Limitations in Subcontracting Video

Limitations in Subcontracting Video February 17, 2020
Trademark Law


I am bringing you the first video blog of the New Year from Whitcomb, Selinsky. Whitcomb, Selinsky, is a veteran owned and operated law firm in Denver Colorado. Our focus is veteran centric. We do a lot of government contract work in our office, so today we're going to be talking specifically on a subject that comes up quite a bit in the context of government contracting, which is referred to commonly as the limitations in subcontracting. That regulation is governed primarily by 13 CFR 125.6, which is under the Small Business Administration regulations. The regulation was promulgated in July of 2016 and there were several iterations of the rule that came out afterwards. Several that year and then some subsequent modifications of the rule.

Limitations in Subcontracting

1. [The New Rule]


The gist of the rule remains the same. Promulgation of a rule was in 2016. The law that gave way to the rule was passed by Congress and signed into law in January of 2013. The point of the new rule was to shift the limitations and subcontracting from sort of an aspirational rule that was and remains in part governed by FAR provision 52.219-14. Under the old rule there wasn't much by way of enforcement. The old rule primarily focused on personnel cost and did not contain any clauses regarding similarly situated entities. So, under the old rule if you were a small business contractor and you submitted a bid on a contract that was a small business set-aside, then the old rule required that at least 50% of personnel costs be spent on the prime contractor. Now the idea being that you wouldn't, as a small business, have gotten an award and then subcontracted you know the entire thing or more than 50% of personnel cost to another entity. Under the old rule there was no allowance for subcontracting to another small business and still remaining within the limitations. But also under the old rule, there weren't a lot of toothy penalties for failing to follow that rule. The worst you were looking at under the old rule was a negative CPARS, which is a past performance evaluation for your contract performance. And the measure of your performance under the old limitation subcontracting was the entire contract period, so theoretically you could win a contract, submit a proposal, be awarded and then subcontract one-hundred percent of the contract for the first two years or two and a half years of a five-year contract, take over and start still performing the second two and a half years and you could still remain compliant.

2. [Big Changes: Fines and Similarly Situated Entities]

Under the new rules in the 13 CFR 125.6, a couple of things have changed. A big one is that it added a penalty of a minimum of five hundred thousand dollars for violating the limitations in subcontracting. It was, it's actually written, it's the greater of five hundred thousand dollars or the difference between the fifty percent that you were allowed to subcontract to other similarly situated entities and what you actually subcontracted. The other important thing is it did add the language about similarly situated entities, so a small business awardee under a small business set-aside can subcontract to another small business awardee and not violate the rule. The same thing with an SDVOSB. Our firm deals with a lot of service-disabled veteran-owned small businesses or SDVOSBs. So, if an SDVOSB pursues and wins an SDVOSB set aside contract and subcontracts to another SDVOSB then they're not going to run afoul of 13 CFR 125.6 and will remain in compliance. But if that same SDVOSB wins your contract and subcontracts more than fifty percent of that contract value to, say, another small business that is not an SDVOSB, then they could be suffering some pretty hefty penalties. The other thing that 13 CFR 125.6 does is it creates a time measurement [for compliance]. The measurement is the base year or the base period of performance. So, not all contracts are awarded for a base year. Your timeline for complying with the limitations in subcontracting is that base period whether it be six months or a year or some shorter period. You have to comply with that and then each option year is a separate compliance period.

3. [Independent Contractors]

It added the similarly situated entity [language]. It also for the first time dealt with the issue of independent contractors. The new rule in 13 [CFR] 125.6 specifically defines independent contractors for the purpose of complying with limitation subcontracting, as subcontractors that is. There is no language under the old rule dealing with independent contractors. Now there is, so if again if this becomes particularly sticky or nuanced if you're an SDVOSB that is competing for a VA SDVOSB set aside, because then not only does your subcontractor have to be a veteran owned or service disabled veteran-owned small business, but that company must also be registered in the CVE database in order for you to be compliant with the limitations and subcontracting. They can't be simply a self verified SDVOSB, who’s verified on SAM[.gov].

