The Supreme Court of Virginia Addresses Commonwealth’s Use of the Defense of Sovereign Immunity When a Contract is at the Center of the Dispute

Article co-written by Andrew Gay, Jeff Southard, and Summer Associate Carter Leverette

In early May, the Supreme Court of Virginia’s decision in Montalla, LLC v. Commonwealth, established some favorable legal precedent for contractors doing business with the Commonwealth of Virginia.[1] Specifically, the Court noted that the Doctrine of Sovereign Immunity cannot be used as a defense by the Commonwealth when a party brings a claim against it based upon a valid contract entered into by a duly authorized government agent.[2] Traditionally, the doctrine of sovereign immunity prevents parties from being able to sue federal or state governments when they are acting within the scope of their governmental authority unless the government consents to being sued. The Court’s finding in Montalla is critical as it clarifies that actions based upon a valid contract renders sovereign immunity inapplicable, making the government liable to suit even without their consent. Additionally, remedies usually barred by sovereign immunity are now available to parties bringing contract claims against the Commonwealth. In this case, the Court held that the plaintiff could seek an equitable remedy against the government (e.g., to seek equitable recission of a settlement agreement)[3] and a statutorily provided remedy even though the statute itself did not expressly waive sovereign immunity.[4]

Montalla, LLC acquired the rights to service contracts that a previous company (NXL) had entered into with the Virginia Department of Transportation (VDOT). During NXL’s dealing with VDOT, VDOT refused to reimburse NXL for overhead costs that the service contracts had initially obligated VDOT to reimburse due to conflicting interpretations of the Federal Acquisition Regulations (FAR). VDOT’s position was that VDOT did not have to reimburse NXL for overhead costs that were not eligible for federal reimbursement. NXL’s position was that although certain overhead costs may not have been eligible for federal reimbursement, the FAR did not forbid VDOT from still reimbursing NXL under the service contracts. Ultimately, NXL began to lose money on the service contracts and was forced into a position where NXL agreed to settle with VDOT for reimbursements far below the original agreed-upon percentage.

During the settlement negotiations, VDOT sought guidance from the Federal Highway Administration (FHWA) on how the FAR provisions in question should be interpreted. The FHWA sided with NXL’s interpretation of the FAR provisions. VDOT planned to adopt the FHWA and NXL’s position as VDOT’s official policy moving forward but intentionally chose to hold off on doing so until it entered a favorable VDOT settlement with NXL. However, VDOT was not forthcoming about this development with NXL and used NXL’s deteriorating financial situation to its advantage. Once NXL caught wind of the FHWA interpretation and VDOT’s policy maneuvering VDOT was unwilling to revisit settlement discussions.

Montalla filed a five count lawsuit against the Commonwealth of Virginia, VDOT, and the Comptroller of Virginia. Montalla sought to rescind the settlement agreement on two claims due to VDOT’s use of its self-induced economic leverage and less than candid dealings with NXL during the settlement negotiations. These first two counts became the focus of the litigation, and the Supreme Court of Virginia’s decision. The first count sought a declaratory judgment that the settlement agreement entered into by NXL was void due to economic duress. Montalla’s second count sought to vacate the settlement agreement pursuant to a Virginia statute, which provided that a court shall vacate any agreement “reached in a mediation … where … [t]he agreement was procured by fraud or duress, or is unconscionable[.]”[5] The third, fourth, and fifth counts were claims that VDOT breached its duty of good faith and fair dealing, material breach of the service contracts, and that VDOT’s actions constituted a regulatory taking without just compensation in violation of Article I, Section 11 of the Constitution of Virginia.

At the trial, the circuit court dismissed the entire complaint, with prejudice, on the grounds that sovereign immunity barred all five counts. Montalla appealed the trial court’s ruling to the Court of Appeals, but its luck didn’t change. The Court of Appeals affirmed the circuit court’s ruling, “concluding that Counts I-III of the complaint were barred by sovereign immunity and that Counts IV-V were barred by the entry of a settlement agreement entered into by the pertinent parties.”[6]

Montalla then appealed its claims to the Supreme Court of Virginia, which stated that the lower courts were correct in that the doctrine of sovereign immunity “is alive and well in Virginia.”[7] However, the court of appeals erred on the basis that “Virginia has ‘never extended th[e] defense [of sovereign immunity] to actions based upon valid contracts entered into by duly authorized agents of the government.’”[8] The Court then reasoned that “ the sole remaining question regarding the Commonwealth’s claim of sovereign immunity is whether Montalla’s claims are ‘based upon valid contracts[.]’”[9] Further reasoning that “it is the nature of the dispute and not the remedy sought that determines whether an action is based upon [a] contract.”[10] If the court must focus on a “duty or obligation” that the plaintiff claims has been breached, then “the nature of the dispute” is based upon a contract.[11]

Diving deeper, the Supreme Court held that the court of appeals erred in applying sovereign immunity to count one (equitable rescission of the settlement agreement) because it did not limit “its focus to the source of the duty allegedly breached, but rather, focused on the nature of the remedy sought.”[12] The Court discussed that while equitable remedies are usually unavailable against the Commonwealth, “equitable contract remedies” must be available against the Commonwealth to prevent it from avoiding “obligations it undertook in validly entered contracts.”[13] As to count two (recission of the settlement agreement pursuant to Va. Code § 8.01-581.26), the Supreme Court once again held that the court of appeals erred in applying sovereign immunity because it “[f]ocused on the remedy sought as opposed to the basis of the action itself[.]” The Court agreed with the appellate court’s reasoning that indeed, “a general statute that does not contain an express waiver of sovereign immunity does not waive the Commonwealth’s immunity.”[14] However, the Supreme Court reasoned that this principle is only applicable if sovereign immunity applies in the first place, which, in a contract dispute, it is not. The Court finally held that the viability of counts three, four, and five would now depend upon the success of counts one and two on remand, which were no longer barred by sovereign immunity.

In conclusion, contractors dealing with the Commonwealth should be aware that when they enter into valid contracts with the Commonwealth, they can hold it accountable for those contracts and seek lawful remedies that may otherwise be unavailable due to sovereign immunity.

[1] Montalla, LLC v. Commonwealth, No. 230364, 2024 Va. LEXIS 28 (2024).
[2] Id. at 15.
[3] Id. at 19.
[4] Id. at 21­­­­­­–22.
[5] Id. at 21 (quoting VA. Code § 8.01-581.26).
[6] Id. at 1.
[7] Id. at 13 (quoting Fines v. Rappahannock Area Cmty. Servs. Bd., 301 Va. 305, 313 (2022)).
[8] Id. at 15 (quoting Wiecking v. Allied Medical Supply Corp., 239 Va. 548, 551 (1990)) (alterations in original). Still, the Court noted that “[t]his is not to say that a party seeking to raise a contractual claim against the Commonwealth or one of its agencies simply may file suit in a circuit court as it would against any other litigant,” a party must follow the procedures established in Va. Code § 8.01-192. Id.
[9] Id. at 17.
[10] Id. at 18.
[11] Id.
[12] Id.
[13] Id. at 19.
[14] Id. at 21–22.