The Small Business Administration (SBA) Office of Inspector General (OIG) has a mission to “provide independent, objective, and timely oversight to improve the integrity, accountability, and performance of SBA and its programs.” As part of this mission, it investigated and recently issued a report on the federal government’s “oversight work to identify opportunities to strengthen federal-wide compliance with limitations on subcontracting requirements for set-aside awards.” The SBA’s rules on limitations on subcontracting limit how much of a federal contract a small business prime contractor can subcontract to subcontractors that are not similarly situated. OIG identified a number of areas where federal agencies could improve their oversight of small business subcontracting, noting “recurring deficiencies in the federal contracting community’s ability to interpret the rule’s requirements, apply them consistently, and monitor and enforce compliance throughout the life of a contract.” SBA has indicated it will issue a revised rule to address some of these concerns. Let’s take a look.
SBA OIG recently issued a report titled “Consolidated OIG Findings on Subcontracting Limitation Concerns for Set-Aside Awards.” Here are some of the main takeaways.
Limitations on Subcontracting (or LOS)
The SBA’s rules on limitations on subcontracting set limits on how much work assigned to a prime contractor may be subcontracted by the prime contractor to subcontractors that are not similarly situated. Our earlier blog post provides a good overview of the regulations in this area, primarily found in 13 C.F.R. § 125.6 and FAR 52.219-14.
As summarized in the OIG report: “Payments to subcontractors that do not share the same small business program status that qualified the prime contractor for the award may not exceed a specified percentage of the total contract value—50 percent for services and supplies; 85 percent for general construction; and 75 percent for specialty trade construction.” In addition, SBA will treat subcontracting dollars “paid to a similarly situated entity as performance by the prime contractor, rather than as subcontracted amounts, when the entity shares the prime’s small business program status that was required for the award, and meets the applicable size standard.”
There can be stiff penalties for noncompliance. These include fines up to $500,000 or “the amount over the allowed subcontracting limit, whichever is higher” and failure to comply can also lead to proposed debarment.
The Report
The report reviewed OIG reports from the (SBA), General Services Administration (SBA), Department of Energy, Department of the Interior (DOI), and Department of War (DoW). The OIG “identified recurring deficiencies in the federal contracting community’s ability to interpret the rule’s requirements, apply them consistently, and monitor and enforce compliance throughout the life of a contract.” The SBA reviewed oversight reports across these agencies.
OIG cited to a situation involving a large contractor who settled with the government for a $21.3 million False Claims Act settlement. This was based on allegations that the large contractor “used small businesses, including several service-disabled veteran-owned firms, as pass-through entities to obtain more than 90 set-aside contracts”; and the contractor allegedly “managed the contracts, performed the vital and primary requirements, assigned the work, and received the majority of the payments while the small business prime (as the original awardee) retained only 1-3 percent of the more than $200 million in aggregate government contract value.”
Report Findings
The OIG found that there was confusion over whose job it was to monitor compliance with the limitations on subcontracting, writing that “contracting personnel misunderstood the subcontracting limitations requirements, which led to confusion about roles and responsibilities, gaps in compliance, and assumptions that other officials were performing key monitoring tasks.” Here are the key areas of concern identified by the OIG:
- Reliance on Contractor’s Intent to Comply. Agencies handle this different ways. GSA simply “accepted the contractor’s self-reported assurance of compliance,” while at DoW, “some personnel relied on the contractor’s proposal and planned work distribution as a form of verification.” The inconsistencies suggest that the regulations should clarify how agencies should check compliance.
- Monitoring, Assessing, and Enforcing Compliance. The report notes that “compliance with LOS is based on the amounts paid by the government and is generally assessed at the end of the base period and each subsequent option period. For a multi-agency contract, the ordering agency must assess compliance separately for each order.” Many agencies demonstrated clear understanding of this component. DOI stated that “personnel were unaware of the correct performance percentage applicable to their contracts and of how deductions for material costs affect compliance calculations.” While DoW “reported that contracting personnel did not believe they were required to track what prime contractors paid their subcontractors, underscoring a disconnect between the duty to monitor compliance and the evidence needed to do so.” The regulations, though, “make it optional for the contracting officer to obtain evidence to enforce compliance.” The regulations should be clarified so compliance is more uniform.
