Z Subcontracting and Flow Down Clauses What's In Your Contract

SUBCONTRACTING and FLOW
DOWN CLAUSES: “What’s in
Your Contract?”

Jeff H. Eckland

Eckland & Blando LLP
Suite 1020 Lumber Exchange Building
10 South Fifth Street
Minneapolis, MN 55402

Midwestern Values, D.C. Connections EcklandBlando.com

AGENDA

 Flow Down Overview
 Subcontracts v. Supplier Agreements
 Case Study: ARRA’s Unique
Requirements
 Compliance


1995 FAR Part 1 Rewrite:
“Core Guiding Principles”
FAR 1.102 Statement of Guiding Principles for the
Federal Acquisition System
...
(d) The role of each member of the Acquisition Team is to exercise
personal initiative and sound business judgment in providing the
best value product or service to meet the customer’s needs.
....

Midwestern Values, D.C. Connections
EcklandBlando.com EcklandBlando.com

1995 FAR Part 1 Rewrite:
“Antibureaucracy Statement”
FAR 1.102 Statement of Guiding Principles for the
Federal Acquisition System
...
(d) In exercising initiative, Government members of the Acquisition
Team may assume if a specific strategy, practice, policy or
procedure is in the best interests of the Government and is not
addressed in the FAR, nor prohibited by [statute or case] law,
Executive order or other regulation, that the strategy, practice,
policy or procedure is . . . permissible . . . .
....


Flow Downs
Clauses prescribed by the government that a
prime contractor* incorporates into subcontracts
and that proscribe rights and responsibilities of the
prime contractor and subcontractor

Examples
– FAR 52.215-12 – Requires contractors to obtain subcontractor’s
cost or pricing data before awarding subcontract

– FAR 52.222-36 – Requires contractors to take affirmative steps
in employing individuals with disabilities


Flow Downs

• Two-step process for identifying Flow
Downs
– Part 1: The implementing clause
– Part 2: The contract clause

• Additional guidance may be found in the Code of
Federal Regulations (CFR)


Flow Down Fundamentals

• Part One – The Implementing Clause

22.810 Solicitation provisions and contract clauses.
(a) When a contract is contemplated that will include the clause at 52.222-26,
Equal Opportunity, the contracting officer shall insert—
(1) The clause at 52.222-21, Prohibition of Segregated Facilities, in the
solicitation and contract.


• Part Two – The Contract Clause
52.222-21 Prohibition of Segregated Facilities.
As prescribed in 22.810(a)(1), insert the following clause:
PROHIBITION OF SEGREGATED FACILITIES (FEB 1999)
(a) “Segregated facilities,” as used in this clause, means any waiting rooms, work areas, rest rooms and wash
rooms, restaurants and other eating areas, time clocks, locker rooms and other storage or dressing
areas, parking lots, drinking fountains, recreation or entertainment areas, transportation, and housing
facilities provided for employees, that are segregated by explicit directive or are in fact segregated on the
basis of race, color, religion, sex, or national origin because of written or oral policies or employee
custom. The term does not include separate or single-user rest rooms or necessary dressing or sleeping
areas provided to assure privacy between the sexes.
(b) The Contractor agrees that it does not and will not maintain or provide for its employees any segregated
facilities at any of its establishments, and that it does not and will not permit its employees to perform
their services at any location under its control where segregated facilities are maintained. The Contractor
agrees that a breach of this clause is a violation of the Equal Opportunity clause in this contract.
(c) The Contractor shall include this clause in every subcontract and purchase order that is subject to
the Equal Opportunity clause of this contract.
(End of clause)


When does a Subcontractor assume responsibility as a
contractor for flowing down to its own lower-tier subs?
• In some FAR clauses, the definition of contractor is written to include
subcontractor

52.222-41 Service Contract Act of 1965.
...
(a) Definitions. As used in this clause—
“Contractor,” when this clause is used in any subcontract, shall be deemed to
refer to the subcontractor, except in the term “Government Prime Contractor.”
...
(l) Subcontracts. The Contractor agrees to insert this clause in all
subcontracts subject to the Act.
....

Categories of Flow Downs

• Mandatory clauses – those that must be
flowed down
• Essential clauses – not mandatory but
must be included for business purposes
• Optional clauses – included at the
discretion of the contractor


Mandatory Clauses
Prescribed by the FAR for different categories
of subcontracts depending upon whether:
• The contract involves a Small Business;
• The contract exceeds a certain $ amount;
• The contract is for the acquisition of commercial
materials; or
• The contract meets other FAR prerequisites.


