Limitations On Subcontracting: Congress Enacts Major Changes

Congress has enacted major changes to the limitations on subcontracting rules for small government contractors.

The 2013 National Defense Authorization Act, signed into law by President Obama on January 3, contains two important changes to the subcontracting limits.  First, for services contracts, compliance with the limitations on subcontracting will be based on the total amount paid to the small business, not the cost of the contract incurred for personnel.  Second, small businesses will be able to meet their own performance requirements by subcontracting to other small companies.

The first change provides that a small business “in the case of a contract for services, may not expend on subcontractors more than 50 percent of the amount paid to the concern under the contract.”  This is a significant deviation from the current SBA regulation, 13 C.F.R. § 125.6(a)(1), which states that “[i]n the case of a contract for services (except construction), the concern will perform at least 50 percent of the cost of the contract incurred for personnel with its own employees.”

The new requirement should make it easier for contractors to determine whether they are complying with the subcontracting limits.  Small businesses will not need to break down their own costs (and those of their subcontractors) in an effort to determine which costs go into the “personnel” bucket–a process that can be especially difficult when a subcontractor does not care to share its cost breakdown with the small prime contractor.

The change from “personnel cost” to “total contract price” also has the advantage of being intuitive.  Over the years, I have spoken with many small contractors who mistakenly believed that the current regulation is based on the total contract price, and were very surprised to learn that they were supposed to be calculating their personnel costs.  The 2013 NDAA aligns the limitations on subcontracting with the underlying expectations of many contractors.

However, some small service contractors may be unhappy with the new rule.  No longer can small contractors exclude the costs of materials, supplies and other non-labor costs from their subcontracting limit calculations.  This means that many small companies may be forced to perform more work at the prime contract level in order to remain in compliance.  Congress intended this result, desiring that at least 50% of the amount paid by the government on set-aside contracts go to small businesses.

The 2013 NDAA also amends the subcontracting limits for supply contracts, providing that in the case of a contract for supplies, other than from a regular dealer in such supplies, the small business “may not expend on subcontractors more than 50 percent of the amount, less the cost of materials, paid to the concern under the contract.”  Compare this requirement to the current regulation, 13 C.F.R. § 125.6(a)(2), which states that in the case of a supply contract, the small business “will perform at least 50 percent of the cost of manufacturing the supplies or products (not including the costs of materials.)”

The 2013 NDAA does not address the limitations on subcontracting for general construction and specialty trade construction contracts, leaving such “other contracts” to the SBA’s discretion.  For now, construction contractors can assume that the current subcontracting limits will remain in place.

For small contractors worried that they will have to self-perform more work in order to meet the new subcontracting limitations, Congress has offered a lifeline of sorts.  Under the new rules created by the 2013 NDAA, a small business may meet its own performance obligations by subcontracting to a “similarly situated entity.”  In other words, a small business may satisfy its own performance requirements by subcontracting to another small business, an 8(a) company to another 8(a) company, and so on.  The rule expands on similar authority currently available to SDVOSBs and HUBZone companies under 13 C.F.R. § 125.6.

The “similarly situated entity” rule will allow small businesses greater flexibility to meet their performance of work obligations and should be welcomed by small government contractors.  My only quibble with the provision is that Congress did not appear to clarify that “similarly situated entity” may vary based on the type of set-aside at issue.  For instance, an 8(a) company may satisfy its performance requirements on an 8(a) set-aside by subcontracting to another 8(a) company, but that same 8(a) company should be able to satisfy its performance requirements on a small business set-aside by subcontracting to a non-8(a) small business.  Hopefully, the SBA will make this clear when it adopts regulations based on the 2013 NDAA provision.

Some small contractors may welcome the subcontracting limit changes enacted in the 2013 NDAA and others may disapprove.  Regardless, Congress has spoken, and it is critical for all small government contractors to understand their new limitations on subcontracting obligations.

One thought on “Limitations On Subcontracting: Congress Enacts Major Changes

  1. Stephen: 1) Are these new regs effectively immediately (upon signing of the NDAA) or do agencies wait to see the words flow into the FAR?
    2) Are these regs retroactive – will they be applied to existing GWACs and IDIQs and Schedule orders?
    Thanks,

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