Contract analysis

From: Priya Anand <panand@calderwoodharkness.com> To: "Marcus J. Whitmore" <mwhitmore@whitmoreaero.com> Cc: Douglas Carmichael <dcarmichael@calderwoodharkness.com> Date: Thu, 08 Aug 2024 03:47:00 -0000 Subject: Whitmore v. Hargrove-Dalton — Settlement Posture Analysis and Recommendations [PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT]

**PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT**

I am writing to provide an updated analysis of Whitmore Aerospace LLC's ("WAL") settlement posture in the declaratory judgment action, *Whitmore Aerospace LLC v. Hargrove-Dalton Defense Systems, Inc.*, No. 1:22-cv-10147-RMB (S.D.N.Y.), in light of the prolonged DCMA administrative review. As you know, the case has been stayed since March 17, 2023, pursuant to Judge Brannigan's order, and we have now filed four joint

**I. Summary of the Dispute and Exposure**

HDDS has demanded indemnification in the amount of $14,726,583, representing the full amount of cost overruns identified in the DCMA Contracting Officer's Preliminary Determination ("COPD") dated August 1, 2022, under Prime Contract No. FA8620-19-C-0337 (the Advanced Tactical Airframe Program). Following WAL's filing of the declaratory judgment action, HDDS filed its Answer and Counterclaim on January 13, 2023, seeki

For context on the range of WAL's exposure:

- **Maximum theoretical exposure** under the Section 11.5 indemnity cap is $88,992,000 (calculated as 120% of WAL's Work Package 4 value of $74,160,000). The actual claimed amount of $14,726,583 is well below this cap, but it remains a substantial figure. - **Attorneys' fees**, if awarded to HDDS under Section 11.6, would increase exposure modestly beyond the $14.7M principal claim. - **COPD allocation**: The COPD at

**II. Assessment of WAL's Defenses — Risk-Adjusted Value**

We have evaluated WAL's principal defenses below, with a candid assessment of the strength of each.

**A. Causation Defense (Section 11.4(b)) — WAL's Strongest Defense**

Section 11.4(b) of the Teaming Agreement requires that cost overruns be "caused by Team Member's acts or omissions" in order to trigger the indemnification obligation. This is WAL's most potent defense because it requires HDDS to establish a causal nexus between WAL's conduct and each category of overrun. The WP-4 overruns break down approximately as follows:

1. **Titanium raw-material cost escalation (~$4.2M).** WAL's position is that the global titanium supply disruption constitutes a force-majeure event, and that this escalation was not caused by any act or omission of WAL. *Strength: Moderate to strong.* The supply disruption is well documented and was widely reported in the defense-industrial press. HDDS will likely argue that WAL assumed raw-material pricing risk un

2. **Rework due to non-conforming machining tolerances (~$5.1M).** WAL contends the non-conformances were attributable to deficient engineering specifications furnished by HDDS, not to WAL fabrication error. *Strength: Fact-intensive, moderate.* This is the area of greatest factual vulnerability. HDDS will argue — and has already asserted in its Counterclaim — that WAL's manufacturing processes were the root cause of

3. **Schedule delays and idle-labor charges (~$2.3M).** WAL attributes these to HDDS's late delivery of government-furnished equipment ("GFE"). *Strength: Moderate.* We believe the documentary record of delivery schedules should support WAL's position, but HDDS will contest the causal link between GFE delays and the specific idle-labor charges. This will also be fact-intensive.

4. **Engineering Change Proposal ("ECP") implementation costs (~$1.2M).** WAL's position is that the ECPs were directed by the government through HDDS and therefore are not attributable to WAL's acts or omissions. *Strength: Moderate to strong.* The ECP directive chain should be traceable through contract modification documentation.

**Overall causation assessment:** WAL has legitimate, colorable defenses on causation for a substantial portion of the WP-4 overruns. The strongest arguments apply to the titanium escalation (~$4.2M) and ECP costs (~$1.2M). The rework component (~$5.1M) represents the core battleground where HDDS's case is most viable. These defenses are governed by New York law (Section 18.1 of the Teaming Agreement), and under New

**B. Overbreadth Defense (Non-WP-4 Overruns)**

HDDS's demand includes $1,909,142 in overruns attributable to work packages other than WP-4, for which WAL has no conceivable indemnification liability. WAL did not perform the work, and the Teaming Agreement plainly limits indemnification to cost overruns attributable to a Team Member's own Work Package. *Strength: Very strong.* This should be a near-certain win on summary judgment or at trial. Even in a worst-case

WAL has maintained the position that the indemnity obligation is not yet triggered because the COPD is preliminary and no costs have been formally disallowed by the government. *Strength: Moderate as a standalone defense.* This is more properly understood as a timing argument. It was instrumental in obtaining the stay and continues to provide strategic advantage by deferring adjudication. However, once the COFD issue

Based on our analysis of the legal and factual landscape, and recognizing the inherent uncertainty at this pre-discovery stage, we offer the following probability-weighted assessment:

| Outcome | Estimated Probability | |---|---| | WAL has zero liability (full win on all defenses) | 25–35% | | WAL's liability is limited to a portion of WP-4 overruns (partial win) | 40–50% | | WAL is liable for the full WP-4 amount (~$12.8M) | 15–25% | | WAL is liable for the full HDDS demand ($14.7M including non-WP-4) | Less than 5% |

**Risk-adjusted expected exposure range: approximately $3.5M–$7.5M (midpoint ~$5.5M).** This range reflects a weighted analysis across the probability bands above and accounts for the relative strength of WAL's defenses on the non-WP-4 overruns and the titanium escalation/ECP components, offset by the genuine uncertainty on the rework and schedule-delay components.

