Basic Procurement Rules
Federal statutes, regulations and "common law" (i.e. case law principles) govern the relationship between U.S. procuring agencies and contractors. The Armed Services Procurement Act governs purchases by DOD and NASA while the Federal Property and Administrative Services Act govern the civilian agencies and the General Services Administration. Then special statues further affect federal acquisitions such as the U.S. General Accounting Office that consider protests and the Contract Disputes Act (CDA) that cover postaward claims and disputes. In addition, the Office of Federal Procurement Policy Act issued the Federal Acquisition Regulation and then most federal agencies have issued their own acquisition regulations supplements. Most federal statutes and regulations do not apply to subcontractors because the federal government and subcontractors generally lack "privity" – a direct contractual relationship. However, in numerous instances that we will discuss the statutes and regulations can apply to federal subcontractors.
Publicizing and Planning Procurements. The FAR provides that the federal government announce most acquisitions exceeding $25,000 at the government-wide point of entry located at www.fedbizopps.gov. Businesses interested in becoming subcontractors for a particular acquisition should contact the agency for a copy of the solicitation and perhaps more importantly, attend the agency’s in person proposal conference in order to gain additional insight about the procurement and interact with other firms especially prospective prime contractors and upper-tier subcontractors. Other FAR provisions in the procurement planning process affecting subcontractor under larger acquisition include (1) agencies must address their plans for achieving subcontract competition (2) establish solicitation mailing lists for interested firms and (3) will have small business specialists to aid small businesses.
Subcontract Competition. Though most federal procurements are subject to the "full and open competition" requirements where all responsible sources must be permitted to compete, these requirements do not apply to subcontracting giving prime contractors great leeway on subcontractor competition. The only exception is for cost reimbursement contracts that include the "Competition in Subcontracting" clause at FAR 52.244-5 that requires prime contractors to select subcontractors "on a competitive basis to the maximum practical extent." The contractor is required to determine the availability of subcontractor sources unless the government includes a warranty of the source’s availability or direct all prospective prime contractors use a particular subcontractor.
Contractor Team Arrangements. Ordinarily the government will recognize the integrity and validity of contractor team arrangements as long as the arrangements are identified and the company relationships are fully disclosed. The chief exception to this rule is where the combination violates a federal antitrust law.
Subcontract Consent. Sometimes the government must consent to the placement of subcontracts. If a prime contractor has a government approved purchasing system prior government consent will be limited only to subcontract limitations set by the CO in the "Subcontract" clause of the prime contract. If there is no such approval consent to subcontract is required for cost reimbursement, time and material, labor hour or letter contracts and for un-priced actions under fixed price contracts exceeding the simplified acquisition threshold (currently $100,000). Under cost type contracts, the contractor must notify the agency before award of any cost-plus-fixed-fee subcontract and any fixed-price contract that exceeds the dollar limits specified by regulation. In granting consent the CO must consider several issues. For example, COs may not accept cost type subcontracts exceeding certain minimum allowable fees or an agreement that requires the CO to deal directly with a subcontractor.
Subcontractor Costs and Pricing. The CO determines price reasonableness for all awards including subcontract costs. Prime contractors (and higher-tier subcontractors) must contribute to this process by (1) conducting appropriate cost or price analysis to determine reasonableness of proposed subcontract prices (2) including the results of these analyses in their price proposal and (3) submitting cost or pricing data, when required, as part of its own cost or pricing data. The meaning of "cost or pricing data" has a long history of dispute but it basically means all verifiable factual information as of the date of price agreement which a prudent buyer and seller would expect to affect price negotiations significantly. The author reminds us the FAR has a rather complex set of rules on when cost or pricing data is required or exempted from prime contracts (e.g. commercial items, adequate price competition). Regarding subcontracts, the prime contractor must obtain and analyze cost or pricing data when the higher-level contractor is required to submit the data and (1) the subcontract is $10 million or more or (2) the agreement is more than $550,000 and is more than 10% of the higher-level contractor’s proposed price, unless the CO considers such data unnecessary. On the other hand, the CO may require submission of cost or pricing data below the above threshold where deemed necessary for reasonable pricing.