- Delegation of Monitoring Duties. “GSA OIG found that a contracting officer believed the COR was responsible for monitoring compliance, even though that task was not delegated in the COR’s delegation letter.”
- Ostensible Subcontractor. An ostensible subcontractor “performs a contract’s primary and vital requirements or one in which the prime contractor is unusually reliant, indicating that the subcontractor is effectively acting as the prime.” OIG reports showed heavy reliance on subcontractors, but there was no follow-up from agencies. For example, “GSA OIG reported that a prime performed no direct labor, had only one superintendent on site, delegated negotiations to a subcontractor, and paid another subcontractor for administrative and closeout work.” This suggests agencies should do more to monitor compliance before and during award.
- CPARS Performance Assessments. The report noted that “assessing limitations on subcontracting compliance and documenting that assessment in CPARS is mandatory.” But “contracting officers often failed to document contractor performance ratings in CPARS within required timeframes, completing them only after audit inquiries prompted them to do so.”
- Sub-Award Reporting Enforcement. Small business prime contractors with gross income over $300,000 must report first-tier subcontract awards of $40,000 or more, but “DoW contracting personnel said they were unaware that small business primes had this reporting obligation.” This info can be used as a proxy for monitoring LOS compliance.
- Contractor Responsibility Assessment Not Performed. In one case, “GSA OIG found that contracting personnel did not evaluate the contractor’s past performance or prior experience—both relevant to a responsibility determination—and did not evaluate its capability to perform the work and comply with limitations on subcontracting requirements. The contractor ultimately subcontracted at least 89 percent of the total project, well above the applicable limit.”
The report provides two main recommendations. 1. Clarifying regulations to make monitoring of LOS mandatory. 2. Increased guidance for contracting personnel.
Other Direct Costs
The SBA LOS rule “was revised in 2019 to permit service contracts to deduct certain other direct costs that are ancillary to the contract’s main purpose from the payment base used to calculate LOS compliance.” “SBA’s rule revision allowed for the deduction of other direct costs without sufficient safeguards, such as documenting agreement at the time of award, costs considered substantive to the contract’s main purpose, and costs which will be considered incidental.” The report notes that “contractors can leverage this flexibility after the fact to meet LOS thresholds, effectively diluting the statutory requirement.”
In one example, “small business prime contractor claimed that more than $13 million in certain data provider fees were excludable other direct costs, allowing it to stay within the 50 percent subcontracting threshold.” And there was little verification of these claimed costs. The OIR best practice is “that SBA establish pre-award procedures to document, at the time of award, agreement on which costs are excludable as other direct costs.”
SBA Response.
“SBA plans to revise regulations to set new subcontracting thresholds, clarify oversight and tracking procedures, strengthen guidance, and remove unclear language that impedes enforceability of the limitations on subcontracting. Management plans to complete a draft revision to 13 CFR 125.6 by April 1, 2027.” This means that LOS enforcement and monitoring should become much more common sometime in 2027 or later once the rule goes into effect.
SBA also pointed out that “[c]urrent regulations on Limitations on Subcontracting allow for wasteful and abusive pass-through contracts, in part by requiring as little as 15 percent of a small business construction contract to be performed by small businesses.” So, this rule may be changing in the upcoming proposed regulation in 2027.
Conclusion
Stay tuned as SBA seems focused and intent on updating enforcement and regulations concerning LOS. This should result in updated regulations to make monitoring more consistent, if not mandatory. And there is the possibility that SBA changes the percentages for various types of contracts, including construction. We will keep you updated on SmallGovCon.
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