Small business prime contractors ordinarily are required to self-perform a certain percentage of small business set-aside contracts awarded to them (generally, 50 percent for supply and service contracts, with lower percentages for different kinds of construction contracts). This requirement is found in the SBA’s regulations at 13 C.F.R. § 125.6 and is applied to small business set-aside solicitations and contracts through the Limitations on Subcontracting clause at FAR 52.219-14. The requirement’s goal is to prevent small business set-aside contracts from becoming a pass-through vehicle for large businesses.
Way back in May 2016, SBA revised its regulations governing the limitations on subcontracting pursuant to the National Defense Authorization Act for Fiscal Year 2013. Prominent among the revisions was a provision that first-tier subcontracts to other similarly situated small businesses count toward the prime contractor’s 50 percent self-performance requirement, not against it. This common-sense rule keeps the limitations on subcontracting focused on the goal they are intended to further: preventing large businesses from performing the majority of the work under contracts set aside for small businesses. The rule also contained other changes, including a slightly different method for calculating the percentages.
The FAR, however, continued to contain the pre-2016 Limitations on Subcontracting clause at FAR 52.219-14, which lacked the exception for similarly situated first-tier subcontractors. Thus, under the old FAR clause, a first-tier subcontract to another small business was treated the same as a subcontract to a large business, and counted against the prime contractor’s self-performance requirement. It was not until December 4, 2018, that the FAR Councils finally issued a proposed rule to implement the similarly situated exception and other features of SBA’s 2016 regulation. The Defense Department, to its credit, got tired of waiting and implemented a class deviation containing a clause reflecting the updated SBA regulation for use in Defense Department solicitations and contracts. Civilian agencies, however, largely continued to use the outdated clause that remained in the FAR, meaning that small business contractors were contractually obliged to comply with small business subcontracting requirements that no longer existed in the small business regulations.
Now, five years after SBA updated its regulations, and nearly three years after issuance of the proposed rule to change the FAR, the FAR Councils at long last have promulgated the final rule, which will become effective on September 20, 2021. Beginning on that date, new solicitations will contain the updated limitations on subcontracting rules. Existing contracts will continue to contain whatever clause they currently contain, although the parties will be free to agree to a bilateral modification replacing the outdated Limitations on Subcontracting clause with the new one.
Key features of the new rule that differ from the old FAR rule:
- Definition of Similarly Situated Entities: The rule defines a similarly situated entity as “a first-tier subcontractor, including an independent contractor, that— (1) Has the same small business program status as that which qualified the prime contractor for the award (e.g., for a small business set-aside contract, any small business concern, without regard to socioeconomic status); and (2) Is considered small for the size standard under the NAICS code the prime contractor assigned to the subcontract.”
- Limitations on Subcontracting: For small business set-aside and sole-source prime contracts for services, the prime contractor must “not pay more than 50 percent of the amount paid by the Government for contract performance to subcontractors that are not similarly situated entities.” For contracts for supplies (except for procurement from a nonmanufacturer of those supplies), the prime contractor must “not pay more than 50 percent of the amount paid by the Government for contract performance, excluding the cost of materials, to subcontractors that are not similarly situated entities.” Analogous limits on the amount of work that may be subcontracted, with the similarly situated entity exception, apply to construction contracts: 85 percent for general construction and 75 percent for special trade construction, excluding the cost of materials. Any lower-tier subcontracts, even if made by a similarly situated entity to another similarly situated entity, count against the limitation requirement. If a contract includes both services and supplies, the assigned NAICS code determines whether the 50 percent limitation applies to services or supplies—it never will apply to both.
- Nonmanufacturer Rule: The final rule clarifies the application of the Nonmanufacturer Rule at FAR 52.219-33 and provides contracting officers additional guidance concerning waivers of the rule. This rule governs the circumstances under which a small business prime contractor under a set-aside contract may supply the Government with articles manufactured by another company.
- Applicability: The rule clarifies that the Limitations on Subcontracting and Nonmanufacturer Rule clauses do not apply to small business set-aside contracts valued below the simplified acquisition threshold, but do apply to set-aside and sole-source awards under other small business/socioeconomic programs regardless of dollar value.
Some industry respondents noted that, while the FAR Councils deliberated on the 2016 SBA rule, SBA has continued to generate new regulations. As a result, although the new final rule brings the FAR’s Limitations on Subcontracting clause into compliance with the 2016 SBA regulations, the 2016 SBA regulations have themselves been partially superseded by regulations SBA issued in 2019. Rather than make the FAR conform to the most current version of the SBA regulations, the FAR Councils decided to kick the can down the road, noting that “[a] new FAR case would have to be opened to implement the additional changes [from 2019].” Maybe that final rule will make it into the FAR in 2024.