Seeking Clarity on Managing Subcontractors

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A prime contractor is responsible for managing its subcontractors. That is an uncontroversial proposition any prime contractor would agree with, but there is little authority to clarify what exactly that management obligation entails.  

Many prime contractors push down legal and contractual requirements to subcontractors at the outset and then, during performance, focus on vetting the subcontractor’s work product. For the many compliance obligations that apply beyond the quality of the subcontractor’s work, however — such as accurate timekeeping and appropriate labor category qualifications — prime contractors verify compliance simply by relying on the subcontractor’s initial certification.  

One thorny dilemma with these matters is that subcontractors are often sensitive to poaching, and unwilling to share information with the prime contractor that would reveal the identities, salaries and resumes of its personnel. Without this type of information, it is tremendously difficult for a prime contractor to independently verify its subcontractor’s full compliance. 

Increasingly, government auditors and contract managers are insisting that prime contractors should obtain this information, review it and be prepared to establish the subcontractor’s compliance in the event of an audit. Otherwise, they fail to fulfill their management role.

The notion that this type of information-gathering is required suffered a substantial blow in a recent decision by the Armed Services Board of Contract Appeals, which decisively rejected arguments from the Defense Contract Audit Agency and a contracting officer that a prime contractor’s costs should be disallowed because the prime contractor could not produce detailed incurred cost information regarding its subcontractor’s performance.

In Lockheed Martin Integrated Sys., Inc., ASBCA Nos. 59508, 59509, the board ruled on a government claim seeking more than $100 million from the company for allegedly breaching an obligation to manage subcontracts. The controversy began when an audit of three contracts led to DCAA questioning $103 million in subcontract costs. 

DCAA claimed that, for the subcontract costs to be allowable, Lockheed Martin had to provide documents showing it had: reviewed subcontractor resumes to confirm personnel qualifications; reviewed subcontractor timesheets to confirm the accuracy of invoiced hours; and tried to obtain incurred cost submissions from its subcontractors — contacting “the Government” for “assistance” if the subcontractors refused the request. 

DCAA insisted that it could find no subcontract costs allowable “[w]ithout an incurred cost submission from the subcontractor,” which it contended was the prime contractor’s responsibility to obtain.  

In reply, Lockheed maintained that it had flowed down all necessary requirements to its subcontractors, and had collected all appropriate (nonproprietary) information from them. It explained that it does not request incurred cost submissions from its subcontractors because by their very nature they contain data of a “broad and proprietary nature.” 

It also maintained that it had followed standard protocols to vet subcontractor costs before submitting them for reimbursement. In support, Lockheed provided the agency “competitively awarded cost proposals, rate verifications between billings and contractual rates and traceability between subcontractors’ incurred costs on the ledger and billings to the government.”  

The contracting officer rejected the company’s arguments, however, and adopted the DCAA’s reasoning in a final decision that demanded payment for the entire $103 million in questioned subcontractor costs.

Lockheed appealed to the ASBCA, and the board then ordered the government to file the complaint. In response, Lockheed moved to dismiss. In a decisive win for contractors, the board expressly rejected the government’s theory. While acknowledging a general responsibility to manage subcontractors, the board found there was no statutory or contractual authority that required “the particular duties alleged by the government.” That contention, the board concluded, was based on “nothing more than a plainly invalid legal theory.”  

The decisions should come as a tremendous relief to contractors. If the board had accepted DCAA’s arguments, it would have established onerous responsibilities for prime contractors and invasive information-sharing obligations for subcontractors, creating a host of complicated questions to negotiate regarding the withholding of proprietary information. Thankfully, the board not only declined to accept the audit agency’s view, it expressly and forcefully rejected it. 

In United States ex rel. Kingsley v. Netcracker Tech. Corp, for example, a qui tam relator alleged that his former company Netcracker Technology Corp. had knowingly violated contract requirements by allowing “back office” support for certain government contracts to be performed by foreign nationals lacking required security clearances. The work in question was performed by Netcracker as a subcontractor to Computer Sciences Corp. And while the relator vaguely alleged that CSC must have known about the non-compliant personnel, it described the non-compliant work as being performed at remote facilities and offered no actual evidence that CSC was aware of the alleged violations.

Neither company emerged unscathed. Netcracker eventually agreed to pay a $11.4 million settlement to the Department of Justice. The government insisted that CSC accept some share of the responsibility as well, on account of its oversight role as prime contractor, and extracted a second $1.35 million settlement from CSC.

The fact that the company paid a significantly smaller settlement would seem to affirm that there was very little, if any, culpability on its part. Yet it presumably was forced to face many of the same headaches and legal expenses as a company that was accused of violating the law itself. 

Luke Meier is special counsel at Covington’s government contracts practice group.

Topics: Defense Contracting