Patent and Data Rights. The FAR has extensive rules governing rights in patents and data in contractor deliverables. These FAR prescriptions are implemented through more than 20 possible contract clauses plus additional ones in individual agency supplements. The authors recommend contacting a legal specialist in these areas but offer a few general observations. FAR Part 27.3 addresses contractor patent rights and the general rule is the policies and procedures covered here apply to all contracts at any tier. FAR Part 27.4 covers data rights and the government’s policy is to strike a fair balance between the agency’s mission needs and the contractor’s legitimate proprietary interests. Since rights in data – such as computer software documentation – frequently concerns subcontractor products the authors urge subcontractors to achieve a full understanding beforehand with their prime contractors about the rights in deliverables provided to the government. As for data right rules in DOD contracts, the applicability of data rights to subcontractors is still "unsettled". DFARS Part 227.71 states data rights are to apply equally to prime contractor and subcontractors which implies that DOD clauses are included in subcontracts as a matter of law; however case law indicates that subcontractor’s rights in technical data are controlled by its contract with the prime, not the prime contract with the government.
Taxes. The FAR provides that prime contractors and subcontractors are generally not considered agents of the government for purpose of claiming the government’s immunity from sate and local taxation. Only an exemption under state or local law – if one exists at all – will provide tax relief for a transaction where the subcontractor provides supplies or services to a higher tier contractor. FAR 29.305 prescribes the rules whereby subcontractors may obtain state and local tax exemptions.
Commercial Item Subcontracting. The FAR expresses a strong preference for prime contractors and higher-tier subcontractors to incorporate "commercial items" or "non-developmental items" as components of items delivered to the government. The prime or upper-tier contractor has the discretion to make this determination and is not required to include any particular FAR clause in its lower level agreement except those required by regulation which is addressed in the "Subcontracts for Commercial Items and Commercial Components" clause at FAR 52.244-6.
Flow-Down Clauses
To maintain control over government agencies and ensure consistency in federal procurements FAR Part 52 contains numerous mandatory clauses to be included in prime Government contracts under stated criteria. (Editor’s Note. We refer the interested reader to our Fourth Quarter 2002 issue of the GCA DIGEST (Vol. 5, No.4) where we provide a complete list of mandatory and recommended FAR clause flow-downs that are identified by the Committee on Federal Subcontracting Section of the Public Law group of the American Bar Association. You can call them at 1-800-285-2221 to obtain a copy of their publication for $45.) Where the FAR authorizes COs to include the clause in the prime contract by reference i.e. FAR citation, title and date as opposed to the entire text, prime contractors must flow down the substance of FAR clauses and not just incorporate them by reference.
The author stresses the need to carefully review the clauses flowed down by the prime or higher-tier subcontract since there is the tendency for subcontracts to indiscriminately include excess FAR clauses including those intended only for a prime contractor. Typically, a prime contractor may use a commercially available standard subcontract that includes fill-ins and preprinted terms (e.g. contract payments, changes, terminations) and then will incorporate wholesale all the FAR prime contract clauses in the subcontract with little consideration for whether it should be flowed down. The results frequently are (1) the FAR clauses duplicate or often conflict with the preprinted commercial terms (2) the clauses have no substantive application to the subcontract because they are prime-contractor unique and (3) inclusion of the referenced FAR clauses likely fails to reflect the intentions between the parties. Another common example is under a cost plus fixed fee prime contract where firm fixed subcontracts are issued, the prime contractor often flows down its cost type clauses resulting in considerable confusion. Problems are not fixed when the prime contractor simply introduces the clauses by stating the word "prime contractor" will substitute for "government" or similar expressions. Subcontractors are encouraged to ensure their agreements do not include all prime contract FAR clauses and also when FAR-prescribed flow-down clauses are incorporated other conflicting terms should be eliminated.
