On December 19, 2022, the U.S. Small Business Administration (SBA) issued a proposed rule that would amend the SBA regulations to implement Section 870 of the National Defense Authorization Act (NDAA) of 2020. Section 870 makes noteworthy changes to the requirements a federal contractor must adhere to when attempting to obtain subcontracting credit for lower-tier subcontracts. 

Federal prime contractors performing on contracts exceeding the simplified acquisition threshold ($250,000) must “ensur[e] that small business concerns have the maximum practicable opportunity to participate in the performance of the contract, including subcontracts for subsystems, assemblies, components, and related services for major systems, consistent with the efficient performance of the contract.” Additionally, most federal contracts require prime contractors to enter subcontracting plans which incorporate certain percentage goals for the use of small businesses and even specific subcategories of small businesses.   

The previous regulations, delineated in the SBA’s final rule published on December 23, 2016, mandated prime contractors to receive credit for lower-tier subcontractors in certain situations. That requirement would change under the December 2022 proposed rule with four notable revisions:

  1. Eliminate the mandate to allow prime contractors to select whether to receive credit for lower-tier subcontracts in certain situations.
  2. Prohibit agencies from setting tier-specific goals for prime contractors using lower-tier subcontract credit.
  3. Implement new record-keeping requirements.
  4. Increase the threshold for a required subcontracting plan to $750,000. 

Eliminating the Mandate

The proposed rule would eliminate the prior mandate, allowing prime contractors to choose whether to receive credit for first-tier subcontracts only or subcontracts at any tier, with certain conditions. The elective option gives prime contractors greater latitude to weigh the administrative costs and strategic benefits of taking credit for work performed by lower-tier subcontractors.  

Importantly, a prime contractor may only count lower-tier subcontracts as credit toward their goals when the subcontracting plan applies to a single contract with a single federal agency. If the plan applies to more than one contract, a contract with multiple agencies, a commercial plan, or is a comprehensive subcontracting plan, the prime contractor may only use first-tier subcontracting credit to meet its goals. Prime contractors performing on government-wide contracts and multi-agency awards are similarly barred from using lower-tier subcontract credit. 

These restrictions may change with the implementation of the final rule, however. The FY 2020 NDAA states, “if the subcontracting goals pertain to more than one contract with one or more Federal agencies, or to one contract with more than one Federal agency, the prime contractor may only receive credit for first-tier subcontractors that are small business concerns.” Meanwhile, the restrictions delineated in the proposed rule seem overly broad. Many in the industry believe the intent behind Section 870 was not to apply these restrictions on government-wide or multi-agency contracts. Further, the restrictions inhibit the government’s ability to glean valuable insight into small business participation by restricting the counting of small business subcontractor data below the first tier.

Additionally, where an eligible prime contractor elects to receive credit for a subcontractor’s work at any tier, the following requirements apply:

  1. The subcontracting plan goals of the prime contractor’s lower-tier subcontractors must be incorporated into its individual-subcontracting-plan goals.
  1. Lower-tier subcontractors must have subcontractor-specific individual subcontracting plans.
  1. The prime contractor and other subcontractors with subcontracting plans are responsible for reporting subcontracting performance under their contracts or first-tier subcontracts. This applies to both individual and summary subcontracting reports.
  1. The prime contractor’s performance will be calculated by combining the prime contractor’s first-tier subcontracting with the achievements of the prime contractor’s lower-tier subcontractors with flow-down subcontracting plans.

Prohibiting Tier-Specific Goals

The 2016 final rule conditioned a prime contractor receiving credit below the first tier of subcontracts with two sets of subcontracting goals – a goal for first-tier and one for the lower tiers. Contractors have long expressed their distaste for the practice as it imparts additional reporting requirements and performance risks. The proposed rule would prohibit this type of tier-specific goals requiring instead that prime contractors only have one set of subcontracting goals. The prime contractor would include “the subcontracting-plan goals of its lower-tier subcontractors into its individual-subcontracting-plan goals.”

New Record-Keeping Requirements

The proposed rule also requires that contractors with subcontracting plans maintain certain records to “substantiate the credit they receive for lower-tier subcontracting.” Now, the prime contractor must provide in a written statement the types of records it will furnish to prove it received the appropriate lower-tier subcontracting credit. 

Increases Threshold

Currently, those awarded contracts that “offer subcontracting possibilities with the Federal Government in excess of $650,000…must submit a subcontracting plan to the appropriate contracting agency.” The proposed rule would increase this threshold to $750,000, aligning it with the Federal Acquisition Regulation (FAR) subpart 19.7 and other parts of 13 C.F.R. § 125.3. 

Going Forward

The proposed rule is a welcome update to the subcontracting plan architecture that should confer benefits to both prime contractors and subcontractors alike, even with certain limitations to its scope of applicability. 

Prime contractors have long argued that the multi-tier reporting system, which this proposed rule eliminates, required resource-intensive oversight and created compliance and performance risks. Additionally, the previous rule required that prime contractors be responsible for subcontractors meeting their subcontracting goals, which brought another level of costs through the administrative burden of collecting relevant data and the impact on performance ratings of subcontractor noncompliance. The optionality in the proposed rule should be particularly enticing to some prime contractors who believe the costs outweigh the benefits of participating. 

The proposed rule should also help the small business community by driving increased participation. The optionality should incentivize prime contractors to use lower-tier small businesses instead of tightening the pool to lower oversight costs.

The Bass, Berry & Sims government contracts attorneys will continue to monitor the implementation of the final rule and update our subscribers on any material changes the final rule makes. For further information on this proposed rule or subcontracting plans more generally please do not hesitate to contact Todd Overman at toverman@bassberry.com.