Today, SBA issued its final rule to implement provisions of the National Defense Authorization Act of 2013, which pertains to the limitations on subcontracting (“LOS”) applicable to small business set-aside contracts, socioeconomic program set-aside contracts, and small business subcontracting. SBA issued this rule after considering all comments provided in the rulemaking and, while we are still reviewing the rule in more detail, we are pleased that the rule accounts for concerns raised during the rulemaking process and is not as onerous as the proposed rule. Here are some of the highlights from the final rule:

  • When calculating compliance with the LOS, the rule permits an exclusion for the cost of materials on supply, construction, and specialty trade contracts (but not service contracts);
  • For mixed service and supply contracts, the LOS applies only to the service or supply, not both, depending on which is the principal purpose of the contract;
  • All costs associated with the services, including overhead and indirect costs, have to be included in determining compliance with LOS on a service contract;
  • LOS applies collectively to prime and first-tier subcontractors that are similarly situated; by including first-tier subcontractors, the goal is to prevent such firms from evading the rule by passing through work to large businesses at the second tier. This also means that small businesses at the second subcontract tier will not count toward compliance with the LOS;
  • No requirement for written agreement between small business prime and similarly-situated subcontractors;
  • No LOS compliance reporting requirement for similarly-situated subcontractors;
  • SBA intends to issue a proposed rule in the future to require LOS compliance reporting from all small businesses;
  • SBA would not initiate suspension or debarment proceedings unless the small business prime had no intent to actually use a similarly-situated subcontractor. SBA would also not initiate if a small business prime had a good faith intent to comply but did not comply due to unforeseen circumstances;
  • Performance by an independent contractor is considered a subcontract and the independent contractor may qualify as a similarly-situated subcontractor if it meets the relevant set-aside program criteria; 
  • Similarly-situated subcontractors must meet the size standard associated with the NAICS code the prime assigned to the subcontract; similarly-situated subcontractors do not have to meet the size standard assigned to the prime contract; 
  • When utilizing similarly-situated subcontractors, the rules envision that the performance requirement applies collectively to the prime and the similarly-situated subcontractor; the rule does not appear to require the prime to do a certain amount of the work itself as long as the prime’s performance, combined with performance by similarly-situated subcontractors, complies with the LOS;
  • The final rule exempts similarly situated subcontractors from ostensible subcontractor affiliation;
  • LOS and nonmanufacturer rule does not apply to small business contracts between $3,000 and $150,000;
  • $500,000 penalty for non-compliance with LOS;
  • If an 8(a) uses a similarly situated 8(a) subcontractor, it all counts toward the prime’s 8(a) work;
  • Contracting officers have discretion to judge LOS compliance on 8(a) set-asides per order;
  • HUBZone similarly-situated subcontractors must meet HUBZone requirements at time of subcontract;
  • Agencies should take into account prior subcontracting plan performance in evaluating a prime’s past performance;
  • SBA review of subcontracting plan performance will be supplemental to the review done by the contracting agency; and
  • The rule finalizes a proposal that requires the prime to provide written notice to small business subcontractors if the prime uses them in its proposal.

This rule also amends SBA’s regulations concerning the nonmanufacturer rule and affiliation rules. Further, this rule allows a joint venture to qualify as small for any government procurement as long as each partner to the joint venture qualifies individually as small under the size standard corresponding to the NAICS code assigned in the solicitation, 81 Fed. Reg. 34243. This rule is effective June 30, 2016.

We will be providing a Client Alert that provides more detail on this important rule shortly. In addition, we will be hosting a seminar on the new rules featuring SBA’s John Klein. Check our website for more details soon.

About the Author: Pam Mazza is the managing partner of PilieroMazza. She may be reached at [email protected]. Jon Williams is a partner with PilieroMazza and a member of the Government Contracts Group. He may be reached at [email protected].