SBA New Rule: Guidelines for Compliance with Limitations on Subcontracting in 13 C.F.R. 125.6

13 C.F.R. § 125.6 sets out the limitations on subcontracting for all small business set-asides (including 8(a), SDVOSB/VOSB, HUBzone, and WOSB/EDWOSB set asides.) These limitations on subcontracting are crucial for any small business federal contractor to be familiar with, and we have discussed how they work here. But, while the regulation does provide for certain legal penalties for violations of these limitations, up until SBA’s recent rule change, it didn’t provide for any direct consequences for a company’s past performance (although conceivably an agency could mention limitations on subcontracting as part of a CPARS review). Furthermore, SBA now will require that compliance with the limitations be looked at on an order-by-order basis for multi-agency set aside contracts where more than one agency can issue orders under the contract, and for full and open contracts where the task order is set aside for small businesses. All this is effective May 30, 2023, and we explore these changes here.

On April 27, 2023, SBA released its long-awaited rule change that it first proposed back on September 9, 2022. We have explored what this change does in general and, more specifically, its impact on the ostensible subcontractor rule for size affiliation. Now, we are going to explore another way in which this rule will change things for federal contractors: the limitations on subcontracting.

Task Order by Task Order Limitations on Subcontracting

In its discussion of the old rule in the April 27, 2023 issuance of the new rule, SBA noted:

“Section 125.6(d) provides that the period of time used to determine compliance for a total or partial set-aside contract will generally be the base term and then each subsequent option period. This makes sense when one agency oversees and monitors a contract. However, on a multi-agency set-aside contract, where more than one agency can issue orders under the contract, no one agency can practically monitor and track compliance.”

This was true. For these contracts, where multiple agencies are involved and will each issue task orders, the contracting officers would not be aware of how the contractor was doing compliance-wise regarding orders issued by other agencies. While the COs could require the contractor to comply on an order-by-order basis, they did not have to. SBA felt this was an oversight, and so now, the rule will state as follows:

“However, for a multi-agency set aside contract where more than one agency can issue orders under the contract, the ordering agency must use the period of performance for each order to determine compliance.” 13 C.F.R. § 125.6(d). In other words, for these set-aside contracts, where there are task orders and different agencies can issue task orders under the contract, the contractor will need to show its compliance with the limitations on subcontracting separately for each order. In addition to this, SBA added another portion to the rule:

“For an order set aside under a full and open contract or a full and open contract with reserve, the agency will use the period of performance for each order to determine compliance unless the order is competed among small and other-than-small businesses (in which case the subcontracting limitations will not apply).” 13 C.F.R. § 125.6(d). This means that for unrestricted contracts that nonetheless allow for set aside task orders, if the order is indeed set aside, the contractor will need to show compliance with the limitations under that order.

For all the other set-asides, however, the rule will remain that unless the CO says otherwise, the contractor just has to show compliance with the limitations on subcontracting from the perspective of the whole contract combined. To clarify, this means that going past the limitations for a task order is not necessarily a problem if the contractor makes up for it with the rest of the contract. If a contractor is not sure how an agency is measuring compliance, though, it’s always good to check with the agency.

Consequences for Violations of Limitations of Subcontracting

While 13 C.F.R. § 125.6 did provide for penalties for violations of the limitations of subcontracting, it did not provide for any impact on a contractor’s past performance. SBA decided to change that. Now, contracting officers are to evaluate compliance with the limitations where they apply:

“(e) Past Performance Evaluation. Where an agency determines that a contractor has not met the applicable limitation on subcontracting requirement at the conclusion of contract performance, the agency must notify the business concern and give it the opportunity to explain any extenuating or mitigating circumstances that negatively impacted its ability to do so.” 13 C.F.R. 125.6(e).

The effects of the rule can be serious. If the contractor does not provide an extenuating or mitigating circumstance, or the agency find the concern’s failure to meet the limitations were due to factors within its control, “the agency may not give a satisfactory or higher past performance rating for the appropriate factor or subfactor in accordance with FAR 42.1503.” 13 C.F.R. § 125.6(e)(1). (While FAR 42.1503 has allowed for past performance evaluation based on “failure to comply with limitations on subcontracting,” the new SBA rule is much more robust). Furthermore, even if the CO accepts the contractor’s excuse, the CO cannot give a satisfactory or higher rating unless “the individual at least one level above the contracting officer concurs with that determination.” 13 C.F.R. § 125.6(e)(2). In other words, the CO needs to get approval to make that call.

What are these extenuating circumstances? Well, it will depend on each case, but the regulation provides examples:

“Extenuating or mitigating circumstances that could lead to a satisfactory/positive rating include, but are not limited to, unforeseen labor shortages, modifications to the contract’s scope of work which were requested or directed by the Government, emergency or rapid response requirements that demand immediate subcontracting actions by the prime small business concern, unexpected changes to a subcontractor’s designation as a similarly situated entity (as defined in § 125.1), differing site or environmental conditions which arose during the course of performance, force majeure events, and the contractor’s good faith reliance upon a similarly situated subcontractor’s representation of size or relevant socioeconomic status.” 13 C.F.R. § 125.6(e)(2)(i).

Note that the language says “could” lead to a satisfactory/positive rating. Don’t assume that because one of these factors are present that that means you’re in the clear. The agency still has to agree with you on it. Furthermore, “an agency cannot rely on any circumstances that were within the contractor’s control, or those which could have been mitigated without imposing an undue cost or burden on the contractor.” 13 C.F.R. § 125.6(e)(2)(ii). If you could have reasonably prevented or mitigated the problem, you will be out of luck.

The limitations on subcontracting already were seriously important for contractors to pay attention to. Now, they are even more important as there is a more direct path for a CO to impose a past performance penalty on a small business. While the new rule does take into account those situations where the contractor could not reasonably comply with the limitations on subcontracting, it does not suggest that any excuses for violations will be accepted readily by the government. If you become aware that meeting the limitations might become an issue and its something you really can’t reasonably do anything about, we now even more strongly recommend you maintain good communications with your CO on this. It could make the difference not just for legal penalties, but for your company’s past performance too. These new tighter rules show SBA is going to be taking the limitations on subcontracting even more seriously, so contractors should follow suit.

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