Christopher C. Bouquet’s Reflections on Government Contracts

Co-authored with Gillian M. Fentoni

Published in Les Nouvelles, the journal of the Licensing Executives Society International (LESI), June 2024

The Bayh-Dole Act (“Bayh-Dole” or the “Act”)ii governs the licensing of federally funded and federally owned inventions. A key requirement, referred to as the “Domestic Manufacturing Requirement”, is that the licensing of such inventions to private sector entities should benefit U.S. industry, specifically by requiring manufacture of products that embody or are made through such inventions “substantially in the United States”. Unfortunately, the plain language of the Act and its implementing regulations does not provide any definition or other guidance on what if any threshold should be exceeded in order for manufacturing to be deemed “substantially in the United States.” Further, the legislative history is only minimally helpful in the interpretation of the language and, as of the writing of this article, there are no published decisions providing guidance on the proper interpretation of this language. This article proposes that, in the absence of a specific binding statutory regulatory, or judicial definition, it is appropriate to look to analogous US government acquisition statutes and their implementing regulations for a workable definition.

This is the first of two articles concerning the “Domestic Manufacturing Requirement”, which is codified at 35 U.S.C. § 204. Here we present an analytical approach to interpreting § 204 and whether it applies to a given invention that arose from U.S. federal funding of research or other activities. While the analysis given below is applicable generally across diverse fields of research and industry, we use federal funding of biomedical research and the development of a novel vaccine or biopharmaceutical as a relevant example. In our second article, we will present the process, current framework, and practice tips for seeking a waiver of the Domestic Manufacturing Requirement from the cognizant U.S. federal funding agency.

Both topics that we address are of particular concern to funding recipients and their licensee partners, who need to understand how the requirement may affect strategic decisions on how to structure their manufacturing operations and supply chains for innovative products years after the receipt and utilization of U.S. research funding. These decisions, in turn, may implicate very significant investments made by licensees and the risk environment in which such decisions are made. The complications and impacts have grown more significant over the forty-plus years since Bayh Dole was enacted, as the global economy has emerged and become increasingly interconnected and interdependent.

Prior to 1980, the U.S. government took title to inventions made by the government or by private sector organizations in the performance of work under grants and other types of government agreements (“Subject Inventions.”)  Thus, awardees of these agreements (“Awardees”) did not have the right to commercialize the inventions made during the course of their work.  However, the government was not effective in out-licensing these inventions to industry. Prior to the enactment of Bayh-Dole less than four percent of inventions made by government employees or made by the private sector through the use of government funding were licensed to industry for commercial use.iii  As a result, while the government had full use of these inventions for its purposes, their potential to benefit the commercial marketplace and society in general was woefully under realized: the taxpayers were not getting the most “bang for their bucks” invested in federal research and development. Without a clear path to securing commercialization rights, innovative organizations were reluctant to incur the opportunity costs associated with accepting government funding.  The enactment of Bayh-Dole in 1980 redressed these deficiencies. Understanding the Act and its implications is therefore essential to development and commercialization of products based on government owned or funded inventions.

Bayh Dole and its implementing regulations gave Awardees a path to securing title to Subject Inventions made by the Awardees in the course of performing work under their agreements with the government (e.g., for research, development, procurement, and/or services). For convenience, we will refer to this type of invention hereafter as a “Federally Funded Invention”. In order to retain title to a Federally Funded Invention, the Awardee must timely disclose the invention to the government, formally elect to retain title, and file a patent application strictly in accordance with the detailed procedures and deadlines set forth in a standardized clause, and subsequently report any decisions not to continue with patent prosecutions in the United States and around the world.iv  Failure to comply with these procedures and deadlines can lead the Awardee to lose title to the invention, which then reverts to the government. These requirements attach for the life of the patent rights, even after performance is completed under the grant or other government agreement. An important point in due diligence investigations for transactions involving Federally Funded Inventions is therefore to verify that the Awardee has timely and properly secured title and remains in compliance with the requirements.

