2010-30566. Federal Acquisition Regulation; Limitation on Pass-Through Charges

AGENCIES:

Department of Defense (DoD), General Services Administration (GSA), and National Aeronautics and Space Administration (NASA).

ACTION:

Final rule.

SUMMARY:

The Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council (Councils) have adopted as final, with changes, the interim rule amending the Federal Acquisition Regulation (FAR) to implement section 866 of the Duncan Hunter National Defense Authorization Act (NDAA) for Fiscal Year (FY) 2009, which applies to executive agencies other than DoD. DoD is subject to section 852 of the John Warner NDAA for FY 2007, which is also implemented in this final rule. Section 866 requires the Councils to amend the FAR, and section 852 requires the Secretary of Defense to prescribe regulations to minimize excessive pass-through charges by contractors from subcontractors, or from tiers of subcontractors, that add no or negligible value, and to ensure that neither a contractor nor a subcontractor receives indirect costs or profit/fee (i.e., pass-through charges) on work performed by a lower-tier subcontractor to which the higher-tier contractor or subcontractor adds no or negligible value.

DATES:

Effective Date: January 12, 2011.

FOR FURTHER INFORMATION CONTACT:

For clarification of content, contact Mr. Edward Chambers, Procurement Analyst, at [phone]. For information pertaining to status or publication schedules, contact the Regulatory Secretariat at [phone]. Please cite FAC 2005-47, FAR Case 2008-031.

SUPPLEMENTARY INFORMATION:

A. Background

DoD, GSA, and NASA published an interim rule in the Federal Register at 74 FR 52853, October 14, 2009, to implement section 866 of the Duncan Hunter NDAA for FY 2009 (Pub. L. 110-417) as well as section 852 of the John Warner NDAA for FY 2007 (Pub. L. 109-364). These acts required the Councils to amend the FAR to minimize excessive pass-through charges by contractors from subcontractors, or from tiers of subcontractors, that add no or negligible value, and to ensure that neither a contractor nor a higher-tier subcontractor receives indirect costs or profit/fee (i.e., pass-through charges) on work performed by a lower-tier subcontractor to which the contractor or higher-tier subcontractor adds no or negligible value.

To enable agencies to ensure that pass-through charges are not excessive, the interim rule included a solicitation provision and a contract clause requiring offerors and contractors to identify the percentage of work that will be subcontracted, and when subcontract costs will exceed 70 percent of the total cost of work to be performed, to provide information on indirect costs and profit/fee and value added with regard to the subcontract work. Seventy percent was selected as the threshold for this information reporting requirement, because it represents a substantial amount of subcontracting.

To ensure that the Government can make a determination as to whether or not pass-through charges are excessive, the interim rule incorporated a reporting threshold that affords the contracting officer the ability to understand what functions the contractor will perform (e.g., consistent with the contractor's disclosed practice) and thus will provide added value, whether it be before award, or if the contractor subsequently decides to subcontract substantially all of the effort. The rule provides a recovery mechanism for the excessive pass-through charges for those situations in which a contractor subcontracts all, or substantially all, of the performance of the contract, and does not perform the subcontract management functions, or other value-added functions, that were charged to the Government through indirect costs and related profit/fee.

The final rule adopts the interim rule with a minor change involving the addition of two types of fixed-price incentive contracts to the list of contracts at FAR 15.408(n)(2)(i)(B)(2) for DoD that are not subject to the limitation on pass-through charges clauses. These additions are fixed-price incentive contracts awarded on the basis of adequate price competition and fixed-price incentive contracts for the acquisition of a commercial item. Section 852 of the John Warner NDAA for FY 2007 (Pub. L. 109-364) 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.

B. Discussion and Analysis

The FAR Secretariat received five responses to the interim rule. These responses included a total of 31 comments on 23 issues. Each issue is discussed in the following sections.

Issue 1: Three respondents expressed their support for the interim rule with one respondent stating that they were in favor of companies being responsible, responsive, and capable of providing adequate management systems to track the level of subcontracting taking place under specific contracts.

Response: The Councils acknowledge their support for the interim rule.

Issue 2: One respondent recommended that guidance should be provided to assist contracting officers with implementing the rule. The respondent cited several examples of what should be in that guidance.

Response: The Councils disagree with the inclusion of such implementation guidance in the FAR. Agencies will provide supplemental guidance and training to implement this rule, as appropriate.

Issue 3: One respondent recommended that the clause language incorporate GAO recommendations relative to “requiring contracting officials to take risk into account when determining the degree of assessment needed.”

Response: The Councils do not concur. The respondent's recommendation goes to procedures for assessing contractor value added. Such procedures are beyond the scope of this case, and reasonably should be implemented through agency guidance.

