Congress Changes the Method for Calculating Small Business Subcontracting Limits

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In the National Defense Authorization Act for Fiscal Year 2013 (“NDAA FY13”), Congress amended the Small Business Act and fundamentally changed the method for calculating subcontracting limits on small business set-aside contracts. Previously, the SBA regulations (13 C.F.R. § 125.6) and implementing FAR clause 52.219-14 focused on the cost of performance. However, the NDAA FY13 amendment focuses on the amount paid under the contract. This change eliminates the contractor’s need to rely on cost-based accounting to ensure compliance and will hopefully make it easier for prime contractors to track their efforts to comply with the rule.

Under both the previous and new rules, the subcontracting limits are calculated based on the type of contract: service, supplies, or construction. Under the previous rules for service contracts, the small business prime contractor was required to perform at least 50% of the cost of labor. For supply contracts, the amount required is at least 50% of the cost of manufacturing supplies, not including the cost of material, and for construction contracts, at least 15% of the cost of the contract, not including the cost of materials. Under the new rules, for service contracts, the prime contractor “may not expend on subcontractors more than 50 percent of the amount paid to the concern under the contract.” (emphasis added). For supply contracts, the limit for subcontracting is 50% of the amount paid under the contract less the cost of materials. And for construction contracts, Congress directed SBA to establish an appropriate percentage of the amount paid under the contract as the limit.

The new rule also includes a provision for calculating subcontracting limits on contracts that combine services and supplies. Congress noted that an increasing number of small business contractors are value added resellers and/or perform hybrid supply/service contracts, but the old rules were written for either service contracts or supply contracts. Although poorly drafted, the NDAA FY13 provision is meant to explain that for contracts which combine both services and supplies, the contractor shall (i) determine which category the greatest percentage of the contract is awarded; (ii) look only at the amount of the contract paid for that category; and (iii) spend no more than 50% of that amount on subcontractors. See H. Rep. No. 112-479 (2012).

Notably, the amendments also allow prime contractors to exclude from their amount expended on subcontractors, any amount paid to “similarly situated entities,” i.e., subcontractors that are of the same socioeconomic status as the prime. Whether a subcontractor is “similarly situated” is determined by the type of set-aside. Thus, if the contract is set aside for a woman-owned small business (“WOSB”) under Section 8(m) of the Small Business Act, then any amount paid to a WOSB subcontractor is not counted as an amount expended on subcontractors. If the contract is set-aside for all small businesses under Section 15(a), then any small business subcontractor is “similarly situated” even if the prime contractor may qualify as a more specific type of small business, such as a service-disabled veteran-owned small business (“SDVOSB”). This provision provides more flexibility in subcontracting than the old rules, which accounted for costs of the prime contractor only.

Finally, Congress granted SBA more flexibility through notice and comment rulemaking to adjust the percent limit for different industry categories if such adjustment is necessary “to reflect conventional industry practices.” And Congress added an additional penalty for prime contractors that exceed their limit – a fine of $500,000 or the amount expended over the limit, whichever is greater.

Unfortunately, the NDAA FY13 does not contain implementing provisions or a time frame in which SBA must issue regulations related to the new rules for service and supply contracts. The Act only directs SBA to implement an appropriate percentage for construction contracts. Presumably, however, SBA will modify its regulations and the FAR council will draft a new clause to incorporate these statutory changes. The question remains as to how quickly this will be done, as SBA has been routinely slow in implementing other statutory requirements. Stay tuned.

For more information, contact Katie Calogero at Jackson Kelly PLLC.

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