Bayh Dole and its implementing regulations also include provisions outlining a clear path for the out-licensing of inventions made by government employees in the course of their work (such as investigators at the National Institutes of Health), or Subject Inventions to which the government has obtained title because the Awardee elected not to retain title or due to error or omission of an Awardee to properly elect to retain title. For convenience, we will refer to this type of invention as “Federally Owned Inventions”. Upon making a determination that licensing a Federally Owned Invention is in the public interest and obtaining the prospective licensee’s commitment to achieve practical application of the invention within a reasonable time, the government may enter into non-exclusive, exclusive or partially exclusive licenses for such inventions under specified terms and conditions. For convenience, where the Act imposes consistent restrictions or requirements on the licensing and commercial development of both Federally Funded and Federally Owned Inventions, we will refer to them collectively as Federal Inventions. We will also point out where the Act and/or its implementing regulations distinguish between these two categories.v 

One of the required conditions for licensing Federal Inventions is that the Bayh-Dole Act bestows on the government a nonexclusive, nontransferable, irrevocable, paid-up license to practice any Federal Invention or to have it practiced for or on behalf of the United States. This so-called “government use license” runs with the technology and binds any original or successor licensee throughout the commercial life cycle of products and/or services based on the Federal Invention.vi All transactions in the nature of licenses or asset transfers, even those that are otherwise of exclusive rights, are subject to the ongoing, irrevocable rights of the government.vii The Act does not define the intended scope of the government use license, but it is generally understood to embrace government research, development, education, manufacture, procurement of products and services, and in some instances incorporation into standards or other requirements of the government. It does not extend to uses for commercial purposes.viii


Another requirement, which reflects Bayh Dole’s original policy objective to promote innovation in the United States, is that all Federal Inventions that are licensed to private sector entities should benefit U.S. industry, specifically by being manufactured substantially in the United States.  This requirement attaches to licenses of the exclusive right to sell or use a Federally Funded Invention in the United States, ix and to all license grants (non-exclusive and partially exclusive as well as exclusive) of commercial rights in Federally Owned Inventions.x  In particular, the Act requires that such licenses provide that any products “embodying” the invention or “produced through the use of” the invention “will be manufactured substantially in the United States,”xi These manufacturing provisions of the Act, which remain applicable through all tiers of sublicensing or transfer of license rights for the commercial lifetime of the corresponding products, are referred to collectively as the “Domestic Manufacturing Requirement” or “DMR” and will be the primary focus of this article.   Recently, the DMR has taken on a renewed prominence in national policy priorities, as reflected in the issue of an Executive Order by President Biden in mid-2023.xii Readers should expect further developments and a focus on promotion of U.S. manufacturing for at least the remainder of the Biden Administration. 

Bayh Dole empowers the government with certain rights to enforce compliance with the DMR. For Federally-Owned Inventions, the government may modify or revoke a license if its licensee (or the exclusive licensee of an Awardee) breaches the DMR.xiii  For Federally-Funded Inventions, failure to comply with this requirement is one of four reasons set out in the Act for which the government may exercise so-called “march in” rights.xiv In a “march in” situation, the government may direct an Awardee or licensee to grant a license to the invention to a third party, or may itself grant such a third party license, notwithstanding the Awardee’s ownership or the existence of prior license rights.xv The potential jeopardy to commercial licensing transactions, coupled with the complexity and expense of manufacturing on an industrial scale, underscore the importance for licensees to understand and comply with the Act’s Domestic Manufacturing Requirement.xviThis article, along with our companion article, collectively provide a guide to navigating the obligations and mitigation strategies for the Domestic Manufacturing Requirement. This requirement, originally conceived of more than forty years ago, can be a challenge for organizations engaged in commercializing highly complex technologies in our current, globally interconnected economy. It is not uncommon that a global supply chain is required to commercialize a Federal Invention.  Thankfully, the Act and its implementing regulations also provide that the DMR may be waived in certain circumstances.xvii In this article, we will analyze the meaning and applicability of the DMR. Our second article will focus on the requirements for securing waivers, as well as what to expect in a waiver grant. We turn now to the question of how to interpret the DMR.

