Nonmanufacturer Rule Violation Leads To Default Termination

A procuring agency appropriately terminated a small business set-aside contract for default when the SBA determined, after contract award, that the prime contractor was not complying with the nonmanufacturer rule.

A recent decision of the Armed Service Board of Contract Appeals involved a very interesting factual situation, in which the small business in question told the SBA that it planned to perform the contract in compliance with the nonmanufacturer rule, but then failed to do so.  This failure, according to the ASBCA, justified a default termination.

The ASBCA’s decision in Third Coast Fresh Distribution, L.L.C., ASBCA No. 59696 (2016) involved a DLA solicitation for the purchase of fresh fruits and vegetables for DLA’s “Dallas TX Zone.”  The solicitation, which was issued as a small business set-aside, contemplated the award of a single IDIQ contract to service two groups: Group 1, which contained DoD customers, and Group 2, which contained non-DoD customers.  Although the DLA intended to award a single IDIQ, the DLA reserved the right to make multiple awards.

Third Coast Fresh Distribution, L.L.C., submitted a proposal.  After evaluating competitive proposals, the DLA announced that TCF was the apparent successful awardee for Group 1.  An unsuccessful competitor then filed a SBA size protest, alleging in in part that TCF would not comply with the nonmanufacturer rule.

The nonmanfacturer rule is codified in the SBA’s regulations at 13 C.F.R. 121.406.  It provides a series of qualifications that a company must meet in order to sell another company’s products under a small business set-aside contract.  Among these conditions, the nonmanufacturer rule requires that the prime contractor take ownership or possession of the items with its personnel, equipment or facilities in a manner consistent with industry practice.

In response to the size protest, TCF informed the SBA Area Office that it would take possession of the produce and would “warehouse and deliver the produce itself” using its own trucks and drivers for the majority of the deliveries.  In reliance on TCF’s representations, the SBA Area Office determined that TCF was an eligible nonmanufacturer, and denied the size protest.

Following the denial of the protest, TCF began to perform the contract.  But during the first month of performance, the Contracting Officer became aware that a third party, Brothers Produce, was making deliveries under the contract.  One DLA official reported that she had never seen TCF make any deliveries itself.

The Contracting Officer then filed a post-award size protest with the SBA.  The Contracting Officer told the SBA that TCF’s actual performance was in “stark contrast with the statements” made to the SBA Area Office during the initial size determination process.

In the course of the second size determination, TCF stated that it “had every intention” of complying with the nonmanufacturer rule, but had not found it “economically feasible” to perform many of the deliveries itself.  TCF admitted that Brothers Produce was performing much of the delivery work, but stated that it was self-performing a portion of the deliveries.

The SBA Area Office issued a second size determination, superseding the first.  In its second size determination, the SBA Area Office concluded that TCF was “other than small” and ineligible for award, because it was not in compliance with the nonmanufacturer rule.  TCF did not appeal the decision to OHA.

After receiving the second size determination, the DLA Contracting Officer issued a modification terminating the contract for default.  The notice stated that TCF had “failed to perform in the manner in which it represented to both [SBA] and the Contracting Officer . . ..”

TCF appealed its termination to the ASBCA.  TCF acknowledged that the SBA’s second size determination required that its contract be terminated, but contented that it had not defaulted on its contractual obligations.  TCF asked the ASBCA to convert the termination to a termination for convenience.

The ASBCA wrote that “the clear purpose of the non-manufacturer rule is to prevent brokerage-type arrangements whereby small ‘front’ organizations are set up to bid [on] government contracts, but furnish the supplies of a large concern.”  The ASBCA continued:

It would be senseless if contractors could merely say they will comply with [the nonmanufacturer rule] at the time of proposal, but not have to perform accordingly.  Qualifying as a small concern was a condition of the contract.  Tak[ing] ownership or possession of the item(s) with its personnel, equipment or facilities was a condition for TCF to qualify as a small concern.  SBA found that TCF failed to do that.  Accordingly, the undisputed facts demonstrate that TCF did not comply with a condition and performance requirement of the contract.

The ASBCA denied TCF’s appeal, and granted the DLA’s motion for summary judgment.

Some contractors believe that if they survive a size protest initiated by a competitor, issues of small business eligibility are “off the table” forever with respect to the contract in question.  Not so.  As the Third Coast Fresh Distribution case demonstrates, a Contracting Officer can raise size eligibility questions at any time, even after the period for competitors to raise such issues has long expired.  And where, as here, the SBA determines that a company performing a small business set-aside contract is not an eligible small business, the Contracting Officer may be entitled to terminate the contract for default.