In the Matter of Instruments for Industry v. United States

Instruments for Industry (IFI) (plaintiff) delivered electronic countermeasure equipment to the Bureau of Naval Weapons of the Navy Department (government) (defendant) pursuant to a government contract. The government inspected and accepted IFI’s delivered goods. Within one year of delivery, the government notified IFI that the delivered equipment was defective and that IFI had to repay the government over $390,000 pursuant to the guaranty clause of IFI’s contract. The guaranty clause stated that (1) IFI guaranteed the delivered goods were free from defects at the time of delivery; and (2) if the government notified IFI of any defects within one year of delivery, then IFI would be required either to replace the defective products or to repay the government for the portion of the contract price allocated to the defective goods. IFI subsequently filed for Chapter 11 bankruptcy, and the government filed its $390,000 claim in IFI’s bankruptcy proceeding. IFI challenged the government’s claim, arguing that, under the inspection clause in IFI’s contract, the government was prohibited from seeking recovery for non-latent defects in goods the government had previously inspected and accepted. The inspection clause of IFI’s contract stated that the government’s acceptance of IFI’s goods was final absent latent defects, fraud, or gross mistake. The bankruptcy court allowed the government’s claim to proceed. IFI appealed, and the district court reversed, holding that the government’s right to recover was barred by the inspection clause because it did not allege latent defects, fraud, or gross mistake. The government appealed to the Second Circuit.