Update to Limitations on Subcontracting

By: John Ford, Senior Consultant

For many years, small business contractors performing on set aside contracts were limited in the amount of work that could be subcontracted. This limitation was generally, and misleadingly, referred to as the 50 percent rule. Under this rule, the amount contractors could subcontract was measured in terms of a percentage of the costs incurred for contract performance usually tied to labor costs. Moreover, the measurement of the amount of work that could be subcontracted depended on whether the contract called for services, supplies, construction by general contractors or construction by special trades. Further, the subcontracts to which the limitation on subcontracting was applied depended on whether the contractor was a Service-Disabled Veteran-Owned Small Business (“SDVOSB”), a HUBZone Small Business (“SB”) or another category of small business. Finally, there are different Federal Acquisition Regulation (“FAR”) clauses that are used to impose these limitations on small business contractors.

Specifically, FAR 52.219-14 is to be inserted in all 8(a) contracts; FAR 52.219-3 is to be inserted in all HUBZone contracts; FAR 52.219-27 is to be inserted in all SDVOSB contracts; FAR 52.219-29 is to be inserted in all contracts awarded to Economically Disadvantaged Woman-Owned Small Businesses “(EDWOSBs”); FAR 52.219-30 is to be inserted in all contracts awarded to Women Owned Small Businesses (“WOSBs”). However, FAR 52.219-14 is only to be inserted in small business set aside contracts that exceed the simplified acquisition threshold (“SAT”). All of this is about to change because of congressional action.

Section 1651 of the 2013 National Defense Authorization Act (“NDAA”) added 15 U.S.C. §657s to the U.S. Code and drastically revised the 50 percent rule. As revised by section 1651, in the case of a sole source or set aside contract for services, a contractor may not expend on subcontractors more than 50 percent of the amount paid to the concern under the contract. In the case of a sole source or set aside contract for supplies, the contractor may not expend on subcontractors more than 50 percent of the amount, less the cost of materials, paid to the concern under the contract. Section 1651 did not provide for specific limitations on subcontracting for construction contracts. Instead, it left it up to the Small Business Administration (“SBA”) Administrator to establish appropriate limitations through the rulemaking process.

As a result of the changes made by the NDAA, the limitation on subcontracting is no longer based on cost of performance, but on the amount paid to the small business contractor. In addition, the NDAA expanded the concept of a similarly situated subcontractor so that it now applies to any category of small business. For these purposes, a similarly situated subcontractor is a small business that falls within the same small business category as the prime contractor. For example, an 8(a) subcontractor would be considered a similarly situated subcontractor as an 8(a) prime contractor. If a contract is set aside for small business concerns without regard to socio-economic status, any small business would be considered a similarly situated subcontractor. This expansion is significant because previously, the concept of a similarly situated subcontractor only applied in regard to contracts set aside for SDVOSBs and HUBZone SBs.

Finally, the NDAA provided that subcontracts awarded to similarly situated subcontractors would not be considered in determining compliance with the revised limitations on subcontracting. Thus, a small business concern may plan on performing 30 percent of the contract itself, subcontracting another 40 percent to other small business concerns and 30 percent to large businesses. In this example, the small business contractor is compliant with the NDAA limitation on subcontracting although it will only perform 30 percent of the work.

Unfortunately, Section 1651 did not address how the revised 50 percent rule would be applied in regard to task or delivery order contracts or explain the period of time that would be used to determine compliance with the new limitations on subcontracting.

The SBA revised its rules on May 31, 2016, to implement Section 1651. The primary changes to the SBA rules are found in 13 CFR §125.6. This section substantially mirrors what is in Sec. 1651, but it adds some clarifying language. Further, the SBA rules addressed revised limitations on subcontracting for construction contracts. In the case of a contract for general construction set aside for any class of SBCs, the contractor will not pay more than 85 percent of the amount paid by the government to it to firms that are not similarly situated. The cost of materials is not considered to be a subcontract cost. Any work that a similarly situated subcontractor further subcontracts will count towards the 85 percent subcontract amount that cannot be exceeded. In the case of a contract for special trade contractors set aside for any category of SBCs, no more than 75 percent of the amount paid by the government to the prime may be paid to firms that are not similarly situated. The cost of materials is not considered to be a subcontract cost. Any work that a similarly situated subcontractor further subcontracts will count towards the 75 percent subcontract amount that cannot be exceeded.

In addition to revising its rules on how the limitation on subcontracting would be computed, the SBA also addressed the period over which compliance would be measured. In this regard, the period of time used to determine compliance for a total or partial set-aside contract will be the base term and then each subsequent option period. For an order set aside under a full and open contract or a full and open contract with reserve, the agency will use the period of performance for each order to determine compliance unless the order is competed among small and other-than-small businesses (in which case the subcontracting limitations will not apply). The contracting officer, in his or her discretion, may require the concern to comply with the applicable limitations on subcontracting for each order awarded under a total or partial set-aside contract.

Although the SBA amended its rules to implement the NDAA in May 2016, it was not until December 4, 2018, that the FAR Councils published proposed revisions to the FAR to recognize the new limitations on subcontracting. Comments on the proposed rule were due February 4, 2019.

Under the proposed FAR changes, the separate clauses listed above would be eliminated from the FAR, except 52.219-14, which will be inserted in all sole source contracts or contracts set aside for any category of small business and, generally, without regard to the expected value of the contract. However, the revised clause is not to be used in small business sole source or set-aside contracts that do not exceed the SAT or contracts for COTS items.

The revised FAR 52.219-14 incorporates the limitation on subcontracting contained in the SBA’s rules, including the concept of similarly situated subcontractors. The proposed FAR rule does not discuss the period used to determine compliance with the limitation on subcontracting. The proposed coverage does not discuss allowing the contracting officer to apply the limitation on subcontracting to each order under a task or delivery order contract.

On December 3, 2018, the Department of Defense issued Class Deviation 2019-0ooo3, Limitations on Subcontracting for Small Business. The class deviation was effective upon issuance and is applicable to solicitations issued and contracts awarded after December 3, 2018. In addition, the revised limitations on subcontracting described in the deviation apply to task and delivery orders to any category of small business concerns. Although the deviation does not specifically state that it applies to task or delivery orders under existing contracts, it clearly indicates that it is. However, the deviation does not discuss modifying existing indefinite delivery contracts to include the clauses revised by the deviation. Nevertheless, such modifications are clearly implied in order to facilitate the use of the revised clauses when issuing orders. Similarly, the deviation does not discuss modifying other contract types to apply to future contract actions such as the exercise of options.

The deviation amended the clauses discussed above to update the limitation on subcontracting language in each to be consistent with the language in the SBA rules (i.e., the amount of the contract price that cannot be paid to firms that are not similarly situated to the contractor). Importantly, the deviation does not change the applicability of any of the current FAR clauses.

The deviation does not discuss the period of time used to determine compliance and does not discuss the discretion the SBA rules give contracting officers to apply the limitation on subcontracting at the order level.