Defense Contractors Must Disclose China Work to US Government

Morgan Lewis
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Morgan Lewis

The Department of Defense issued an interim rule amending the Defense Federal Acquisition Regulation Supplement to require bidders on defense contracts to disclose when work will be performed in the People’s Republic of China, furthering the isolation of targeted countries deemed a threat to US national security at various points in the supply chain.

The rule is not unexpected given the scrutiny of work incorporating Chinese-origin articles that may be performed for the US government and the increase in acquisition regulation provisions focusing on Chinese-origin articles and Chinese entities.[1] It also follows the increased emphasis on supply chain transparency, both for products and for labor, particularly in those instances involving work performed in or goods obtained from the People’s Republic of China (China). [2] For instance, the Uyghur Forced Labor Prevention Act went into effect in June 2022, and the Pentagon recently temporarily suspended delivery of F-35 fighter jets to the US military after it was discovered that a Chinese-origin alloy was incorporated into the engine’s turbomachine pumps.

The interim rule, published with immediate effect on August 25, 2022, implements Section 855 of the National Defense Authorization Act (NDAA) for Fiscal Year 2022, which requires two-phase disclosures from certain government contractors:

  1. An initial disclosure at the time a contractor submits a bid or proposal for a covered contract
  2. An annual disclosure for the government’s fiscal year from any contractor that holds a covered contract during that fiscal year

A covered contract subject to these requirements includes any Department of Defense (DOD) prime contract or subcontract with an expected value in excess of $5 million, other than contracts for commercial products or services. A covered entity is an entity, including a subsidiary, performing work on a covered contract in China, including by leasing or owning real property used in the performance of the covered contract in China. This clause thus may be triggered, for example, through the use of warehousing in China.

The DOD published two corresponding Defense Federal Acquisition Regulation Supplement (DFARS) clauses addressing these obligations. DFARS 252.225-7057 provides for pre-award disclosure and DFARS 252.225-7058 provides for post-award disclosure. The rules do not apply to awards for commercial services and commercial products, including Commercially Available Off-the-Shelf (COTS) items, or to contracts at or below the Simplified Acquisition Threshold (currently $250,000). The disclosure requirements under both clauses may be waived if the Senior Procurement Executive determines in writing that such disclosure would not be in the US national security interest.

PRE-AWARD DISCLOSURE (DFARS 252.225-7057)

DOD may not award a covered contract to a covered entity unless that covered entity has disclosed its use of workforce and facilities in China. At the time of the submission of an offer or bid, the covered entity must disclose the following:

  1. The proposed use of workforce on a covered contract or subcontract if the Offeror employs one or more individuals who perform work in China
  2. The total number of individuals who will perform work in China
  3. A description of the physical presence, including street address(es), in China where such work will be performed

As this clause applies to prime as well as subcontracts, prime contractors will need to assess what disclosures to require from their subcontractors regarding work performed in China. While this provision is not a mandatory flowdown as it is a pre-award requirement, contractors should keep in mind the mandatory flowdown obligations for post-award disclosures in the event the contract is awarded. Contractors may also consider obtaining certifications from their subcontractors that no such work will be performed and no such individuals will be employed absent express disclosure to minimize the risk of inadvertent noncompliance.

POST-AWARD DISCLOSURE (DFARS 252.225-7058)

DOD may not award, extend, or exercise an option on a covered contract with a covered entity unless that entity submits each required post-award disclosure of its use of workforce and facilities in China. Covered entity contractors must disclose, for fiscal years 2023 and 2024, the following:

  1. The total number of individuals who perform work in China on the covered contracts
  2. A description of the physical presence, including street address(es), in China where such work is performed

This clause is also a required flowdown in subcontracts meeting the definition of “covered contract,” meaning the subcontract is noncommercial and with an expected value of over $5 million.

CONSIDERATIONS FOR DOD CONTRACTORS

DOD cites an “urgent and compelling” need for issuing the immediately effective disclosure requirements, namely mitigation of the risk that DOD contracts and subcontracts will be performed at facilities in China, providing “a nation that is not our ally” with an opportunity to gather sensitive information. The agency asserts that “[i]t is a matter of national security to be aware of the entities, contracts, and subcontracts that are exposed to such risks, so that mitigation strategies can be implemented.” In its formation of the final rule, DOD will consider public comments made through October 24, 2022.

The language of the interim rules leaves some items open for interpretation. While clearly targeting work performed in China, the new disclosure requirements do not ask about Chinese-origin products or sourcing from Chinese vendors. Rather, the obligations focus on a contractor’s employment of individuals working in China. The national security policy behind the new rules as well as the references in the rules to “workforce” and those who “perform work” indicate that the rule will be interpreted broadly to include independent contractors, agents, and representatives, and will not be limited to actual employees. The interim rule does not differentiate between on-site and remote workers who may be performing work out of their homes, which has the potential to implicate China’s privacy laws.

Further, the pre-award obligations do not appear to restrict disclosure of the workforce to only those who will be performing work in China on the covered contract, although this is likely not what DOD intended. The clause provides that the disclosures include “The proposed use of workforce on a covered contract or subcontract, if the Offeror employs one or more individuals who perform work in [China.]” The structure of the clause appears to require an offeror to provide the proposed use of workforce on the total contract—not limited to work performed in China—if the offeror employs anyone in China—not limited to those who would be performing work on the covered contract.

Some of these open issues will most likely be the subject of considerable discussion in submitted comments and be clarified through issuance of the final rule. In the meantime, covered entities bidding on or currently participating in DOD contracts should become familiar with their obligations and ensure that they are maintaining accurate and accessible records of information required by the disclosures, which may also require information from subcontractors.

Covered entities should also be aware of the potential impact of privacy and data protection laws in China. If the personal data of Chinese nationals falls within the scope of the disclosures, consent from the Chinese individuals must be obtained based on disclosure of the purpose of the data collection. Pursuant to China’s Data Security Law, the Chinese vendor may be required to obtain the Chinese government’s pre-approval for disclosing any data to its US customer, if the Chinese vendor is aware that such data will be shared with the US DOD.

[1] See, for instance, FAR 52.204-25, Prohibition on Contracting for Certain Telecommunications and Video Surveillance Services or Equipment, and DFARS 252.225-7007, Prohibition on Acquisition of Certain Items from Communist Chinese Military Companies.

[2] The Interim Rule is unclear whether DOD intends to define “China” to include Hong Kong, in accordance with the termination of Hong Kong’s special status pursuant to Executive Order 13936 of July 14, 2020. However, it appears that, in calculating the regulatory burden for the new reporting requirement, DOD took into consideration NATO Commercial and Government Entity (NCAGE) data on entities in Hong Kong as well as mainland China.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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