As PilieroMazza recently noted, SBA released a major proposed rulemaking that will impact government contractors. The proposed rule is focused on SBA’s 8(a) Program (see our client alert highlighting those proposed changes here), but it also impacts the rules for subcontracting on federal projects. This client alert provides contractors with an overview of SBA’s proposals related to the limitations on subcontracting, subcontractor affiliation, and subcontracting plans.

Limitations on Subcontracting (LOS)

SBA’s rules currently provide that the period of time used to determine compliance with the LOS for a total or partial set-aside contract is the base term and then each subsequent option period. SBA thinks this makes sense when one agency oversees and monitors a contract. However, SBA believes that on a multi-agency contract (MAC), under which multiple agencies can issue orders, no one agency can practically monitor and track LOS compliance. Thus, under SBA’s proposed rule, for a set-aside MAC, each ordering agency would be required to measure the contractor’s compliance with the LOS over the period of performance for each order.

If enacted, this proposal could certainly create administrative burden for agencies that are not currently monitoring LOS compliance under these orders. In addition, it could create some concern within the contracting community, as it would require contractors to comply with the LOS for each order issued under their MACs, thereby eliminating the flexibility that comes with measuring LOS compliance over the entire base period and then for each option period. The rule could also create some confusion, at least in the short term, as the Federal Acquisition Regulation (FAR), which contracting officer’s usually follow, has its own LOS rules that do not include this distinction for MACs.

SBA also proposes adding a rule indicating that if a contracting officer determines that a firm failed to comply with the LOS at the conclusion of contract performance, the contracting officer would not be permitted to give a satisfactory or higher (i.e., a positive) past performance rating to the contractor for the appropriate evaluation factor or subfactor (i.e., small business subcontracting). This proposal would not alter the contracting officer’s discretion to require contractors to demonstrate compliance with the LOS where the contracting officer deems it to be appropriate; it would merely provide consequences (i.e., a negative past performance evaluation) when the contracting officer determines that a contractor did not comply with the LOS at the conclusion of contract performance. This rule would further elevate the importance of LOS compliance.

Affiliation Based on Subcontracting

SBA’s affiliation rules provide that a prime contractor and its ostensible subcontractor are treated as a joint venture (JV) and therefore affiliated for size purposes when the subcontractor is not similarly situated (i.e., does not have the same small business status that the prime needed to qualify for award) and either (1) performs the primary and vital requirements of the contract or (2) the prime contractor is unusually reliant on the subcontractor. The proposed rule would make the following changes related to ostensible subcontractor affiliation:

  • The rule clarifies that so long as each concern is small under the applicable size standard (or the prime contractor is small if the subcontractor is its SBA-approved mentor), the ostensible subcontractor/JV arrangement will still qualify as a small business.
  • The rule explains that an ostensible subcontractor analysis should consider whether the subcontractor’s incumbent managers will transfer to the prime contractor and whether the prime contractor relies on the subcontractor’s experience because it lacks relevant experience of its own. This proposal would partially codify a four-factor test that SBA’s Office of Hearings and Appeals created in the Size Appeal of DoverStaffing, Inc., SBA No. SIZ-5300 (2011), and has been using for several years to determine when a prime contractor’s relationship with a subcontractor is suggestive of unusual reliance under the ostensible subcontractor rule. As with the existing rule, SBA would still consider all aspects of the prime contractor’s relationship with the subcontractor and would not limit its inquiry to the factors outlined in DoverStaffing. SBA seeks public comment on this proposed change to the ostensible subcontracting rule.
  • The rule would also clarify that in a general construction contract, the primary and vital requirements of the contract are the management and oversight of the project, not the actual construction or specialty trade construction work performed. SBA recognizes that on general construction contracts, subcontractors often perform the majority of the actual construction work, as the prime contractor must often engage multiple subcontractors specializing in different trades and disciplines. SBA believes the ostensible subcontractor rule for general construction contracts should be applied to the management and oversight of the project—and not to the actual construction or specialty trade construction performed. In other words, SBA’s proposal would confirm that in a general construction contract, the prime contractor must retain management of the contract but can delegate a large portion of the actual construction work to its subcontractors without violating the ostensible subcontractor rule.
  • The rule would also clarify that when a Small Business Innovation Research (SBIR) or Small Business Technology Transfer (STTR) offeror is determined to be a joint venturer with its ostensible subcontractor, SBA will apply the ownership and control requirements for SBIR/STTR joint ventures to the arrangement. This clarification is consistent with how SBA treats entities that are determined to be joint venturers with their ostensible subcontractor for other small business program set-asides. Visit this link for PilieroMazza’s coverage on the extension of the SBIR/STTR Programs.
  • The proposed rule would add a paragraph to each of the SDVOSB, HUBZone, and WOSB/EDWOSB status protest provisions to clarify that any protests relating to ostensible subcontractor affiliation claims will be reviewed by the SBA Government Contracting Area Office serving the geographic area in which the principal office of the protested concern is located. SBA’s Government Contracting Area Offices decide size protests and render formal size determinations. SBA believes they are best suited to decide ostensible subcontractor issues. So, for example, if a status protest filed in connection with a WOSB contract alleges that the awardee should not qualify as a WOSB because (1) the husband of the firm’s owner actually controls the business and (2) a non-WOSB subcontractor will perform primary and vital requirements of the contract, SBA’s WOSB staff in the Office of Government Contracting would review the control issue and the appropriate SBA Government Contracting Area Office would review the ostensible subcontractor issue.

Subcontracting Plans

  • The rule clarifies that a prime contractor cannot count an award to a joint venture—within which it is a partner—towards its subcontracting goals.
  • The rule deletes bank fees from the list of costs excludable from the subcontracting base when a contractor seeks to comply with its subcontracting plan. SBA believes this exclusion gives large contractors little incentive to work with small banks, of which there are over 900 registered in the Dynamic Small Business Search (DSBS). SBA estimates that after subtracting the amount already spent with small-business banks, the new spending with small business subcontractors under the rule would be $228,000 annually.
  • The rule requires large businesses to include indirect costs in their subcontracting plans. Currently, large businesses have the option of including or excluding indirect costs in their individual subcontracting plans. According to SBA, many large businesses opt to exclude indirect costs and, as a result, small businesses that provide services generally considered to be indirect costs—such as legal services, accounting services, investment banking, and asset management—are often overlooked by large contractors. SBA believes that by requiring indirect costs to be included in individual subcontracting plans, large businesses will have an incentive to give work to small businesses that provide those services.

If you have questions about SBA’s proposed changes or need to discuss a subcontracting issue, please contact the author, Sam Finnerty, or another member of PilieroMazza’s Government Contracts Group. Visit this link to access additional coverage on this major new SBA rulemaking.

If your firm is affected by these proposed changes and would like to submit public comments to SBA, please make sure to do so before the deadline on November 8, 2022.