• The Meaning of “Manufactured Substantially in the United States”

The first step in analyzing the requirements for compliance with the Domestic Manufactuirng Requirement is to determine whether the invention will be “manufactured substantially in the United States.” If so, then a waiver is not necessary. If not, then a waiver is necessary if the invention is a Federally Funded Invention that will be exclusively licensed in the US or if the invention is a Federally Owned Invention. If the invention is a Federally Funded Invention that will be manufactured by the Awardee and/or not exclusively licensed in the US, no waiver is necessary. This is an easy question to answer if the “manufacturing” takes place in a single facility – it is either in the U.S. or it is not. It is an entirely different and more complex question if instead the “manufacturing” requires multiple processes that are carried out at multiple facilities located in different geographies across the world – that is, a global supply chain.

 To assess the more complex questions, we need to interpret the statute. The first step in construing any statute is to determine whether its language has a plain and unambiguous meaning.xviii Unfortunately, neither the Act, the main implementing regulations promulgated by the National Institute of Standards and Technology (NIST), nor agency-specific regulationsxix define what is meant by “manufactured substantially in the United States”. The focus of analysis is on the word “substantially” – for which the ordinary meaning is “considerable in importance, value, degree, amount or extent.”xx However, the plain English definition of this term lacks the precision needed to support business and legal decisions as consequential as whether a waiver of the Domestic Manufacturing Requirement is needed for a specific Federal Invention under consideration. Indeed, the language of the Act does not indicate whether this analysis should be based on the number or geographic location of components, manufacturing steps or another metric, such as cost or value. Similarly, the Act does not provide any definition or other guidance on what if any threshold should be exceeded in order for manufacturing to be deemed “substantially in the United States.” If the plain English meaning as specified in dictionaries is insufficient to interpret a statute, it becomes necessary to look at its legislative history.xxi Hence we next review the legislative history of the Bayh Dole Act.

• Legislative History

The legislative history of the Act provides some limited insight into Congress’ intent in enacting it. The Senate Judiciary Report on the requirements for Federally Funded Inventions states as follows:

Section 205. Preference for United States Industry.

 Section 205 provides that persons receiving an exclusive license to use or sell a subject invention in the United States must agree to manufacture any products embodying the invention substantially in the United States. Agency approval is required to dispense with this requirement. This section is designed to maximize the probability that the jobs created through the commercialization of new products and technologies based on Government supported inventions will benefit American workers.xxii

Based on this history, it appears that Congress wanted agencies to interpret the Domestic Manufacturing Requirement in a manner that maximizes the probability of creating American jobs through the commercialization of the inventions. Thus, the interpretation of “manufactured substantially in the United States” that creates the most United States jobs should be favored over alternative interpretations. It is also clear that the Act prioritizes manufacturing jobs over other types of jobs, such as research and development, distribution and sales, etc. While this provides some limited help in assessing different approaches, it does not provide much help in fleshing-out a specific workable definition of the term “substantially”.xxiii Nor have any court decisions construing this term in the Bayh Dole Act been issued as of this writing. In the absence of a specific binding statutory regulatory, or judicial definition, it is appropriate to look to analogous US government acquisition statutes and their implementing regulations for guidance. We have identified two such acquisition statutes, discussed below.

• Analogous Acquisition Provisions.

