Tagged: National Aeronautics and Space Administration

In December, 2010, the Department of Defense (“DoD”), General Services Administration (“GSA”), and National Aeronautics and Space Administration (“NASA”) modified the Federal Acquisition Regulation (“FAR”) to further discourage “excessive pass-through charges.” Over a year later, this amendment is of critical importance to contractors and subcontractors alike.

History and Context. Sometimes, the DoD, GSA, and NASA modify the FAR without any statutory impetus. Often, however, these agencies are amending the FAR in reaction to, and in furtherance of, new statutes. In short, statutes may be found toothless without the implementing regulations, which add a necessary regulatory bite. Such was the case for the subject amendment, which was in response to the John Warner National Defense Authorization Act for Fiscal Year 2007 (“FY 2007 NDAA”). Section 852(b)(1) of the FY 2007 NDAA stipulates that, “Not later than May 1, 2007, the Secretary of Defense shall prescribe regulations that ensure that pass-through charges on contracts or subcontracts (or task or delivery orders) that are entered into for, or on behalf of, the Department of Defense are not excessive in relation to the cost of work performed by the relevant contractor or subcontractor.” The amendments to the FAR, proposed as an interim rule in October, 2009, and established as a final rule on December 13, 2010, do just this.

What IS An “Excessive Pass-Through Charge”? FAR Subpart 52.215-23, which was added through the interim rule, defined an “excessive pass-through charge” as, “with respect to a Contractor or subcontractor that adds no or negligible value to a contract or subcontract,…a charge to the Government by the Contractor or subcontractor that is for indirect costs or profit/fee on work performed by a subcontractor (other than charges for the costs of managing subcontracts and any applicable indirect costs and associated profit/fee based on such costs.)” This Subpart further defines “no or negligible value” as meaning that, “the Contractor or subcontractor cannot demonstrate to the Contracting Officer that its effort added value to the contract or subcontract in accomplishing the work performed under the contract (including task or delivery orders).” Lastly, “added value” means “that the Contractor performs subcontract management functions that the Contracting Officer determines are a benefit to the Government (e.g., processing orders of parts or services, maintaining inventory, reducing delivery lead times, managing multiple sources for contract requirements, coordinating deliveries, performing quality assurance functions).” Overall, excessive pass-through charges are costs submitted by contractors/subcontractors that are not providing substantive goods/services to the Government but are, rather, merely facilitating the substantive work performed by other subcontractors/lower-tier subcontractors.

Cracking Down. The aforementioned rule was implemented to give the Government greater visibility into situations in which excessive pass-through costs may be incurred, and to give the Government the ability to either reject such charges or recoup such costs in the form of a price reduction.  The interim rule added Subparts 52.215-22 and 52.215-23. In addition to prohibiting proposals from containing excessive pass-through charges, generally, 52.215-22 requires contractors/subcontractors to identify in their proposals the work to be performed by such offeror, and the total work to be performed by subcontractors, as measured by total cost.

Furthermore, where the contractor/subcontractor ”intends to subcontract more than 70 percent of the total cost of work to be performed under the contract, task order, or delivery order” to its subcontractor/lower-tier subcontractor, the contractor/subcontractor must identify in its proposal:

“(i) The amount of the offeror’s indirect costs and profit/fee applicable to the work to be performed by the subcontractor(s) [or lower-tier subcontractor(s)]; and

(ii) A description of the added value provided by the offeror as related to the work to be performed by the subcontractor(s) [or lower-tier subcontractor(s)].”

Additionally, FAR Subpart 52.215-23 establishes a reporting requirement which is triggered when the contractor “changes the amount of subcontract effort after award such that it exceeds 70 percent of the total cost of work to be performed under the contract, task order, or delivery order”, or when the subcontractor “changes the amount of lower-tier subcontractor effort after award such that it exceeds 70 percent of the total cost of the work to be performed under its subcontract.” Specifically, the contractor must “identify the revised cost of the subcontract effort and shall include verification that the Contractor will provide added value” and the subcontractor must “identify the revised cost of the subcontract effort and shall include verification that the subcontractor will provide added value as related to the work to be performed by the lower-tier subcontractor.”

