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Subcontracting and Flow Down Clauses: Understanding What the FAR Does - and Does Not - Require

Subcontracting and Flow Down Clauses: Understanding What the FAR Does - and Does Not - Require. Breakout Session #605 Name: Jeff H. Eckland, Eckland & Blando LLP Date: July 20, 2010 Time: 3:45 PM. 2. AGENDA. Flow Down Overview Subcontracts v. Supplier Agreements

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Subcontracting and Flow Down Clauses: Understanding What the FAR Does - and Does Not - Require

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  1. Subcontracting and Flow Down Clauses:Understanding What the FAR Does - and Does Not - Require Breakout Session #605 Name: Jeff H. Eckland, Eckland & Blando LLP Date: July 20, 2010 Time: 3:45 PM 2

  2. AGENDA • Flow Down Overview • Subcontracts v. Supplier Agreements • Case Study: ARRA’s Unique Requirements • Compliance

  3. 1995 FAR Part 1 Rewrite: “Core Guiding Principles” FAR 1.102 Statement of Guiding Principles for the Federal Acquisition System . . . (d) The role of each member of the Acquisition Team is to exercise personalinitiative and sound business judgment in providing the best value product or service to meet the customer’s needs. . . . .

  4. 1995 FAR Part 1 Rewrite: “Antibureaucracy Statement” FAR 1.102 Statement of Guiding Principles for the Federal Acquisition System . . . (d) In exercising initiative, Government members of the Acquisition Team may assume if a specific strategy, practice, policy or procedure is in the best interests of the Government and is not addressed in the FAR, nor prohibited by [statute or case] law, Executive order or other regulation, that the strategy, practice, policy or procedure is . . . permissible . . . . . . . .

  5. 1995 FAR Part 1 Rewrite (cont.) (b) The Federal Acquisition System will— (1) Satisfy the customer in terms of cost, quality, and timeliness of the delivered product or service by, for example— (i) Maximizing the use of commercial products and services; (ii) Using contractors who have a track record of successful past performance or who demonstrate a current superior ability to perform; and (iii) Promoting competition; (2) Minimize administrative operating costs; (3) Conduct business with integrity, fairness, and openness; and (4) Fulfill public policy objectives. . . . .

  6. Commercial Item Flow Down Clauses 52.212-5  Contract Terms and Conditions Required to Implement Statutes or Executive Orders— Commercial Items. (e)(1) . . . the Contractor is not required to flow down any FAR clause, other than those in paragraphs (i) through (vii) of this paragraph in a subcontract for commercial items. (i) 52.219-8,Utilization of Small Business Concerns (ii) 52.222-26, Equal Opportunity (iii) 52.222-35, Equal Opportunity for Special Disabled Veterans, Veterans of the Vietnam Era, and Other Eligible Veterans (iv) 52.222-36, Affirmative Action for Workers with Disabilities (v) 52.222-39, Notification of Employee Rights Concerning Payment of Union Dues or Fees (vi) 52.222-41, Service Contract Act of 1965, as Amended (vii) 52.247-64, Preference for Privately Owned U.S.-Flag Commercial Vessels

  7. Flow Downs to be included by CommercialItem Subcontractors 52.219-8, Utilization of Small Business Concerns (May 2004) (15 U.S.C. 637(d)(2) and (3)) . . . in all subcontracts that offer further subcontracting opportunities. If the subcontract(except subcontracts to small business concerns) exceeds $500,000 ($1,000,000 for construction of any public facility), the subcontractor must include 52.219-8 in lower tier subcontracts that offer subcontracting opportunities.

