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Government Contractors

SBA Final Rules on Subcontracting Limitations and More

By: John N. Ford, JD; Senior Consultant 

On May 31, 2016, the U.S. Small Business Administration (“SBA”) issued its long-awaited final rule that implements certain small business-related provisions of the National Defense Authorization Act of 2013 (“NDAA”). The final rule includes key changes in the Limitations on Subcontracting regulation.

In most cases, the final rule was adopted with little or no changes to the provisions of the proposed rule issued on December 29, 2014. However, in response to public comments on the proposed rule, SBA made important changes, including amendments regarding subcontractors that qualify as “similarly situated” for purposes of the limitations on subcontracting, as well as how contracts for both services and supplies – described as “mixed” contracts – are treated for such purposes.

In addition to the limitations on subcontracting provisions, the final rule addresses numerous other SBA programs and requirements, including: the HUBZone program, subcontracting plans, the identity of interest affiliation rule, joint ventures, the calculation of annual receipts, recertification following a merger or acquisition, the Small Business Innovation Research /Small Business Technology Transfer programs, size protests and North American Industry Classification System appeals, application of the non-manufacturer rule to software procurements, “adverse impact” analyses on construction contracts and the Certificate of Competency program.

Limitations on Subcontracting

Section 1651 of the NDAA changed the formula for calculating the limitations on subcontracting under all types of small business set-aside contracts. The change provides that the analysis, rather than being based on costs, will be based on contract value. SBA regulations and the implementing Federal Acquisition Regulation (“FAR”) clause 52.219-14, Limitations on Subcontracting, required a small business prime contractor to perform with its own personnel a certain percentage of the cost of total direct labor on the contract, depending on whether the contract is primarily for services, supply, construction or specialty trade construction. According to the new Section adopted in the May 31 final rule, compliance will be determined by a percentage cap on the total amount of the prime contract that may be paid to subcontractors.

The final rule changes the approach to making the calculation, but the basic percentage limits remain the same. For service and supply contracts, small business prime contractors can have no more than 50 percent of the total amount paid under the prime contract paid to subcontractors. For general construction contracts, the percentage is 85 percent, and for specialty trade construction, the percentage is 75 percent. In all such contracts, amounts paid to “similarly situated” entities are not considered “subcontracted,” and thus excluded from the limitation.

Similarly Situated Subcontractors

Big differences between the May 31 final rule and the December 29, 2014, proposed rule relate to “similarly situated” subcontractors. Consistent with the underlying statute, the proposed rule, and now the final rule, make clear that a small business prime contractor need not include the amounts subcontracted to a “similarly situated” subcontractor (i.e., another business concern that falls into the same size or socioeconomic category for purposes of set-aside contracts) in determining the subcontracted percentage allowed. In other words, work subcontracted to similarly situated subcontractors will count as work done by the prime contractor for Limitation on Subcontracting purposes. The exception for similarly situated subcontractors applies to all four types of contracts described in FAR 52.219-14:

  1. Services;
  2. Supplies;
  3. Construction; and
  4. Specialty Trade.

The exception will also apply to any analysis under the ostensible subcontractor affiliation rule.

The final rule did not include the language “at any tier” in the proposed rule. It seems then that only first-tier subcontractors will count as similarly situated.

Another issue revised in the final rule due to responses in public comments is that individuals classified as “independent contractors” by the Internal Revenue Service, also known as “1099” personnel, will be considered subcontractors and may count toward meeting the applicable limitation on subcontracting when the independent contractor qualifies as a similarly situated entity.

In response to public comments, the final rule also removed the requirements in the proposed rule that the prime contractor enter into a written agreement with and report to the contracting officer on compliance with respect to similarly situated entities. This removes some of the administrative burden that the proposed rule would have applied to prime contractors seeking to take advantage of the exception for similarly situated subcontractors.

Mixed Contracts/Cost of Materials

The final rule uses the term “mixed contract” for a contract that combines both services and supplies. For such a contract, the rule requires that the contracting officer select a ”…single NAICS code which best describes the principal purpose of the product or service being acquired.” That NAICS is then used to determine which limitation on subcontracting – services or supplies – is applicable.

The final rule states that the subcontracting limitation applies only to the portion of the award amount determined to represent the principal purpose of the contract.

Additional Provisions

Small businesses may be impacted by language in the final rule on issues such as affiliation, joint ventures and recertification.

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