Prime Contractor Source Selections and Subcontracts
Most acquisitions over $100,000 are government negotiated contracts governed by FAR Part 15 where price and non-price factors are considered, discussions are allowed and revisions to proposals are common once proposal deficiencies are pointed out. Under negotiated proposals, subcontractor information and eligibility are key items.
Subcontractor Participation. Some regulations or contract terms may limit the offeror’s ability to use subcontractors In small business set aside prime contracts the "Limitations on Subcontracting" clause (FAR 52.219-14) restricts the amount of subcontracting in service contracts where the prime must use at least 50% of the cost of contract performance incurred for personnel for its own employees. Construction contracts will commonly prescribe certain percentages of the work done. Several clauses strongly encourage prime government contractors to subcontract with small business concerns and disadvantaged small businesses and FAR 52.219-10 requires that each successful offeror on a contract exceeding $500,000 ($1 million for construction) submit an acceptable subcontracting plan where monetary incentives for outstanding performance (FAR 52.219-10) and penalties for lack of good faith performance (FAR 52-219-6) is included. Subcontracting is important in research and development contracting where in FAR 35 the government emphasizes agencies need to know whether proposed subcontractors are qualified and hence need to have advanced knowledge of subcontracts for technical or scientific work.
Organization Conflict of Interest. Sometimes organizational conflict of interest (COI), which exists when because of other activities or relationships an organization is unable or potentially unable to render impartial assistance to the government, can create grounds for protests. The GAO has held an awardee will have an unfair competitive advantage when the proposed subcontractor possessed competition-available information through its prior government work which is not available to other offerors.
Subcontractor Experience. When the solicitation has no restrictions on subcontracting there is significant room to use subcontractor to enhance proposals because the government may accept a proposal with substantial subcontracting and no offeror may be penalized merely for proposing subcontractors. Agencies may reasonably consider a proposed subcontractor’s experience when rating prime contractor qualification if the solicitation allows subcontractors to perform the particular work and if the RFP does not prohibit such evaluations. Also, no prohibition exists against more than one offeror proposing the same contractor.
Subcontractor Past Performance. When evaluating an offeror’s past performance the agency may grade the offeror based on the performance of its proposed subcontractors on previous projects because the prime contractor is responsible for its subcontractors’ performance. Government evaluators may reasonably decide not to credit the offeror with its subcontractor’s performance when the subcontractor would do minimal work under the contract.
Mistakes in Subcontract Offers. The general principle is that awards can be adjusted for mistakes when they are clear-cut clerical or mathematical errors or misreading of specifications as opposed to judgmental errors. When the prime contractor’s error is based on the subcontractor’s error the prime contract is still adjustable as long as the prime contractor was unaware of the underlying error.
Subcontractor Responsibility. COs are prohibited from awarding contracts to "nonresponsible" contractors (e.g. deficient in financial resources, ability to meet contract requirements, satisfactory performance record, integrity and ethics) so contractors need to affirmatively demonstrate its responsibility including that of its subcontractors. Agencies may assume the prime properly ascertained its subcontractor’s responsibility unless evidence shows the prime made an insufficient investigation. The government is entitled to make its own independent determination of a subcontractor’s responsibility.
Debarment and Suspension. Agencies may debar or suspend subcontractors form participating in government contracts when they are debarred or suspended. The government uses the List of Parties Excluded From Federal Procurement and Non-procurement Programs available at http://epls.arnet.gov.
Subcontractors’ Right of Protest. In general, since subcontractor arrangements are essentially private matters between prime contractors and subcontractors, aggrieved subcontractors have few rights in a federal forum to challenge alleged violations of procurement rules before award of the contract. The General Accounting Office is the usual forum for "protests" - a written objection by an interested party to a solicitation or award where the objection alleges improprieties in the award of a contract. Since an "interested party" is defined as an "actual or prospective bidder or offeror whose direct economic interest would be affected by the award" a subcontractor would not meet this definition. This interested party exclusion also applies to protest efforts at either the U.S. Court of Federal Claims and at the agency level since the definition of interest party is the same.