  8. Flow Downs • Clauses prescribed by the government that a prime contractor* incorporates into subcontracts • The definition of prime contractor varies and some clauses are required to be flowed down from first-tier subcontractors to second (and third . . .) – tier subcontractors

  9. Flow Downs Proscribe rights and responsibilities of the prime contractor and subcontractor • Examples • FAR 52.215-12 – Requires contractors to obtain subcontractor’s cost or pricing data before awarding subcontract • FAR 52.222-36 – Requires contractors to take affirmative steps in employing individuals with disabilities

  10. Flow Downs • Flow Down clauses are located in multiple sources: the Federal Acquisition Regulation (FAR); Defense DFARS, and FAR Supplements • The clauses are amended regularly; these changes are identified and made available for public opinion in the Federal Register www.federalregister.com

  11. Flow Downs • Two-step process for identifying Flow Downs • Part 1: The implementing clause • Part 2: The contract clause • Additional guidance may be found in the Code of Federal Regulations (CFR)

  12. Flow Down Fundamentals • Part One – The Implementing Clause 22.810Solicitation provisions and contract clauses. (a)When a contract is contemplated that will include the clause at 52.222-26, Equal Opportunity, the contracting officer shall insert— (1) The clause at 52.222-21,Prohibition of Segregated Facilities, in the solicitation and contract.

  13. Flow Down Fundamentals • Part Two – The Contract Clause 52.222-21  Prohibition of Segregated Facilities. As prescribed in 22.810(a)(1),insert the following clause: Prohibition of Segregated Facilities (Feb 1999) • “Segregated facilities,” as used in this clause, means any waiting rooms, work areas, rest rooms and wash rooms, restaurants and other eating areas, time clocks, locker rooms and other storage or dressing areas, parking lots, drinking fountains, recreation or entertainment areas, transportation, and housing facilities provided for employees, that are segregated by explicit directive or are in fact segregated on the basis of race, color, religion, sex, or national origin because of written or oral policies or employee custom. The term does not include separate or single-user rest rooms or necessary dressing or sleeping areas provided to assure privacy between the sexes. (b) The Contractor agrees that it does not and will not maintain or provide for its employees any segregated facilities at any of its establishments, and that it does not and will not permit its employees to perform their services at any location under its control where segregated facilities are maintained. The Contractor agrees that a breach of this clause is a violation of the Equal Opportunity clause in this contract. (c) The Contractor shall include this clause in every subcontract and purchase order that is subject to the Equal Opportunity clause of this contract. (End of clause)

  14. Flow Down Fundamentals When does a Subcontractor assume responsibility as a contractor for flowing down to its own lower-tier subs? • In some FAR clauses, the definition of contractor is written to include subcontractor 52.222-41  Service Contract Act of 1965. . . . • Definitions. As used in this clause— “Contractor,” when this clause is used in any subcontract, shall be deemed to refer to the subcontractor, except in the term “Government Prime Contractor.” . . . (l) Subcontracts. The Contractor agrees to insert this clause in all subcontractssubject to the Act. . . . .

  15. Categories of Flow Downs Mandatory clauses – those that must be flowed down Essential clauses – not mandatory but must be included for business purposes Optional clauses – included at the discretion of the contractor

  16. Mandatory Clauses Mandatory Clauses are prescribed by the FAR for different categories of subcontracts depending upon whether: • The contract involves a Small Business; • The contract exceeds a certain $ amount; • The contract is for the acquisition of commercial materials; or • The contract meets other FAR prerequisites.

  17. Mandatory Clauses Generally, the clauses fall into one of two categories: • Clauses implementing socio-economic policies of the federal government (socio-economic); or • Clauses intended to provide oversight of the use of federal funds (oversight).

  18. Example 52.222-26  Equal Opportunity – Category 1 (socio-economic) The contracting officer shall insert the clause at 52.222-26, Equal Opportunity, in solicitations and contracts unless the contract is exempt from all of the requirements of E.O. 11246 (see FAR 22.807(a)).  … (10) The Contractor shall include the terms and conditions of this clause in every subcontract or purchase order that is not exempted by the rules, regulations, or orders of the Secretary of Labor issued under Executive Order 11246, as amended, so that these terms and conditions will be binding upon each subcontractor or vendor.

