Limitations on Subcontracting – Long Overdue Reforms May Come Soon

Introduction

For federal contract awards reserved partially or exclusively for qualified small business prime contractors, there is a long-standing statutory and regulatory limitation on the percentage of prime contract work that could be subcontracted to firms who are not themselves small business. This so-called “Limitation on Subcontracting” (“LoS”) is designed to ensure that small business prime contractors gain maximum benefit from the set-aside work and do not circumvent the procurement process by allowing an “other than small” concern to do the preponderance of the work.¹

As originally implemented, the LoS for contracts for services provided that no more than 50 percent of the value of all services to be subcontracted could be awarded to an “other than small” concern. But this calculation was hard to monitor, could often only be done at the end of the contract period of performance, and left the federal buying agency with few if any meaningful remedies if it was not complied with.

In 2013, Section 1651 of the Fiscal Year 2013 National Defense Authorization Act standardized the LoS requirements across all federal small business socio-economic programs, shifted the measure of the limitation from a percentage of work to be subcontracted to a percentage of the dollar value of the prime contract, and specified that a “similarly situated entity”² subcontractor must perform the work with its own employees.
The Small Business Administration implemented this statutory change to the LoS provision in a series of rules in 2016, 2019, and 2020. The Federal Acquisition Regulation (FAR) was amended in 2021, but it only partially implemented the law and SBA regulations.

FAR 2024 Proposed Rule

On January 17, 2024, the FAR Council published a proposed rule³ to more fully (and, in my view, finally) implement the 2013 law and the three-year old final SBA regulations. The key changes made by the proposed FAR rule include:

1. Making it clear that only one of the several variants of the limitations on subcontracting apply to a contract; previously numerous contracting officers tried to apply multiple LoS limitations if the contract had a combination of goods and services, or even multiple line-items for different services.
2. Permitting the exclusion of certain direct costs of the performance of a services contract from the subcontracting limitation, even though that work was not performed directly by a small business; examples include costs of hotels or air travel for contracts for events support, or the cost of advertising placed under a contract to support an agency’s ad campaign.⁴
3. Excluding work performed by a small business outside the United States on a contract approved or financed under the Foreign Assistance Act.
4. Clarifying that any subcontract issued by a “similarly situated entity” under the LoS would count towards the prime contract’s LoS achievement; and
5. Eliminating the unique LoS regulatory requirements affecting 8(a) contractors.

Conclusion

It still takes the FAR Council too long to catch up with SBA on important federal procurement regulations affecting small businesses and federal agency small business contracting. This proposed rule is but another example of that slow pace, and it is still only a proposed rule. It is likely that it will take the balance of this calendar year, at least, before we see a final rule on this matter. But the rule provides the proper changes to the FAR that will benefit small businesses and federal agencies. Maybe a final FAR rule will be implemented before the four-year anniversary of SBA’s October 2020 last final rule.

In the interim, small business prime contractors who win work under set-aside contracts will be forced to carefully navigate the limitation on subcontracting rules applicable to their awards or face significant contractual and past performance risk for failing to do so.

At Centre Law, we are well-versed in these LoS provisions and regularly counsel companies on interpreting the application of the LoS provisions in solicitations and awards and in working with prime contractors in fulfilling their compliance obligations. Centre Law will continue to monitor the progress of this regulation. In the interim, if you have any questions or need any additional information, please do not hesitate to contact the author or the Centre Law attorney with whom you normally work.

¹ A related provision addresses limitation on the nonmanufacturer rule when the small business is not the original manufacturer of a product to be provided under the contract. These restrictions are important, but not addressed in this blog.
² A “similarly situated entity” is any first-tier subcontractor that has the same socio-economic status as the prime contractor. For example, if the prime is a certified woman-owned small business, another certified woman-owned small business would be a “similarly situated entity.” If the prime is a HubZone certified entity, another HubZone certified entity would be a “similarly situated entity.”
³ FAR proposed rule: “Limitations on Subcontracting Revisions, 89 Fed. Reg.2910 (Jan 17, 2024), available at https://www.govinfo.gov/content/pkg/FR-2024-01-17/pdf/2024-00728.pdf (last viewed Feb 19, 2024)
⁴ To its credit, SBA recognized the importance of these changes long ago and incorporated them in their final rule. But, in my view, SBA did not go far enough in excluding other types of direct costs of contract performance for certain services contracts over which a small business has no control.