Trade Agreements Act Clause. The first analogous acquisition provision is found in the regulations that implement the Trade Agreements Act (“TAA”)xxiv on federal acquisitions. The TAA authorizes the President to waive discriminatory purchasing requirements with respect to countries that (i) become parties to the World Trade Organization Government Procurement Agreement (”WTO GPA”) and (ii) provide appropriate reciprocal competitive government procurement opportunities to United States end products and suppliers of such products.xxv  Under the definitions set forth in the TAA, for purposes of determining whether an end product is made in a country that is a signatory to the WTO GPA, an article is considered an end product of a country if (i) ”it is wholly the growth, product, or manufacture of that country” or (ii) in the case of an article which consists in whole or in part of materials from another country, it has been substantially transformed in that country into a new and different article of commerce.xxvi Federal Acquisition Regulation (“FAR”) 52.225-5, Trade Agreements, implements this statute. It requires that, in certain acquisitions the contractor may deliver either “US-made” or “designated country end products.” However, whereas under the statute, a U.S.-made end product has to be “wholly” made or substantially transformed in the US, under the FAR a “U.S.–made end product” means an “article that is [1] . . . manufactured in the United States or [2] that is substantially transformed in the United States into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was transformed.”xxvii There is no requirement that the article be “wholly” manufactured in the US. This is referred to as the “FAR TAA Test”. The regulatory history makes clear that “U.S. made end products” are “products that are manufactured or substantially transformed in the United States, regardless of the source of the components” (emphasis added).xxviii

The case of Acetris Health, LLC v. United Statesxxix involved an offer submitted in response to a Department of Veteran’s Affairs (“DVA”) solicitation for pharmaceutical tablets to treat hepatitis B. While the active pharmaceutical ingredient (“API”) for the offered tablets was made in India, the weighing, mixing, and compounding involved in formulating the API into final tablet form was performed in New Jersey. The DVA ruled that the offeror was ineligible for award of a contract because the manufacturing process for the tablets did not meet the FAR TAA Test and the offeror appealed. On appeal, the government argued that the FAR TAA Test impermissibly varied from the test in the TAA statute itself.xxx Based on the statutory test, the government argued that the tablets were not US made end products because they were not wholly manufactured in the US and the offeror’s activities in the US (formulating an imported drug into tablets) did not rise to the level of “substantial transformation.” However, the court held that the FAR Councilxxxi had authority to promulgate a test that varied from the statutory test and that, under that test, as long as the end product is “manufactured” in the US, regardless of the source of its components, it is a US end product.  Based on Supreme Court precedent interpreting the meaning of the term “manufacturing” in an old customs statute, the Acetris court indicated that a product is “manufactured” for purposes of the FAR TAA Test if “a new article is produced of which the imported material constitutes an ingredient or part.”  Further, the court held that the formulating activities for the tablets in New Jersey qualified as “manufacturing”, regardless of whether these activities rose to the level of “substantial transformation”.  Finally, the court noted that the “products may very well be [also] substantially transformed in the United States, but we need not decide this question here.”

Thus, if the FAR TAA Test were adopted as a definition of “manufactured substantially in the United States” under the Bayh-Dole Act, any products embodying the pertinent invention or produced through the use of the invention would have to be either (1) manufactured in the United States or (2) substantially transformed in the United States into a new and different article of commerce. However, the first prong of the test only assesses whether the product is “manufactured” in the United States to some degree or extent. It does not assess whether or not the manufacture in the United States was “substantial” for purposes of the Bayh Dole Act DMR – i.e., whether it was “considerable in importance, value, degree, amount or extent”xxxii in relation to the total manufacturing process for the tablets. For example, in the Acetris case, the first prong does not assess whether, in relation to the manufacturing activities for the imported API abroad, the formulating that was performed the United States was considerable in importance, value, degree, amount or extent. Turning to the alternative “substantial transformation” prong under the FAR TAA Test, this “does not require some minimum quantum of manufacturing or assembly to be performed”xxxiii and therefore also fails to assess whether the manufacturing in the United States was substantial. Thus, even if the tablets in Acetris were substantially transformed in New Jersey into a new and different article, it would be quite difficult for an agency applying Bayh Dole to determine whether the US manufacturing processes were substantial in relation to the processes that occurred in India. As such, the FAR TAA Test fails to provide a workable definition of “manufactured substantially in the United States” for purposes of the Bayh-Dole Act.

