Federal government contractors that contract or team with small businesses must become familiar with recent changes resulting from the National Defense Authorization Act of 2013, signed into law in early January (the “NDAA”).

Years ago, Congress established a small business prime contracting goal of 23% across all federal agencies. See 15 U.S.C. § 644(g). For more than a decade, the Government has missed this target. The NDAA’s changes, including the following, are intended to help businesses meet this contracting goal:

1. Increase of Surety Bond Cap for Construction Contracts. Construction contractors must obtain surety bonds under the Miller Act to ensure completion of Government construction contracts. Before the NDAA was passed, the Small Business Administration (“SBA”) was permitted to guarantee surety bonds for Government construction contracts up to $2 million. 15 U.S.C. § 694b(a)(1). Section 1695 of the NDAA now allows the SBA to guarantee surety bonds for construction contracts up to $6.5 million, and this cap will be adjusted for inflation.

2. No Contract Award Cap for Women-Owned Small Business Concerns. Before the NDAA, women-owned small businesses (“WOSBs”) could not be awarded a WOSB set-aside contract valued at more than $5 million for manufacturing contracts and $3 million for all other types of contracts. 15 U.S.C. § 637(m)(2)(D). Section 1697(a)(2) of the NDAA removes the contract award cap for WOSBs.

3. Possible Expansion of Mentor-Protégé Program. The SBA is authorized, but not required, to expand the existing mentor-protégé program (which currently covers only 8(a) businesses) to other small business categories. It is yet to be seen whether the SBA will exercise this authority. The SBA now must approve mentor-protégé programs of other agencies except for the mentor-protégé program of the Department of Defense or any mentoring program under a Small Business Technology Transfer Program (“STTR”) or Small Business Innovation Research Program (“SBIR”). The SBA is to issue regulations on mentor-protégé programs, including eligibility requirements, within 270 days of the NDAA’s effective date. See NDAA § 1641.

4. Changes to Performance Percentages by Small Business Prime Contractors. Under prior law, small business prime contractors must perform a certain percentage of the contract work with their own forces. This requirement is intended to ensure that small businesses do not subcontract away performance to “ostensible subcontractors.” The NDAA changes the way small business contractors calculate their performance obligations under contracts set-aside for them. NDAA § 1651.

Under prior regulations, small business prime contractors with non-construction service contracts were required to perform 50% of the cost of direct labor with their own employees. The NDAA now bases the Government’s percentage requirements for service contracts on the total contract cost (including costs for materials and other direct costs) instead of direct labor only. In other words, the NDAA prohibits small business prime contractors from spending on subcontractors “more than 50 percent of the amount paid” for the entire services contract.

For supply contracts, the NDAA prohibits small business concerns from subcontracting out more than 50% of total contract price, less material costs.

For construction contracts, the SBA is required to make regulations after seeking public comments. Under present regulations, 25% of the labor costs for general construction contracts must be paid by the small business concern; for specialty construction contracts, the small business concern must pay 15% of the labor costs. FAR 52.219-14(b)(3)-(4).

The NDAA allows small business prime contractors to satisfy the foregoing percentage requirements by subcontracting with “similarly situated entities.” Thus, for example, under the NDAA a WOSB prime contractor who is awarded a service contract set-aside to WOSBs should be able to count its subcontracts with WOSB’s towards the 50% of the amount paid requirement, but not subcontracts it has with small businesses that are not WOSB’s.

There are now stiff penalties for violating these subcontracting limits. The NDAA requires that contractors violating these subcontracting limitations be assessed a $500,000 penalty or the dollar amount expended on subcontractors in excess of the cap, whichever is greater. Prior law included no specific financial or other penalties for violation of these limitations although presumably other laws, such as the False Claims Act, would apply.

5. Failure to comply with subcontracting plans will impact past performance evaluations. The NDAA formalizes certain provisions in the Federal Acquisition Regulations regarding subcontracting plans for small businesses. Under current law, contractors that are not “small business concerns” often must negotiate a subcontracting plan that sets subcontracting goals covering six categories of small business concerns, including veteran-owned small businesses, HUBZones and small disadvantaged businesses. The plan, once finalized, becomes a part of the Government contract, and must include “[g]oals, expressed in terms of percentages of total planned subcontracting dollars,” for the use of these small businesses as subcontractors. The small business contracting plan requirement must be flowed down to subcontractors that are not small and who receive subcontracts valued above certain thresholds.

Before the NDAA, the failure to negotiate a subcontracting plan was a basis for the Government not to award the contract. FAR 52.219-9 and prior law provided that non-compliance was a breach of the contract. Section 1653 of the NDAA provides that a failure of a contractor or subcontractor to comply “in good faith” with any plan required of the contractor is “a material breach of such contract or subcontract and that may be considered in any past performance evaluation of the contractor.” The SBA also will establish a reporting mechanism to allow subcontractors to report fraud or “bad faith” conduct by a contractor with respect to its subcontracting plan.

6. Penalties for Misrepresenting Small Business Status, and a New Safe Harbor. 15 U.S.C. § 645(d)(2)(C) subjects a contractor to suspension, debarment, fines and imprisonment for misrepresenting its status as a small business to obtain a government prime contract or subcontract. Section 1681 of the NDAA grants a safe-harbor for companies that act “in good faith reliance on a written advisory opinion” from a Small Business Development Center or an entity participating in the Procurement Technical Assistance Cooperative Agreement Program. The SBA is required within 270 days to issue regulations defining what is an “adequate advisory opinion” and issue a compliance guide to assist companies in determining their small business status.