Mandatory Clauses
Generally, the clauses fall into one of two
categories:
1. Clauses implementing socio-economic
policies of the federal government (socio-
economic); or
2. Clauses intended to provide oversight of the
use of federal funds (oversight).


Example
52.222-26 Equal Opportunity – Category 1 (socio-economic)

The contracting officer shall insert the clause at 52.222-26, Equal
Opportunity, in solicitations and contracts unless the contract is exempt
from all of the requirements of E.O. 11246 (see FAR 22.807(a)).
…
(10) The Contractor shall include the terms and conditions of this
clause in every subcontract or purchase order that is not
exempted by the rules, regulations, or orders of the Secretary of
Labor issued under Executive Order 11246, as amended, so that
these terms and conditions will be binding upon each
subcontractor or vendor.


Example
52.215-12 Subcontractor Cost or Pricing Data– Category 2
(oversight)
SUBCONTRACTOR COST OR PRICING DATA —MODIFICATIONS
(OCT 1997)
...
(d) The Contractor shall insert the substance of this clause,
including this paragraph (d), in each subcontract that exceeds the
threshold for submission of cost or pricing data at FAR 15.403-
4 on the date of agreement on price or the date of award, whichever
is later.


Essential Clauses
Essential, while not mandatory, flow down
clauses contractors should include to protect their
business interests.

Failure to include these clauses in a subcontract
puts the contractor at extreme risk.


Example
Termination for Convenience – FAR Subpart 49.5

• Permits the federal government to cancel a prime
contract at any time

• Failure of the prime contractor to include a similar clause
in subcontracts can result in significant adverse
consequences
– Obligations remain under its subcontract but the
prime contract has been terminated


Example
Change Orders – FAR Subpart 43.2

• Contracting officers may issue change order, permitting
unilateral changes to the prime contract at any time.

• Failure of the prime contractor to include a similar clause in its
subcontracts can result in significant adverse consequences.
– Obligations remain under its subcontract but the prime
contractor’s needs have changed.


Supplemental Clauses
Broad Clauses – recommend incorporation

FAR 52.222-35 Equal Opportunity for Special Disabled Veterans,
Veterans of the Vietnam Era, and Other Eligible Veterans.
...
(f) Noncompliance. If the Contractor does not comply with the requirements of
this clause, the Government may take appropriate actions under the rules,
regulations, and relevant orders of the Secretary of Labor issued pursuant
to the Act.
(g) Subcontracts. The Contractor shall insert the terms of this clause in all
subcontracts or purchase orders of $100,000 or more unless exempted
by rules, regulations, or orders of the Secretary of Labor. The Contractor
shall act as specified by the Deputy Assistant Secretary of Labor to enforce
the terms, including action for noncompliance.


Applicability of Flow Downs
• Generally, the FAR creates flow down
obligations based upon the relationships
among the parties:
“The Contractor shall include the terms and conditions of this
clause in every subcontract or purchase order that is not
exempted by the rules, regulations, or orders of the Secretary
of Labor issued under Executive Order 11246, as amended, so
that these terms and conditions will be binding upon each
subcontractor or vendor.”
FAR 52.222-26 Equal Opportunity


Contractor Relationships
Prime
Contractor

The Federal Supplier of
Government specially
contracted items

Supplier
of raw
Materials


Web of Relationships
Prime
Contractor
SUBCONTRACT

The Federal Supplier of
Government specially
contracted items

SUPPLIER
Supplier AGREEMENT
of raw
Materials


Determining the Relationship

• Subcontract or Supplier Agreement?
• Federal law and regulations distinguish
between a subcontractor and a material
supplier


Distinctions between
Suppliers and Subcontractors
“[i]n the event of such termination, the Contractor shall
immediately stop all work hereunder and shall immediately
cause any and all of its suppliers and subcontractors to cease
work.”
FAR 52.212-4 Contract Terms and Conditions

While the FAR does distinguish the term subcontractor from
supplier, the FAR’s multiple definitions of subcontractor often
are inconsistent with one another. Consequently, it is always
necessary to read the FAR provision closely.


FAR Definitions
• FAR Part 2, which “defines words and terms that are
frequently used in the FAR,” does not contain a
general definition of subcontractor or supplier.

