Prime contractors and higher tier subcontractors understand they have certain responsibilities for the selection and management of their subcontractors. Federal Acquisition Regulation (FAR) clauses address such responsibilities and prime contractors flow down certain of these obligations to subcontractors in their supply chains.

What happens when the government asserts that a prime contractor’s responsibility for subcontractor management includes the duty to act in the shoes of the government and perform contract administration functions that are not required by the terms of the prime contract? The Armed Services Board of Contract Appeals (ASBCA) recently addressed this question and rejected an attempt by the government to disallow costs based on an overbroad interpretation of a prime contractor’s responsibility to manage its subcontractors.

The ASBCA’s December 20, 2016 decision in Lockheed Martin Integrated Sys., Inc., ASBCA Nos. 59508, 59509, involved a government claim denying $103 million in costs because of an alleged breach of the contractor’s responsibility to manage its subcontractors. The government’s claim was based on the Defense Contract Audit Agency’s (DCAA) contention that a “literal interpretation of FAR 42.202 [Assignment of Contract Administration] requires the prime contractor to act on behalf of the government and serve as both the Contracting Officer (CO) and the Contracting Administrative Office (CAO) for each subcontract that it awards under a government flexibly priced contract.” (Decision at 10) The DCAA then claimed, and the US Army adopted in its complaint, FAR 42.202 required Lockheed as the prime contractor to perform certain specific actions with respect to its subcontractors. The government disallowed subcontractor costs based on Lockheed’s alleged failure to do so.

What Happened?

The DCAA audited and questioned $103 million in subcontract costs included in a Lockheed incurred cost submission. The audit alleged Lockheed failed to prove it had (1) confirmed subcontractor personnel qualifications through a resume review, (2) confirmed the accuracy of subcontractor invoiced hours through a timesheet review, and (3) obtained subcontractor incurred cost submissions or would contact the government if it was unable to obtain them. With respect to the latter, the DCAA asserted no subcontract costs were allowable “[w]ithout an incurred cost submission from the subcontractor,” (Decision at 11), that certain subcontractors had failed to provide adequate incurred cost submissions to Lockheed, and that prime contractors were required “to audit their subcontracts or request audit assistance from the cognizant DCAA office when the subcontractor denies the prime contractor access to their records based on the confidentiality of propriety [sic] data.” (Decision at 10, 14, 24)

In response to the audit, Lockheed acknowledged there are FAR requirements regarding management of subcontractors and stated it did flow all applicable requirements down to its subcontractors. (Decision at 13) However, it also stated its practice was not to collect incurred cost submissions from its subcontractors and advised them “of their responsibility to submit . . . all applicable schedules” to DCAA. Lockheed also contended there was no requirement in the FAR or DCAA audit manual for subcontractors to submit incurred cost proposals to the prime contractor and industry practice required subcontractors to submit such proposals directly to DCAA. (Decision at 13)

After the CO issued the final decision, Lockheed appealed to the ASBCA and then moved to dismiss the government’s complaint. The ASBCA agreed with Lockheed and dismissed the appeal.

Why did the ASBCA Dismiss the Government Claim?

The dispute in this case focused on FAR Subpart 42.2 “Contract Administration Services.” In that regard, DCAA in its audit and the US Army in its complaint relied on FAR 42.202(e)(2), which states that "[t]he prime contractor is responsible for managing its subcontracts,” and FAR 42.302(a) regarding determination of allowable costs as the basis for the alleged requirement that the prime contractor act on behalf of the government. While the government admitted that FAR 42.202 was not a contract term, it contended “it was the government's intent to require the prime contractor to act as both contracting officer ... and the CAO,” and that Lockheed “breached its inherent duty to properly manage its subcontracts, which led to the government paying for unallowable costs.” (Decision at 23)

The ASBCA rejected the government’s interpretation of FAR 42.202. The Board found that FAR Part 42 (and Part 44) was not incorporated into Lockheed’s prime contracts and went on to hold even if this language was included, it did not impose the duties on the prime contractor asserted by the government. (Decision at 25) With respect to the government’s specific contention that Lockheed breached the contract by failing to “to produce ‘proof of [incurred cost] submissions [to Lockheed] or proof of requests for audit’ for subcontractors DCAA had determined did not submit incurred cost submissions,” the Board stated that “FAR Part 42 reveals no requirement (literal or implied) that a prime contractor act as both CO and CAO with respect to its subcontracts.” (Decision at 26) (The Board likewise rejected the government’s claims that Lockheed had breached duties imposed by FAR 42.202 with respect to review of resumes and accuracy of invoiced hours, relying in part on other contract provisions. (Decision at 25))

Observations on Prime Contractor Responsibilities

This case rejects an attempt by the government to impose responsibilities on prime contractors for management of their subcontractors pursuant to FAR 42.2 that are not required by the terms of the prime contract. However, contractors should note that prime contractors and higher tier subcontractors do have many contractual responsibilities for the management of subcontractors in their supply chain. In addition, recent regulations issued by the Obama Administration have added to those responsibilities.

For example, the US Department of Labor’s final Paid Sick Leave and the recent implementation of an interim FAR clause include a flow down requirement, and provide that a prime contractor is “responsible for the compliance by any subcontractor with the requirements of Executive Order 13706, 29 CFR part 13, and this clause.” (FAR 52.222–62(c)(6)) The Steptoe advisory on that FAR clause is available here.

Moreover, prime contractor management of subcontractors has been part of the fabric of government contracting for some time. For example, the government uses extensive source selection procedures to select prime contractors. Although the government does not generally choose (or have “privity of contract”—i.e., a direct legal relationship with) subcontractors and suppliers, the government’s source selection criteria may include an assessment of the prime contractor’s ability to select and manage the suppliers it proposes to use to perform the contract. (FAR 9.104-4(a)).