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The goal of the limitation on subcontracting requirement is to ensure that a certain amount of work is performed by a small business concern (SBC) when it qualifies for a small business program set-aside or sole source procurement due to its socioeconomic program status. SBA’s final rule, Small Business Government Contracting and National Defense Authorization Act of 2013 Amendments, implements numerous changes to this requirement contained in the National Defense Authorization Act of 2013 (FY2013 NDAA).  This rule becomes effective June 30, 2016. However, changes to the parallel FAR requirements are still needed for regulatory consistency and implementation.

Key Changes

The current method of calculating compliance with the limitations on subcontracting requires the prime contractor to perform a certain percentage of work under a set-aside contract.

The FY2013 NDAA replaced this method with one that limits the percentage of the award amount received by the prime contractor that may be spent on subcontractors. Under this method, work done by “similarly situated” first-tier subcontractors does not count as subcontracted work for purposes of determining compliance with the limitation on subcontracting requirement.  “Similarly situated” means a SBC subcontractor that is a participant of the same SBA program that qualified the prime contractor as an eligible offeror and awardee of the contract (and it must also qualify as small for the subcontract based on the NAICS code assigned by the prime to the subcontract).  To address concerns as to potential pass-through schemes, SBA is applying the limitations on subcontracting collectively to the prime and any similarly situated first-tier subcontractor, such that any work performed by a similarly situated first-tier subcontractor will count toward compliance with the applicable limitation on subcontracting.  But, any work that a similarly situated first-tier subcontractor subcontracts, to any entity, will count as subcontracted to a non-similarly situated entity for purposes of determining whether the prime/sub team performed the required amount of work.

Interestingly, the final rule clarifies that performance by an independent contractor is considered a subcontract but will only qualify as a “similarly situated” entity if the contractor meets the “relevant criteria,” i.e., is a participant of the same SBA program that qualified the prime contractor as an eligible offeror and awardee of the contract.

The method for calculating compliance will continue to be based on what the acquisition is for, as defined by the NAICS code assigned to the contract. The limits in the final rule are:

  • 50% for services
  • 50% for supplies
  • 15% for general construction, and
  • 25% for specialty trade construction.

So, under the new methodology, in the case of a service or supply contract, the prime contractor is prohibited from paying more than 50% of the amount paid by the Government to firms that are not similarly situated.   In a departure from the proposed rule, SBA is not requiring different or multiple tests in circumstances in which the contract is for a combination of supplies and services, and, instead, only the test based on the identified NAICS code applies.  The final rule also makes clear that the cost of materials is excluded from the calculation and not considered to be subcontracted.

Tracking & Reporting of Compliance

In the final rule, SBA is not imposing a requirement that the prime SBC enter into a written agreement with its similarly situated subcontractors in order to be able to rely on the work to be performed by them so as to not impose administrative burdens on SBCs, among other reasons. Nor is SBA moving forward with requiring regular reporting on compliance from SBCs that rely on similarly situated entities to meet their performance obligations under a set aside.  Instead, SBA will issue a proposed rule to request public comment on the issue of whether all SBCs (and not only those that are using similarly situated entities to perform a contract) should be required to report on compliance with the limitations on subcontracting on set-aside contracts.

Penalties for Non-Compliance

SBA has implemented in the final rule the penalty for concerns that violate the limitations on subcontracting requirement contained in the FY2013 NDAA. Whoever violates the limitations on subcontracting provisions will now be subject to the penalties listed in 15 U.S.C. 645(d), except that the fine associated with these penalties will be the greater of either $500,000 or the dollar amount spent in excess of the permitted levels for subcontracting.

Impact on Teaming

The impact of this new method of calculating limitation on subcontracting is obvious: for a small business program set-aside or sole source procurement due to its socioeconomic program status, it will impact the way that SBCs chose subcontractors and teaming partners. SBC prime contractors will likely look to target subcontracts to “similarly situated” entities so that those dollars subcontracted will not count against it, and will need to consider status carefully when identifying NAICS codes to assign to subcontracts.  Moreover, in scenarios in which the prime relies on one or more similarly situated entities, a large business subcontractor could actually perform the largest single percentage of work on the contract.  At the same time, reliance on “similarly situated” entities will require the SBC prime contractor to have insight into the subcontracting practices of those entities in order to be able to ensure that the prime is in compliance with the applicable limitation on subcontracting.

Beware the Period of Uncertainty

Keep in mind that between the time that this rule becomes effective and the time that the FAR Council revises the FAR solicitation provisions and contract clauses to marry up with the revised SBA regulations, there will be a period of uncertainty as to which calculation method will apply to procurements.  If a solicitation references the FY2013 NDAA language or new version of 13 C.F.R. § 125.6 but contains FAR 52.219-14 (NOV 2011), use the Q&A process to seek clarity as to how the agency intends to determine offerors’ compliance with the limitations on subcontracting requirement.

To the extent that an agency is using the new calculation method, consider seeking clarity from the agency as to how offerors must demonstrate independent contractors are similarly situated.  Will it be sufficient to merely state in the proposal that a SBC prime contractor will use ‘independent contractors’ and ensure compliance with the limitations on subcontracting provision?  Does an offeror have to separately identify its similarly situated independent contractors in its proposal?  Must an offeror have received certifications from its independent contractors as to size and status prior to proposal submission?  Will these independent contractors be registered on SAM with DUNS numbers and CAGE codes?  Perhaps additional guidance will be forthcoming to impose uniformity in the treatment of independent contractors for purposes of determining an offeror’s compliance with the limitation on subcontracting requirement.  Until it does, it is too important of an issue in proposal evaluation – not to mention contract performance – to not seek clarification.

Other questions to think about moving forward under this new regime include: How will the revisions impact teaming agreement terms?  How will prime contractors choose to assign NAICS codes to subcontracts?  How will this actually impact workshare ratios between large and small businesses?

We will be posting discussions of other important aspects of this final rule over the next several days.