We have been meaning to write a serious article for publication on this topic, but the time has never seemed right. So you get this blog article intead. The topic really deserves more; it matters because how you define your subcontracts impacts many things, from content to how they are reviewed by government auditors. For example, you will include the mandatory flow-down clauses from your higher-tier contract in your subcontracts, but you won’t do that in your general supplier agreements if you don’t consider them to be subcontracts. When the DCMA Contractor Purchasing System Review (CPSR) team finally comes to visit, they will have different expectations for your subcontracts than they will for your general supplier agreements (though likely they will look at both). So the definition of subcontract matters.

The problem is, there’s no definition of subcontract in the FAR. Or, rather, there’s far too many and they vary significantly, depending on where you’re looking.

Let’s start here: Go to FAR 2.101 (Definitions) and look for “subcontract.” You won’t find it. Sure, you’ll find a definition for “contract” and for “delivery order” and for “task order”—but you won’t find a definition for subcontractor. And that’s the problem.

Vern Edwards, a demi-god in the pantheon of government contracting experts, tackled this topic in the April 2012 edition of the Nash & Cibinic Report, in his article entitled, “What is a Subcontract? Who is a Subcontractor?” He compared the FAR 44.101 definition of “subcontract” to the definition of subcontractor found in that same Subpart. Here’s what the definitions say—

“Subcontract” means 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.

“Subcontractor” means any supplier, distributor, vendor, or firm that furnishes supplies or services to or for a prime contractor or another subcontractor.

So according to the definitions above, a subcontract is a contract entered into “for performance of a prime contract or subcontract,” but a subcontractor is an entity that furnishes any supplies or services “to or for a prime contractor or to another subcontractor.” That’s confusing, at least to us. And apparently to others as well, since comments submitted to the DAR Council in relation to the promulgation of the DFARS Business Systems administration regime pointed out that same confusion.

What did the DAR Council say in response to the public comments regarding the confusing definitions? It said, “Because the Government reimburses contractors for its applicable share of indirect expenses, it would be inappropriate to revise the definitions of subcontracts and purchase orders to exclude agreements with vendors that would normally be applied to a contractor’s G&A expenses or indirect costs.”

So according to the DAR Council, every prime contractor should be flowing-down its prime contract clauses into every single purchase order and contract it enters into with every single one of its suppliers. They don’t address what happens if any of those prime contract mandatory flow-down clauses contradicts the mandatory flow-down clauses of another prime contract. They don’t mention how to handle different DPAS ratings. It doesn’t address the implication that, by its definition, every single supplier agreement valued in excess of $100,000 should be submitted to a Contracting Officer for consent.

In other words, they got it wrong.

Mr. Edwards was much more diplomatic when he wrote –

It is reasonable to interpret the definition of ‘subcontract’ in FAR 44.101 to encompass purchases charged to contractor indirect cost accounts? Such purchases include materials, parts, equipment, and services that are to be used in operations but that will not be incorporated into any deliverable item. We think the answer is no, but to the best of our knowledge that question has never been answered authoritatively by any policy body, board, or court. We have been told and believe that different COs and contractors interpret the definition of ‘subcontract’ in FAR 44.101 differently in that regard, some to include purchases charged to indirect cost pools and some not.

Mr. Edwards’ article notes that the term “subcontract” is officially defined 15 different times throughout the FAR. Suffice to say, while some of the definitions overlap, many others are contradictory. This situation naturally leads to problems when trying to define exactly what a subcontract is and what it is not. The best that can be said is that the official definition of a subcontract is the one that applies, based on the part of the FAR that one is working with.

We have lightly touched on this issue before, notably here, when we wrote—

So now we have the FAR Councils asserting that the term “contract” definitely encompasses a task or delivery order—but only with respect to evaluating whether a TINA exemption is applicable. We have the DAR Council clearly stating that the term ‘contract’ definitely encompasses a task or delivery order with respect to mandatory arbitration. But so far nobody has taken the next logical step—which would be to find that the term ‘contract’ encompasses a task or delivery order for purposes of applying CAS.

We also addressed, more directly, the disparate definitions of “subcontract” in this article. We noted that the Office of Management and Budget (OMB) expressly defined “subcontractor” as encompassing both agreements under prime or higher-tier subcontracts, and agreements for provision of “general supplies” unrelated to any particular contract. (We later noted that the DOD policy-makers undercut the problematic OMB definition, by making the clause in question a mandatory flow-down provision. In other words, according to the DOD, if you don’t have a prime contract or higher-tier subcontract that includes the clause, you don’t need to comply with it—which is not at all what we thought OMB was directing.)

