Limitations on Subcontracting Rules and Small Businesses FAR 52.219 14 & 13 CFR 125.6

Theodore P. Watson, Esq.  When it comes to the famous limitations on subcontracting rules under FAR 52.219 and 13 CFR 125.6, small businesses find themselves making disastrous mistakes when they use a teaming partner or named subcontractor when bidding on federal government contracts. Many companies lose federal contracts due to a bid protest. Whether you are a prime or subcontractor or have a teaming agreement or joint venture, you are still responsible for compliance with the law.

Small businesses that find themselves litigating 13 CFR 125.6 limitations on subcontracting disputes and FAR 52.219-14 should be aware of the potential jurisdictional limitations of the courts. 

• DOJ is now holding contractors criminally liable for violating the limitations on subcontracting rules (pass-through contracts)
• Having a similarly situated small business as a subcontracting could ease the pressure under new SBA rules.
• Find out how it all works before you submit a bid for a multi-million dollar contract.

Competitors are aware of the rules and their challenge in a bid protest lawsuit can cause you to lose the contract.  The new SBA and FAR limitations on subcontracting for small business rules, if not applied correctly, can place the awardee in a difficult position without the proper help. 

• The struggle to avoid getting potential attacks under the FAR subcontracting rules starts at the proposal writing stage. Companies should take the time to spell out what their subcontractors will be doing on the contracts.
• You should not leave the government to speculate whether you a complying with the subcontracting regulations.

How Does This Clause Apply to You?

The FAR limitations on subcontracting clause are generally included in all federal solicitations and ultimately in your contract. This means that by submitting your bid, you have to comply with this requirement.  The clause means that as a small business you must comply with the minimum percentage of work for you as the prime contractor.

Are you the subcontractor? Then, this subcontracting clause means that you are still responsible for making sure that you do not perform more than the required amount of work.

If your contract involves supplies, services, and construction, and if any portion of the requirement is to be set aside or reserved for small business and the contract amount is expected to exceed $150,000, then the limitations on subcontracting for small business clause applies to you.

Do FAR Limitations on Subcontracting for Small Business Firms Apply to 8(a)Companies?

The limitations on subcontracting clause apply to FAR Subpart 19.8, “Contracting with the Small Business Administration (the 8(a) Program)”.

How to Calculate Limitations on Subcontracting? What are the Key Requirements? 

Under the FAR limitations clause, government contractors are agreeing to perform the contract but to abide by the statutory limitations on the amount of work to be passed through to a subcontractor. The following amounts apply when figuring out how to calculate limitations on subcontracting requirements:

• Services (except construction).  At least 50 percent of the cost of contract performance incurred for personnel shall be expended for employees of the concern.
• Supplies (other than procurement from a nonmanufacturer of such supplies). The prime contractor shall perform work for at least 50 percent of the cost of manufacturing the supplies, not including the cost of materials.
• General construction. The prime contractor will perform at least 15 percent of the cost of the contract, not including the cost of materials, with its own employees and can pass on no more than 85 percent.
• Construction by special type contractors. If you are performing in an industry with a unique or specialized NAICS code, then as the prime you must perform at least 25 percent of the cost of the contract, not including the cost of materials, with its own employees.

Who Checks For Compliance? First, you should have an internal quality control mechanism that measures compliance with the FAR limitations on subcontracting rules. The government will usually rely on the Contracting Officer Technical Representative (COTR) and/or the Contracting Officer.

Why Does Compliance Even Matter?

The limitation of subcontracting clause is especially important because more and more small businesses are being caught and charged for procurement fraud if intentionally done.

Small businesses found in non-compliance can also be proposed for suspension and debarment. 

The limitations in subcontracting is serious business also because the FAR states that if you are not in good faith complying with the limitations clause, then you are in material breach of contract.

Tip: Never file a bid protest for limitations on subcontracting disputes at the SBA. It will probably be dismissed.

Tip: When submitting your bid, take the extra time to explain how your company will comply with the limitations on subcontracting clause.

Tip: Understand how the analysis for a similarly situated small business will apply to whether or not you are violating the limitations clause.

RECENT CHANGES UNDER SMALL BUSINESS SET ASIDE SUBCONTRACTING RULES 

Under the new changes for small business set aside subcontracting rules, Section 1651 of the NDAA, as codified at 15 U.S.C. 657, requires that the various types of small business set-asides be based on the percentage of the overall award amount that a prime contractor pays subcontractors.

As a new benefit to small businesses, the new rules for government contracts that are set aside for small businesses have included the confusing term “similarly situated” businesses. The legal applications of the rule further the notion that the rules will exclude the statutorily required percent when primes subcontract to “similarly situated companies.”

WHAT IS A SIMILARLY SITUATED SMALL BUSINESS?

Under small business set aside subcontracting rules, the definition of this new government contracting term focuses on the subcontractor being a small business that is part of the socio-economic designation or SBA program for which the prime contractor is eligible. The subcontractor must also be small under the assigned NAICS code from the prime contractor.

When calculating compliance with the new SBA rules and subcontract work, government small business contractors also have to look at whether the procurement is for services, construction, supplies or a specialty trade. The FAR limitations on subcontracting rules now focus on the amount spent on subcontractors.