FAR Subpart 52.215-23 also empowers the Government to reject excessive pass-through charges as unallowable where they are incurred on other than fixed-price contracts and to secure a price reduction for such charges on “applicable DoD fixed-price contracts, as identified in [FAR Subpart] 15.408(n)(2)(i)(B)“. Under the interim rule, price reductions were not authorized on firm-fixed price contracts awarded on the basis of adequate price competition; fixed-price contracts with economic price adjustment awarded on the basis of adequate price competition; firm-fixed price contracts for the acquisition of commercial items; or fixed-price contracts with contracts with economic price adjustment for the acquisition of a commercial item. However, the final version of the rule made such price reductions also inapplicable to fixed-price incentive contracts awarded on the basis of adequate price competition and fixed-price incentive contracts for the acquisition of commercial items. The rationale for this modification is traceable to Section 852 of the FY 2007 NDAA which, according to the FAR Councils, ”is clear that DoD contracts awarded on the basis of adequate price competition, and DoD contracts for the acquisition of a commercial item are not subject to the limitation on pass-through charges.”

Lastly, FAR Subpart 52.215-23 gives the contracting officer auditing authorization and identifies the contracts into which this new clause must be inserted as a flowdown.

It All Comes Down to Contract Types. As a sophisticated business entity, by now you should know that a rule will be applicable or inapplicable depending on the contract type at issue. FAR Subpart 52.215-22 is simply included in all contracts containing Subpart 52.215-23. The applicability of Subpart 52.215-23, however, is more complicated, and is thus captured using the following diagram:

• Civilian Agencies- Included if:

1. “The total estimated contract or order value exceeds the simplified acquisition threshold as defined in [FAR] Section 2.101 and
2. The contemplated contract type is expected to be a cost-reimbursement type contract as defined in [FAR] Subpart 16.3…”

Why Seventy Percent? In response to the final rule, one respondent challenged the 70% threshold, suggesting that 90% was more appropriate. The FAR Councils disagreed, however, as they “identified 70 percent as the threshold  whereby a greater risk is assumed by the Government in paying excessive pass-through charges.” Furthermore, “[t]he Councils consider this 70 percent threshold reasonable, because it affords the parties an opportunity to address subcontracting management requirements above this level in more detail and to ensure the contracting officer is able to determine the disclosed subcontract management functions are of benefit to the Government.”

Commercial Contracts Exemption? Not So Fast. Two respondents to the interim rule specifically recommended that all commercial item contracts be exempted from this new rule. However, the FAR Councils did not believe such an exemption to be within either the letter or the “spirit” of Section 852 of the FY 2007 NDAA. Sometimes, commercial item contracts receive a break. That they did not in this case is arguably the result of at least two factors: First, this rule is driven by a specific statute, giving the FAR Councils less discretion to grant exemptions than they may normally have. Second, and perhaps more fundamentally, is the fact that excessive pass-through costs are sufficiently abhorrent to the Government that the commercial or non-commercial nature of a contract will be irrelevant to the calculus.

Scared? Don’t Be! At first glance, this is precisely the type of rule that would appear to severely impact small businesses. However, a more focused review of the rule’s intention will allay such concerns. Small businesses such as yours are far more likely to be the contract participant that is performing the disproportionate share of the contract performance than they are the participant that is simply facilitating such work. Furthermore, where your prime contractor is identified as a potential pass-through violator, the information that you will have to provide under this rule is negligible. As the interim and final rule asserted in assessing the modification’s impact under the Regulatory Flexibility Act, “we do not expect a significant number of entities to propose excessive pass-through charges under contracts or subcontracts, and the information required from offerors and contractors regarding pass-through charges is minimal.”

So What? As discussed above, this FAR modification is unlikely to have a substantial impact on small business entities. Regardless, there is a valuable lesson to be learned from the information contained herein. In the private sector, contracts are written on a daily basis that disproportionately benefit the buyer or the seller. Specifically, unsophisticated private buyers are often disadvantaged by intricate contracts and sellers with superior experience. The Government, however, is not an unsophisticated buyer. On the contrary, it is highly educated and has anticipated your strategies before you have developed them. More importantly, the Government is the most cost-conscious buyer you will ever deal with- its pennies are the taxpayer’s pennies, so it WILL count them. Overall, the Government will not tolerate arrangements in which it is paying contractors for meaningless non-value-added services. Keep this principle in mind and you will save yourself from a myriad of conflicts with your Government customer.

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Adam Munitz is a lawyer at Fluet Huber + Hoang, a full service law firm focused on the needs of growing government contractors. Adam specializes in Government Contracts Law and Export Compliance. You can reach him by email here.