Based on the risk-adjusted analysis above, we believe a reasonable settlement range for WAL would be in the vicinity of **$3.0M–$6.0M**, depending on the strength of documentary evidence that ultimately emerges in discovery. Several additional factors bear on settlement dynamics:

- **HDDS's own incentives to resolve.** HDDS, as a $3.4 billion defense prime contractor, faces its own exposure under the prime contract. The DCMA review could result in a COFD that is unfavorable to HDDS at the prime-contract level — for example, requiring HDDS to bear overruns under the 70/30 CPIF share ratio for contractor-responsible cost overruns. HDDS may prefer to have WAL absorb a negotiated share of those o

- **Attorneys' fees exposure.** Section 11.6 of the Teaming Agreement provides for fee-shifting to the prevailing party. If WAL loses the indemnity claim, it could owe HDDS's legal fees (i.e., Voss, Trager & Kendall's fees in addition to the indemnity amount). Conversely, if WAL prevails, it could recover its own fees. This provision cuts both ways and adds settlement incentive for both sides — neither party wants to

- **WAL's financial capacity and accounting treatment.** WAL's FY 2022 revenue was $287M. Pinnacle Advisory Partners LLC has classified the HDDS contingency as "reasonably possible" (not "probable") under ASC 450, with footnote disclosure of exposure up to $14.7M. A settlement within the $3–6M range would be well within WAL's financial capacity and would eliminate the contingent-liability overhang that has been carri

As you will recall, WAL tendered the HDDS indemnity demand to Meridian Surety & Insurance Group on September 22, 2022, under both the D&O policy (Policy No. MSI-DO-2022-07814, $10M aggregate, $250K retention) and the CGL policy (Policy No. MSI-CGL-2021-33291, $25M aggregate, $500K SIR). Meridian issued a reservation-of-rights letter on November 1, 2022, reserving its rights based on the contractual-liability exclusio

1. **Before making any settlement overture to HDDS**, WAL should consider pressing Meridian again — forcefully — for a definitive coverage position. If any portion of the HDDS claim is covered under either policy, it would materially affect WAL's settlement calculus and out-of-pocket exposure. We recommend that we send a further demand letter to Meridian framing the prolonged delay as prejudicial to WAL's interests a

2. **Any settlement with HDDS must be coordinated with Meridian** to preserve WAL's rights under the policies. Settling the HDDS claim without Meridian's consent — or at minimum without proper notice and an opportunity for Meridian to participate — could jeopardize WAL's ability to recover under the policies. This is a standard but essential precaution.

**V. Impact of COFD Timing on Settlement Leverage**

The COFD will be the single most significant event affecting settlement leverage in this dispute. It will establish whether the government formally disallows costs, the quantum of any disallowance, and — critically — the allocation of disallowed costs between WP-4 and non-WP-4 work packages. The potential scenarios and their impact on WAL's negotiating position are as follows:

- **If the COFD reduces the WP-4 allocation below $12.8M**, WAL's leverage increases substantially, as HDDS's indemnity claim would be correspondingly reduced at its foundation. - **If the COFD confirms the full COPD allocation**, HDDS's bargaining position strengthens, though WAL's causation defenses under Section 11.4(b) remain fully available and would still need to be litigated. - **If the COFD finds no disallowa

The DCMA field audit is complete and the cost analysis is under internal legal review at DCMA headquarters. This suggests the COFD could issue in the coming months, though as you know, DCMA timelines are notoriously unpredictable. Harold Reeves and Natalie Cheng at Ashford & Reeves LLP continue to monitor the administrative review and will alert us promptly when there is movement.

Based on the foregoing analysis, our recommendations are as follows:

**Primary Recommendation: Defer any settlement overture to HDDS until after the COFD issues.**

The rationale for this position is straightforward:

- The COFD will materially clarify WAL's actual exposure and will either significantly strengthen or weaken WAL's negotiating position. Settling before the COFD issues means settling in a fog of uncertainty that is likely to lift in the relatively near term. - Approaching HDDS now, while the administrative review is pending and the litigation is dormant, risks signaling weakness and inviting a demand at or near the f

**Secondary Recommendation: Press Meridian for a definitive coverage determination.**

In parallel with the above, we recommend sending a further letter to Meridian Surety & Insurance Group demanding a definitive coverage position on both the D&O and CGL policies. The letter should frame the seventeen-month delay since our March 2023 follow-up as prejudicial to WAL and should expressly reserve WAL's rights to pursue all available remedies, including a bad-faith claim, if Meridian continues to withhold

**Tertiary Recommendation: If HDDS initiates settlement discussions, be receptive but non-committal.**

If HDDS or its counsel (e.g., Leonard Trager at VTK) makes a settlement overture, WAL should be receptive and professional but should not make the first monetary offer. Any such approach should be communicated to our team immediately so that we can coordinate the response. Allowing HDDS to anchor the discussion with its own number will provide valuable intelligence about HDDS's internal assessment of the claim and it

**Procedural Note:** The fifth joint status report will be due in approximately early November 2024. Our team will continue to monitor the DCMA review through our coordination with Harold Reeves and Natalie Cheng at Ashford & Reeves LLP and will promptly advise you of any material developments.

I would like to schedule a call with both of you — and with Doug Carmichael and Patrick Gallagher on our side — to discuss this analysis and the recommendations in further detail. Please let us know your availability over the next week or so, and we will coordinate a time.

In the interim, please do not hesitate to reach out if you have any questions or if any developments arise on your end.

**Priya Anand** Partner Calderwood & Harkness LLP 600 Lexington Avenue, 28th Floor New York, NY 10022 T: (212) 554-7100 panand@calderwoodharkness.com

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