FAR Council Publishes Three Final Rules Aimed at Boosting Small Business Contracting

The Federal Acquisition Regulatory (FAR) Council published three final rules on Aug. 11, 2021, amending the FAR to implement changes mandated by various National Defense Authorization Acts (NDAAs) and to homogenize the FAR with regulatory changes made by the U.S. Small Business Administration (SBA).

Specifically, the final rules 1) provide examples of what constitutes a good faith effort to comply with a small business subcontracting plan, 2) revise the limitations on subcontracting under FAR 19.505, Limitations on Subcontracting and Nonmanufacturer Rule and 3) allow SBA procurement center representatives to review any proposed acquisition so that they may make recommendations for improving competition from small business concerns.

The long awaited changes bring the FAR small business contracting requirements in line with SBA's existing regulations, and, in the case of the limitation on subcontracting provisions, a deviation to the Defense Federal Acquisition Regulation Supplement (DFARS), which was issued in late 2018.

Each of the final rules, summarized below, become effective on Sept. 10, 2021 (arguably once the revised FAR clauses are incorporated into new solicitations, contracts and orders). 

Small Business Subcontracting Plans and "Good Faith" Efforts

For negotiated procurements with an expected contract value in excess of $750,000 ($1.5 million for construction), a large prime offeror (i.e., an other than small business offeror) must submit an acceptable small business subcontracting plan to the contracting officer in order to be eligible for award. FAR 19.704, Small Business Subcontracting Plan Requirements, and FAR 52.219-9, Small Business Subcontracting Plan, list the required contents of small business subcontracting plans, which must include an offeror's percentage goals for subcontracting work to small business concerns and a description of the efforts the offeror will make to ensure small business concerns "have an equitable opportunity to compete for subcontracts."

Subcontracting goals for commercial plans must include indirect costs

Under the existing regulations, contractors using commercial small business subcontracting plans – the "preferred type of subcontracting plan for contractors furnishing commercial items" – must include their indirect costs in their Summary Subcontract Reports (SSRs), which must be submitted to the government annually using the Electronic Subcontracting Reporting System (eSRS). While contractors are required to include their indirect costs in their SSRs submitted to eSRS, they are not required to include their indirect costs in establishing their small business subcontracting goals when creating a commercial plan. According to the FAR Council, this has led to inconsistencies when comparing the data reported in contractors' SSRs with their small business subcontracting goals. 

The final rule amends FAR 19.704 and FAR 52.219-9 to require contractors' subcontracting goals established for commercial plans include all their indirect costs, with the exception of the following: "Employee salaries and benefits; payments for petty cash; depreciation; interest; income taxes; property taxes; lease payments; bank fees; fines, claims, and dues; original equipment manufacturer relationships during warranty periods (negotiated up front with the product); utilities and other services purchased from a municipality or an entity solely authorized by the municipality to provide those services in a particular geographical region; and philanthropic contributions."

The FAR Council believes this change will lead to increased small business subcontracting goals, and thus increased funds spent by prime contractors on small business concerns, "providing more opportunities for subcontract awards to small business concerns." At the same time, large businesses electing to utilize commercial plans that previously omitted indirect costs will need to adjust and expand the reach of their future commercial plans. Both plan development (goal setting) and plan administration (from market research to consideration of small business availability to fill requirements) will now have to include indirect costs, a change that may require new data collection regarding small business spending in the contractor's financial system and requests for size certifications from providers of indirect supplies and services by the purchasing organization.

Examples of a good faith effort and examples of a failure to make a good faith effort

A contractor's failure to "comply in good faith" with the requirements of its own small business subcontracting plan is considered a material breach of the contract and entitles the government to liquidated damages, in addition to any other remedies the government may have. (SeeFAR 19.705-7, Liquidated Damages; and FAR 52.219-16, Liquidated Damages—Subcontracting Plan.)

The final rule revises FAR 19.705-7 (no longer titled "Liquidated Damages" but instead "Compliance with Subcontracting Plan") to include the following non-exhaustive list of "indicators of good faith:"

• breaking out work to be subcontracted into economically feasible units, as appropriate, to facilitate small business participation
• conducting market research to identify potential small business subcontractors through all reasonable means, such as searching the System for Award Management (SAM), posting notices or solicitations on SBA's Subcontracting Network System (SUBNet), participating in business matchmaking events and attending preproposal conferences
• soliciting small business concerns as early in the acquisition process as practicable to allow them sufficient time to submit a timely offer for the subcontract
• providing interested small businesses with adequate and timely information about plans, specifications and requirements for performance of the prime contract to assist them in submitting a timely offer for the subcontract
• negotiating in good faith with interested small businesses
• directing small businesses that need additional assistance to SBA
• assisting interested small businesses in obtaining bonding, lines of credit, required insurance, necessary equipment, supplies, materials or services
• utilizing the available services of small business associations as well as local, state and federal small business assistance offices and other organizations
• participating in a formal mentor-protégé program with one or more small business protégés that results in developmental assistance to the protégés
• although failing to meet the subcontracting goal in one socioeconomic category, exceeding the goal by an equal or greater amount in one or more of the other categories
• fulfilling all of the requirements of the subcontracting plan

