Congress Looks to Redefine the ‘Subcontract’

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If an agreement qualifies as a “subcontract” under a government contract, then it may be subject to certain flow-down, compliance and reporting requirements.

These requirements are intended to protect the government’s interests, and have significant ramifications for contractors such as increasing transaction costs and expanding potential areas of exposure. These compliance obligations and risks can even deter some companies from performing under government contracts, especially those companies offering commercial items.

So what is a “subcontract?”

Currently, there is no uniform definition of subcontract in the applicable procurement regulations or in the procurement chapters under Titles 10 and 41 of the U.S. Code. Indeed, there are more than 20 varying definitions of subcontract in the Federal Acquisition Regulation and Defense Federal Acquisition Regulation Supplement, with many clauses failing to specify which definition applies.

Congress is looking to address this lack of uniformity.

The House version of the fiscal year 2019 National Defense Authorization Act, which passed on May 24, offers a single definition of subcontract that would be added to Chapter 1 of Title 41 and Chapters 137 and 140 of Title 10. Section 832 of the House NDAA generally defines a “subcontract” to mean “a contract entered into by a prime contractor or subcontractor for the purpose of obtaining supplies, materials, equipment, or services of any kind under a prime contract. The term includes a transfer of a commercial product or commercial service between divisions, subsidiaries, or affiliates of a contractor or subcontractor.”

More importantly, Section 832 excludes the following categories of agreements from the definition of subcontract: “a contract the costs of which are applied to general and administrative expenses or indirect costs; or an agreement entered into by a contractor or subcontractor for the supply of a commodity, a commercial product, or a commercial service that is intended for use in the performance of multiple contracts.” (See Section 831 for the definitions of a “commercial product” and a “commercial service,” which would replace the term “commercial item.”)

The House Armed Services Committee report explains that a single definition of subcontract would provide “clarification, simplicity and consistency for defense procurement actions.” The Section 809 Panel — an independent advisory board on streamlining Defense Department acquisition regulations — likely would agree with the committee’s assessment, as the House’s definition of “subcontract” appears to have been taken directly from the panel’s January 2018 report.

The House’s proposed definition of subcontract is significant because it would exclude a broad range of agreements from that definition. As a result, fewer agreements would be subject to the mandatory flow-down, compliance and reporting requirements imposed on procurement contracts.

"Questions that must be answered include: would this new definition apply retroactively?"

This approach is consistent with the intent of the Section 809 Panel, which noted in its January report that excluding commodities, commercial products and commercial services from the definition of subcontract “makes clear to both government and industry that Congress is serious about simplifying the procurement process, especially for items that are clearly available on the commercial market, for which the burden would be the greatest.”

However, there still remain a number of hurdles before contractors can rely on this narrowing of obligations. First, this new definition of subcontract must make its way into the final version of the 2019 NDAA. The definition is missing from the Senate version which passed on June 18.

Second, even if this new definition becomes part of the final bill that is signed into law, it still must be implemented through the FAR and DFARS.

Similarly, questions surrounding the implementation of this new definition and its potential impact would need to be addressed. For example, would this new definition apply to every mention of the word “subcontract” in the FAR and DFARS? Or, would exceptions to the general definition be needed, for example, to avoid potential ambiguity in a clause or subpart, to ensure that particular requirements flow-down to certain categories of agreements?

Other questions that must be answered include: would this new definition apply retroactively? What is the definition of a “commodity”? How will this new definition reconcile with requirements that exist, at least in part, outside the FAR and DFARS, such as requirements pertaining to Department of Labor regulations and related executive orders?

And, finally, how would the new definition impact the underlying regulatory requirements that higher-tier contractors currently must flow-down to certain of their suppliers?

As for timing, that remains unclear. To draw a parallel, Section 874 of the 2017 NDAA and Section 820 of the 2018 NDAA both included a definition of subcontract with less expansive exclusions that would apply only to commercial item subcontracting under 10 U.S.C. § 2375 and 41 U.S.C. § 1906, respectively. To date, regulations still have not been promulgated, though the government has signaled that they are likely to be issued soon.

Accordingly, government contractors at all tiers should closely monitor developments related to this new definition of subcontract, as it will have significant ramifications downstream.

Susan B. Cassidy is partner and Justin M. Ganderson is special counsel with the government contracts practice group at Covington & Burling LLP.

Topics: Defense Contracting, Government Policy, Defense Department