The GAO does recognize an exception for subcontractor protests where the subcontract selection is "by" the government. This process occurs when all or most meaningful aspects of the procurement are controlled by the federal agency officials and the prime contractor is a mere conduit of the agency whose primary concern is administrative. Also, subcontractors may be entitled to monetary relief when their prime contractors prevail in a joint effort protest to the GAO where successful protesters may recover costs for bid and proposal preparation costs and protest costs.
Contract Administration Issues
Miller Act Payment Bonds. Contracts covered by the Miller Act require payment bonds from the prime contractor on projects exceeding $100,000. The Act is intended as a substitute for a subcontractor’s right to obtain a mechanics lien under state law because federal property is immune and the Miller Act is quite effective in ensuring payments to subcontractors. The payment bond protects subcontractors by ensuring payments to all persons supplying labor or material for the contract. Payment bond coverage is limited to the first and second tier subcontractors so no coverage exists for subcontractors of suppliers or third or lower tier subcontractors.
Subcontractor Payment. Subcontractors’ ability to obtain assistance from the government in collecting payments from the prime contractor is pretty limited. Congress amended the Prompt payment Act in 1988 to help ensure timely subcontractor payments on construction contracts by adding the "Prompt Payment for Construction Contracts" clause at FAR 52.232-27 that requires subcontractor payments for satisfactory performance within seven days out of payments received from the government with an interest penalty for late payments. This clause has flow-down coverage for each lower-tier subcontractor. Since the statute and clause are unclear how COs should deal with subcontractor complaints of untimely payments Congress enacted another statute (National Defense Authorization Act for 1992 and 1993) requiring COs to take certain actions upon receiving complaints of subcontractor nonpayment for all type of contracts. Implementing the statute in FAR 32.112, if the CO finds the prime contractor is not in with compliance with subcontractor payment terms the CO may (1) encourage the contractor to make timely payments or (2) reduce or suspend progress payments to the prime as authorized by the applicable payments clause. Subcontractors should not expect extensive CO mediation or resolution of the controversy since lacking privity with the subcontractor, the government usually does not wish to expend the time and resources to investigate all the facts and instead, expects the prime and subcontractor to resolve their own disputes. Most COs, however, will be concerned about whether the prime contractor’s certification of payment of a subcontractor or supplier accompanying its payment request accurate. As a final aid to subcontractors, FAR 32.112 provides that upon request of a subcontractor or supplier, the CO must promptly advise the inquirer as to certain information such as whether the prime contractor has submitted requests for progress payments to the government or whether it has received final payment.
Government Contract Quality Assurance. The various QA functions such as inspection provided in the contract will generally will not performed for subcontracts except in limited circumstances. For example, the government must perform the QA function at the subcontract level when the item is to be shipped from the subcontractor’s facility to the using activity and the inspection at the source is required. It should be noted that such government review does not relieve the prime contractor of its contract responsibilities.
Use of Government Supply Sources. Addressed in FAR 51 the government may permit the subcontractor to use government supply sources (e.g. GSA Federal Supply Schedules) under cost type contracts or other subcontracts where the majority of the supplier’s subcontracts are cost type.
Effect of Subcontractor Default. Under the standard "default" clauses the prime contractor is accountable for excess costs of re-procurement based on a default stemming from delays in providing goods or services even when such default is caused by the subcontractor. An exception is allowed when the failure to perform based on the subcontractor’s default is beyond the control of the prime or subcontractor and neither is at fault or negligent. Cases have held that illness or death of subcontractor personnel is not excusable because contractors must provide acceptable workforces but prime contractors can be excused for subcontractor delays due to production difficulties beyond the existing state of the art and that were outside the contemplation of the principle parties at award.