• FAR Part 44,“Subcontracting Policies and Procedures”
A subcontract is any contract as defined in Subpart 2.1
entered into by a subcontractor to furnish supplies or
services for performance of a prime contract or a
subcontract. It includes but is not limited to purchase
orders, and changes and modifications to purchase
orders.

Subcontract or Supplier
Agreement?
• Determine whether the procurement
involves a specialized or non-
specialized good or service
– i.e., a good or service procured “for
performance of a prime contract” as opposed
to a good or service procured regularly, or
available in the commercial market.


Specialized Goods or Services
• Specialized goods and services are
characteristic of a Subcontract:
– End product specified in the government contract;
– Custom-made product or service pursuant to statement of work;
– Product procured solely for government contract;
– Contractor is generally advised or required to know the identity
of the final government customer;
– Provides an end product purchased in a “non-competitive”
environment;
– Contract negotiated/awarded exclusively to fulfill government
contract (but for the contract, the purchase would not have been
made).


Examples of Specialized
Purchases
• An order for armored trucks.
• An order for specialized bullet-proof vests.
• An order for customized software.


Non-Specialized Goods or Services
• Non-specialized goods or services are
characteristic of a Supplier Agreement:
– Goods or services are produced within normal business
operations;
– Goods or services are provided to multiple purchasers without
modification;
– Goods or services are sold in a competitive environment;
– Contractor is generally uninformed and has no reason to know
identity of final government customer;
– Contract for goods or services negotiated/awarded
independently of FAR requirements for government contracts.


Examples
• An order for a fleet of trucks.
• An order for commercially available night-
vision goggles.
• An order for off-the-shelf Windows 7
software.


Difficulty in Appropriately
Flowing Down Clauses
• Ambiguity – it can be difficult to determine
when a clause must be flowed down
– For example, some flow downs are limited to
subcontracts, yet the FAR contains
numerous, conflicting definitions of
subcontract, as noted above


Consequences of Failing to
Appropriately Flow Down
Noncompliance may:
• Become part of Contractor’s past performance
record under FAR Subpart 42.15;
• Result in the government withholding
payments for the period of noncompliance;
• Result in a breach of the terms of the prime
contract.


Importance of Appropriately
Flowing Down Clauses
• Protect your business
• Comply with federal requirements
• Retain Opportunity to Participate in
Government Contracts


Failure to Flow Down
The Christian Doctrine
G.L. Christian & Associates v. The United States, 160 Ct. Cl. 1
- Depending upon the nature of the clause, the
Government may be able to read it into the contract despite
the fact that it is not included in the terms of the contract.
- Because a Termination for Convenience Clause may be
read into a prime contract via the Christian Doctrine, a
prime contractor’s failure to flow down this clause even if
not included in the prime contract can result in
substantial losses.

ARRA Case Study
The American Recovery and Reinvestment Act (ARRA) is
an important resource; however, it comes with strings
attached.

The obligations attached to ARRA funding can be
daunting to a prime contractor but they need not be.

Distinguishing between a prime’s suppliers and
subcontractors is key to the success of a prime
contractor operating under ARRA funded projects.


To Whom Do ARRA Flow Downs
Apply?
• All suppliers and subcontractors of goods and
services used in whole or in part for ARRA
funded projects
OR
• Those subcontractors that provide goods and
services funded directly by ARRA


Example
• Commercial company with a long-standing Supplier
Agreement for the purchase of chocolate chips
– The company produces chocolate chip cookies
• Chocolate chip Supplier
– Sells chocolate chips in the commercial market to
multiple customers
– Sells chocolate chips at prices negotiated in a
competitive environment
– Contracts are negotiated independently of FAR
requirements


Example continued
• What flow down requirements exist for the Company if
the Government decides to purchase chocolate chip
cookies from the Company under an ARRA funded
prime contract and the Government’s cookies are baked
with the chocolate chips supplied under the existing
Supplier Agreement?
– Broad Interpretation of “Subcontract”
• Flow Downs apply to Supplier Agreement
– Functional Interpretation of “Subcontract”
• Flow Downs do not apply to Supplier Agreement