  19. Example 52.215-12 Subcontractor Cost or Pricing Data– Category 2(oversight) Subcontractor Cost or Pricing Data —Modifications (Oct 1997) (a) The requirements of paragraphs (b) and (c) of this clause shall— • Become operative only for any modification to this contract involving a pricing adjustment expected to exceed the threshold for submission of cost or pricing data at FAR 15.403-4; and (2) Be limited to such modifications. (b) Before awarding any subcontract expected to exceed the threshold for submission of cost or pricing data at FAR 15.403-4, on the date of agreement on price or the date of award, whichever is later; or before pricing any subcontract modification involving a pricing adjustment expected to exceed the threshold for submission of cost or pricing data at FAR 15.403-4, the Contractor shall require the subcontractor to submit cost or pricing data (actually or by specific identification in writing), unless an exception under FAR 15.403-1 applies. (c) The Contractor shall require the subcontractor to certify in substantially the form prescribed in FAR 15.406-2 that, to the best of its knowledge and belief, the data submitted under paragraph (b) of this clause were accurate, complete, and current as of the date of agreement on the negotiated price of the subcontract or subcontract modification. (d) The Contractor shall insert the substance of this clause, including this paragraph (d), in each subcontract that exceeds the threshold for submission of cost or pricing data at FAR 15.403-4 on the date of agreement on price or the date of award, whichever is later.

  20. Example 52.203-13  Contractor Code of Business Ethics and Conduct-- Category 2(oversight) . . . (d) Subcontracts. (1) The Contractor shall include the substance of this clause, including this paragraph (d), in subcontracts that have a value in excess of $5,000,000 and a performance period of more than 120 days. . . . .

  21. Essential Clauses Essential, while not mandatory, flow down clauses contractors should include to protect their business interests. While not mandated by the FAR or DFARS, failure to include these clauses in a subcontract puts the contractor at extreme risk.

  22. Example Termination for Convenience – FAR Subpart 49.5 • Permits the federal government to cancel a prime contract at any time • Failure of the prime contractor to include a similar clause in subcontracts can result in significant adverse consequences • Obligations remain under its subcontract but the prime contract has been terminated

  23. Example Change Orders – FAR Subpart 43.2 • Contracting officers may issue change order, permitting unilateral changes to the prime contract at any time. • Failure of the prime contractor to include a similar clause in its subcontracts can result in significant adverse consequences. • Obligations remain under its subcontract but the prime contractor’s needs have changed.

  24. Supplemental Clauses Broad Clauses – recommend incorporation FAR 52.222-35  Equal Opportunity for Special Disabled Veterans, Veterans of the Vietnam Era, and Other Eligible Veterans. . . . (f) Noncompliance. If the Contractor does not comply with the requirements of this clause, the Government may take appropriate actions under the rules, regulations, and relevant orders of the Secretary of Labor issued pursuant to the Act. (g) Subcontracts. The Contractor shall insert the terms of this clause in all subcontracts or purchase orders of $100,000 or more unless exempted by rules, regulations, or orders of the Secretary of Labor. The Contractor shall act as specified by the Deputy Assistant Secretary of Labor to enforce the terms, including action for noncompliance.

  25. Applicability of Flow Downs • Generally, the FAR creates flow down obligations based upon the relationships among the parties: “The Contractor shall include the terms and conditions of this clause in every subcontract or purchase order that is not exempted by the rules, regulations, or orders of the Secretary of Labor issued under Executive Order 11246, as amended, so that these terms and conditions will be binding upon each subcontractor or vendor.” FAR 52.222-26 Equal Opportunity

  26. Contractor Relationships Prime Contractor Supplier of specially contracted items The Federal Government Supplier of raw Materials

  27. Web of Relationships Prime Contractor SUBCONTRACT Supplier of specially contracted items The Federal Government SUPPLIER AGREEMENT Supplier of raw Materials

