On July 21, 2008, the U.S. Department of Defense ("DOD") issued for comment proposed rules implementing 10 U.S.C. § 2533b, the latest statutory restrictions on DOD purchases of non-domestic specialty metals. 73 Federal Register 42300.

If this topic is of interest to you, please note that these proposed rules are not yet final and DOD is still accepting comments through September 19, 2008.

We have written at length about the specialty metals restrictions, including their patch-work and chaotic evolution, as well as the administrative and cost burdens they impose. (Click here, here, and here for background discussion). Most recently, we have tracked Congressional efforts to modify – all in the name of "reform" – the onerous effect of the prohibitions, highlighting the fact that, currently, no less than five (5) different sets of specialty metals rules could apply to a company's various contracts. (Click here, here, and here for discussion of the 2008 statutory changes and various Class Deviations).

This blog posting does not attempt either: (a) to repeat our prior analyses or (b) to dissect the new proposed rules in painstaking detail. Rather, it is our intention here to alert the reader to the proposed rules and to some of their more problematic aspects. We invite you to review for yourselves the complete text of the proposed rules, but it would be advisable to be seated while doing so. The proposed rules are apt, in certain respects at least, to induce a spell of dizziness worthy of Hitchcock’s "Vertigo."

Select Features of the Proposed Rules

We start with the unqualified good news – the exemptions for electronic components and items manufactured in a qualifying country continue in place. Beyond this, the “good news” is quite limited.

1. Expanded Scope of Specialty Metals Restrictions to Permit Delivery of Metals "Melted or Produced" in the U.S.

Previously, the regulations prohibited the purchase of specialty metals that were not "melted" in the United States. See DFARS 252.225-7014(b) (2006). The statute and the proposed regulations modify this prohibition to permit the purchase of specialty metals that were “melted or produced” in the United States. One may question just how liberalizing this change really is – the proposed definition of “produce” refers to the “quenching or tempering of steel plate, gas atomization or sputtering of titanium, or final consolidation of non-melt derived titanium powder or titanium alloy powder.” Nonetheless, domestic melting is no longer the sole basis for qualifying a specialty metal to be of “U.S.” origin.

2. Exceptions for (Some) Commercial Off-The-Shelf Products – Complete with Additional Administrative Requirements.

Despite overwhelming calls from industry, Congress agreed to a commercial off-the-shelf ("COTS") exception reluctantly – making the exception extraordinarily narrow (some might say “illusory”) and instructing DOD to collect various types of information relating to the purchase of high-value COTS end items and noncommercial end items incorporating COTS items containing non-domestic specialty metals. Plainly, Congress is wary of making any type of a commercial item or COTS exception too easy to satisfy lest it offend the specialty metals lobby.

Generally, but subject to significant limitations, COTS products sold without modification are not subject to the specialty metals restrictions. "COTS" refers to any item that is: (a) a commercial item (as defined in the regulations); (b) sold in substantial quantities in the commercial marketplace; and (c) offered without modification in the same form in which it is sold in the commercial marketplace.

This is where you may feel the onset of vertigo –

  • The key to whether a product qualifies for the exception is whether it is truly purchased and incorporated without modification.
  • If the purchased product is a non-standard (i.e., non-COTS) modification by the original manufacturer, then it does not meet the definition of "COTS" and must satisfy the specialty metals restrictions.
  • If a COTS product is delivered to a company and later modified as it is inserted into a larger assembly, it will still be a COTS product. It will not, however, meet the requirement for a COTS product delivered "without modification" because that requirement is evaluated when the item incorporating the COTS product is presented for contractual acceptance at the next higher tier in the supply chain.
  • The regulations give additional examples of various types of COTS products that would or would not qualify for the exception. While one may applaud DOD’s efforts to clarify the proposed rule, the very need for so much clarification suggests that the text of the rule is overly complex and needlessly ambiguous. When the U.S. Department of Justice is hovering in the background, waiting to pounce on the next mistake as the pretext for a fraud claim, is it really too much to expect clearly written and readily comprehensible rules from our Government?
  • The newly proposed COTS exception perpetuates the incongruous policy contained in Class Deviation 2008-00002, which makes the exception inapplicable to large classes of COTS products (e.g., mill products, castings, forgings, high performance magnets) unless they are in turn incorporated into a higher level COTS end item, subsystem, assembly, or component. This makes no sense – it guts the COTS exception of much of its value for large categories of specialty metals COTS products and fails completely to alleviate the burden associated with compliance when the same COTS product is: (a) compliant if incorporated into a higher tier COTS item, but (b) non-compliant if incorporated into a higher tier non-standard item. As we have noted before in this blog, Congress itself has openly criticized this formulation.
  • The proposed rules also include a new contract clause through which information will be gathered regarding COTS purchases incorporated in non-commercial end items. Currently, DOD contemplates collection online here. For each COTS product incorporated in a non-commercial deliverable item, the contractor must provide:
    • The contract and/or order number;
    • The product category to which the acquisition applies (i.e., aircraft, missiles and space systems, ships, tank or automotive items, weapon systems, or ammunition);
    • The NAICS code of the COTS item;
    • The total cost of the COTS item;
    • The total cost of the non-commercial item into which the COTS item is incorporated.

