Limitations on Subcontracting: FAR Council Finally Proposes Rule Change

For small government contractors, the disconnect between the SBA’s updated limitations on subcontracting rule and the FAR’s outdated rules has been very confusing.  For more than two years, the FAR and SBA regulation have used different formulas to determine compliance, and the SBA rule–but not the FAR–allows the use of “similarly situated entities” on small business set-asides and 8(a) contracts.

This has created major headaches for small businesses, who have had no definitive answer to what should be a simple question: “which rule do I follow?”  Now, finally, there is some important progress to report in clearing up this discrepancy: yesterday, the FAR Council issued a proposed rule to update the FAR’s limitations on subcontracting provisions and conform them to the SBA’s rule.

By way of quick background, way back in January 2013, former President Obama signed the 2013 National Defense Authorization Act into law. The 2013 NDAA made major changes to the limitations on subcontracting.  The law changed the way that compliance with the limitations on subcontracting is calculated for service and supply contracts–from formulas based on “cost of personnel” and “cost of manufacturing,” to formulas based on the amount paid by the government.  And, importantly, the 2013 NDAA allowed small primes to claim performance credit for “similarly situated entities.”

Interestingly, about a year later–well before either the SBA or the FAR Council had amended the corresponding regulations–the GAO issued a decision suggesting (although not directly holding) that the similarly situated entity concept was currently effective.  But most contractors and Contracting Officers continued to apply the “old” rules under the FAR and SBA regulations.

On May 31, 2016–about three and a half years after the 2013 NDAA was signed into law–the SBA published a final rule implementing the changes, now codified at 13 C.F.R. 125.6.  The SBA’s regulation took effect on June 30, 2016.  Less than a month later, the VA issued a Class Deviation, incorporating by reference the new SBA regulations for VA SDVOSB and VOSB acquisitions.  But for many other procurements, contracting officers continued to include FAR 52.219-14, which uses the old formulas and makes no mention of similarly situated entities.  (FAR 52.219-14 applies to small business and 8(a) contracts.  For HUBZone, non-VA SDVOSB procurements, and WOSB/EDWOSB contracts, the subcontracting limits are implemented by other clauses).

This, of course, has led to a lot of confusion.  Does a prime contractor comply with the SBA regulation?  The FAR clause?  Both?  Some contracting officers have taken the position that the FAR clauses govern until they’re amended.  But the SBA, of course, wants contractors to follow the SBA regulations.  Indeed, a joint venture formed under the SBA’s regulations must pledge to comply with 13 C.F.R. 125.6.  It’s been (to use official legal terminology), a hot mess.

Now, more than two years after the SBA updated its regulations, the FAR Council has finally taken the first major step toward corresponding changes.  Yesterday, the FAR Council published a proposed rule in the Federal Register, which, when finalized, will update the FAR to conform with the SBA’s regulation and the underlying statute.

The substance of the proposed FAR rule isn’t terribly surprising, nor should it be.  Substantively, the rule largely conforms with the SBA’s rule codified in 13 C.F.R. 125.6.  Indeed, in its commentary discussing the proposed rule, the FAR Council repeatedly mentions the intent to align the FAR with the SBA’s regulation.

That said, I thought a few points were worthy of mention:

  • FAR 52.219-14 Expanded.  Instead of the hodgepodge of FAR clauses governing limitations on subcontracting, the revised FAR proposal would consolidate the limitations on subcontracting for all small business programs in FAR 52.219-14.
  • Nonmanufacturer Rule Changes.  The proposed rule would provide more guidance to Contracting Officers and contractors alike regarding the application of the nonmanufacturer rule.  Among other things, the proposed rule implements a 2016 SBA change requiring Contracting Officers to notify offerors when a nonmanufacturer rule waiver will apply.  The proposed rule would also eliminate the requirement under FAR 19.1303, that, for a HUBZone firm to qualify as a nonmanufacturer, the end manufacturer also must be a HUBZone company.
  • Similarly Situated Entities.  The proposed rule would, as expected, allow prime contractors to use similarly situated entities to meet their performance thresholds.  This is great news for small businesses, many of whom have wondered whether, in the absence of a FAR change, they can avail themselves of the statutory and SBA provisions regarding similarly situated entities.
  • HUBZone Price Preference.  The proposed rule would allow HUBZone firms to obtain the HUBZone price preference by subcontracting to other HUBZones.  So far, so good.  More troubling, however, the proposed rule states that in a HUBZone joint venture, the “HUBZone small business concerns to the joint venture” would have to meet the applicable limitations on subcontracting.  That strikes me as an incorrect conflation of the limitations on subcontracting, on the one hand, and the SBA’s internal work share rules for joint ventures, on the other.  We’ll see how this gets addressed in the final rule but I hope the SBA weighs in to help clear this up.

The FAR Council is accepting comments on the proposed rule until February 4, 2019.  From there, public comments will be considered and a final rule issued, probably sometime in mid-to late-2019.

For now, of course, this remains a proposed rule, and the disconnect between the FAR and the SBA regulation remains.  But at least things are moving in the right direction.