The regulation also includes the following non-exhaustive list of "indicators of a failure to make a good faith effort:"

• failure to attempt through market research to identify, contact, solicit or consider for contract award small business, veteran-owned small business, service-disabled veteran-owned small business, Historically Underutilized Business Zone (HUBZone) small business, small disadvantaged business or women-owned small business concerns, through all reasonable means including outreach, industry days or the use of federal systems such as SBA's Dynamic Small Business Search (DSBS) or SUBNet systems
• failure to designate and maintain a company official to administer the subcontracting program and monitor and enforce compliance with the plan
• failure to submit an acceptable Individual Subcontracting Report (ISR) or the Summary Subcontract Report (SSR), using the eSRS or, as provided in agency regulations, by the report due dates specified in 52.219-9, Small Business Subcontracting Plan
• failure to maintain records or otherwise demonstrate procedures adopted to comply with the plan including subcontracting flow-down requirements
• adoption of company policies or documented procedures that have as their objectives the frustration of the objectives of the plan
• failure to pay small business subcontractors in accordance with the terms of the contract with the prime contractor
• failure to correct substantiated findings from federal subcontracting compliance reviews or participate in subcontracting plan management training offered by the government
• failure to provide the contracting officer with a written explanation if the contractor fails to acquire articles, equipment, supplies, services or materials or obtain the performance of construction work as described in 19.704(a)(12)
• falsifying records of subcontract awards to small business concerns

While some of these indicators may seem obvious, it is helpful to have examples for reference and to understand just what the government considers "good faith efforts" to entail. But, by providing examples of a failure to make good faith efforts, the final rule substantially increases compliance risk for large contractors.

The final rule is clear that better enforcement is a goal: providing examples of a failure to make good faith effort is intended to "enable contracting officers to . . . hold large prime contractors accountable for failing to make good faith efforts to comply with their subcontracting plans." The enforcement mechanisms include adverse past performance assessments, default termination for a material breach and liquidated damages, all of which are linked directly to a finding of a failure to make good faith efforts per FAR 19.705-7(d).

For individual plans, the amount of liquidated damages is "an amount equal to the actual dollar amount by which the contractor failed to achieve each subcontracting goal." For commercial plans, the amount of liquidated damages is the amount by which the contractor failed to achieve each subcontracting goal, adjusted to reflect the percentage of the government's total payments contributed to the contractor's total sales. (SeeFAR 19.705-7(f).) The bottom-line is that the risk of liquidated damages is much more present now that contracting officers have a clear basis to find when a large prime has failed to make good faith efforts.

Limitations on Subcontracting

The second of the three final rules revises the FAR requirements with respect to limitations on subcontracting applicable to small business concerns and clarifies that the nonmanufacturer rule does not apply to small business set-asides at or below the simplified acquisition threshold (SAT), which is currently $250,000.

The revisions implement changes made to the Small Business Act by Section 1651 of the National Defense Authorization Act for Fiscal Year 2013 (NDAA FY 2013), which changed the formula for calculating the limitations on subcontracting under all types of small business set-aside contracts, principally to convert the analysis from one based on costs to one based on contract value. SBA revised its regulations in 2016 to implement section 1651 of the NDAA, which the U.S. Department of Defense (DoD) adopted in a 2018 class deviation – issued at the same time the FAR Council published its proposed rule amending the FAR. Finally, eight years after the NDAA FY 2013 revised the formula – and three years after issuing the proposed rule – the FAR Council has updated the FAR to catch up with SBA's regulations and DoD's class deviation. 

Determining compliance with the limitations on subcontracting

Under the existing FAR regulations, FAR 19.505 and FAR 52.219-14, Limitations on Subcontracting, small business prime contractors are required to measure their compliance with the limitations on subcontracting based on the percentage of work they, as the prime contractor, have performed, as measured by the cost of the work. For example, under the preexisting version of the regulation small business prime contractors are required to perform "at least 50 percent of the cost incurred for personnel with its own employees" for set-aside services contracts (except construction).