  28. Determining the Relationship • Subcontract or Supplier Agreement? • Federal law and regulations distinguish between a subcontractor and a material supplier

  29. Distinction between Suppliers and Subcontractors • FAR: “[i]n the event of such termination, the Contractor shall immediately stop all work hereunder and shall immediately cause any and all of its suppliers and subcontractors to cease work.” FAR 52.212-4 Contract Terms and Conditions

  30. Distinction between Suppliers and Subcontractors • Judiciary: “[a subcontractor is] one who performs for and takes from the prime contractor a specific part of the labor or material requirements of the original contract, thus excluding ordinary laborers and materialmen.” Clifford F. MacEvoy Co. v. United States, 322 U.S. 102, 109 (1944)

  31. Distinction between Suppliers and Subcontractors • Comptroller General Decisions A string of decisions issued by the Comptroller General beginning seventy-five (75) years ago recognizes the functional interpretation of the term “subcontract” in a variety of government contract fact patters. See e.g.,Comptroller General Warren to the Federal Works Administrator, B-24602, 22 Comp. Gen. 14 (1942): “subcontract” relates to performance of a particular portion of the prime contract work.

  32. Distinction between Suppliers and Subcontractors • Comptroller General Decisions (Contd.) John J. Kirlin, Inc., Comp. Gen. B-187458, Apr. 7, 1977, 77-1 CPD ¶ 242 (fan-coil manufacturer, properly classified as a supplier where standard off-the-shelf commercial items, i.e., fan- coil units, did not require substantial alteration and no performance of onsite work was required, did not need to be disclosed as a subcontractor pursuant to Solicitation terms.

  33. Distinction between Suppliers and Subcontractors John J. Kirlin, Inc. (Contd.) The GAO’s Opinion Supports Three (3) Principles: • First, commercial items generally are procured pursuant to supplier agreements rather than subcontracts; • Second, in determining whether a commercial item has been procured under a subcontract, the issue is the extent to which the manufacturer must participate in the contract’s performance; and

  34. Distinction between Suppliers and Subcontractors John J. Kirlin, Inc. (Contd.) • Third, a purchase is properly characterized as made pursuant to a subcontract rather than a supplier agreement when the specially manufactured portion is “significant or critical” to the item and the manufacturer performs substantial on-site work. A “trivial” customization will not affect the proper classification of a purchase order as a supplier agreement. Moreover, multiple “trivial” customizations will not be combined by the GAO to create a “significant” or “critical” customization requiring that the purchase order be classified as a subcontract.

  35. Distinction between Suppliers and Subcontractors • Independent Offices Appropriations Act of 1953 (“IOAA”) The GAO was asked to interpret the term “subcontract” – undefined in the IOAA– by the Atomic Energy Commission. Specifically, the Comptroller General addressed whether, in the context of access to books and records, the contractor or any of its subcontractors engaged in the performance of and involving transactions related to [specified prime] contracts, the term subcontractor includes contracts and purchase orders which the prime contractor may enter into for general inventory items that are not specifically identifiable with the work called for under the prime contractor. Comptroller General Warren, B-112178, 32 Comp. Gen. 277 (1952).

  36. Distinction between Suppliers and Subcontractors • Independent Offices Appropriations Act of 1953 (“IOAA”) The GAO specifically rejected an interpretation of subcontract that would encompass general inventory items not specifically called for under the prime contract. In rejecting this definition, the GAO referred to the definition of subcontract found in the Renegotiation Act of 1951: A subcontract is defined . . . as any purchase order or agreement to perform all or any part of the work or to make or furnish any materials required for the performanceof any contract with the United States.

