United States: New Department Of Defense Requirements Relating To Supply Chain Risk

On October 30, 2015, the Defense Acquisition Regulations System of the Department of Defense (DoD) published in the Federal Register (80 FR 67244) a final rule (the "Final Rule") that adopts with changes an interim rule (78 FR 69268) amending the Defense Federal Acquisition Regulation Supplement (DFARS) to implement § 806 of National Defense Authorization Act (NDAA) for FY 2011, "Requirements for Information Relating to Supply Chain Risk," as amended by § 806 of the NDAA for FY 2013 (the "Interim Rule"). The Final Rule, effective October 30, 2015, requires inclusion of an evaluation factor regarding supply chain risk in specified types of procurements relating to national security systems. While the Final Rule addresses some of the concerns raised in a Client Alert we published on November 26, 2013, DoD has the right to exclude contractors and subcontractors from certain procurements without notice or an opportunity to understand the nature of and resolve any alleged supply chain risk.

Positive Changes from the Interim Rule

There were three primary positive changes to the Interim Rule. First, the scope of the Final Rule covers only covered systems as discussed below and not all information technology. Second, contractors no longer have to flow down the contract clause to subcontractors. Third, the Final Rule deletes the requirement to maintain controls because DoD could not identify specific standards or controls that are appropriate for all procurements. This does not mean that controls will not be required, however, as each DoD agency will establish its own standards or controls particular to each procurement.

Section 806 Authority

Under § 806(a) of the NDAA, DoD has the right to carry out covered procurement actions and, notwithstanding any other law, limit disclosure of information relating to the basis for carrying out a covered procurement action. A "covered procurement action" means any of the following actions that may be taken by a covered agency (i.e., DoD, Army, Navy, and Air Force):

  1. Excluding a source that fails to meet qualification standards established in accordance with the requirements of 10 U.S.C. § 2319 for the purpose of reducing supply chain risk in the acquisition of covered systems;
  2. Excluding a source that fails to achieve an acceptable rating on a supply chain risk evaluation factor in the evaluation of proposals for the award of a contract or issuance of a task or delivery order; and
  3. Deciding to withhold consent to a particular subcontractor or to direct a contractor to exclude a particular source from consideration for a subcontract.

The Final Rule states that DoD does not presently plan to use § 806 authority to exclude a source based on failure to meet a qualification standards to reduce supply chain risk. Before this § 806 authority may be used, DoD must develop qualification standards in accordance with the requirements of 10 U.S.C. § 2319 and provide these standards to potential offerors.

"Supply chain risk" is broadly defined in § 806(e)(4) as "the risk that an adversary may sabotage, maliciously introduce unwanted function, or otherwise subvert the design, integrity, manufacturing, production, distribution, installation, operation, or maintenance of a covered system so as to surveil, deny, disrupt, or otherwise degrade the function, use, or operation of such system."

De Facto Debarment Without Remedies

Under DFARS 239.7305, DoD may disclose information related to a § 806 exclusion to "appropriate parties." "Appropriate parties" is not defined; however, § 806(d)(2) lists other DoD components or Federal agencies. Thus, DoD presumably can notify nearly every Federal agency that manages procurements that may be subject to the same or similar supply chain risk. It is only a limited consolation that the Final Rule states who will be notified is to be determined on a case-by-case basis (allowing for the DoD agency to be judicious in its use of the exclusion authority), that DoD will try to work with contractors on mitigation strategies to avoid a § 806 exclusion, and that contractors are eligible to compete for future solicitations even after a § 806 exclusion. The fact is that if information regarding the contractor's exclusion is disseminated to other agencies, a § 806 exclusion can serve as a de facto debarment. Per the Final Rule, any such exclusion "will be based generally on classified intelligence information" and accordingly "a dispute resolution mechanism is not appropriate under these circumstances." Section 806(d)(1) states that if an agency takes a covered procurement action and limits disclosure of information, this action is not subject to bid protest before the Government Accountability Office or in any Federal court. With respect to DoD's authority to refuse to consent to a particular subcontractor or to direct a contractor to exclude a particular source from consideration for a subcontract, the Final Rule says that "DoD does not intend to provide equitable adjustments or other remedies." To make it worse, if the DoD agency decides to limit what it discloses to the excluded contractor, the contractor might be unable to fully resolve any alleged deficiencies.

What Procurements Are Covered?

The Final Rule limits the new DFARS solicitation provision and contract clause to "solicitations and contracts for information technology, whether acquired as a service or as a supply, that is a covered system, is a part of a covered system, or is in support of a covered system." This includes commercial (FAR Part 12) solicitations and contracts.

In lieu of the definition in FAR 2.1, DFARS 202.101 defines "Information technology" as:

  • Any equipment, or interconnected system(s) or subsystem(s) of equipment, that is used in the automatic acquisition, storage, analysis, evaluation, manipulation, management, movement, control, display, switching, interchange, transmission, or reception of data or information by the agency.
    • (1) For purposes of this definition, equipment is used by an agency if the equipment is used by the agency directly or is used by a contractor under a contract with the agency that requires—
      • (i) Its use; or
      • (ii) To a significant extent, its use in the performance of a service or the furnishing of a product.
    • (2) The term "information technology" includes computers, ancillary equipment (including imaging peripherals, input, output, and storage devices necessary for security and surveillance), peripheral equipment designed to be controlled by the central processing unit of a computer, software, firmware and similar procedures, services (including support services), and related resources.
    • (3) The term "information technology" does not include any equipment acquired by a contractor incidental to a contract.

Section 806(e)(5) of the NDAA defines "covered system" as a national security system as that term is defined in 44 U.S.C. § 3542(b):

  • (A) The term "national security system" means any information system (including any telecommunications system) used or operated by an agency or by a contractor of an agency, or other organization on behalf of an agency—
    • (i) the function, operation, or use of which—
      • (I) involves intelligence activities;
      • (II) involves cryptologic activities related to national security;
      • (III) involves command and control of military forces;
      • (IV) involves equipment that is an integral part of a weapon or weapons
        system; or
      • (V) subject to subparagraph (B), is critical to the direct fulfillment of
        military or intelligence missions; or
    • (ii) is protected at all times by procedures established for information that have
      been specifically authorized under criteria established by an Executive order or
      an Act of Congress to be kept classified in the interest of national defense or
      foreign policy.
  • (B) Subparagraph (A)(i)(V) does not include a system that is to be used for routine administrative and business applications (including payroll, finance, logistics, and personnel management applications).

How to Mitigate Impact

Contractors should consider the following actions to mitigate against the risk of a covered procurement action being taken or, if it is, minimizing the economic impact to contract performance:

  • Supplement existing compliance and purchasing system reviews and audits to include a segment that focuses on supply chain management of information technology sourcing;
  • When a procurement includes DFARS 239-7017 (Notice of Supply Chain Risk) or includes language on covered systems and/or an obligation to mitigate or control supply chain risk, the potential subcontractors and vendors should be thoroughly vetted with this in mind and primary and second sources secured; relying on a sole source is risky given that a source could be excluded and there is no equitable adjustment allowed in this event; and
  • Pose questions where possible prior to submitting bids in order to develop details on what the DoD agency is expecting.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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