Originally published by Aerospace & Defense Law360, Government Contracts Law360, Mergers & Acquisitions Law360, Private Equity Law360, and Public Policy Law360, August 2016
On July 14, 2016, the Federal Acquisition Regulation Council
issued a final rule implementing changes to the Federal Acquisition
Regulation small business subcontracting regulations.[1] These
changes — which will become effective on Nov. 1, 2016 —
are consistent with the 2013 regulatory changes to small business
subcontracting made by the U.S. Small Business Administration to
implement the Small Business Jobs Act of 2010 (Pub. L. 111-240). In
addition to existing recertification requirements for small
businesses following a merger or acquisition, the new rules add
requirements for new subcontracting plans, notification, and
reporting; create new compliance obligations; and have implications
for past performance evaluations in future procurements.
Acquirers of a company that identifies itself as a "small
business" under the SBA regulations should consider the
potential impact of the new regulations under the key FAR
provisions amended by the Final Rule: FAR Subpart 19.7 (The Small
Business Subcontracting Program) and the contract clauses at FAR
52.219-8 (Utilization of Small Business Concerns) and FAR 52.219-9
(Small Business Subcontracting Plan). Acquirers, including private
equity firms and strategic buyers, should evaluate the impact that
the acquisition and the new small business subcontracting rules may
have on the sustainability of the target company's government
business.
The Transaction May Limit the Target's Business
Opportunities
A company bidding on a government procurement reserved for small
businesses must certify in its proposal its qualification for small
business status. Such companies may face additional certification
requirements after contract award. Specifically, if a company is
awarded a government contract based on its small business status,
and if that company is later acquired by or merges with another
entity, the contract awardee must recertify its size status within
30 days following the merger or acquisition.[2] The new SBA
regulations impose additional recertification requirements on a
small business concern if a merger or acquisition occurs after the
small business concern submits its proposal but prior to contract
award.[3]
To determine a government contractor's size status, the SBA
looks at both the entity itself and the contractor's
affiliates. Affiliates are entities under common control with the
contractor, based on ownership, management, previous relationships,
and contractual relationships.[4] In determining whether
affiliation exists, the SBA considers the totality of the
circumstances and may find affiliation even in circumstances where
no single factor alone may be sufficient to constitute affiliation.
If the SBA determines that affiliation does exist, it will count
the receipts or number of employees of the contractor whose size is
at issue, combined with the receipts or number of employees for all
of the contractor's domestic and foreign affiliates to
determine if the contractor still qualifies as a small business
under the specified North America Industry Classification System
code and corresponding size standard following the merger or
acquisition.[5]
The acquirer may try to structure the transaction with the small
business government contractor in a manner to avoid affiliation,
such as by having the target retain majority ownership and
management control of itself. Often, however, the target and the
acquirer will be deemed to be affiliates, and the target will no
longer qualify as a small business under the SBA's
regulations.
Following a merger or acquisition resulting in a change in size
status, the small business must notify all contracting officers for
its outstanding bids and proposals and existing contracts and make
updated representations regarding its size status. Generally, the
target will retain its status as a small business for the life of
its existing government contracts, and the change in size status
will not change the terms and conditions of the contracts. The
target will be permitted to complete its performance on its
existing small business set-aside contracts. However, once the
target recertifies that it is no longer a small business, the
contracting agencies will no longer be permitted to count
additional orders placed with, contract options exercised with, or
modifications issued to that contractor towards the fulfillment of
the agencies' small business procurement goals. In other words,
the agencies will not be entitled to receive small business credit
for such orders or contracts.
As a result, agencies may be less motivated to award future
business — including exercising options or placing orders
under existing contracts — to the contractor. The contractor
also will no longer be eligible for participation in future
procurements reserved for small businesses. Similarly, prime
contractor customers will no longer be able to consider contract
extensions or modifications of the target's subcontracts
towards meeting their goals under their small business
subcontracting plans, and may be less motivated to continue doing
business with the target company following the loss of the target
company's status as a small business. Thus, the value of a
small business target and the overall sustainability of its
government contracts business could decrease dramatically after
size recertification and loss of small business size status.
The Transaction May Create a New Obligation to Submit
Subcontracting Plans
The changes to the FAR small business subcontracting requirements
under the final rule will, under certain circumstances, impose
additional subcontracting obligations on acquirers.