Pricing of Contract Adjustments. When the government and prime contractor negotiate a pricing adjustment action from, say an upward equitable adjustment for a change, the prime ordinarily will make the adjustment to its price when the change affects its subcontractor where the adjustment made below the prime contract level is governed by the subcontractor clause addressing changes. Conversely, the prime contractor and subcontractor can be affected when the government and prime contractor negotiate a downward price adjustment from say, deleted government work, but difficulties arise when the subcontract does not include the subcontract clause. Board cases have held the that where the prime contract change reduces subcontract costs the prime contractor can be liable to the government even though it is unable to obtain a price reduction from its subcontractor so the prime must protect itself by inserting appropriate coverage in the subcontract.
Impact of Terminations. When the government terminates a prime contact the prime makes a corresponding subcontract termination and the provisions of FAR 49 spell out the procedures for settling both the prime contracts and subcontracts. The overriding principle is the subcontractor has no contractual rights against the government upon termination of the prime contract and the prime contractors and subcontractors are responsible for the prompt settlement of their termination settlement proposals.
Subcontractor Claims and Disputes With the Government. Under the Contract Disputes Act a "contractor" has the right to have a claim against the government be considered by the contracting officer and appeals hear by agencies boards of appeal or the U.S. Court of Federal Claims.It is quite common for a subcontractor to believe it has sustained damages by government action but since the CDA and the FAR "Disputes" clause (FAR 52.233-1) use the term "contractor" subcontracts generally do not have a right to seek and collect damages because they are not in privity with the government. Accordingly, where the subcontractor seeks relief from the government it can proceed indirectly through the prime contractor in one of two ways: first, the prime contractor must sponsor and certify the subcontractor’s claim where the certification reflects the prime contractor’s belief there is "good ground" for the claim and second, a prime contractor filing a claim can include a component for its liability to a subcontractor. It should be noted that in an old 1943 case of Severin v. United States the government held the prime contract is not entitled to collect for the subcontractor when it has no liability for the subcontractor’s costs. Later cases put the burden on the government to prove there was no liability.
There are rare exceptions to the general "no-direct right of action" rule for subcontractors in CDA cases. First, the subcontractor will have a direct right of action where the contract terms state that parties indeed to give the subcontractor the right to direct appeal but since the FAR prohibits the COs from consenting to such an arrangement this circumstance is practically non-existent. Second, privity for CDA purposes will exist where the contract provides that the contractor will act as a purchasing agent for the government. Third, subcontract privity will be present when the government so circumvents the authority of the contractor that the contractor becomes a mere agent of the government. For example when the Small Business Administration awards an agency a contract under the "8(a) program" the agency subcontracts with an 8(a) firm the firm amy take direct action against the government.
The author provides a summary checklist:
1. Subcontractors generally do not have a direct contractual relationship – privity – with the federal government and hence have few contractual rights and responsibilities to each other.
2. The FedBizOpps has valuable information for prospective subcontractors seeking business opportunities with prime contractors. Prospective subcontractors should also be familiar with other avenues of potential business such as pre-proposal conferences for the prime contractors and a particular agency’s website.
3. Guard against inappropriate flow-down clauses from the prime contract especially where they conflict with other subcontract clauses. Also make sure that applicable key clauses such as those addressing data rights, pricing of adjustments and rights upon government terminations are included in the subcontract.
4. Since prime contract awards commonly depend on the quality of proposed subcontractor’s technical qualifications and past performance work closely with your prime contractor to ensure these are in order.
5. Prime contractors need to ensure their proposed subcontractors are not debarred or suspended.
6. Subcontractors generally have no right of protest but one narrow exception is the can recover subcontract proposal preparation costs where the prime contractor prevails in a protest.
7. Subcontractors have only limited rights to obtain the assistance of government COs when prime contractors do not pay on time. However, the Miller Act under construction projects give subcontractors extra protection when a payment bond is available.
8. Subcontractors having a dispute with the government generally have no rights of direct appeal so if they believe the government action warrants a remedy they should attempt to persuade their prime contractor to either "sponsor" a claim or include your costs in the prime contractor‘s claim. Also, investigate whether one of the rare circumstances for privity exists.
9. Familiarize yourself with FAR Part 49 if your subcontract is terminated to maximize your recovery.
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