3. [First Tier Subcontractors: Same as Prime Contractor]

The other new addition to the 13 CFR 125.6 in the limitation subcontracting is that it treats first tier subcontractors the same as prime contractors for the purpose of compliance with limitations. So, if you if you had the time [] and the the energy to read the Federal Register when these rules were promulgated back in May of 2016 when the proposed rule was being promulgated, one of the things that the the SBA and the FAR Council or the SBA Small Business Administration considered was what happens if I'm a service-disabled veteran-owned small business and I go out and win an SDVOSB set-aside and I subcontract to another CVE verified SDVOSB company and then they turn around and subcontract to a large company or to another small business that's not an SDVOSB? The language in the proposed rule and the discussion about the proposed rule stated that first and prime contractors and first tier subcontractors would be treated the same. Meaning that the prime contractor is responsible for ensuring that their first year subcontractor does not subcontract out more than the allowable percentage to other than similarly situated small business, be this a woman owned or SDVOSB.

I don't have any examples handy where that particular provision of the regulation is enforced but it is something that the DOJ has taken a particular interest in. The US Attorney's Office rather has taken a particular interest in in making sure that prime contractors who are awarded are complying with these limitation subcontracting. Again, there's a minimum of a half a million dollar fine associated [with a violation]. It's a statutory fine that was written into the statute in 2013. Again, it's designed to give this regulation teeth and to make sure that contracts that are set aside for small businesses or service- disabled veteran-owned small businesses are actually benefiting the companies that they were designed to benefit.

4. [Simplified Acquisition Threshold]

Now, there is one caveat within the first paragraph of the new regulation in 13 CFR 125.6, which is if it's a small business set-aside...total small business set-aside and it is beneath...the total contract value falls below the simplified acquisition threshold, which is now $250,000, and it's a total small business set-aside, meaning not an 8(a), HUBZone, woman-owned, SDVOSB or what have you, then the limitations on subcontracting do not apply. Meaning that you can if it's a total small business [and yours] and you win that contract, you could subcontract you know every dime of that contract to another than small businesses or to, you know, to large businesses, if you wanted to. Maybe this would defeat the purpose of winning, but that's a business decision for you and your company to make and there is no enforcement.

5. [Responsibility Determinations by the Contracting Officer]

But, if it's at 8 a HUBZone or any other socio-economic set aside and the case law demonstrates that it is up to the Contracting Officer to enforce the limitations in subcontracting. But an important fact is that some cases have demonstrated that if you if on the face of your proposal or your company's proposal and when you submit your proposal to the government as part of their responsibility determination they should review that proposal to make sure that on its face it does not violate the limitations in subcontracting. So, if your proposal, for example, were the state that you know we have you know we have the capabilities to perform this contract however we are our firm is only going to perform 30 or 40 year you know less than 50% of this contract then on then that would be grounds for a bid protest by disappointed offer who had reason to believe that your proposal was not compliant on its face. It most often I would expect it would come up in raising additional grounds for protest once the protestor got their hands or the protesters attorney got their hands on the administrative record and got it got an opportunity to look at your proposal.

6. [Total Small Business Mentor Protégé Program]

The other thing to keep in mind there are you know paths around these limitations and subcontracting the mentor-protege program for example allows that the Protege in a mentor-protege relationship only has to perform 40 percent of the contract value if they are working on a joint venture with their with their mentor. that is one workaround on the 50 percent rule.

7. [The measure of Work is Dollars]

The other thing is that the measure of work whether or not the prime contractor is performing for the percent of the contract value is measured in dollars.

8. [Services Contracts]

So, again if it's a 1 million-dollar contract then typically in a services contract the prime contractor, the awardee, would be required to not spend more than five hundred thousand dollars of that million dollars on other than seminary situated subcontractors in the performance of that contract.

9. [Construction Contracts]

Now if it's a construction contract, as many of you already know, the rule is that and you’re the general contractor the rule is 15 percent for self performance and that's where the limitations come in.

10. [Manufacturing Contracts]

And in manufacturing contracts it's 50 percent but you're allowed to take you're allowed to subtract from that 50 percent or required to subtract from that 50 percent the cost of materials for the purpose of manufacturing. So, it's kind of a detailed formula for figuring that out in non service related contracts. And the services contract again you can take out the cost the hard cost of performance if there's you know hard cost associated with performance. And not more than 50% of that remainder can be spent on other than similarly situated subcontractors.

[Conclusion]

If you have any questions that are not answered by this video on the limitations subcontracting then of course feel free to reach out to my law firm or to a law firm that you trust or to an adviser that you trust on the issue of government contracting and I'm sure they will be able to point you in the right direction. Again, my name is Joe Whitcomb owner and founder of Whitcomb Selinsky. I thank you for your time and attention.

Tags: Government Contracts