Over the past two weeks, the Small Business Administration has issued two significant rules that affect both large and small business government contractors. Although both rules were issued to protect small businesses, they will increase the potential financial penalties associated with small business prime contracts and the burden of tracking small business subcontracts. In addition, the new rules will likely trigger a push by contractors of all sizes to confirm the size status of their teammates and subcontractors.

The Presumed Loss Rule

On June 28, 2013, the Small Business Administration (SBA) issued a final rule to implement provisions of the Small Business Jobs Act of 2010 relating to small business size and status integrity. 78 Fed. Reg. 38811, June 28, 2013. The most notable of these provisions is the so-called presumed loss rule. This rule, and its use in conjunction with the False Claims Act, 31 U.S.C. §§ 3729–3733 (FCA), creates the potential for significant penalties that require both small and large contractors to revise their contracting processes. The regulations go into effect on August 27, 2013.

In general, the measure of single damages under the FCA is based on the difference in value between the amount paid and the value of goods and services provided. Under this new rule, damages for willful small business misrepresentations will be calculated as if the firm in question provided no value whatsoever to the government. Further, the rule provides that submission of an offer or registration in the System for Award Management (SAM) may be considered a deemed certification for purposes of the presumed loss rule. In each of these respects, the new rule embodies litigation positions the Department of Justice has been advocating, with mixed results, in FCA cases around the country. In addition, the rule requires that entities must recertify their size status annually to continue to be listed as small or disadvantaged in SAM.

SBA’s final rule contains significant differences from its proposed rule. The most significant difference is deletion of the word “irrefutable” from the presumption of loss. This was based on concerns raised by commenters. Not only was the term contradictory to the limitations on liability for unintentional errors or technical malfunctions and suggested that contractors would be barred from presenting defenses to the presumed loss at trial, but it also was derived from Senate Report language that did not possess statutory authority. The final rule clarifies that the presumed loss stemming from a willful false certification is rebuttable, and that contactors will have an opportunity to present defenses to overcome the presumption.

To be subject to the presumed loss rule, a small business contractor’s miscertification must be “willful.” SBA’s final rule does not define this key term. Instead, SBA explains that “the finder of fact, notice requirements, and means of defense will depend on the specific action taken against the business concern.” SBA’s rule confirms that an adverse size determination, in and of itself, will not automatically trigger a presumption that the concern willfully misrepresented its status and will require a case-by-case determination. This will allow small businesses to argue that any misrepresentation was in good faith. The factors for determining willfulness include: “the firm’s internal management procedures governing size representation or certification, the clarity or ambiguity of the representation or certification requirement, and the efforts made to correct an incorrect or invalid representation or certification in a timely manner.”

SBA also broadened the scope of the final rule to include not only full small business set-asides, but also “reserves, partial set-asides, price evaluation preferences, source selection factors, and any other mechanisms which are not specifically addressed by the FAR.” This laundry list of circumstances significantly increases the breadth of the rule and will require contractors to be extremely attentive to compliance given that it may apply to a wide variety of procurements in which small business status plays a role.

The increased scope also raises the question of how the presumed loss rule will apply to large businesses that claim small business credit for their subcontractors under a source selection factor. Although the rule states that it may apply to source selection factors, it also provides that prime contractors will not face liability for willful misrepresentations by their subcontractors as “[a] prime contractor acting in good faith should not be held liable for misrepresentations made by its subcontractors regarding the subcontractors’ size.”

Although the presumed loss rule likely will be most relevant in FCA cases, SBA’s final rule states that the presumed loss rule applies to “all manner of criminal, civil, administrative, contractual, common law, or other actions, which the United States government may take to redress willful misrepresentations.”

The final rule, and the potential for significant monetary damages, requires prudent contractors to take a number of steps:

  • Small businesses should review their own size status certifications. This may include a “self audit” of a firm’s current contract portfolio, revenue rates, employee headcount and all possible affiliates.
  • Small businesses should also institute internal management procedures governing size representations and certifications. These should include a review of the System for Award Management before the submission of any proposal, regular updating of certifications and overlapping review of all other certification submissions.
  • Large businesses should protect themselves from subcontractor miscertifications by requiring certifications that include current revenue and employee figures as appropriate per the relevant North American Industry Classification System (NAICS) code(s).
  • Large businesses acting as subcontractors or teaming partners with small businesses should include provisions in their agreements protecting them from any termination risk or liability based on the prime contractor’s false certification.
  • Firms interested in acquiring or investing in small businesses should increase their diligence efforts and include significant protection for the possibility of a willful misrepresentation. As a FCA action based on a misrepresentation could result in damages of more than the full contract value, firms should be hesitant to accept lower caps on these types of damages.