Issue 4: One respondent recommended that the final rule be written such as to “serve as a tool to ensure consistency to the extent practicable between contractor's proposals and actual performance rather than to serve as a basis to disallow cost after incurrence.”

Response: The Councils do not concur with the respondent's recommendation. Unless otherwise required under the contract, contractors have the right to revise and manage workload under the contract as they see fit. The clauses provide sufficient protection to the Government for such cases where the contractor revises the workload from what had been negotiated to a situation where excessive pass-through charges exist.

Issue 5: One respondent recommended that the final rule be written such as to “carefully consider the potential effects on those small businesses performing as prime contractors on contract set-asides given that small business prime contractors could experience significant financial impacts as a result of disallowed pass-through costs under this rule.”

Response: The Councils do not concur with the respondent's recommendation. Section 866 of the FY 2009 NDAA does not set forth an exclusion for small businesses under this rule.

Issue 6: One respondent recommended that the final rule should reconcile DoD policies to avoid confusion. Specifically, they assert that the Wynne memorandum dated July 12, 2004, and the policies enacted in the Weapons Systems Acquisition Reform Act of 2009 are contrary to this rule, which “exerts pressure on contracting officials to keep work in-house to address the reporting requirement.”

Response: The Councils do not concur with the respondent's recommendation. The Councils do not agree that there are conflicts between this rule and DoD policy. Competition and teaming arrangements are not hindered by this regulation, and subcontracting efforts are not limited to 70 percent of the total effort. The 70 percent threshold triggers an information reporting requirement. This rule is emphasizing that value is to be added by the contractor to the subcontracted effort.

Issue 7: One respondent recommended that “a distinction be made with regard to G&A applied to contracts versus applied profit. This will serve to protect the contractor's recovery of allowable G&A if incurred in accordance with CAS and the contractor's disclosed practices, while focusing the Government's attention to the negotiated item of profit.”

Response: The Councils do not concur with the respondent's recommendation. The Councils disagree that a distinction should be made with regard to G&A applied to contracts versus applied profit because the statutes prohibit application of overhead to excessive pass-through charges, as well as profit.

Issue 8: One respondent recommended that the rule should use the threshold in FAR 15.403-4 to ensure a consistent minimum threshold among all executive agencies in lieu of multiple thresholds currently in the rule. The respondent believed that if the Councils utilize the threshold in FAR 15.404-4, the rule “will exclude a significant number of subcontracts from this burdensome requirement but still cover the vast majority of the total value of subcontracts.”

Response: The Councils do not concur with the respondent's recommendation. By statute, civilian agencies are required to establish the threshold at the simplified acquisition threshold, while DoD established its threshold at the threshold for obtaining cost or pricing data in FAR 15.403-4.

Issue 9: One respondent recommended that the provision and clause be amended to include definitions of “total cost of the work” and “total cost of work”. As such, the respondent recommended that “FAR 52.215-22 be amended to provide that, for purposes of determining whether the 70 percent subcontracting threshold is reached, the `total cost of the work' to be performed by the prime contractor or a higher-tier subcontractor shall include the prime contractor's or higher-tier subcontractor's direct and indirect costs of the work, excluding applicable profit or fee, to be performed under the contract or higher-tier subcontractor, as the case may be, and the `total cost of the work' to be performed by each subcontractor to the prime contractor or to a higher-tier subcontractor shall include its direct and indirect costs, including applicable profit or fee, of the work to be performed under its subcontract.” Also, the respondent recommended that “FAR 52.215-23 be amended to provide that, for purposes of determining whether a prime contractor, or higher-tier subcontractor, changes the amount of subcontractor effort after award such that it exceeds 70 percent of the total cost of work to be performed under the contractor or higher-tier subcontractor, the `total cost of the work' to be performed by the prime contractor or higher-tier subcontractor under the contract or higher-tier subcontractor shall include the contractor's or higher-tier subcontractor's direct and indirect costs of the work, excluding applicable profit or fee, to be performed under the contract or higher-tier subcontractor, as the case may be, and the `total cost of the work' to be performed by each subcontractor to the prime contractor or to a higher-tier subcontractor shall include its direct and indirect costs, including applicable profit or fee, of the work to be performed under its subcontract.”

Response: The Councils do not concur with the respondent's recommendation. The Councils believe that the respondent's recommended definitions are not necessary, as they are universally understood within the acquisition community.