Another related area of contention is whether a Teaming Agreement is an enforceable contract. Courts have been divided on the issue, from what we (non-lawyers) can tell. A current lawsuit against a Top 10 defense contractor may create another opportunity for the Courts to offer an opinion on the matter.

Right now, a small business, L’Garde, is suing The Raytheon Company in a California Court. Though we are not privy to the details, from the late July decision by the California District Court (Central Region) we gather that Raytheon issued to L’Garde a Letter Subcontract, which (allegedly) included a promise to negotiate, in good faith, “a future definitive subcontract.” Thus, apparently a Letter Subcontract is analogous to a Undefinitized Contract Action (UCA)—which has also proved to be problematic for the Department of Defense when used. L’Garde sued Raytheon, claiming that Raytheon issued the Letter Subcontract solely in order to win a subcontract from Lockheed Martin and, once the LockMart award was received, failed to definitize the Letter Subcontract. Raytheon, quite naturally, disagreed with L’Garde’s characterization of the situation.

Raytheon advanced a number of arguments in its defense, including trying to persuade the Court that Federal common law should replace state law in the case. The Court was not persuaded, and wrote—

This Case is factually analogous to Northrop Corp. v. AIL Systems, Inc., 959 F.2d 1424 (7th Cir. 1992), in which the plaintiff sued the defendant for an alleged breach of a ‘teaming agreement.’ There, the parties successfully ‘teamed’ up to win a bid for an Air Force contract and while they initially worked together, defendant eventually refused to subcontract out the work to plaintiff in order to realize a cost-reduction. … The Seventh Circuit held the teaming agreement did not rise to the level of a unique federal interest sufficient to warrant the imposition of federal law because ‘[t]he federal government is not liable for any damages [Defendant] may owe [Plaintiff] for the alleged breaches of the teaming agreement. Nor is there any indication that the government will pay a higher price for the [contract] if [Defendant] is found liable to [Plaintiff].’

Thereafter, the Ninth Circuit held the New SD and Northrop decisions to be in harmony because the source of the Northrop dispute arose from the ‘teaming agreement,’ not the actual ‘subcontracts which govern actual work being performed on federal projects that implicate federal interests much more directly.’ New SD, 79 F.3d at 955 (quoting Northrop, 959 F.2d at 1428).

Accordingly, we see in the case above that the Courts have been readily able to distinguish between Teaming Agreements and subcontracts. We wonder if they would have the same perspicacity when asked to distinguish between a subcontract and a general supplier agreement?

Isn't it time for the FAR Councils to address this issue in Part 2.101?

One of our favorite things here is when several strands of issues/concerns/challenges come together and align. For example, in this article we discussed the confluence of DCAA’s push for access to contractors’ internal audit reports with the push for access to attorney-client privileged documents—both topics that we had discussed previously in multiple individual articles. Similarly, in this pithy article we linked DCAA”s push for access to attorney-client documents with Sikorsky’s ongoing CAS 418 litigation, as well as to the various Contract Disputes Act Statute of Limitations articles we’ve published here.

Now we get another opportunity to link disparate strands into a cohesive whole! Today’s article links our recent article on the False Claim Act risks posed by disgruntled employees with our long-time (and multiple article) concerns about the importance of effective subcontractor management. Today is truly a special day!

So, to the point:

First, let us note the recent Department of Justice press release announcing that El Paso-based ReadyOne Industries (formerly known as the National Center for the Employment of the Disabled, or NCED)—a not-for-profit AbilityOne® entity—had settled allegations that it had violated the FCA, for the reasonable sum of $5 million. (Well, it seems reasonable to us. But let’s all remember that’s $5 million that is now not going to be available for ReadyOne’s programs.)

According to the DOJ, a former NCED employee, Michael Ahumada, had filed a qui tam suit as a relator under the FCA. (If any of those terms or acronyms seems unfamiliar, you may want to review our article on the risks posed by disgruntled employees, link above.) Mr. Ahumada alleged that NCED/ReadyOne failed to accurately report its ratio of disabled labor hours to appropriate AbilityOne® authorities.

