The U.S. Department of Defense (DOD) recently published its first set of proposed regulations that would impose specific anti-counterfeiting obligations on defense contractors. These proposed regulations represent a partial implementation of Section 818 of the fiscal year (FY) 2012 National Defense Authorization Act (NDAA), which directed DOD to issue regulations making certain “covered” defense contractors responsible for detecting and avoiding the use or inclusion of counterfeit electronic parts in the products they supply to DOD. These impact of these regulations will not be limited solely to the large defense contractors, however, as the rules require contractors to flow counterfeit parts avoidance and detection responsibilities down throughout their supply chains. Thus, the impact of DOD’s counterfeit parts regulations will ripple through the defense supply chain and ultimately impact companies large and small.

A comprehensive analysis of DOD’s proposed regulations is available here. This post examines one specific, but critical, aspect of those proposed regulations: DOD’s proposed definition of what constitutes a “counterfeit part.”

That definition is critical, because it establishes the baseline from which all of the other obligations under the proposed regulations flow. If an electronic part is defined as “counterfeit” or “suspect counterfeit,” then the contractor or supplier has a duty to detect it and avoid its use, and faces potentially massive liability if the “counterfeit” or “suspect counterfeit” part is not detected and requires later rework or corrective action.

The proposed regulations include three definitions of counterfeit parts, one of which is particularly troublesome for contractors in its breadth. Under the proposed regulations, a counterfeit part is:

1. An unauthorized copy or substitute part that has been identified, marked, and/or altered by a source other than the part’s legally authorized source and has been misrepresented to be from a legally authorized source;
2. An item misrepresented to be an authorized item of the legally authorized source; or
3. A new, used, outdated, or expired item from a legally authorized source that is misrepresented by any source to the end-user as meeting the performance requirements for the intended use.

The first definition tracks the definition of “counterfeit materiel” in the recently-issued DOD Instruction (DODI) 4140.67, which establishes internal DOD policy and responsibilities regarding the prevention and detection of counterfeit materiel. That consistency makes sense, in that DOD understandably would want contractors to apply the same definition of “counterfeit” as DOD applies in establishing its own internal anti-counterfeiting policies and procedures. Yet the proposed regulations do not stop with that first definition, but instead offer two additional categories of “counterfeit” parts. It is not clear why DOD believes these additional categories of counterfeit parts should be addressed by contractor systems, when they would not necessarily fall within the definition of “counterfeit material” in DOD’s own internal anti-counterfeiting policy guidance.

The third definition of counterfeit part in the proposed regulations is particularly problematic for contractors and their suppliers, because it sweeps so broadly and would arguably encompass any non-conforming part – even new, unused, genuine parts from the original manufacturer – that are discovered to have a quality issue and therefore fail to meet “the performance requirements for the intended use.” Section 818 did instruct DOD that its definition of counterfeit electronic parts should include “previously used parts represented as new,” but if giving effect to that congressional directive is what DOD intended to accomplish through its third definition, DOD far overshot the mark. Rather than limiting itself to previously used parts, the third definition includes new parts, and would label them as “counterfeit” simply for failing to meet the performance requirements for the intended use, despite a representation that they would do so.

In other words, a garden-variety quality issue could now potentially result in DOD labeling a genuine, brand-new part as a “counterfeit” (or, at least, as a suspect counterfeit), if the non-conforming part had been supplied with a certificate of conformance representing it as meeting specification or contract requirements. Such a result would carry with it potentially devastating financial consequences for contractors and their suppliers, given the unallowability of costs associated with investigating, repairing, or remediating suspect counterfeit and suspect counterfeit electronic parts.

The public has the opportunity to submit comments on DOD’s proposed regulations – including these proposed definitions of “counterfeit parts” – until July 15, 2013. Companies concerned about aspects of the proposed regulations or about DOD’s implementation of Section 818 should strongly consider filing comments on the proposed regulations to apprise DOD of their concerns and to advocate for changes or refinements in the final regulations.