Broad Interpretation
This is a Subcontract
• The goods are used in the performance of a specific prime contract
that is funded by ARRA
• Any amount of sales to the Government – e.g., 0.1% of the total
amount of chocolate chips supplied to the Company are allocated to
the Government’s cookies, subjects the “subcontractor” to additional
ARRA flow downs reserved for subcontracts
Thus, the Prime Contractor must re-negotiate the Agreement to
include the necessary flow down clauses
• The value and duration of the contract will dictate which additional
clauses reserved for subcontracts must be included


Broad Interpretation
• A broad definition of “Subcontract” would
defeat the stated objectives of ARRA:
– Promotion of cost control
– Minimization of burdens
– Enhanced efficiency
– Speedy recovery


Functional Interpretation
• This is Supplier Agreement
– The chocolate chips were not purchased expressly
for the performance of the government contract
– The chocolate chips are supplied to multiple
contractors
– The goods are non-specialized and were procured in
a competitive environment
• No additional flow downs reserved for subcontracts are
necessary

Functional Interpretation

The functional approach to defining the
term “Subcontract” is supported by:
• Purpose and intent of ARRA
• Implementing FAR clauses
• FFATA (Federal Funding Accountability
and Transparency Act of 2006)


ARRA
• Purpose: to provide speedy economic
recovery through preferred use of existing
competitive, firm, fixed-price contracts
• OMB implementing guidance:
– Optimize transparency
– Impose a minimum burden on contracting
parties
– Control costs and perform efficiently


ARRA: Implementing FAR
Clauses
FAR 4.1501 Procedures
...
(b) To maximize transparency of Recovery Act funds that must be
reported by the contractor, the contracting officer shall structure
contract awards to allow for separately tracking Recovery Act
funds. For example, the contracting officer may consider awarding
dedicated separate contracts when using Recovery Act funds or
establishing contract line item number (CLIN) structures to
mitigate commingling of Recovery funds with other funds.
....


ARRA and the FFATA
• ARRA’s reporting requirements are the same as
those imposed by the Federal Funding
Accountability and Transparency Act (FFATA)
See FAR 4.1500

• The FAR’s implementation of FFATA defines
Subcontractor as:
any contract as defined in FAR Subpart 2.1 entered into by the
Contractor to furnish supplies or services for performance of this
contract. It includes, but is not limited to, purchase orders and
changes and modifications to purchase orders, but does not include
contracts that provide supplies or services benefiting two or
more contracts.


Recent FAR Interim Regulations Support
a Functional interpretation of
“Subcontract Agreement”
• First-Tier Subcontract means a subcontract awarded directly by a Contractor to
furnish supplies or services (including construction) for performance of a prime
contract, but excludes supplier agreements with vendors, such as long-term
arrangements for materials or supplies that would normally be applied to a
Contractor's general and administrative expenses or indirect cost. FAR 52.204-10
(July 8, 2010)

• First-Tier Subcontract means a contract awarded directly by a Federal Government
prime contractor whose contract is funded by the Recovery Act, to furnish supplies or
services (including construction) for performance of a prime contract, but excludes
supplier agreements with vendors, such as long-term arrangements for materials or
supplies that would normally be applied to a contractor's general and administrative
expenses or indirect cost. FAR 52.204-11 (July 2, 2010)


Compliance Tools
• Flow Chart – Process by which to
distinguish Supplier Agreements from
Subcontracts
• Flow Down Table – Generally categorizes
clauses pursuant to their application in
supplier agreements and subcontracts


All Suppliers &
Subcontractors:
U.S. Government
Provisions

-Universal Flow Downs

Nonspecialized Specialized
Nonspecialized or
Suppliers/Vendors Specialized good Subcontractors
or Service?

Construction only:
Add Add'l
Construction
Add Add'l U.S. Government
Provisions to contract Provisions
ARRA
- Construction Flow
Construction only: FUNDING?
Downs
Add Add'l Construction - Subcontractor Flow Downs
Provisions to contract; add No
Davis-Bacon Act to Contract
only if work performed on
construction site Construction only:
Yes
Add Add'l Construction Add Add'l U.S.
- Construction Flow Downs Provisions to contract; add Government Provisions
STOP
ARRA version of Davis- to contract
No Bacon Act to Contract
- Recovery Act
- Construction Flow Downs
STOP ARRA funded
portions STOP
segregable?
Construction only:
Yes Add Add'l U.S.
Add Add'l Construction
Provisions to contract; add Government Provisions
ARRA version of Davis- to segregable portion
Bacon Act to segregable
portion - Recovery Act