Issue 10: Two respondents believed that the determination of value-added work be performed before contract award and not during contract performance. One respondent recommended that “the rule be placed in FAR Part 15 (for example, in 15.404-1, Proposal Analysis) rather than in a clause to affirm and emphasize the basic contract formation policy that contracts should not be entered into where the contracting officer determines after a thorough proposal analysis that an offeror adds no or negligible value to the proposed acquisition.” The respondent believed that the pass-through rule, as currently written, “would unfairly continue to subject contractors to continuing post-award reviews by the government of pass-through charges and potential disallowances throughout the life of the contract which is unjustified, inappropriate, onerous, and not required by sections 866 or 852 of the NDAAs.” Similarly, another respondent recommended that FAR 52.215-23 be changed to add language from Alternate I to the standard clause, thus, mandating that contracting officers determine prior to award that the contractor will add value. The respondent also recommended that FAR 52.215-23(c) be changed “to require the contracting officer to make a determination as to whether the contractor will, in fact, provide ‘added value’, thereby putting the contractor on notice as to whether it can apply indirect costs and profit to work performed by subcontractors.” This determination should be required to be made in a reasonable time not to exceed 30 days and if no determination made by 30 days, consider work to be value-added.

Response: The Councils do not concur with the respondent's recommendations. The statute's requirements are not limited only to pre-award restrictions, but instead set forth the requirements to ensure that neither a contractor nor a subcontractor receives indirect costs or profit on work performed by a lower-tier subcontractor to which the higher-tier contractor or subcontractor adds no or negligible value at any time.

Issue 11: One respondent recommended that the final rule include an exemption for cost accounting standard (CAS)-covered contracts since allocability and allowability of pass-through charges are already covered in CAS and cost principles.

Response: The Councils do not concur with the respondent's recommendation. The statutes do not set forth an exclusion for CAS-covered contracts. Furthermore, CAS does not ensure that the Government does not pay excessive pass-through charges as required by the statutes.

Issue 12: One respondent recommended that the final rule include an exemption for contracts issued subject to the Truth In Negotiations Act (TINA) requirements since already existing cost or pricing data requirements would provide necessary data relative to pass-through charges.

Response: The Councils do not concur with the respondent's recommendation. The statutes do not set forth an exclusion for contracts subject to TINA. Furthermore, TINA does not ensure that the Government does not pay excessive pass-through charges as required by the statutes.

Issue 13: Two respondents recommended that the final rule include an exemption for all commercial item acquisitions since, as currently written, commercial items/services procured by DoD through time-and-materials or labor-hour contracts could be subject to the pass-through clause. One of these respondents believed that applying these requirements to commercial contracts would be unnecessary; contrary to TINA; inconsistent with the Federal Acquisition Streamlining Act, as well as the Services Acquisition Reform Act; and exceed Congressional authority.

Response: The Councils do not concur with these respondents' recommendations. The statutes do not set forth an exemption for commercial item/service time-and-materials or labor-hour contracts. Furthermore, the Councils do not believe it would be within the spirit of the statute to implement such exemptions.

Issue 14: Two respondents recommended that FAR 52.215-23(e) be removed as redundant or re-worded to specifically address what additional records or data the contracting officer requires access to that is not currently addressed by FAR 52.215-2.

Response: The Councils do not concur with the respondent's recommendation. The audit and records FAR clause at 52.215-2 does not provide access to all of the necessary records to show excessive pass-through charges. The final rule maintains the access to records FAR provision at 52.215-23(e) because it is needed to fully implement the statutes and ensure that the Government is not paying excessive pass-through charges.

Issue 15: One respondent recommended that the 70 percent threshold be raised to 90 percent which reflects the level initially contemplated by Congress in the Senate version of the bill (section 844 of S2766). The respondent believed there was no basis for the 70 percent threshold.

Response: The Councils disagree with this recommendation. As permitted by section 852 of the “John Warner NDAA for FY 2007”, the Councils have identified 70 percent as the threshold whereby a greater risk is assumed by the Government in paying excessive pass-through charges. The 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. The statute requires that the Government not pay excessive pass-through charges on any contract, subcontract, or order.

Issue 16: One respondent recommended that the flowdown provisions of the solicitation provision and clause be limited to first-tier subcontractors. The respondent believed that there was little benefit in micro-managing pass-through charges deep into the supply chain.

Response: The Councils do not concur with the respondent's recommendation. It is very apparent from the language of the statutes that Congressional intent is to flow down this requirement beyond the first tier-subcontract level.

Issue 17: One respondent recommends that the final rule include a set of narrowly defined definitions for all key terms, such as, but not limited to “no or negligible value”, “substantial value”, and “added value”.

Response: In general, the Councils do not concur with the respondent's recommendation. The Councils believe that the respondent's recommended definitions are not necessary, as they are universally understood within the acquisition community. However, the rule does provide definitions of five of the more commonly understood terms, including “no or negligible value” and “added value”.

