Limitations on Subcontracting Rule Goes into Effect June 30, SBA Says

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The Small Business Administration published the final rule to implement requirements for small business federal contractors set by Congress in the 2013 National Defense Authorization Act.

The new rules take effect on June 30, according to the Federal Register notice. However, SBA officials have acknowledged that some agencies may not enforce the new rule fully until it is part of the Federal Acquisition Regulation, which could take several more months.

The final rule covers a number of different aspects of small business federal contracting, including limitations on subcontracting, affiliation, “mixed contracts,” joint ventures and the nonmanufacturer rule, among others.

Legal observers say the final rule softened some of the requirements in the proposed rule. “We are pleased that the final rule accounts for concerns raised during the rulemaking and is not as onerous as the proposed rule,” attorneys Pamela Mazza and Jon Williams, of PilieroMazza PLLC, wrote in an analysis.

Limitation on Subcontracting

The NDAA created a change in the way federal small business set-aside contracts are to be performed by contractors and subcontractors. Instead of requiring a set percentage of work to be done by the prime, the NDAA limited the amount of work that could be performed by the subcontractor to 50% or less of the value of the contract. The limitations apply to set-asides of $150,000 or more.

Under the final rule, the cost of materials is excluded on supply, construction and specialty-trade contracts, but not service contracts.

Also excluded is any work performed by a “similarly situated” subcontractor, which is a small business participating in the same program in which the set-aside was awarded. The similarly-situated subcontractor also must have the appropriate size standard for the NAICS code used for the subcontract.

For example, if a small business subcontracts with another small business to perform on a small business set-aside contract, and the sub has the appropriate NAICS code and size, then the subcontracted work is not subject to the 50% limitation. There is no limit on how much work the subcontractor may perform in such cases.

“The new rule effectively means that there is no limit on the amount of work that may be subcontracted at the first-tier level provided the work is subcontracted to other like firms,” according to an analysis by Venable LLP.

The same principles would apply to similarly-situated firms for set-aside contracts over $150,000, including set-asides for small businesses and set-asides for small vendors certified as 8(a), HUBZone, women-owned and service-disabled veteran-owned.

The exclusion only applies to the first tier similarly situated subcontractor. The second tier will not be excluded.

Separate NAICS code for subs

Another important point is that the similarly-situated entity must be small under the NAICS code for the subcontract, attorney Steven Koprince recently pointed out in an analysis.

Koprince said that provision in many cases is a benefit to small businesses, because the subcontractor need not be small under the NAICS code that applies to the prime contract. Also, the prime contractor determines the NAICS code that applies to the subcontractor.

“The final rule…implicitly emphasizes the importance of assigning NAICS codes and size standards to subcontracts–something many primes (large and small alike) are not doing,” Koprince wrote.

Financial Penalties

Contractors also should note that Congress required in the NDAA that businesses that violate the limitations on subcontracting rule are subject to a fine of $500,000, or the dollar amount spent in excess of permitted levels for subcontracting, whichever is greater.

“Mixed Contract”

The final rule has provisions for “mixed contracts” combining services and supplies. For a mixed contract, the contracting officer must select a single NAICS code that best describes the principal purpose of the contract. The subcontracting limitation then applies to the portion of the award amount that represents the principal purpose.

Non-Manufacturer Rule

Under the new rules, the SBA clarified that the nonmanufacturer rule does not apply to small business set-aside contracts valued between $3,500 and $150,000.

Affiliation

The final rule includes language that codifies decisions made by the SBA’s Office of Hearings and Appeals. The final rule states that affiliation is presumed to exist for firms that conduct business with each other and are owned and controlled by persons who are married couples, parties to a civil union, parents and children, or siblings. SBA said the presumption would be rebuttable.

Joint Ventures

Under the new rules, a joint venture of two or more concerns may submit an offer as a small business as long as each business is small under the size standard corresponding to the NAICS code assigned to the contract.

Passive income

Passive income must be included when calculating annual receipts for size purposes.

Mergers and Acquisitions

If a small business submits an offer as a small business concern, but then is acquired or subject to a merger after the offer but before the award, it must recertify its size to the contracting officer prior to award.

Other provisions

Other provisions in the final rule cover the HUBZone program, subcontracting plans, the identity of interest affiliation rule, the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs, size protests and NAICS code appeals, application of the non-manufacturer rule to software procurements, “adverse impact” analyses on construction contracts and the Certificate of Competency (COC) program, according to a Holland & Knight LLP analysis.

More information: Federal Register notice https://goo.gl/3Vab9R
PilieroMazza PLLC analysis http://goo.gl/RFyd7Q
Steven Koprince analysis http://goo.gl/YvTSH3
Venable LLP analysis
Holland & Knight LLP analysis http://goo.gl/ak8KNn