Subcontracts and Flow-Down Clauses

By John N. Ford, Cherry, Bekaert & Holland, L.L.P. (CB&H)
Email: jford@cbh.com

One of the more intriguing things that we see in our practice is how government contracting officers and prime contractors view subcontracts and the clauses that are appropriate for use in such subcontracts. There appears to be a general lack of understanding regarding the nature of a subcontract and the concept of “flow-down” clauses.

As to what is a “subcontract,” FAR 2.000 states that FAR Part 2 “[d]efines words or terms that are frequently used in the FAR.” It further provides that other parts of the FAR may define other words or terms and those definitions only apply to the part where the word or term is defined. With this in mind, a review of FAR 2.101 reveals that it does not contain a definition of the word “subcontract.” Consequently, there is no universal definition of that word in the FAR. Moreover, a cursory examination of the FAR and related statutes reveals several definitions of “subcontract.”

Most contractors should be familiar with the definition found in FAR 44.101 to the effect that a subcontract is “any contract as defined in [FAR] Subpart 2.1 entered into by a subcontractor to furnish supplies or services for performance of a prime contract or a subcontract. It includes but is not limited to purchase orders, and changes and modifications to purchase orders.” However, this definition only applies to Part 44 and the requirement for government consent to subcontract.

While the definition of “subcontract” in Part 44 appears fairly narrow, compare it to the definition found in FAR 22.801 for purposes of defining what is a “subcontract” within the meaning of FAR 52.222-26. There, it is stated that a subcontract means:

any agreement or arrangement between a contractor and any person (in which the parties do not stand in the relationship of an employer and an employee) –

1. For the purchase, sale, or use of personal property or nonpersonal services that, in whole or in part, are necessary to the performance of any one or more contracts, or
2. Under which any portion of the contractor’s obligation under any one or more contracts is performed, undertaken, or assumed.

As illustrated here, the definition of “subcontract” in Part 22 is much broader than in Part 44, possibly because of the remedial purposes of FAR 52.222-26. In any event, for EEO purposes, a subcontract can relate to more than one prime contract. This may even apply to a purchase for inventory replenishment when no specific contract is in mind when the purchase is made.

While these two examples are not the only definitions of “subcontract” in the FAR, they serve to illustrate the point that the various Parts of the FAR need to be examined carefully to determine if they contain a definition of “subcontract,” and, if so, what that definition is for that particular Part. This will help in determining whether a contract clause prescribed by that Part must be included in a particular agreement, i.e., whether the agreement is a subcontract for purposes of that FAR Part.

This leads to the next point regarding so-called “flow-down” clauses. For purposes of this article, “flow-down” clauses will be clauses from the prime contract that are to be included in subcontracts. There are two types of “flow-down” clauses: mandatory and necessary. Mandatory flow-down clauses are those that, by their terms, must be included in subcontracts. Prime examples of this type of clause are the audit clause FAR 52.215-2 and the EEO clause discussed above, FAR 52.222-26.

Even if a clause is a mandatory flow-down clause, there still may be identification issues in regard to whether a subcontract exists to which it applies. That is because such clauses may be limited by subcontractor status, contract value, contract type, or contract object. Thus, a determination must be made as to whether the subcontract meets the criteria for inclusion of the clause. For example, FAR 52.219-9, Small Business Subcontracting Plan, requires such a plan from all subcontractors, other than small business concerns, whose subcontracts are expected to exceed $550,000 or $1,000,000 for construction. The prime contractor is responsible for making these determinations in the first instance, subject to an override by the contracting officer.

Because several clauses, such as 52.219-9, have thresholds for application, it is important to know how to compute the value of a contract. FAR 1.108(c) provides the following guidance:

Unless otherwise specified, a specific dollar threshold for the purpose of applicability is the final anticipated dollar value of the action, including the dollar value of all options. If the action establishes a maximum quantity of supplies or services to be acquired or establishes a ceiling price or establishes the final price to be based on future events, the final anticipated dollar value must be the highest final priced alternative to the government, including the dollar value of all options.

Note that under this guidance, if a contract has priced options, you consider the priced options in determining the total value of the contract. Concluding on this point, it will be noted that this guidance does not specifically address IDIQ contracts that contain a maximum quantity the government may, but is not obligated to order, and a minimum quantity that the government is obligated to order, but no more.

Typically, the government takes the position that the maximum quantity is to be used in determining the value of an IDIQ contract. However, this is illogical in regard to multiple award IDIQ contracts under which no contractor is assured of receiving more than the minimum amount. Further, as a general matter, it is questionable whether this is a valid interpretation of this guidance in light of some fairly recent Federal Circuit Court decisions determining the value of IDIQ contracts in the context of a termination. In those decisions, the Court held that the anticipated value of the contracts was the minimum quantity.

What are “necessary” flow-down clauses? These are clauses that are necessary for the prime contractor to carry out its responsibilities under the prime contract. For example, prime contractors should include a Changes clause, an Inspection clause and a Convenience Termination clause in their subcontracts. In this regard, it must be remembered that there is no requirement that a subcontract be of the same type as the prime contract. Thus, it is conceivable to have a fixed-price subcontract under a time-and-materials prime contract.

In this situation, the clause in the subcontract would be different from the clause in the prime contract, but would serve the same purpose. Moreover, because these clauses are not mandatory, the language used in these clauses does not have to mirror the language in a standard FAR clause. For example, a prime contractor can modify the language of a standard FAR Changes clause to suit its own purposes when including such a clause in subcontracts.

When flowing clauses down from a prime contract to a subcontract, one of the worst things a prime contractor can do is simply incorporate the clauses from its prime contract in the subcontract. First, many of the clauses may not apply to the subcontractor, for example either because of its status as a small business or the dollar value of the subcontract is below the threshold for application of the clauses. Second, one of the primary rules of contract interpretation is that a contract is to be read so that a reasonable meaning is given to all its terms if possible, rendering no part meaningless.

If a clause is inserted into a subcontract improperly, this complicates the contract interpretation process. Finally, if you are the prime contractor, improper incorporation of clauses from the prime contract into a subcontract without critical analysis does not put your best foot forward in your dealings with your subcontractor business partners.

John is a Senior Government Contracting Consultant with CB&H and a member of the Firm's Government Contractor Services Group.