Issue 18: One respondent recommended that the definition of “added value” in FAR 52.215-23(a), where “e.g.” is included in parentheses, be changed to “including, but not limited to”.

Response: The Councils do not concur with the respondent's recommendation. The term “e.g.” means for example, which does not imply that these functions are all inclusive.

Issue 19: One respondent recommended that the pass-through provision and clause be limited to only sole source contracts (firm-fixed-price, time and materials, or otherwise) below the TINA threshold.

Response: The Councils do not concur with the respondent's recommendation. The statutes do not limit implementation of the requirements on such a limited basis.

Issue 20: One respondent recommended that the intent of FAR 52.215-23(d) be clarified since, as written, it is an open invitation to contracting officers to revisit contract terms and price agreements after the fact, which is unfair and unproductive, and further be clarified as to how this section will be implemented in light of other contract compliance requirements and/or other operative contract clauses.

Response: The Councils do not concur with the respondent's recommendation. This is not an invitation to revisit contract terms or price agreements. This is a compliance function performed under, and in conjunction with, standard contract administration.

Issue 21: One respondent recommended that the final rule specifically address small business goals. The respondent did not want to have the rule inadvertently discourage substantial subcontracting to small firms that do provide value added solutions. In general, the respondent recommended clarifying intent and wording of the final rule to prevent contracting officers from leaving out legitimate small firms or discouraging prime contractors from subcontracting. Specifically, the respondent recommended that the following language be added to the rule, “not intended to penalize companies with substantial small business goals that may on individual task orders exceed 70 percent”.

Response: The Councils disagree with including the respondent's recommended language. It is not the Government's intention to establish a disincentive for a company from achieving their small business subcontractor goals. This rule merely requires that the Government not pay excessive pass-through charges to contractors who add no or negligible value. The contracting officer has the discretion to make the determination whether the contractor has added value.

Issue 22: One respondent recommended that the definition of value-added at FAR 52.215-23(a) be “expanded to include all activities with respect to subcontractor sourcing, selection, negotiation, and administration that facilitate performance of services and delivery of goods to the Government and reduce Government's risk.”

Response: The Councils disagree. The recommended language is too broad and does not adhere to the intent of the statute. The interim rule language provided examples for the contracting officer to consider, but ultimately this is a contracting officer determination.

Issue 23: One respondent recommended that the Defense Federal Acquisition Regulation Supplement (DFARS) language in the second interim rule that was published in the Federal Register at 73 FR 27464, May 13, 2008, be eliminated since it is no longer required based upon this rule.

Response: Although this comment is outside the scope of this case, the language has been removed from the DFARS (DFARS Case 2006-D057, 75 FR 48278, effective August 10, 2010).

C. Regulatory Planning and Review

This is not a significant regulatory action and, therefore, was not subject to review under Section 6(b) of Executive Order 12866, Regulatory Planning and Review, dated September 30, 1993. This rule is not a major rule under 5 U.S.C. 804.

D. Regulatory Flexibility Act

The Department of Defense, the General Services Administration, and the National Aeronautics and Space Administration certify that this final rule will not have a significant economic impact on a substantial number of small entities within the meaning of the Regulatory Flexibility Act, 5 U.S.C. 601, et seq., because 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.

E. Paperwork Reduction Act

The Paperwork Reduction Act does apply; however, these changes to the FAR do not impose additional information collection requirements to the paperwork burden previously approved under OMB Control Number 9000-0173.

List of Subjects in 48 CFR Parts 15, 31, and 52

• Government procurement

Dated: November 24, 2010.

Millisa Gary,

Acting Director, Acquisition Policy Division.

Interim Rule Adopted as Final With Changes

Accordingly, the interim rule amending 48 CFR parts 15, 31, and 52, which was published in the Federal Register at 74 FR 52853, October 14, 2009, is adopted as final with the following changes:

PART 15—CONTRACTING BY NEGOTIATION

1. The authority citation for 48 CFR part 15 continues to read as follows:

Authority: 40 U.S.C. 121(c); 10 U.S.C. chapter 137; and 42 U.S.C. 2473(c).

2. Amend section 15.408 by—

a. Removing from paragraph (n)(2)(i)(B)( 2)(iii) the word “or”;

b. Removing the period from the end of paragraph (n)(2)(i)(B)( 2)(iv) and adding a semicolon in its place; and

c. Adding paragraphs (n)(2)(i)(B)( 2)(v) and (n)(2)(i)(B)(2)(vi) to read as follows:

15.408

Solicitation provisions and contract clauses.

* * * * *

(n) * * *

(2)(i) * * *

(B) * * *

(2) * * *

(v) A fixed-price incentive contract awarded on the basis of adequate price competition; or

(vi) A fixed-price incentive contract for the acquisition of a commercial item.