How will the FY 2013 National Defense Authorization Act impact your business as a government contractor?

The recently passed National Defense Authorization Act for Fiscal Year 2013 ("NDAA") includes a number of acquisition policy provisions applicable to contractors doing business with the Department of Defense ("DoD").  Among the provisions included in the NDAA are significant contracting-related provisions that defense contractors should pay particular attention to, including the following:

• DoD Policy on Contractor Profits (Section 804).  The NDAA requires DoD to review the profit guidelines included in the Federal Acquisition Regulation ("FAR") and Defense FAR Supplement ("DFARS") to identify any changes that are necessary to ensure an appropriate link between contractor profit and performance.  DoD's review must consider the appropriate levels of profit needed to sustain competition, the amount of risk assumed by contractors and subcontractors, and incentives for superior performance in delivering quality products and services in a timely and cost-effective manner.
• Limitation on the Use of Cost-Type Contracts (Section 811).  Under the NDAA, DoD is now prohibited from using cost-type contracts in connection with major defense acquisition programs, with certain limited exceptions.
• Whistleblower Protections for Subcontractor Employees (Section 827).  The NDAA extends whistleblower protections to subcontractors who report contracting violations or fraud, waste, or mismanagement of federal funds.  In light of this provision, contractors should ensure that they have strong internal mechanisms in place for handling complaints and reported violations.
• Access to Contractor Internal Audit Reports (Section 832).  Although the NDAA grants the Defense Contract Audit Agency ("DCAA") access to contractors' internal audit reports, it provides that DCAA can use the reports only for the purpose of assessing risk and evaluating the efficacy of a contractor's internal controls and the reliability of associated contractor business systems.  The NDAA specifically provides that DCAA's review of a contractor's internal audit reports cannot be the sole basis for finding a contractor's internal controls inadequate.  Notably, the NDAA leaves out proposed provisions that would have essentially given DCAA unlimited access to contractors' internal audit reports and allowed DCAA to declare an internal control system inadequate if a contractor refused to provide its internal audit reports and supporting materials to DCAA.
• Detection and Avoidance of Counterfeit Electronic Parts (Section 833).  The NDAA provides certain protections for contractors performing corrective action to remedy the use of counterfeit electronic parts.  The costs of any rework or corrective action required to remedy the use of counterfeit electronic parts are now allowable, provided that (1) the contractor has an approved system in place to detect and avoid counterfeit parts; (2) the counterfeit parts were provided to the contractor as government property; and (3) the contractor provides timely notice to the government of the actual or suspected use of counterfeit parts.
• Compensation of Contractor Employees (Section 864).  The expectation within the contracting community was that the NDAA would impose strict caps on executive compensation, including tying allowability limits on contractor compensation to the U.S. Vice President's salary as the Senate version of the bill would have required.  As passed, the NDAA does not impose a cap on executive compensation, but does require the Government Accountability Office to conduct a study and report to Congress on the effects of reducing the allowable costs of contractor compensation.

• Reports on the Use of Indemnification Agreements (Section 865).  DoD must now report to Congress each time it enters into a contract that includes an indemnification provision "relating to bodily injury caused by negligence or relating to wrongful death," and it must also provide written justification for the provision.  This section does not prohibit the use of contractor indemnification agreements altogether, but subjects any indemnification language to greater public and congressional scrutiny and may decrease the government's willingness to agree to include these clauses in future agreements.

• Provisions Relating to Small Businesses (Section 1621-1699).  The NDAA includes a variety of provisions targeted at increasing contracting opportunities for small businesses, including (1) placing limitations on subcontracting, with certain exceptions for subcontracts awarded to other small businesses; (2) requiring contractors to notify potential subcontractors that they will include in their subcontracting plans a reporting mechanism that allows the subcontractor to report "fraudulent activity or bad faith" by the contractor with respect to its subcontracting plan; and (3) requiring the Small Business Administration to conduct a study every five years to identify industries underrepresented by small businesses owned and controlled by women.

• Trafficking in Persons (Sections 1701-1708).  The NDAA now requires contractors to include a condition in their contracts that authorizes the government to take punitive action against a contractor, subcontractor, their employees, or their agents if they engage in certain activities related to sex or labor trafficking.  It requires a compliance plan and annual certifications for all companies with contracts over $500,000 that will be performed outside of the United States.  The NDAA also imposes mandatory disclosure obligations on contractors that receive "credible information" from "any source" that an employee has engaged in trafficking-related activities.

In light of these new requirements and restrictions, companies should closely review the NDAA and their contracting policies to assess the impact on their businesses and what compliance measures are necessary.  We will be on the watch for proposed implementing DFARS provisions as these requirements and restrictions come into effect.