One of the common questions small business contractors ask themselves when planning performance of a contract is “how much of this work are we allowed to subcontract?” Trying to answer this question inevitably leads contractors to one of the most commonly used and frequently misunderstood rules in federal contracting, the Limitations on Subcontracting. In this post, we will break down some of the basics of this rule, and hopefully clear up any basic misunderstandings regarding it.
What is the Limitations on Subcontracting rule?
The Limitations on Subcontracting rule is found at 13 C.F.R. § 125.6 and FAR 52.219-14. The rule sets limits on how much work assigned to a prime contractor may be subcontracted by the prime contractor to subcontractors that are not similarly situated.
Why does the Limitations on Subcontracting rule exist?
The Limitations on Subcontracting rule was created to help balance two policy goals: 1) ensuring small businesses don’t serve as “pass-throughs” for large entities; and 2) allowing small businesses the resources needed to complete set-aside and sole source contracts. By allowing subcontracting by small businesses who were awarded contracts, it gives small businesses a better chance to adequately perform contracts and gain experience they may not be able to do on their own. Meanwhile, by placing limits on the amount that can be subcontracted, it ensures that the small business has to perform some amount of meaningful work, so they don’t simply serve as pass-throughs.
When does the Limitations on Subcontracting rule apply?
This rule is applied in two situations:
- When a contract is set-aside for small business that has a value above the simplified acquisition threshold; or
- When a contract is set aside or sole-sourced for 8(a) BD Program, SDVOSB/VOSB, WOSB/EDWOSB, or HUBZone participants.
Does the anticipated performance provided under the contract effect the Limitations on Subcontracting rule?
The Limitations on Subcontracting rule dictates how much a prime contractor may subcontract, based on what category of contract was awarded. The rule places contracts in four categories:
- Services contracts
- Supplies contracts
- General Construction contracts
- Specialty Trade Construction contracts
What category a contract falls into is determined by the NAICS code assigned to it. For example: if the NAICS code description states it is for services, it is likely that it would fall under the services contract category.
What are the limitations on subcontracting?
- Service contracts allow for 50% of the work to be subcontracted out
- Supply contracts allow for 50% of the work to be subcontracted out
- IMPORTANT NOTE: This does not apply when the nonmanufacturer rule is being utilized, as it has its own rules around subcontracting. For more information on the nonmanufacturer rule, check out our Back to Basics post on the nonmanufacturer rule.
- General Construction contracts allow for 85% of the work to be subcontracted
- Specialty Construction contracts allow for 75% of the work to be subcontracted
How are the limitations on subcontracting applied?
To determine how much can be subcontracted and apply the designated percentage, contractors should look at the overall dollar value amount of the contract itself. Then, the designated percentage is applied to the dollar value amount of the contract. This should give contractors the amount of the contract that may be subcontracted. For example, if there is a service contract for $500,000, 50% of $500,000 (or $250,000) would be the maximum that could be subcontracted.
Are there any exceptions to the Limitations on Subcontracting rule?
Depending on the category of the contract, there are certain designated items in the rule that could have their dollar value subtracted from the total contract dollar value amount prior to applying the subcontracting percentage. The most common exception is that the cost of materials is excluded from the calculation for all construction contracts and for supply contracts as well. Additionally, if the small business prime contractor subcontracts to a “similarly situated entity,” it can actually count towards the prime contractor’s required performance and is considered not to be subcontracted for purposes of the rule.
What is a “Similarly Situated Entity”?
A similarly situated entity is a subcontractor that has the same socioeconomic designation required by the prime contract (i.e., SDVOSB, 8(a) etc.). It is important to remember that being a similarly situated entity is not something that is set in stone for the life of a contract, but rather is something that could change at any time based on the subcontractor’s business growth, certification status, or other changes in circumstance. So, any prime contractors looking to use this portion of the Limitation on Subcontracting, should be in regular contact with their subcontractor regarding its size and/or certification status.
What happens if I don’t follow the Limitations on Subcontracting rule?
The consequences for not following the Limitations on Subcontracting rule can be quite varied. The regulation itself states that there could be substantial fines placed on contractors, and possibly even debarment.
The Limitations on Subcontracting rule can feel quite complicated, and its application is always very contract specific. Hopefully this blog post will help clear up the basics of the rule, and some of the rationale behind it. If you find yourself grappling with the Limitations on Subcontracting rule, give us a call and we would be happy to help analyze your situation.
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