SBA Rules Amended: Awards to Lower-Tier Subcontractors Now Count Toward Small Business Subcontracting Goals

January 3, 2017Alerts Federal Government Contracts & Procurement Alert

After years of pushing by industry groups and the passage of the National Defense Authorization Act for Fiscal Year 2014, the U.S. Small Business Administration (SBA) has acted to allow other than small (i.e., large in SBA speak) federal prime contractors to receive credit for lower-tier subcontracting awards to small business concerns (SBCs) and other socioeconomically disadvantaged SBCs.

Specifically, the SBA issued a final rule to amend the federal small business subcontracting plan requirements.

Effective January 23, 2017, federal prime contractors will no longer be limited to counting only the subcontract awards they make at the first tier toward satisfying their small business subcontracting goals. They will now be able to count the awards their other than small first-tier subcontractors make to SBCs as well.

The amended 13 CFR Section 125.3 reads in relevant part:

Where the prime contractor has an individual subcontracting plan, the prime contractor shall establish two sets of small business subcontracting goals, one goal for the first tier and one goal for lower-tier subcontracts awarded by other than small subcontractors with individual subcontracting plans. Under individual subcontracting plans the prime contractor shall receive credit for small business concerns performing as first-tier subcontractors (first-tier goal) and subcontractors at any tier … in an amount equal to the dollar value of work awarded to such small business concerns (lower-tier goal).

The prime contractor’s performance under its individual subcontracting plan will be calculated using its own reporting at the first tier and its subcontractor’s first-tier reports under their plans for lower-tier subcontracting goals. The prime contractor’s performance … must be evaluated based on its combined performance under the first- and lower-tier goal.

Up until this regulation change, the Federal Acquisition Regulation (FAR) limited contractors to counting only next tier subcontractors toward achieving goals.

For example, prime contractors were permitted to count only their first-tier subcontractors toward the goals identified in subcontracting plans. A federal contractor could not count a second-tier subcontractor toward its goals, even when the second-tier subcontractor was a qualified SBC.

Similarly, first-tier subcontractors could count only next-tier (second-tier) subcontractors to satisfy subcontracting goals. Because of this limitation, a contractor could still theoretically achieve its goals even if its first-tier SBC subcontracted a large portion of its work to a large, second-tier contractor. The result was that a higher-tier contractor received subcontracting credit regardless of the fact that the SBC did not perform an equivalent amount of work. More likely than not, the cause of this problem lay in the pre-electronic submission era where government agencies had to compare separate pieces of paper from large prime- and first-tier subcontractors.

To put this in context, unrestricted federal procurements more than $700,000 ($1.5 million for construction of any public facility) include FAR clauses 52.219-8 (Utilization of Small Business Concerns) and 52.219-9 (Small Business Subcontracting Plan), which require prime contractors to make a “good faith effort” to meet or to exceed the procuring agency’s small business subcontracting goals.

Under FAR part 19.704, a “flow-down provision,” large subcontractors must also formulate subcontracting plans if they receive a subcontract in excess of the monetary threshold.

The higher-tiered contractor is responsible for obtaining, approving and monitoring the subcontracting plans of lower-tiered contractors. Failure to make this effort could result in liquidated damages, default termination and negative performance evaluations.

SBCs, HUBZone businesses, women-owned small businesses (WOSBs), economically disadvantaged women-owned small business concerns (EDWOSBs), small disadvantaged businesses (SDBs), veteran-owned small businesses (VOSBs) and service-disabled veteran-owned small businesses (SDVOSBs) count toward achieving subcontracting goals. In addition, Alaska Native Corporations (ANCs) and Indian tribes satisfy subcontracting goals and unlike other SBCs, do not need to qualify as small to count toward subcontracting goals.

Under this regulation change, prime contractors may rely on paper self-certifications as to size or socioeconomic status or a subcontractor’s electronic certification such as size representations or certifications made in the System for Award Management (SAM).

Another important change is that the amended regulation now requires contractors to assign a specific North American Industry Classification System (NAICS) code and corresponding size standard that best describes the principal purpose of the subcontract to each small business subcontract. Specifically, contractors must provide some sort of written notice of the NAICS code and size standard to potential small business subcontractors before acceptance and award of the subcontract.

The ability to count lower tier SBC subcontract awards is a long awaited change. That said, federal contractors must carefully understand federal subcontracting plan requirements and how they have changed. This includes knowing what information other than small contractors need from SBCs and what information they must provide SBCs prior to awarding subcontracts. The penalties for failure to make good faith efforts to satisfy the requirements are huge.

For more information about this alert, please contact Reginald M. Jones at 202.461.3111 or [email protected] or any member of the firm’s Federal Government Contracts & Procurement Practice.