Government Contracts Monitor

Changes to Limitations on Subcontracting

February 2, 2015

By: Eric Whytsell

As reported in this blog back in March of 2013, the National Defense Authorization Act (NDAA) for Fiscal Year 2013 (FY13) made significant changes to the limitations on subcontracting for small business set-aside contracts. Now, twenty-one months later, the Small Business Administration (SBA) has proposed a new rule to implement those changes. While faithfully implementing the statutory requirements, the proposed rule also addresses issues left open by the FY13 NDAA.

The key changes reflected in the proposed rule are first, the shift from subcontract limitations based on a percentage of the work to be performed to a percentage of the award amount to be spent on subcontracts; and, second, the use of one method for almost all set-aside programs (i.e., varying only on whether the contract is for services, supplies or products, general construction, specialty trade construction).

Under the proposed rule, small businesses awarded a small business set-aside, 8(a), SDVO small business, HUBZone, or WOSB/EDOSB contract cannot subcontract more than a specified percentage of that contract’s value: in general, for supplies and services other than construction, the limitation is 50%; and for general and specialty trade construction contracts 85% and 75%, respectively. If the contract is for both services and supplies, the value to which the percentage will be applied will depend on the NAICS code chosen by the contracting officer (CO). If, for example, the CO choses a manufacturing NAICS code, the portion of contract value and subcontracting cost attributable to the supplies will be used – and the services portion of contract value and subcontract costs disregarded – in determining whether the prime contractor has met the limitation.

Significantly, work done by “similarly situated entities” (i.e., a participant of the same small business program as the prime contract awardee that is small under the applicable NAICS code) does not count as subcontract work for purposes of calculating the subcontract potion. For example, a prime contractor awarded a $100,000 8(a) set-aside supply contract could enter into a $49,000 subcontract with a large business and hire an 8(a) firm to perform $25,000 worth of the work and still be in compliance with the limitation because the $25,000 subcontract would not be counted as a subcontract for the purposes of determining compliance. In an attempt to prevent abuses, however, the SBA has proposed that the limitations not be limited to first-tier subcontractors. “Any work that a similarly situated entity further subcontracts to an entity that is not similarly situated will count towards” the applicable subcontracting limitation. Thus, in the example above, if the 8(a) subcontractor further subcontracted $10,000 of its work to a large business (or even a non-8(a) small business), the prime contractor would not be in compliance since more than 50% of its prime contract value was subcontracted – at some tier – to non-similarly situated entities.

The proposed rule also requires small business prime contractors to certify their compliance and provides that the CO must be satisfied on this point as of the time of award. Further, in the event a contractor intends to use similarly situated entities as subcontractors, it must identify the entities in question and the percentage of the prime contract award amount to be spent on each. In this regard, the proposed rule appears to alter the period of time used to determine compliance, changing it from the period of performance used by the agency to evaluate the proposal or bid (the current approach, which can amount to the entire contract term if option pricing is considered in the evaluation) to “the base term and then each subsequent option period.”

In order to maintain consistency with current FAR provisions, the SBA has proposed that the limitations on subcontracting will not apply to small business set-aside contracts with a value greater than the micro-purchase threshold but not greater than the simplified acquisition threshold (or between $3,500 and $150,000, as those terms are currently defined). Note this exemption would apply only to small business set-aside contracts, not 8(a), SDVO small business, HUBZone, or WOSB/EDOSB contracts.

The proposed rule provides that violators of the limitations on subcontracting shall be subject to the penalties described in the Small Business Act at 15 U.S.C. 645(d), except that the fine “shall be treated as the greater of $500,000 or the dollar amount spent, in excess of permitted levels, by the entity on subcontractors.”

All of the provisions of the proposed rule (some of which have not been detailed here) deserve careful review. Comments on the proposed rule should be submitted to the points of contact in the Federal Register notice by February 27, 2015. We will continue to monitor this rulemaking and report on future developments.

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