As noted, a contractor must recertify its size status after a
merger or acquisition. Under FAR 19.301-2(e) as revised by the
Final Rule, contracting officers may require a contractor -- and
its new parent entity -- to submit a subcontracting plan for each
contract, if the contractor no longer certifies as a small
business. While recognizing that the contractor's change in
size status does not change the terms and conditions of the
contract, revised FAR 19.301-2(e) will provide that "the
contracting officer may require a subcontracting plan for a
contract containing 52.219-9, Small Business Subcontracting Plan,
if a prime contractor's size status changes from small to other
than small as a result of a size rerepresentation (see
19.705-2(b)(3))." The final rule also supplements the existing
guidance to determine if a subcontracting plan is necessary. It
revises FAR 19.705-2 to direct contracting officers to consider
— in addition to the factors already included in the FAR
— the total contract dollars, and whether the contractor may
acquire any portion of work from potential subcontractors with
minimal or no disruption to performance and at a fair market
value.
As revised, FAR 19.702(a)(3) will mandate that contracting officers
require subcontracting plans under certain circumstances (unlike
with recertification, where contracting officers have discretion
regarding whether or not to require subcontracting plans, see FAR
19.301-2(e)). If a contract modification causes the value of a
contract without an existing subcontracting plan to exceed $700,000
— or $1.5 million for a construction contract — the
contracting officer must require the contractor to submit a
subcontracting plan for the contract, if the contracting officer
determines that subcontracting opportunities exist. In addition,
FAR 19.705-1(b)(1) as revised will require that, unless the
contractor has a commercial plan,[6] the contracting officer must
require a subcontracting plan for each indefinite-delivery,
indefinite-quantity contract — including task order delivery
order contracts, Federal Supply Schedules, governmentwide
acquisition contracts, and multiple award contracts — if the
estimated value of the contract meets the subcontracting plan
thresholds at FAR 19.702(a)(1), and the contracting officer
determines that small business subcontracting opportunities
exist.
Under the final rule, a subcontracting plan must include fourteen
different types of information and assurances. Among other
requirements, a subcontracting plan must include:
- Separate goals, expressed in terms of total dollars subcontracted, and as a percentage of total planned subcontracting dollars, for the use of small business, veteran-owned small business, service-disabled veteran-owned small business, HUBZone small business, small disadvantaged business, and women-owned small business concerns as subcontractors;
- A statement of total dollars that the contractor plans to subcontract for an individual subcontracting plan; or the contractor's total projected sales, expressed in dollars, and the total value of projected subcontracts to support the sales for a commercial plan;
- A description of the principal types of supplies and services that the contractor will subcontract, and an identification of the types planned for subcontracting;
- An assurance that the contractor will cooperate with certain studies or surveys and will submit certain periodic reports;
- Assurances that the contractor will make a good faith effort to acquire supplies, services, or construction work from the small business concerns listed;
- Assurances that the contractor will provide the contracting officer with a written explanation if the contractor fails to meet its described subcontracting goals; and
- Assurances that the contractor will not prohibit any of its subcontractors from discussing with the contracting officer any material matter pertaining to payment to or utilization of a subcontractor.[7]
The final rule specifies that, if the contractor adds a
subcontracting plan as a result of a size reclassification —
or a modification to the dollar value of the contract — then
the subcontracting goals will apply from the date of incorporation
of the subcontracting plan into the contract.[8] The
contractor's subcontract reporting obligations, including
submission of an individual subcontracting report, will be
triggered on a cumulative basis from the date that the
subcontracting plan is incorporated into the contract.[9]
The New Rule Attempts to Reduce Instances of "Bait and
Switch" Involving Proposed Subcontractors
In addition to creating new small business subcontracting
obligations, the final rule will revise the FAR to make it more
difficult for contractors to propose the use of small business
subcontractors for a government contract and then fail to follow
through with those proposed subcontractors during contract
performance. Specifically, the final rule will add paragraph
(a)(12) to FAR 19.704 to require that each offeror's
subcontracting plan include assurances that the offeror will make a
"good faith effort" to acquire supplies, services, or
construction work from the small business concerns that the offeror
included in its bid or proposal, and in the same or greater scope,
amount, and quality as used in preparing and submitting the bid or
proposal.[10] The final rule will also add paragraph (a)(13) to FAR
19.704 to require a prime contractor to submit a written
explanation to the contracting officer within 30 days of contract
completion if the contractor fails to utilize its small business
subcontractors in the manner proposed in its bid or proposal.
Under the final rule, contractors may be subject to additional
consequences for failing to implement their subcontracting plans.
Under the current FAR provisions, if a contractor does not comply
in good faith with its approved subcontracting plan, the contractor
may be found to have materially breached its contract.[11]
Beginning Nov. 1, 2016, a contractor's failure to comply in
good faith with its small business subcontracting plan also
"may be considered in any past performance evaluation of the
contractor."[12]
On a related point, the FAR as revised will require a prime
contractor to allow its subcontractors to communicate directly with
the contracting officer concerning "any material matter
pertaining to payment to or utilization of a
subcontractor."[13] While this change will not create privity
between the subcontractor and the government, it could alert a
contracting officer to instances where a prime contractor may not
be utilizing proposed small business subcontractors post-award or
is otherwise failing to abide by its small business subcontracting
plan.