It is also worth noting that these will not be the final developments on the presumed loss rule. SBA is currently preparing rules to implement §1651 of the National Defense Authorization Act of 2013 (NDAA). That Act expanded coverage of the presumed loss rule to include violations of subcontracting limitations (e.g., workshare limitations) under small business contracts. Although final implementing regulations have not been issued, this provision could result in penalties in the millions of dollars against small business prime contractors, far beyond the original $500,000 cap found in the current regulations. The NDAA also created a “safe harbor” for small businesses that represent themselves as small or disadvantaged in “good faith reliance on a written alert opinion from a Small Business Development Center . . . or an entity participating in the Procurement Technical Assistance Cooperative Agreement Program. . .” If implemented appropriately, this safe harbor could mitigate some of the potential risk in this area.

The Small Business Subcontracting Rule

SBA also issued a final rule on July 16, 2013, to implement additional provisions of the Small Business Jobs Act of 2010 relating to small business subcontracting. 78 Fed. Reg. 42391, July 16, 2013. This creates several new and possibly extensive reporting requirements and obligations for large business contractors, including:

  • Contractors must represent they will make good faith efforts to award subcontracts to the same small business contractors at the same percentages as in the subcontracting plans submitted with their bids. If a contractor fails to do so, it must provide a written justification to the contracting officer, who is tasked with monitoring and evaluating subcontracting plan performance.
  • Contractors must report annually on their small business subcontracting achievements under multi-agency contracts at the task order level. This requirement appears to include a reporting requirement for every order placed under some of the most common contracting vehicles, including General Services Administration (GSA) Schedule contracts.
  • Contractors must notify the contracting officer, in writing, every time it pays a small business subcontractor a reduced price for goods or services or is more than 90 days past due in making a payment to a small business subcontractor. Contracting officers must consider this information when evaluating contract performance and report contractors with a “history of unjustified untimely payments” (three or more self-reports in a one-year period) in the Federal Awardee Performance and Integrity and Information System (FAPIIS).

In addition to the reporting requirements for contractors, the rule also authorizes agencies to use subcontracting plan compliance as an enumerated evaluation factor or subfactor in making award decisions. The rule also clarifies which subcontracts should be included and excluded from subcontracting data reports and makes changes to subcontracting plan thresholds.

Before issuing the final rule, SBA received numerous comments from industry arguing that the new reporting requirements, especially those relating to multi-agency contracts like the GSA Schedule, would create a heavy administrative burden and do little to assist small businesses. In its final rule, SBA refused to put any meaningful limitation on these reports and declined to adopt even the smallest monetary threshold for reporting. SBA’s only concession was to require the reports only annually as opposed to biannually as it initially considered. As a result, contractors have to prepare thousands of these reports for orders of any magnitude, providing extensive information about their dealings with small business subcontractors.

In a separate but related sign of the times, SBA’s Office of Hearings and Appeals (OHA) has also allowed for increased scrutiny of small business subcontracting in size protests. In the recent Appeal of IAP World Services Inc., SBA No. SIZ-5480 (2013), OHA explained that large business prime contractors may challenge the size status of other offeror’s small business subcontractors. This decision opens the door for size challenges to subcontractors in the context of full and open competitions. Particularly when combined with the recent regulatory changes, OHA’s decision underscores the critical importance of large business prime contractors exercising the utmost diligence to ensure that their small business subcontractors truly are small.

Given this increase in reporting and scrutiny from the Government and private parties, it is fair to wonder what a prime contractor’s liability could be for a small business subcontractor’s false certification. Are prime contractors required to investigate each small business subcontractor? The current rule emphasizes that prime contractors can rely in good faith on the representations of their subcontractors, but it also notes that inaccurate reporting at the prime contract level may result in poor past performance reviews. With the expansion of the presumed loss rule discussed above and the implied certification theories under the FCA that have been advanced by the Department of Justice, we could well see increased liability in this area in the future.

The final SBA subcontracting rule goes into effect August 15th, 2013, but many reporting requirements require additional implementation by the FAR Council.