Limitations on Subcontracting: SBA Proposes Sweeping Changes

The limitations on subcontracting would undergo sweeping changes under a recent SBA proposal.

On December 29, the SBA issued a proposed rule to enact the changes implemented by Congress in the National Defense Authorization Act of 2013–including a thorough re-write of the way that compliance with the subcontracting limits is calculated and enforced.

As longtime SmallGovCon readers may recall, the 2013 NDAA contained two major changes in the subcontracting limits for set-aside contracts.

First, for service and supply contracts, the 2013 NDAA changed how compliance is calculated. For services contracts, the NDAA replaced the “personnel costs” formula with a formula based on the amount paid to the prime contractor. Similarly, for supply contracts, the 2013 NDAA replaced the “manufacturing costs” formula with one based on the amount paid to the prime contractor (less materials costs).

Second, the 2013 NDAA allowed small businesses to meet their own performance requirements by subcontracting to “similarly situated entities.” In other words, for a small business set-aside, a company could achieve its own performance requirements, in part, by subcontracting to other small businesses.

The 2013 NDAA was signed into law in January 2013 and added to the Small Business Act. For the past two years, confusion has reigned as to whether the “new” subcontracting limitations contained in the Small Business Act are presently effective, or whether those changes will only affect contractors once regulations are adopted implementing the statutory provisions. The SBA’s proposed rule hopefully signals that an end to this confusion is coming (although the FAR Council has yet to act on an amendment to FAR 52.219-14).

Key Regulatory Changes: Program-by-Program

The SBA’s proposed rule includes the following major changes to the limitations on subcontracting:

Small Business Set-Aside Contracts

The proposed rule rewrites 13 C.F.R. § 125.6, which governs the limitations of subcontracting for small business set-aside contracts. Key revisions include:

For small business set-aside contracts for services, “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”
For small business set-aside contracts for supplies (other than from a nonmanufacturer), “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”

The proposed rule confirms that “[w]hether particular specific entities perform the forecasted amount of work is not material, as long as the similarly situated entities collectively meet the performance of work requirement.”

8(a) Set-Aside Contracts

The proposed rule rewrites 13 C.F.R. § 124.510 and 13 C.F.R. § 125.6, which govern the limitations of subcontracting for 8(a) set-aside contracts. Key revisions include:

For IDIQ contracts, an 8(a) prime contractor may satisfy the requirement to perform the appropriate amount of work by subcontracting to similarly situated entities.
For 8(a) set-aside contracts for services, “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”
For 8(a) set-aside contracts for supplies (other than from a nonmanufacturer), “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”

SDVOSB Set-Aside Contracts

The proposed rule rewrites 13 C.F.R. § 125.15 and 13 C.F.R. § 125.6, which govern the limitations of subcontracting for SDVOSB set-aside contracts. Key revisions include:

For SDVOSB set-aside contracts for services, “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”
For SDVOSB set-aside contracts for supplies (other than from a nonmanufacturer), “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”

HUBZone Set-Aside Contracts

The proposed rule rewrites 13 C.F.R. § 126.700 and 13 C.F.R. § 125.6, which govern the limitations of subcontracting for HUBZone set-aside contracts. Key revisions include:

For HUBZone set-aside contracts for services, “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”
For HUBZone set-aside contracts for supplies (other than from a nonmanufacturer), “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”
The regulation deletes the unpopular requirement under 13 C.F.R. § 126.700(b) that requires HUBZone companies to spend at least 50% of the cost of the contract incurred for personnel on all HUBZone set-asides, including set-asides for general and specialty trade construction. Thus, under the proposed rule, HUBZone construction firms would be able to take advantage of the “ordinary” 15% and 25% limits for such contracts without the added worry of complying with the HUBZone-specific 50% requirement.

WOSB Set-Aside Contracts

The proposed rule rewrites 13 C.F.R. § 127.504 and 13 C.F.R. § 125.6, which govern the limitations of subcontracting for WOSB and EDWOSB set-aside contracts. Key revisions include:

For WOSB/EDWOSB set-aside contracts for services, “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.
For WOSB/EDWOSB set-aside contracts for supplies (other than from a nonmanufacturer), “no more than 50% of the amount paid by the government to the prime may be paid to firms, at any tier, that are not similarly situated.”