The New Rule Adds Additional Obligations Vis-a-Vis
Subcontractors
The final rule will amend the FAR to impose an additional
notification requirement on prime contractors for competitive
subcontracts over the simplified acquisition threshold in which a
small business concern received a small business preference. In
such instances, the prime contractor must, prior to award of the
subcontract, inform each unsuccessful small business subcontract
offeror, in writing, of the name and location of the apparent
successful offeror and if the successful subcontract offeror is a
small business, veteran-owned small business, SDVOSB, HUBZone small
business, small disadvantaged business, or women-owned small
business concern.[14]
Under the revised FAR, prime contractors also will need to assign
to each subcontract the NAICS code and corresponding size standard
that the prime contractor determines best describes the principal
type of supplies or services to be subcontracted.[15] Prime
contractors will no longer be permitted to simply flow down the
NAICS code selected by the contracting officer for the prime
contract.
The New Rule Adds Liability Protection for the Prime
Contractor
The final rule includes one change that prime contractors may
welcome. Under FAR 19.703, as revised by the final rule, prime
contractors will not be held liable for a subcontractor's
misrepresentation about its size or socioeconomic status, assuming
the prime contractor acted in good faith.[16] The final rule
further provides that a prime contractor may accept size and
socioeconomic representations from a potential subcontractor either
from the subcontractor's self-certifications included in its
System for Award Management registration or by direct written
representation. There is no order of preference for either method
of representation by a small business subcontractor, but SBA
regulations require that, for subcontracting purposes, a concern
must qualify as small as of the date that it certifies its size
status for the subcontract.[17]
Conclusion
Acquirers and their advisers should be mindful of the revisions to
the FAR small business subcontracting regulations during the due
diligence process, particularly where the acquisition involves a
target company identifying itself as a "small business."
The transaction may expose the target company and its parent
company to new subcontracting plan requirements, along with
additional notification, reporting and compliance obligations. More
broadly, the new FAR small business subcontracting rules may impact
the value and sustainability of the target company's government
business.
[1] See 81 Fed. Reg. 45833 (July 14, 2016) (the "Final
Rule").
[2] See FAR 19.301-2(b)(2) (rerepresentation by a contractor that
represented itself as a small business concern) and FAR
52.219-28(b)(2) (Post-Award Small Business Program
Rerepresentation).
[3] See 13 C.F.R. § 121.404(g)(2)(ii)(D); 81 Fed. Reg. 34243
(May 31, 2016) (implementing provisions of the National Defense
Authorization Act of 2013; final rule effective June 30, 2016). The
new recertification requirements under SBA's regulations
require that if a merger or acquisition occurs after a small
business concern submits its proposal, but prior to contract award,
the offeror must recertify its size to the contracting officer
before award. According to the SBA, "[i]f recertification is
required for an existing contract, it should be required for a
pending contract. An agency's receipt of small business credit
should not depend on whether an acquisition or merger occurs the
day before award of contract." 81 Fed. Reg. 34243 at
34253.
[4] See 13 C.F.R. § 121.103(a) and (b).
[5] See 13 C.F.R. § 121.104(d)(1) and 13 C.F.R. §
121.106(b)(1).
[6] The FAR defines a "commercial plan" as "a
subcontracting plan (including goals) that covers the offeror's
fiscal year and that applies to the entire production of commercial
items sold by either the entire company or a portion thereof (e.g.,
division, plant, or product line)." FAR 19.701.
[7] See FAR 52.219-9(d) as revised by the Final Rule.
[8] See FAR19.705-2(f) as added by the Final Rule.
[9] See id.
[10] See also FAR 52.219-16, Liquidated Damages - Subcontracting
Plan (defining the terms "failure to make a good faith effort
to comply with the subcontracting plan" and providing for
potential assessment of liquidated damages for a contractor's
failure to meet its subcontracting goals and if the contracting
officer determines that the contractor failed to make a good faith
effort to comply with its small business subcontracting
plan).
[11] See current FAR 52.219-9(k).
[12] See FAR 52.219-9(k) as revised by the Final Rule.
[13] See FAR 19.704(a) as added by the Final Rule; FAR
52.219-9(d)(14) as added by the Final Rule.
[14] See FAR 52.219-9(e)(6) as revised by the Final Rule.
[15] See FAR 52.219-9(e)(7) as added by the Final Rule.
[16] See FAR 19.703(a)(2)(iv) as revised by the Final Rule.
[17] See 13 C.F.R. § 121.404(e).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.