In February 2019, comments were closed on a proposed revision to the Federal Acquisition Regulations related to limitations on subcontracting for small business contractors. Once finalized, the revisions will bring closure to a process that began in 2013. The stated goal of the revisions is to streamline guidelines for permissible subcontracting, but neither the process to arrive at the rule nor the final result are quite as simple as planned.
For years, the FAR has placed limits on how much work may be subcontracted by a small business performing under a federal contract. Agencies make a concerted effort to invite small businesses into the federal marketplace through preferential contract solicitations and do not want large companies to obtain these contracts through the backdoor, by having a small business serve as the ostensible contractor and then subcontracting the substantive work.
Simultaneously, the government does not want to burden small businesses with unreasonable performance expectations, as there may be a legitimate need to subcontract aspects of the work.
Until recently, the permissible subcontracting line was fuzzy. A small business prime was required to perform 50% of the work for service and supply contracts and 85% of the work for construction contracts. How that 50% (or 85%) was calculated, however, could vary. Depending on the type of contract, a contractor might be required to track performance costs for personnel and manufacturing, to exclude certain cost pools (such as material costs), and ultimately to arrive at a number that may not reflect how much work the contractor actually performed.
As a result, a simpler calculation was established through changes to the National Defense Authorization Act, and later through revisions to Small Business Administration regulations. Rather than tracking costs, the relevant consideration became how much of the prime contract amount remained with the contractor. If the prime contractor retained 50% or more of the contract balance, it was in compliance. Further, the SBA regulations provide that if a contractor subcontracts with a similarly situated business, that subcontracting does not count toward the applicable threshold. For example, if a minority-owned prime pays 60% of the contract value to another minority-owned subcontractor, those funds are excluded from consideration.
The change is meant to simplify, however, depending on the industry and contract, the new threshold may have unintended complications. In particular, certain small businesses may provide a core service to an agency, but must necessarily rely on ancillary goods or services that can only be obtained from non-small businesses. The supplementary items may represent a large portion of the total costs of the contract. Under the prior regime, those costs might be able to be excluded from the subcontracting calculus, but under the new framework, the overriding question is how much money the contractor retains. In some situations, it might be virtually impossible for a small business to meet its subcontracting targets.
A further complicating factor is timing. The SBA regulations went into effect in 2016, but the FAR, which actually governs the terms of federal contracts, was not correspondingly amended. Contractors were left to guess as to which framework should apply. Certain contracting officers took the position that old regime needed to apply until any FAR changes went into effect. Conversely, certain Board of Appeals decisions simply assumed the SBA standards applied even though they were not made a part of the FAR.
In late 2018, changes to the FAR establishing the new thresholds were finally proposed. As of the writing of this article, the comment period has closed, but the new regulation has not gone into effect. Businesses and practitioners are encouraged to review the current status of the applicable regulations for any final modifications.
Even if the changes are adopted without further revisions, however, the fit between the FAR and the SBA regulations is imperfect. The FAR does not simply adopt the SBA framework, but instead writes its own. If the SBA regulations change, the FAR will not update automatically. Indeed, the SBA has proposed further reforms to subcontracting limits, but these exclusions would not necessarily be matched by the FAR. Additionally, the SBA regulations address certain items that the FAR update does not, such as the time period for measuring compliance with the subcontracting limitations. How contracting officers will reconcile discrepancies remains to be seen.
A further layer of complexity is that some agencies decided not to wait for the FAR to change. In particular, in early 2019, the Department of Veterans Affairs and the Department of Defense issued class deviations – permitting contracts to vary from FAR mandates – that sought to put into effect the new thresholds. Although addressing the same basic issue, the deviations do not exactly mirror the SBA guidelines, and may not match precisely with the final FAR rule. Any differences could present problems, particularly for long-term contracts, where perhaps an old framework was in effect at the time of solicitation, but new guidelines are in place when an option period is exercised.
Small businesses that has not yet had to deal with these changes should review their subcontracting practice to make sure it complies with the new formula. While meeting the new threshold may be simple, if complying presents unexpected issues, consider reaching out to counsel to discuss strategies to ensure that the business model continues to succeed.