Buy American Act Clause. The second analogous legal test, also in the FAR, implements the Buy American Act (“BAA”), which requires that in certain acquisitions, agencies must procure only items “that have been manufactured in the United States substantially all from articles, materials, or supplies mined, produced, or manufactured in the United States,” unless the agency grants a waiver (emphasis added).xxxiv These items are referred to in the FAR implementing regulations as “domestic end products.” Under FAR 25.003, the term “end product” means “those articles, materials, and supplies” acquired by the government for public use. Following are applicable definitions of various types of “domestic end products”:

• For end products that do not consist wholly or predominately of iron or steel or a combination of both, a domestic end product is “an unmanufactured end product mined or produced in the United States” and certain end products manufactured in the United States. End products manufactured in the United States are domestic end products if the cost of their “components mined, produced, or manufactured in the United States exceeds 65 percent of the cost of all its components.”xxxv
• For end products that consist wholly or predominately of iron/steel, a domestic end product is an end product [i] manufactured in the United States, if [ii] the cost of foreign iron or steel constitutes less than 5 percent of the cost of all components used in the end product.
• These requirements for the domestic content of the end products are referred to as the “Component Tests.” xxxvi

Thus, the test required by the BAA (the “BAA Test”) requires BOTH manufacturing of the end product in the US and the satisfaction of the applicable Component Test. The Comptroller General of the United States has held that, under the BAA, the term “manufacture” means:

[C]ompletion of an article in the form required for use by the government. Manufacturing may include a mechanical operation performed on a foreign product or assembly of separate items, whereby the identity and character of the end item is established and fixed as to its current and future use. Thus, the key in determining whether a process constitutes manufacturing for [BAA] purposes is whether the item being purchased by the government is made suitable for its intended use and its identity established.

Packaging is not considered manufacturing under the BAA.xxxvii

For the following reasons, unlike the FAR TAA Test, the BAA Test provides a workable definition of the term “manufactured substantially in the United States” under the Bayh-Dole Act:

Packaging is not considered manufacturing under the BAA.xxxvii

For the following reasons, unlike the FAR TAA Test, the BAA Test provides a workable definition of the term “manufactured substantially in the United States” under the Bayh-Dole Act:  

• The BAA Test precisely defines manufacturing as the place where the product is made suitable for its intended use.
• The Component Test addresses the “substantiality” requirement of the Act’s Domestic Manufacturing Requirement. If the cost of components manufactured in the United States do not meet the specified percentage of the total cost of all components, then the product would not be considered as manufactured substantially in the United States.
• The United States component manufacturing requirements of the BAA Test likely would result in the creation of more United States jobs than the FAR TAA Test. Therefore, the BAA Test is aligned with Congressional intent as expressed in the legislative history of the Bayh-Dole Act.

Therefore, under the Bayh-Dole Act, products embodying the Federal Invention or produced through its use should be considered to be “manufactured substantially in the United States” if the products (1) are manufactured in the United States under the Comptroller General’s definition (i.e., they are made suitable for their intended use) and (2) meet the applicable Component Test.xxxviii It should be noted that, while we have expressed a view on how to assess compliance with Bayh Dole’s requirement for manufacture “substantially in the United States,” there is still no directly applicable precedent or regulatory or statutory guidance on this topic. In light of the complex technologies and/or complex products that are subject to Bayh Dole Act, we believe that it is important to document the details of the approach that is utilized for making this analysis and, if there is any question about whether aspects of the approach comply with the Act or the approach varies from the BAA Test, to proactively address the situation with the agency, especially since different potential approaches can yield different results. This is particularly important where a commercial developer/licensee has reasonably concluded that a product that is subject to the Act is indeed manufactured “substantially in the United States” despite having some imported components and/or some manufacturing steps carried out outside of the U.S., such that a waiver of the Domestic Manufacturing Requirement is not necessary and therefore is not sought from the funding agency. Depending on the degree of uncertainty in the analysis, it may be prudent to apply for a waiver nonetheless so that the funding agency may issue a decision affirming that a waiver is not required.

