- The Navy later terminated All-State’s contract for default.
- All-State appealed to the Armed Services Board of Contract Appeals (ASBCA), arguing that (1) the FAR retainage provision incorporated into the contract capped any withholding at 10% of the progress payment, and (2) the government could not set off liquidated damages before issuing a default termination.
- The Navy argued that it could withhold progress payments because default termination was imminent and, separately, that its common-law setoff right—reflected in a contract clause making payments subject to government claims—permitted withholding the full invoice amount.
- The ASBCA granted summary judgment for All-State, holding the Navy breached the contract by withholding the entire progress payment rather than limiting withholding to 10%.
- The Navy appealed to the United States Court of Appeals for the Federal Circuit.

## Issues

1. Whether the government may withhold progress payments simply because it is considering, or views as likely, a termination for default.
2. Whether the government’s common-law setoff right—recognized in the contract’s specification clause subjecting payments to government claims—allows withholding the entire progress payment to cover liquidated damages, despite the FAR retainage limit and before a default termination issues.

## Decision

- The Federal Circuit rejected the Navy’s argument that the FAR default/termination provisions give the government a standalone right to withhold progress payments merely because default termination is being considered.
- The court held that the government could withhold the entire progress payment under its common-law setoff right, as reinforced by contract language providing that the government’s payment obligations were subject to any claims it had against the contractor under or in connection with the contract, including liquidated damages.
- The court reversed the ASBCA’s decision and remanded for further proceedings.

## Legal Principles

- The United States has a broad common-law right to set off amounts it owes a contractor against debts the contractor owes the government, unless that right is clearly limited by statute or contract.
- A contract clause stating that the government’s obligation to make payments is subject to government claims against the contractor preserves the government’s ability to set off contract-related claims (including liquidated damages) against otherwise due progress payments.
- FAR progress-payment/retainage provisions governing the amount of retainage (such as a 10% limit) address retainage as a payment administration device and do not, without clear limiting language, eliminate or cap the government’s separate setoff right.
- The FAR default-termination framework sets out termination remedies but does not itself create a general pre-termination authority to withhold progress payments solely because the government is considering a default termination.

## Conclusion

In *Johnson v. All-State Construction, Inc.*, the Federal Circuit held that the Navy lacked a standalone “imminent default” basis to withhold a progress payment, but it could withhold the full amount of the contractor’s progress-payment invoice under the government’s common-law (and contract-recognized) setoff right to satisfy a liquidated damages claim, so the ASBCA’s contrary summary judgment was reversed and the case remanded.


Johnson v. All-State Construction, Inc., 329 F.3d 848 (2003)