• The rule attempts to limit the potential for affiliation allegations
• It also increases oversight for small businesses that pass on work to contractors that are other than small.

Under 13 CFR 125.6 and FAR 52.219 14 Companies that are small businesses, HUBZone SBCs, SDVO SBCs, WOSBs/EDWOSBs, and 8(a) certified must still be mindful that although the limitations on subcontracting rules reduce the chance of affiliation, the SBA affiliation rules can still apply in certain situations.

CONTRACTING OFFICER’S CHOICE OF NAICS CODES

The application of the new rules will first depend on what NAICS code the contracting officer chooses for the procurement.

The cost of materials: under the new FAR limitations on subcontracting rules,  the cost of materials does not apply to service contracts. Instead, government contractors should focus on applying material costs to supply, construction contracts, or specialty trade construction set-aside contracts. See Basics of Small Business SDVOSB Fraud in Government Contracts.

MIXED CONTRACTS

 When implementing the limitation of subcontracting rules, the contracting officer will first make a decision as to which category, services or supplies, has the greatest percentage of the contract value, and then assign the appropriate NAICS code.

•  If there is a procurement mixed with supplies and services, the subcontract rules apply only to subcontracts that correspond to the principal purpose of the prime contract.
• In a government contract that is mostly for services, but also has a supplies component, the prime contractor or its similarly situated subcontractors cannot subcontract more than 50 percent of the services to other than small concerns. However, the prime contractor can subcontract all of the supply components to any size business.

GAO Bid Protest Analysis and Formula FAR 52.219-14: In its bid protest decisions dealing with government contracts for small businesses and limitations on subcontracting, GAO has adopted the following formula for determining whether a contractor is in compliance with the limitation on subcontract clause (FAR 52.219-14(c)(2)) when issuing subcontracting work:

“[T]he total contract cost (including profit) fewer materials and subcontracting costs is to be compared with all subcontracting costs less the subcontractor’s materials costs.”

Although the text of FAR 52.219 14(c)(2) might be assumed to require a simple comparison of the labor costs of the prime contractor and the labor costs of all of its subcontractors, both the GAO and the Small Business Administration (SBA) have found that a more comprehensive formula is required to find compliance with FAR 52. See information on 8a Program Size Determinations & SBA Non Manufacturer Rule.

COFC FAR Limitations of Subcontracting Rules Analysis — 13 CFR 125.6 and FAR 52.219-14: In Excel Manufacturing Ltd. v. U.S., Case No. 13-361C (July 24, 2013), the Court of Federal Claims decided how to comply with FAR Limitations clause. This case involved a post-award bid protest in which the protestor asserted that the awardee would not perform the requisite amount of work under the supply contract to comply with the clause. See information about 13 CFR 125.6 and What is the Government Simplified Acquisition Threshold & micro purchase threshold.

The protestor contended that General & Administrative (“G&A”) and profit should not be considered in determining whether the awardee would comply with the FAR subcontracting limitations contained in the small business Limitations on Subcontract Clause. See also information about FAR 52-219-9.

In the bid protest, the Court of Federal Claims scrutinized the language of the Small Business Limitations on Subcontracting clause which states that the contractor “shall perform work for at least 50 percent of the cost of manufacturing the supplies, not including the cost of materials.” See Ostensible Subcontractor Rule: Primary and Vital Contract Requirements.

Application of FAR Limitations on Subcontracting Rules for Small Business Services Contracts: When it comes to government contracts for services, there is a different application for the Small Business Limitations on Subcontracting Clause. The rules require that for service contracts, calculations apply labor cost. In other words, you should look at the “cost of contract performance” in determining compliance with the FAR clause.

• Unless a proposal “leads” the agency to question the awardee’s work as a possible violation of the Limitation on Subcontracting Clause, it is generally reasonable for the agency to accept your proposal and determine compliance with that clause after the award decision has been made.

As a general rule, an agency’s judgment as to whether a small business concern will comply with the FAR subcontracting regulations is a matter of responsibility, and the contractor’s actual compliance with the provision is a matter of contract administration. See Orincon Corp., B-276704, July 18, 1997, 97-2 CPD ¶ 26 at 4. 

SBA Responsibility Determination: If you are a small business and the agency’s judgment as to whether you will be able to comply with the Small Business Government Subcontracting Clause is a question of responsibility for review by the SBA. See 13 CFR 125.6(f).

However, the GAO has consistently held in bid protests that where your proposal, on its face, should lead an agency to the conclusion that you have not agreed to comply with the FAR limitations on subcontracting clause, the matter is one of the proposal’s acceptability. 

Tips for Government Contractors

When you write a government proposal, you should articulate the portions of the work that you intend to perform as well as that of your subcontractors.

• Failure to do so may cause the contracting agency to guess (sometimes wrong) that you have not met the FAR subcontracting requirements and it may cause you to be eliminated from the competition.
• Understand how submitting a joint venture impacts your obligation to the government and to the law.

See also information about government small business subcontracting plans.

SBA Office of Hearings and Appeals Reverses Totality of the Circumstances Test & Affiliation Analysis

For more information regarding FAR 52.219-14  – FAR Limitations on Subcontracting Clause, 13 CFR 125.6 or for help with small business FAR subcontracting rules and plans, call our legal professionals at 1-866-601-5518 for a free initial consultation.