DoD Proposes Cost Allowability Rule for Correcting Counterfeit Electronic Parts

by Sheppard Mullin Richter & Hampton LLP
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The Department of Defense (“DoD”) recently proposed to make specified costs allowable that are associated with discovering and correcting counterfeit or suspect counterfeit electronic parts.  DoD’s proposed rule would amend the Defense Federal Acquisition Regulation Supplement (“DFARS”) to implement the National Defense Authorization Act (“NDAA”) for Fiscal Year 2016.

The proposed rule provides that certain costs associated with counterfeit or suspect counterfeit electronic parts may be allowable if three conditions are met:

  1. The counterfeit or suspect counterfeit electronic parts were obtained by the contractor in accordance with the regulations described in section 818 of the 2012 NDAA regulations. The 2012 NDAA required covered contractors to implement counterfeit part detection and avoidance systems; to purchase electronic parts from trusted suppliers, where possible; and to report counterfeit or suspect counterfeit electronic parts within 60 days to the Government.
  2. The contractor must discover the counterfeit or suspect counterfeit electronic parts.
  3. The contractor must provide timely notice to the Government. Timely notice means within 60 days after the contractor becomes aware of the counterfeit or suspect counterfeit parts.

The new rule will complement DFARS 252.246-7007, Contractor Counterfeit Electronic Part Detection and Avoidance System, issued in May 2014.  That clause applies to contractors subject to full or modified coverage under the Cost Accounting Standards (“CAS”) and subcontractors to CAS-covered primes.  It requires contractors to have an acceptable counterfeit electronic part detection and avoidance system that meets specified criteria.  Failure to maintain an acceptable counterfeit electronic part detection and avoidance system may result in disapproval of the purchasing system and/or withholding of payments.  The system must include risk-based policies and procedures that address topics including training personnel, inspection and testing electronic parts, and processes to abolish counterfeit parts proliferation.

Relatedly, in September 2015, the DoD proposed a new DFARS clause, “Sources of Electronic Parts” which would require contractors at all tiers—not just those subject to CAS—to acquire electronic components from trusted suppliers.  If an electronic component is obtained from a supplier other than the original manufacturer, contractors and subcontractors would be required to have a risk-based system to trace the parts back to the original manufacturer, find alternative parts, or test and inspect the parts.  It would also remove software from the definition of “electronic part.”

The cost allowability regulations will be published as a final rule under DFARS Case 2016-D010.  This proposed rule would alleviate some of the financial burden of addressing counterfeit or suspect counterfeit electronic parts by allowing covered defense contractors to pass on certain compliance and remediation costs to the Government.  Comments on the proposed rule may be submitted in writing until May 24, 2016.  The final rule will not be published until after the publication of the final rule on “Sources of Electronic Parts.”

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