• Determining Whether Products Embodying or Produced Through Use of the Federal Invention Will be Substantially Manufactured in the United States 

Having established a workable definition of “manufactured substantially in the United States” we now come to the next question – exactly what subject matter is ‘in scope’ of the required analysis of the Domestic Manufacturing Requirement? The Bayh-Dole Act regulates manufacturing activities related to Federal Inventions including both Federally Funded Inventions and Federally Owned Inventions. Conceptually, while the invention is the ‘hook’ through which the Act becomes applicable, the law requires that the analysis encompass the place(s) of manufacturing of the components and the final manufacturing activities for the end product that “embodies” the invention or is “produced through the use of the invention.” It is not a valid approach to isolate the place of manufacturing of the portion of a product that most closely relates to the invention, such as, in the case of a pharmaceutical product, an active pharmaceutical ingredient. Rather, the source materials and place(s) of manufacture of the end product must be considered in a wholistic manner: the entire manufacturing process must be considered end-to-end, starting from raw material inputs and culminating in the finished product ready for end-use.

 However, as noted above, for Federally Funded Inventions, the Act’s DMR only applies to exclusive licenses to use or sell products based on the inventions in the United States.xxxix A threshold question is therefore: is the product covered by a license that includes rights for the US market? And does the license confer exclusive rights to commercialize in the United States? If not, the DMR will not apply. However, given the state of worldwide markets for pharmaceuticals and other advanced technologies, the US is frequently a key market driving value of biomedical license transactions.

 There are also important differences in the timing for when a commercial developer of a product must undertake analysis of the DMR: if, for a Federally Owned Invention, the time horizon from the licensing transaction to commercialization is short, a waiver of the requirement may need to be negotiated for and included up front in the license agreement between the agency and the licensee. As a practical matter, this is only done if the commercial developer can articulate plans to serve the US commercial market at the time the license is negotiated. Alternatively, if the commercialization horizon is long, a waiver may only be sought after the license has been executed and the manufacturing process fully designed, sometimes years later. This situation is actually fairly common in the case of biopharmaceuticals (therapeutics and vaccines) as the path from initiation of development to commercial launch can take from 6-7 years to 10-20+ years. Given the rate of candidate failure during this lengthy development period, many developers understandably wait until a biologic product candidate has reached advanced development (Phase II clinical trials) before confronting the business question of how best to tackle commercial manufacture. Unfortunately, the lapse of time and the expertise of those usually involved in this industrial manufacturing decision can create a risk for compliance with the requirements of the Bayh Dole Act. We recommend that in-house counsel proactively monitor the product’s progress through development stage gates and assure that the analysis of whether a waiver of the DMR is required is coordinated with the development of a commercial manufacturing strategy for the US market.

 In the case of a complex technology or a complex product, a global supply chain is often required. Modern manufacturing is seldom a single process carried out in a single factory: given the need, consistent with the BAA Test, to cover the entire transformative process from primary source materials to a finished product ready for end-use, it is important to consult with the corporate functions responsible for pilot, scale-up, and commercial manufacturing planning and operations. Ideally, this investigation is carried out early in the planning process so as to guide decision-making for key investments and capability development. A supply chain diagram showing the end-to-end manufacturing process is an invaluable tool to support the compliance analysis as well as decision-making. Counsel should educate manufacturing strategy and logistics executives on the risks and consequences of not complying with the Domestic Manufacturing Requirement or seeking a waiver. As mentioned, failure to do so is one of the four grounds for the U.S. government to exercise march-in rights under the Act. Thus, the licensee developer is at risk of losing exclusivity of its license rights, with potentially grave consequences to its returns on investment and ability to achieve its business goals. And the investment required can be substantial: one current estimate puts the value of a new, industrial scale biologics manufacturing facility at around $150,000,000 and the lead time required from breaking ground to a production-ready, FDA approved, fully staffed facility at around four years.xl