  37. Distinction between Suppliers and Subcontractors • Independent Offices Appropriations Act of 1953 (“IOAA”) There are three material determinations in the Comptroller’s decision which impact the distinction between suppliers and subcontractors: - First, if no definition of subcontract is found in a particular statute, it is appropriate to consider the meaning of the term as used in other statutes with similar purposes; - Second, the similarity between the Renegotiation Act of 1951 and the IOAA was sufficient to justify the application of the former Act’s definition of subcontract to the later Act; and - Third, for the purpose of defining the scope of GAO access to records and audit rights, the term subcontract should exclude entities that provide “general inventory items not specifically identifiable with . . . work under the prime contract.”

  38. Distinction between Suppliers and Subcontractors • DCAA Audit Manual • Differentiates between suppliers and subcontractors in the context of conducting an audit: requires that subcontractors, but notsuppliers, produce accurate cost or pricing data for audits. • Additionally, also in the context of the audit process, suppliers are not investigated for reimbursements, whereas subcontractors are investigated to determine whether they received refunds or credits.

  39. The FAR’s Definitions ofSuppliers and Subcontractors While the FAR does distinguish the term subcontractor from supplier, the FAR’s multiple definitions of subcontractor often are inconsistent with one another. Consequently, it is always necessary to read the FAR provision closely.

  40. FAR Definitions FAR Part 2, which “defines words and terms that are frequently used in the FAR,” does not contain a general definition of subcontractor or supplier.

  41. FAR Definitions FAR Part 44 “Subcontracting Policies and Procedures” 44.101  Definitions Any contract as defined in Subpart 2.1 enteredintoby a subcontractor to furnish supplies or services for performance of a prime contract or a subcontract. It includes but is not limited to purchase orders, and changes and modifications to purchase orders.

  42. Subcontract or Supplier Agreement? • Determine whether the procurement involves a specialized or non-specializedgood or service • i.e., a good or service procured “for performance of a prime contract” as opposed to a good or service procured regularly, or available in the commercial market.

  43. Specialized Goods or Services • Specializedgoods and services are characteristic of a Subcontract: • End product specified in the government contract; • Custom-made product or service pursuant to statement of work; • Product procured solely for government contract; • Contractor is generally advised or required to know the identity of the final government customer; • Provides an end product purchased in a “non-competitive” environment; • Contract negotiated/awarded exclusively to fulfill government contract (but for the contract, the purchase would not have been made).

  44. Examples of Specialized Purchases An order for armored trucks. An order for specialized bullet-proof vests. An order for customized software.

  45. Non-Specialized Goodsor Services • Non-specializedgoods or services are characteristic of a Supplier Agreement: • Goods or services are produced within normal business operations; • Goods or services are provided to multiple purchasers without modification; • Goods or services are sold in a competitive environment; • Contractor is generally uninformed and has no reason to know identity of final government customer; • Contract for goods or services negotiated/awarded independently of FAR requirements for government contracts.

  46. Examples An order for a fleet of trucks. An order for commercially available night-vision goggles. An order for off-the-shelf Windows 7 software.

  47. Indirect Costs • The apportionment of costs is recognized as an additional indicator of whether an agreement is a subcontract agreement or a supplier agreement. • “Subcontract agreements” should not be interpreted to include general purpose items or services the cost of which is charged to intermediate or final indirect cost pools . . . • 32 Pub. Cont. L.J. 739 (2003) • Whether the cost of the agreement should be charged as a direct cost to the contract, as opposed to an indirect charge, may be considered in distinguishing between “subcontract agreements” and “supplier agreements.” • Int’l Gov. C., Vol. 5, No. 4 at ¶ 26 (April 2008).

  48. Difficulty in AppropriatelyFlowing Down Clauses • Ambiguity – it can be difficult to determine when a clause must be flowed down • For example, some flow downs are limited to subcontracts, yet the FAR contains numerous, conflicting definitions of subcontract, as noted above

  49. Consequences of Failing to Appropriately Flow Down Noncompliance may: • Become part of Contractor’s past performance record under FAR Subpart 42.15; • Result in the government withholding payments for the period of noncompliance; • Result in a breach of the terms of the prime contract.

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