- Construction Flow Downs


Addendum – Universal Flow Downs

FAR Requirements
Construction ARRA Suppliers and
Suppliers Subcontractors Construction Suppliers Subcontractors Vendors ARRA Subcontractors
FAR 52.222-21, Prohibition of Segregated
Facilities X* X X X X X
FAR 52.222-26, Equal Opportunity X X X X X X
FAR 52.222-35, Equal Opportunity for Special
Disabled Veterans, Veterans of the Vietnam Era,
and Other Eligible Veterans X X X X X X
FAR 52.222-36, Affirmative Action for Workers
with Disabilities X X X X X X
FAR 52.222-37, Employment Reports on Special
Disabled Veterans, Veterans of the Vietnam Era,
and other Eligible Veterans X X X X X X
FAR 52.222-39, Notification of Employee Rights
Concerning Payment of Union Dues or Fees X X X X X X
FAR 52.247-64, Preference for Privately Owned
U.S. Flag Commercial Vessels X X X X X X


Example: Universal Flow Downs
52.222-26 Equal Opportunity.
As prescribed in 22.810(e), insert the following clause:
Equal Opportunity (Mar 2007)
...
(2) The Contractor shall take affirmative action to ensure that applicants are employed, and that
employees are treated during employment, without regard to their race, color, religion, sex, or
national origin. This shall include, but not be limited to—
(i) Employment;
(ii) Upgrading;
(iii) Demotion;
(iv) Transfer;
(v) Recruitment or recruitment advertising;
(vi) Layoff or termination;
(vii) Rates of pay or other forms of compensation; and
(viii) Selection for training, including apprenticeship.
(10) The Contractor shall include the terms and conditions of this clause in every subcontract or
purchase order that is not exempted by the rules, regulations, or orders of the Secretary of
Labor issued under Executive Order 11246 . . . .


Addendum – Supplemental Flow Downs
• FAR 52.203-11 - Certification and Disclosure Regarding Payments to Influence Certain Federal
Transactions
• FAR 52.203-12 - Limitation on Payments to Influence Certain Federal Transactions
• FAR 52.203-13 - Contractor Code of Business Ethics and Conduct
• FAR 52.203-14 - Display of Hotline Poster(s)
• FAR 52.212-5 - Contract Terms and Conditions Required to Implement Statutes or Executive
Orders - Commercial Items
• FAR 52.219-8 - Utilization of Small Business Concerns
• FAR 52.222-6 - Davis-Bacon Act.
• FAR 52.222-27 - Affirmative Action Compliance Requirements for Construction
• FAR 52.222-29 - Notification of Visa Denial
• FAR 52.222-41 - Service Contract Act of 1965
• FAR 52.222-50 - Combating Trafficking in Persons
• FAR 52.222-51 - Exemption from Application of the Service Contract Act to Contracts for
Maintenance, Calibration, or Repair of Certain Equipment--Requirements
• FAR 52.222-53 - Exemption from Application of the Service Contract Act to Contracts for
Certain Services--Requirements (Feb 2009) (41 U.S.C. 351, et seq.)
• FAR 52.222-54 - Employment Eligibility Verification
• FAR 52.225-8 - Duty Free Entry
• DFARS 252.247-7023 - Transportation of Supplies by Sea
• DFARS 252.247-7024 - Notification of Transportation of Supplies by Sea


Example: Supplemental Flow Downs
DFARS 252.247-7023 Transportation of Supplies by Sea
...
(5) “Subcontractor” means a supplier, materialman, distributor, or vendor at any
level below the prime contractor whose contractual obligation to perform results
from, or is conditioned upon, award of the prime contract and who is performing any
part of the work or other requirement of the prime contract.
...
(h) In the award of subcontracts for the types of supplies described in paragraph
(b)(2) of this clause, the Contractor shall flow down the requirements of this clause as
follows:
(1) The Contractor shall insert the substance of this clause, including this paragraph
(h), in subcontracts that exceed the simplified acquisition threshold in Part 2 of
the Federal Acquisition Regulation.
(2) The Contractor shall insert the substance of paragraphs (a) through (e) of this
clause, and this paragraph (h), in subcontracts that are at or below the simplified
acquisition threshold in Part 2 of the Federal Acquisition Regulation.


Questions?
Jeff Eckland – (612) 236-0161

Eckland & Blando LLP
Suite 1020 Lumber Exchange Building
10 South Fifth Street
Minneapolis, MN 55402


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