A new Small Business Administration (SBA) final rule that impacts both small businesses and large businesses that work with small businesses to perform work on federal contracts became effective on June 30, 2016. The final rule is intended to increase opportunities for small businesses to work on federal contracts and to implement certain provisions of the National Defense Authorization Act of 2013 related to small businesses. A copy of the final rule can be found here.

The rule, among other things, modifies the SBA’s regulations related to Limitations on Subcontracting, Small Business Subcontracting Plans, Affiliation, and Joint Ventures involving Small Businesses.

Changes to the SBA limitation on subcontracting regulations:

  • Revises the limitation on subcontracting amount, for full or partial set aside contracts with a value greater than $150,000, to a percentage of the award amount received by the small business prime contractor, instead of requiring a minimum percentage of work that the small business prime contractor had to perform under the prior SBA regulations.
  • Establishes the limitation or cap on the dollar amount of subcontracting by a small business prime contractor at 50% of the award amount of the prime contract for contracts for supplies and services; 85% of the award amount for general construction subcontracts; and 75% of the award amount for “special trade” subcontracts.
  • Establishes a different set of rules for contracts for both services and supplies (i.e., “mixed contracts”), clarifying that the limitations on subcontracting apply only to subcontracts that correspond to the principal purpose of the prime contract. The Contracting Officer will be responsible for determining the principal purpose of the prime contract and assigning the appropriate NAICS code based on whether the supplies portion or services portion of the contract represents the greatest percentage of contract value. Therefore, for a contract principally for services, but which also requires supplies, the prime contractor or its similarly situated subcontractors cannot subcontract more than 50% of the services to other than small concerns but can subcontract all of the supply components to any size business.
  • Excludes amounts paid to “similarly situated” small businesses from the limitations on subcontracting by considering the work performed by such firms not as not subcontracted work but rather as work performed by the small business prime contractor.
    • “Similarly situated” subcontactor is defined as an entity that is a participant in the same small business program in which the prime contractor is a certified participant and that qualified the small business prime contractor to receive the award but limits the exclusion of similarly situated entities to the types of contracts identified in FAR Part 52.219-14.
    • Distinguishes work subcontracted by a first tier similarly situated subcontractor, which will count against the cap on subcontracting.
    • Excludes “similarly situated subcontractors” from the application of the “ostensible subcontractor” rule for purposes of the SBA’s affiliation rules.
  • Prescribes penalties for any small business prime contractor that violates the limitations on subcontracting requirements including, but not limited to, suspension, debarment, and/or fines that are the greater of $500,000 or the dollar amount spent on large subcontractors in excess of the permitted levels for subcontracting.

The potentially severe consequences for a violation of the subcontracting limitations make it important for small business prime contractors to monitor compliance with those limitations. The amendments further encourage small businesses to subcontract to other small businesses through the “similarly situated” exclusion. In addition, the “similarly situated” first-tier subcontractor exclusion rule allows small businesses to subcontract to large businesses up to the full amount of the subcontracting limitation, while maintaining the opportunity to use a similarly situated small business since the work performed by the similarly situated first-tier subcontractor does not count as subcontracted work.

Revisions to requirements relating to small business subcontracting plans:

  • Requires prime contractors to provide prior written notice to a subcontractor that it intends to identify the small business by name as a potential subcontractor in a proposal, offer, bid or subcontracting plan in connection with a federal contract.
  • Requires the contracting agency to collect, report, and review data on the extent to which the large contractor complies in good faith with the goals and objectives of its subcontracting plan.
  • Implements requirements for reporting to the SBA Office of Inspector General where there is a reasonable basis to believe a prime contractor or subcontractor made a false statement to the government or to an employee or representative of the prime contractor with respect to a subcontracting plan. The Final Rule also permits, but does not require, other concerns regarding prime contractor or subcontractor compliance with SBA regulations or bad faith actions to be reported to the Government Contracting Area Office where the firm is headquartered.
  • Provides that a contractor’s failure to provide a written corrective action plan after receiving a marginal or unsatisfactory rating for its subcontracting plan performance or failure to make a good faith effort to comply with its subcontracting plan will constitute a material breach of the contract and the failure will be considered in the past performance evaluation of the contractor.

The consequences of a contractor’s failure to meet the goals of its subcontracting plan can therefore extend into future procurements through consideration of the contractor’s past performance. These amendments further evidence an increased focus on reporting fraudulent and/or bad faith action with respect to subcontracting plans.

Clarification of the identity of interest and economic dependence factors of affiliation under the SBA regulations:

  • Clarifies that firms owned or controlled by married couples, parties to a civil union, parents, children, and siblings are the type of relationships that create a rebuttable presumption of affiliation due to an identity of interest, where they conduct business with each other either as subcontractors or joint venturers, or share or provide loans, resources, equipment, locations or employees.
  • Adopts a rebuttable presumption of affiliation based on economic dependence if a firm derives 70% or more of its revenue from another firm.
  • Measures the economic dependence over a three year period.

The 70% fixed percentage of economic dependence provides contractors with a bright line test for assessing economic dependence, and therefore affiliation. However, exceeding that standard is also likely to increase the risk that a contractor may not qualify as a small business. Small businesses should also carefully monitor the source of their revenue against the 70% standard.

Changes to Joint Ventures Involving Small Businesses:

  • Removes the current restriction on the type of contracts for which small businesses may joint venture without being affiliated for size determination purposes by providing that a joint venture of two or more business concerns may qualify as a small business so long as each partner to the joint venture qualifies individually as small under the size standard corresponding to the NAICS code assigned to the contract. This change should expand the range of contract opportunities for which small businesses are able to compete.

Contractors should be alert for revisions to the FAR that address the changes made by this SBA Final Rule.