Definitions and Interpretation

The SBA’s proposed rule includes a number of important definitions, as well as insights as to how the SBA will interpret the new regulations. Among the key changes:

“Similarly Situated Entity” Definition

As seen in the program-by-program analysis above, the concept of a “similarly situated entity” is critical to the understanding and enforcement of the new rules. The proposed rule provides that “a similarly situated entity subcontractor is a small business concern subcontractor that is a participant of the same SBA program that qualified the prime contractor as an eligible offeror and awardee of the contract.”

Simplified Acquisitions

The proposed rule would exempt small business set-aside contracts between $3,000 and $150,000 from the limitations on subcontracting requirements. In its rule, the SBA notes that the FAR only requires the use of the limitations on subcontracting clause, FAR 52.219-14, in acquisitions above the simplified acquisition threshold. Thus, the SBA states, its proposed rule “would merely adopt what the FAR has done.” However, the proposed rule makes clear that this exception applies only to small business set asides. Under the proposed rule, “[t]he limitation on subcontracting requirements would continue to apply to all 8(a), HUBZone, SDVO, and WOSB/EDWOSB set aside contract awards regardless of value, including but not limited to contracts with values between $3,000 and $150,000.”

Which Limitation Applies?

When a solicitation combines supplies and services, the proposed rule provides that “the contracting officer’s selection of the NAICS code is determinative as to which limitation on subcontracting and performance requirement applies.” The rule states that “in no case” will both the service and supply limits apply to the same contract, and further states that the applicable limitation “shall apply only to that portion of the contract award amount.”

Certification and Enforcement

The proposed rule also includes important new provisions regarding certifications and enforcement of the limitations on subcontracting.

Certification of Compliance

The proposed rule requires a small business seeking a set-aside contract to “certify that it will meet the applicable limitation on subcontracting.” If it is not clear from the offer that the small business will satisfy the applicable limitation on subcontracting, the Contracting Officer may seek a Certificate of Competency from the SBA. The Contracting Officer “must be satisfied that the small business concern prime contractor will satisfy the applicable limitation on subcontracting at the time of award.”

Identification of Subcontractors

The proposed rule states that if a prospective prime contractor intends to use similarly situated entities to comply with the applicable limitation on subcontracting, the prime contractor “must identify the similarly situated entities in its offer . . ..” Further, the “percentage of the prime contract award that will be spend on each similarly situated entity must be identified in a written agreement” between the prime contractor and similarly situated subcontractor. The written agreement “must identify the solicitation number at issue, be signed by each entity, and be attached to the prime contractor’s offer.”

Notification of Changes

If, after the award of a prime contract, the prime contractor modifies a subcontractor’s award amount, thereby “increasing the percentage of the prime contractor’s award amount spent on subcontractors that are not similarly situated entities such that the prime contractor is no longer in compliance” with the applicable limitation on subcontracting, the prime contractor must “notify the contracting officer in writing of the change and how the change will affect the prime contractor’s compliance with the limitations on subcontracting.”

Penalties

The proposed rule provides that violations of an applicable subcontracting limitation may result in a variety of significant penalties, including suspension, debarment, administrative remedies, fines, and even imprisonment. If a fine is imposed as a result of a violation, the fine will be “the greater of either $500,000 or the dollar amount spent in excess of the permitted levels for subcontracting.”

Additional Matters

As if these changes were not enough, the SBA’s proposed rule also includes certain changes regarding the non-manufacturer rule, joint ventures, NAICS appeals, the affiliation rules, and more. In the interest of keeping this post shorter than a Tolstoy novel, I will address these changes in separate posts later this week.

Public Comment and Next Steps

It is important to note that this is a proposed rule, not a final rule. It is not yet effective, and the final rule will likely vary in certain respects from this proposal.

The SBA is accepting public comments on the proposed rule on or before February 27, 2015. Instructions for submitting comments can be found in the proposed rule itself. After the SBA receives comments, it will publish a final version of the rule, which will ultimately have the force of law.

Sweeping changes to the limitations on subcontracting are not here yet–but they are coming. I will keep you posted.

Author: Steven Koprince – Steven is a partner with Petefish, Immel, Heeb & Hird, LLP in Lawrence, KS, with a practice focusing on federal government contracts and small business law.

This article originally appeared on Steven’s Blog, SmallGovCon, and is reprinted with their permission.