At Long Last…The FAR Catches up on Limitations on Subcontracting!

On August 10, the Federal Acquisition Regulatory (FAR) Council issued a final rule, revising the Federal Acquisition Regulations (FAR) relating to the limitations on prime contractors’ ability to subcontract on small business set-aside contracts.  This long-awaited FAR revision finally reconciles the FAR with other regulatory changes that were made about 5 years ago!

The purpose of the Limitations on Subcontracting regulations is to ensure that the financial benefits of small business set-aside contracts remain with legitimate small business contractors. The government wants to prevent situations in which a small business could be used as a “pass-through” for a larger entity.  In other words, while subcontracting is fine, the government does not want small business primes who win small business set-aside contracts subcontracting too much of their contract work to large businesses.  Such practices would deprive small businesses of the contract revenue, instead of placing that revenue in “big business” pockets; this would negate the purpose of the agency’s small business programs.  To avoid this problem, regulations were put in place, requiring that the small business prime perform a certain percentage of the work itself.  The percentage itself depends on the type of contract at issue.

The Small Business Administration (SBA) codified this in the SBA’s own small business regulations (specifically, at 13 CFR 125.6) but there are also certain provisions in the FAR itself (most notably FAR 19.507(e) and FAR 52.219-14) that addressed the same concept.

The SBA regulations relating to “Limitations on Subcontracting” were overhauled in 2016.  These revisions were, themselves, mandated by the 2013 National Defense Authorization Act, which modified the Small Business Act.   The 2016 revisions to 13 CFR 125.6 made a couple of significant changes:

  • First, it changed the overall approach to subcontracting limitations. As the SBA itself explained at the time, the revised regulation “create[d] a shift from the concept of a required percentage of work to be performed by a prime contractor to the concept of limiting a percentage of the award amount to be spent on subcontractors.”   By way of example, rather than require a prime contractor to perform 25% of the work, the regulation would preclude the prime contractor from subcontracting out more than 75% of the work.  See how they shifted from a bottom-up to a top-down approach?
  • Second, the manner in which the percentages were calculated was modified somewhat. Prior to the 2016 revision, the calculation could differ based on the type of contract at issue: For some types of contracts, requirements were calculated using “the cost of the contract incurred for personnel” while others used “the cost of the contract (not including the costs of materials)” or “the cost of manufacturing the supplies or products (not including the costs of materials).”  The 2016 revision specified that, for each type of contract, the percentages would be calculated using “the amount paid by the government to [the contractor]”.  The one caveat?  For prime contractors dealing with supply contracts or general and specialty construction contracts, they had to remember that “[c]ost of materials are excluded and not considered to be subcontracted.”
  • Third, in perhaps the most important change, the 2016 revision introduced the concept of the “similarly situated entity.” The idea was that prime contractors subcontracting to “similarly situated entities” did not have to count those subcontracts towards the applicable subcontracting limit.  A similarly situated entity was defined as “a small business subcontractor that is a participant of the same small business program that the prime contractor is a certified participant and which qualifies the prime contractor to receive the award.”  So, on an 8(a) set-aside, an 8(a) could subcontract to another 8(a), without counting those subcontracts towards the applicable subcontracting limit.  On a SDVOSB set-aside, the prime contractor SDVOSB could subcontract to another SDVOSB, etc.

Generally, these changes were looked on favorably by the small business community.   Though the “similarly situated entity” exception, and a couple of exceptions thereto, could, on occasion, cause some confusion, and there were still some thorny issues relating to how to calculate costs, 13 CFR 125.6, itself, was fairly easy to navigate.  The only problem was that the FAR provisions were now out of sync with the new 13 CFR 125.6.  This caused a lot of confusion for contractors, who wondered what they really had to do to be compliant.  How should they calculate percentages?  Did the similarly situated entity exception apply, or not?  Until the FAR caught up with the SBA regulations, these questions would remain a concern for small business prime contractors.

Now, with the coming change to the FAR, there should be more clarity, as the FAR will now be consistent with the SBA regulations.  On the issue of how to calculate self-performance and subcontracting percentages, the revised FAR regulation will, like the SBA regulation, calculate percentages using “the amount paid by the government to the prime contractor” as a denominator.  The revised FAR regulation will also adopt the similarly situated entity exception.  Overall, this is great – albeit inexcusably delayed – news for small business contractors. 

If you have any questions about subcontracting limitations, the similarly situated entity exception, or how to ensure your own compliance, please do not hesitate to reach out to the Obermayer Government Contracting Team.


The information contained in this publication should not be construed as legal advice, is not a substitute for legal counsel, and should not be relied on as such. For legal advice or answers to specific questions, please contact one of our attorneys.

About the Authors

Maria L. Panichelli

Partner

Maria is a partner and the Chair of the Government Contracting department.   She focuses her practice exclusively on federal government contracting and procurement, guiding her clients throughout the entire lifecycle of their...

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Karen L. Douglas

Of Counsel

Karen provides full-spectrum legal support to prime and subcontract federal government contractors, supporting their bid and proposal efforts, providing protest services, change order responses, requests for equitable adjustments, claims and disputes, audits,...

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