The press release stated—

The [AbilityOne®] program uses the purchasing power of the federal government to buy approved products and services from participating, community-based nonprofit agencies nationwide. These community-based nonprofit agencies, like NCED, must ensure that 75 percent of all annual direct labor hours on certain government contracts are performed by employees who are blind or severely disabled.   The program is managed by the Committee for Purchase From People Who Are Blind or Severely Disabled, which is a federal agency. The United States alleges that, between 2000 and 2006, NCED employed a large number of non-disabled employees to work on contracts for the manufacture of archival boxes, apparel and other items, and did not appropriately account for their hours as part of the overall ratios it certified and submitted to the committee.

We have worked with AbilityOne® entities before, and this is not the first time we’ve heard of troubles in calculating the NISH ratios. But this is a nice example of the point we made in our earlier article, which is that companies are much better off listening to their employees’ concerns, investigating them, and reporting back to the employee the results of those investigations, when compared to the legal and settlement costs associated with settlements under the FCA.

The next strand concerns another qui tam action under the FCA, this time brought by an employee of a subcontractor against both the subcontractor and the prime contractor. We were tipped to a nice summary of the court decision, penned by two wily government contracts attorneys at Wiley Rein. Their summary focused on FCA liability associated with the Davis-Bacon Act, but what caught our eye was the following—

After finding that it had primary jurisdiction to decide the plaintiffs’ FCA claim, the court concluded that the contractor acted with reckless disregard concerning the falsity of the payroll certifications, and thus violated the FCA.  The prime contractor conceded that it understood the Davis-Bacon requirements, and yet did not supervise the subcontractor’s payment of its employees, and did not verify the payroll certifications for accuracy and completeness.  This lack of supervision and verification resulted in payroll certifications that did not account for the subcontractor’s electrical workers and falsely certified that they received Davis-Bacon wages. 

[Emphasis added.]

We followed the article’s link to the full Sixth Circuit Appellate decision. We were interested in the following bits—

Circle C’s contract explicitly incorporated the Davis-Bacon requirements and included an hourly wage determination for electrical workers…. Circle C, as a frequent contractor with the government, admitted its familiarity with these requirements…. Circle C conceded that it should submit payroll certifications for all employees on the project, but did not include Phase Tech employees on the original certifications, although it did submit separate payroll certifications for the other subcontractors. Circle C acknowledged that it never paid or supervised the payment of any Phase Tech employees and had no first-hand knowledge regarding Phase Tech’s payments to its employees. It was only in 2006 that Circle C finally informed Phase Tech of the need to submit payroll certifications to Fort Campbell. Once the records were provided by Phase Tech, Circle C never verified their accuracy. In fact … there were 62 inaccurate submissions, 53 of which pertained to 2004 and 2005 and failed to list any Phase Tech workers. The 62 certifications also were false because they wrongly certified that the prevailing wages were paid. …

For the reasons stated by the district court, the totality of the circumstances show that Circle C, an experienced contractor, made false statements, acted in reckless disregard of the truth or falsity of the information, and that the false statements were “material” to the government’s decision to make the payment sought in Circle C’s claim. Thus, we affirm the district court’s grant of summary judgment in favor of plaintiffs on their FCA claim.

Circle C did not effectively manage the administrative details of its subcontract with Phase Tech. The Court didn’t dwell on it, but it appeared that Circle C was not aware for some months—perhaps as long as two years—that Phase Tech was actually its subcontractor, performing work in the field. Certainly, the normal administrative procedures and controls that a government construction contractor would impose, as a matter of routine, seemed to be largely lacking. Consequently, the Circle C’s failure to properly manage its subcontractor led to a finding of liability under the FCA, a liability that will likely cost Circle C millions to settle.

The Circle C litigation started out as a qui tam suit, filed by relator Brian Wall, a Phase Tech employee who worked at the construction site. We didn’t see how Mr. Wall learned that Circle C and Phase Tech were failing in their Davis-Bacon Act-imposed duties, or how Mr. Wall came to the realization that there might be some FCA liability associated with those lapses. We like to imagine that Mr. Wall became disgruntled and decided to get even for some slight, but the truth is, we have no idea.

The fact of the matter is that Mr. Wall’s emotional state is irrelevant. For whatever reason, Circle C failed to properly manage its subcontractor, Phase Tech, as required by its contract with the U.S. Army, and that failure created liability under the FCA. Just like ReadyOne failed in its own labor-related administrative requirements.

Clearly, the False Claims Act is not only about accurate invoices and properly claiming allowable costs. It encompasses such back-office administrivia as payroll certifications and direct labor hour ratio reporting. So perhaps the moral here is not to stint on systems, policies and procedures, because sometimes that stuff is as important as project execution and delivery.