SUBCONTRACTING LIMITATIONS Robert Ruggieri Michael Richard October 11, 2018

Essential Concepts Small Business Regulations in Context What is a Set Aside Contract What is Small Which law governs When do these regulations become important

Context When does this come up? Most often in the teaming context. But, could be any subcontract.

Context To understand how these regulations work, you have to understand the rationale SBA is concerned about “pass-through” situations To avoid this problem, SBA enacted 13 C.F.R. § 125.6, which establishes minimum self- performance requirements for small business prime contractors performing various types of set- aside contracts.

OLD Regulation Explained Under the old version of the regulation, compliance with the performance of work requirements differed based on the type of small business program set- aside at issue. It further differed based on whether the acquisition was for services, supplies, general construction, or specialty trade construction Also, the way in which the percentage was calculated was different

NEW REGULATION EXPLAINED Percentage changes, but ... not as much as it seems. As the SBA explains, the revised regulation “creates a shift from the concept of a required percentage of work to be performed by a prime contractor to the concept of limiting a percentage of the award amount to be spent on subcontractors.” It is a slightly different, but important, change in perspective. But the goal is the same—to keep the benefits of the set- aside programs with the intended beneficiaries

New Regulation (13 C.F.R. § 125.6) In order to be awarded a full or partial small business set-aside contract with a value greater than $150,000, an 8(a) contract, an SDVO SBC contract, a HUBZone contract, a WOSB or EDWOSB contract pursuant to part 127 of this chapter a small business concern must agree that:

New Regulation (13 C.F.R. § 125.6) In the case of a contract for services (except construction), it will pay no more than 50% of the amount paid by the government to it to firms that are not similarly situated. In the case of a contract for supplies or products (other than from a nonmanufacturer of such supplies), no more than 50% of the amount paid by the government to it to firms that are not similarly situated. In the case of a contract for general construction, it will not pay more than 85% of the amount paid by the government to it to firms that are not similarly situated. In the case of a contract for special trade contractors, no more than 75% of the amount paid by the government to the prime may be paid to firms that are not similarly situated.

SIMILARLY SITUATED ENTITIES Under the revised subcontracting limitation regulations, similarly situated entities do not count towards the percentage limitation on subcontracting A similarly situated entity is defined as “a small business subcontractor that is a participant of the same small business program that the prime contractor is a certified participant and which qualifies the prime contractor to receive the award” Additionally, an SSE must also be small for the NAICs Code applicable to the subcontract work that it is performing.

SIMILARLY SITUATED ENTITIES The SSE must perform the work subcontracted with its own employees, if not it does not that work is considered to be subcontracted to a non-SSE Example: An SSE subcontractor hired employees from its large subcontractor to perform work on its subcontract as independent contractors. Because it was not performing that work with its own employees, that portion of the work was not considered to have been performed by an SSE and the small prime ended up in violation of the limitations on subcontracting.

SIMILARLY SITUATED ENTITIES There is an exception for HUBZone procurements for commodities: In the case of a HUBZone contract for the procurement of agricultural commodities, a HUBZone SBC may not purchase the commodity from a subcontractor if the subcontractor will supply the commodity in substantially the final form in which it is to be supplied to the Government. 13 C.F.R . § 125.6(d)

Key Calculation Issues Only First Tier Subcontractors Qualify as SSE Any work that a similarly situated subcontractor further subcontracts will count towards the 50% [85% or 75%] subcontract amount that cannot be exceeded.” Exclusion for Cost of Materials This applies to supply and construction contracts, not to services contracts

Exemption from Affiliation Ostensible Subcontractor Rule “SBA will also exclude a subcontract to a similarly situated entity from consideration under the ostensible subcontractor rule” 13 C.F.R . § 125.6(c) An ostensible subcontractor is a subcontractor that is not an SSE “and performs primary and vital requirements of a contract, or of an order, or is a subcontractor upon which the prime contractor is unusually reliant.” 13 C.F.R . § 121.103(h) “[The] role of SSEs in analysis of the ostensible subcontractor rule is similar to that of the limitations on subcontracting rule, and work performed by the SSEs must be considered the equivalent of work performed by the prime contractor.” Size Appeal of: Synaptek Corp., Appellant Re: Open San Consulting, LLC d/b/a Osc Edge, SBA No. SIZ-5954, 2018 (Aug. 24, 2018)

Mixed Contracts Contracting Officer is required to select a single NAICs Code which bests describes the principal purpose of the product or service being acquired. The subcontracting limitation applies only to the portion of the award amount determined to represent the principal purpose of the contract. (need to understand more about this.)