The final rule shifts the focus of FAR's limitations on subcontracting from a percentage cost of work performed by the prime to a percentage of the overall award amount to be spent by the prime on subcontractors in relation to the total amount paid by the government to the prime. For example, under the revised FAR 19.505 and FAR 52.219-14, small business concerns must "not pay more than 50 percent of the amount paid by the Government for contract performance to subcontractors that are not similarly situated entities" when performing set-aside service contracts (except construction). 

The final rule also increases workshare opportunities for first-tier small business subcontractors by exempting the amount prime contractors spend on subcontracts with "similarly situated entities" for purposes of determining compliance with the subcontracting limitations. Work performed by "similarly situated" first-tier subcontractors will be treated as if it were performed by the small business prime. In other words, a small business prime can determine compliance with the 50 percent limitation by including the amount performed by similarly situated first-tier subcontractors. (The final rule clarifies that lower tier subcontracting to similarly situated subcontractors cannot be counted towards compliance.) In a significant change from the proposed rule, the FAR Council is revising the definition of "similarly situated entity" to specify that the entity 1) must have the same small business program status as that which qualified the prime for award and 2) must be small under the North American Industry Classification System (NAICS) code assigned to the subcontract.

The final rule also clarifies the compliance period for the limitations on subcontracting. For a contract that has been set aside – including a set-aside indefinite delivery, indefinite quantity (IDIQ) contract – compliance with the limitations on subcontracting rule is required "by the end of the base term and then by the end of each subsequent option period, or by the end of the performance period for each order issued under the contract, at the contracting officer's discretion." For task orders set aside issued under full and open IDIQ contracts, partial set-aside contracts or contracts with small business reserves, compliance is required "by the end of the performance period for the order."

Significantly, the final rule makes no mention of the penalties articulated by SBA at 13 C.F.R. § 125.6(g). In SBA's regulation, whoever violates the limitations on subcontracting requirement "shall be subject to penalties prescribed in 15 U.S.C. 645(d), except that the fine shall be treated as the greater of $500,000 or the dollar amount spent, in excess of permitted levels, by the entity on subcontractors." Unlike in the instance of large businesses' compliance with small business subcontracting plans, the FAR Council elected not to assign any responsibility to contracting officers to monitor compliance with the limitations on subcontracting or to determine the applicability of penalties. With no reporting requirement imposed on prime contractors and no procedure for procuring agencies to monitor or audit compliance, it is uncertain how robust the government's enforcement will be.

The FAR Council believes that the shift in the focus of the limitations on subcontracting rules will reduce the "substantial burden" for small business contractors associated with tracking compliance and provide small businesses more options "for pursuing and winning larger contracts than before."

Clarifications to the nonmanufacturer rule

Additionally, the final rule clarifies that the nonmanufacturer rule, which requires prime contractors who are resellers of products (i.e., a nonmanufacturer) to provide end products manufactured by small business concerns, does not apply to set-asides for small businesses with no additional socioeconomic restriction that are at or below the SAT. For small business socioeconomic category procurements (i.e., a set-aside or sole source contract for 8(a) participants, women-owned small businesses, HUBZone small businesses or Service-Disabled Veteran-Owned Small Business (SDVOSBs)), the limitations on subcontracting and the nonmanufacturer rule continue to apply to procurements regardless of contract value. For non-socioeconomic small business set-asides, this clarification is a welcomed change from the existing regulation, which had applied the nonmanufacturer rule to small business set-asides above $25,000.

Procurement Center Representative Review

Lastly, the final rule amends FAR 19.202-1, Encouraging Small Business Participation in Acquisitions, to allow SBA "procurement center representatives" to review any acquisition – even those set-aside or partially set-aside for small business concerns – when they deem it appropriate to do so.

Procurement center representatives are SBA personnel located at federal agencies, designed to assist contracting officers in identifying set-aside opportunities, conducting market research and communicating with the industry. Under the existing regulations, the contracting officer is required to provide the procurement center representative with a copy of the proposed acquisition package only in certain instances (e.g., if the proposed acquisition is for supplies or services currently being provided by a small business concern and "the proposed acquisition is of a quantity or estimated dollar value, the magnitude of which makes it unlikely that small businesses can compete for the prime contract").

The final rule revises FAR 19.202-1 to require contracting officers to provide procurement center representatives copies of any proposed acquisition package and other reasonably obtainable information related to the acquisition, if the representatives exercise their discretion to review the acquisition. Further, the rule revises procurement center representatives' duties under FAR 19.402, Small Business Administration Procurement Center Representatives, to allow them to recommend procurements be set-aside or awarded on a sole-source basis to a small business concern; advise the contracting officer to breakout discrete components, items and requirements for competition, and suggest other ways to improve competition for small business concerns.

The intent is that, with further input from SBA advocates, more opportunities will be set-aside or reserved for small business concerns, increasing small businesses' chances of performing federal prime contract work with the government.