3. Exceptions for (Some) COTS Fasteners – Depending on a Number of Different Factors.

The proposed rules create a series of exceptions for fasteners.

First, COTS fasteners that are incorporated into higher tier COTS end items, subsystems, assemblies or components are exempt.

Second, COTS fasteners that are not incorporated in turn into other COTS items may nonetheless be exempted if the manufacturer of the fasteners certifies that it will purchase during a relevant calendar year from domestic sources at least 50% of the total amount of the specialty metal (“in the required form”) that it will purchase to carry out the production of these commercial fasteners for all customers.

Third, “commercial item” fasteners (presumably as defined in FAR 2.101) may also be exempted if the fastener manufacturer makes the same certification with respect to these “commercial items” as is described above in connection with the exemption of COTS fasteners. Given the foregoing, purchasing fasteners from "certifying" sources would seem to be the preferred course. There would be no need to track the subsequent history of the fastener into a COTS or non-COTS assembly and there would be no need separately to bin and track compliant and non-compliant fasteners as they enter the manufacturing facility and are allocated from inventory to military and non-military contracts. Fastener suppliers, however, may not be all that ready to offer up another liability inducing certification or, at a minimum, to do so without passing on the cost of compliance to the buyer. Since the cost of the domestic material is likely to be higher than that of the foreign material (which is why we have these regulations in the first place), a certifying fastener supplier is, in effect, agreeing to increase the average cost of all its fasteners. It will not be absorbing that cost increase in a fit of altruistic or patriotic fervor. The "certified fastener exception," moreover, has its own definitional flaws because the certification is not to purchase a specified percentage of specialty metals “melted or produced” in the United States, but rather, of specialty metals that have been “melted” in the United States. Curiously, the salutary change effected in the proposed rules to liberalize the requirements by allowing contractors to provide metals “melted or produced” in the United States did not find its way into the exceptions fashioned by DOD for COTS and commercial item fasteners. Hopefully, this was an oversight but, when it comes to specialty metals, one can never be sure.

4. New Exception for Commercial Derivative Military Articles – Along With New Certification Requirements.

Another new exception is for "commercial derivative military articles" – articles manufactured for DOD and for non-governmental purposes using common facilities, a common supply chain and basically the same production processes. The exemption for these products is mind numbing –

  • The PCO must agree that the items, in fact, are “commercial derivative military articles;”
  • The contractor must enter into agreements with its subcontractors in connection with each such item to purchase domestically melted or produced (compare this formulation with the more limited language used for the COTS and commercial item fastener exceptions) specialty metals “in the required form” and “during the period of contract performance” that is not less than “the Contractor’s good faith estimate of the greater of:”
    • 120% of the amount of specialty metal required to produce the commercial derivative military article; or
    • 50% of the amount of specialty metal purchased during that period in the production of the commercial product and the commercial derivative military article.
  • The contractor must certify its compliance with these requirements, consistent with a newly proposed contract clause.

Conclusion

Otto von Bismarck is reputed to have said that “No one who loves sausage and respects the law should ever watch either one being made.” Wherever he is, he must feel vindicated in his judgment.