Mixed Contracts Example: A procuring agency is acquiring both services and supplies through a small business set-aside. The total value of the requirement is $3,000,000, with the supply portion comprising $2,500,000, and the services portion comprising $500,000. The contracting officer appropriately assigns a manufacturing NAICS code to the requirement. The cost of material is $500,000. Thus, because the services portion of the contract and the cost of materials are excluded from consideration, the relevant amount for purposes of calculating the performance of work requirement is $2,000,000 and the prime and/or similarly situated entities must perform at least $1,000,000 and the prime contractor may not subcontract more than $1,000,000 to non-similarly situated entities.

Determining Compliance Compliance required during the base period and all option periods Not addressed in Rule, BUT likely required to comply for each order under a multiple award contract. Compliance will be considered an element of responsibility and not a component of size eligibility. Work performed by an independent contractor shall be considered a subcontract, and may count toward meeting the applicable limitation on subcontracting where the independent contractor qualifies as a similarly situated entity

Limitations on Subcontracting Don’t Apply Small business set-aside contracts under $150,000. However, the limitations do apply to 8(a), WOSB/EDWOSB, SDVO SBC and HUBZones set-aside contracts regardless of contract dollar amount To Subcontracts that are not to SSE’s Example: HUBZone prime contractor subcontracts 40% of the work on a services contract to a large business. That large business may subcontract as much of the work to any other business as it wants. But prime contractor still can’t exceed the applicable limitations.

Penalties and Fraud Violation of limitations on subcontracting can result in: Imprisonment for up to ten years A fine of up to $500,000 or the excess amount spent on subcontractors Suspension and debarment Ineligibility to participate in SBA programs for 3 years 13 C.F.R . § 125.6(d); 15 U.S.C. 645(d)

Penalties and Fraud Government will pursue criminal fraud charges under the right circumstances: See United States v. Crummy, 249 F. Supp. 3d 475, 478 (D.D.C. 2017): contractor convicted of fraud for obtaining 8(a) set aside contracts that were then secretly subcontracted to non-8(a) business in violation of limitations on subcontracting.

Protests Small businesses, including HUBZones, that cannot comply with limitations on subcontracting will be subject to protests from competitors: Matter of: Dorado Servs., Inc., B-411691.4 (Nov. 18, 2016) Protestor alleged that HUBZone contract awardee could not comply with limitations on subcontracting Protest was denied because there was insufficient evidence “An offeror, however, need not affirmatively demonstrate compliance with subcontracting limitations in its proposal.”

FAR 52.219-3(d) vs. SBA Regulation (13 C.F.R. 125.6) Services (except construction), at least 50 percent of the cost of personnel for contract performance will be spent for employees of the concern or employees of other HUBZone small business concerns; Supplies (other than acquisition from a nonmanufacturer of the supplies), at least 50 percent of the cost of manufacturing, excluding the cost of materials, will be performed by the concern or other HUBZone small business concerns;

FAR 52.219-3(d) vs. SBA Regulation (13 C.F.R. 125.6) General construction. At least 15 percent of the cost of contract performance to be incurred for personnel will be spent on the HUBZone prime contractor's employees; At least 50 percent of the cost of the contract performance to be incurred for personnel will be spent on the HUBZone prime contractor's employees or on a combination of the HUBZone prime contractor's employees and employees of HUBZone small business concern subcontractors; and No more than 50 percent of the cost of contract performance to be incurred for personnel will be subcontracted to concerns that are not HUBZone small business concerns

FAR 52.219-3(d) A HUBZone joint venture agrees that, in the performance of the contract, the applicable percentage specified in paragraph (d) of this clause will be performed by the aggregate of the HUBZone small business participants. Nothing in new SBA regulations changes these FAR requirements

AVOIDING PROBLEMS How to combat potential problems with work percentage requirements: Prime Contractor and Subcontractor roles are generally defined in teaming agreement provisions Make sure Prime Contractor scope of work is appropriately, and very specifically, defined Explicitly state percentage of work (be sure to use the right calculation) to be performed by each party in teaming agreement provisions Also describe in narrative form the type of work

AVOIDING PROBLEMS Ensure access to sufficient resources to accomplish required percentage of work Consider alliances with SSEs Confirm application of limitations on IDIQ Contracts. Monitor amounts paid to subcontractors to identify shortfalls before end of Contract.

Questions?