 A well-constructed supply chain diagram will reveal whether and how much of the manufacturing process will be carried out at sites that are on U.S. soil. Then, costs of all starting materials or components can be calculated and allocated as being either U.S.-sourced or imported.xli For example, assume that, under a research and development contract funded by the US Department of Defense, an engineering firm made a Federally Funded Invention of a next generation aerial drone that will have both military and commercial logistics applications. The contractor then exclusively licenses the invention to a drone manufacturer for use and sale in the United States. As required by the FAR clause implementing the Bayh Dole Act in government procurement contracts, the contractor includes the Domestic Manufacturing Requirement in the license agreement.xlii Thus, the drone manufacturer will have to make any products embodying the invention substantially in the United States.

 The manufacturer has sites in both the United States and Canada in which it can perform the final assembly, integration and testing of the drone. To comply with the DMR, it selects the US site for these operations and reflects that decision on its supply chain diagram. Therefore, as long as the manufacturer does not shift those final manufacturing operations to the Canada site, it will meet the “manufacturing in the United States” prong of the BAA Test. To ensure compliance with the Component Test, the manufacturer plots out on the supply chain diagram the places of manufacture of the components of the drones and prepares a component cost calculation. It shows the following:

As mentioned above, the Component Test is satisfied if the cost of the components of the drones “manufactured in the United States exceeds 65 percent of the cost of all its components.” Since the cost of the components of the drones manufactured in the US will be 70% of the total costs of the componentsxliii, the manufacturer has developed a manufacturing plan for the drones that satisfies the Component Test and is compliant with the DMR.

 It is also important to understand whether the process being diagrammed and assessed is robust enough to handle future demand for the product: is it sufficient to serve peak markets in the U.S.? Will the same process be utilized for global markets? In what circumstances might it become necessary to outsource any of the manufacturing steps to contract manufacturers? Many multinational businesses regularly revisit and reevaluate their manufacturing and supply chain operations, and the decision of whether to “buy or build” a new facility or enhance an existing one can be quite significant, often reflected prominently in the financials and strategic outlook for the developer.xliv Once a decision is made, it can be quite difficult to alter, even when the consequences of failure to comply with the Act are well articulated and understood. It is therefore particularly important to educate supply chain executives that the DMR attaches for the lifetime of the product and that the manufacturing plan must be robust enough to remain in compliance throughout or, if variations become necessary, that they are implemented in a way that maintains compliance with DMR. As explained in our companion article, even a waiver of the DMR permitting ex-U.S. manufacture may be phrased narrowly enough to restrict otherwise rational economic choices affecting product supply chains.

In this article, we have provided an interpretative analysis of the Domestic Manufacturing Requirement of the Bayh Dole Act and a framework for analyzing whether the DMR applies to a given Federal Invention, such that a decision can be made on whether a waiver is necessary or desirable. Compliance with the Domestic Manufacturing Requirement of the Bayh-Dole Act is an important requirement affecting licenses of inventions made through the investment of U.S. taxpayer funds, throughout the licensing process from due diligence to ongoing compliance with the parties’ obligations, lasting throughout the commercial lifetime of the corresponding products. It is critical that counsel as well as business negotiators understand the implications of the DMR for consequential investments in the relevant products, including the construction and/or enhancement of manufacturing facilities in the United States and globally. This is also the case in mergers and acquisitions of businesses that have acquired license rights to Federal Inventions. The investigation of whether a waiver of the DMR is required is a highly fact specific endeavor, that must be undertaken with a wholistic view of the entire supply chain and manufacturing process for end products that embody or are made through the use of Federal Inventions. We expect continued government scrutiny and focus on strategies to promote U.S. manufacturing competencies and capabilities as an important aspect of national security and U.S. strategic leadership in innovative industries. Our companion article will focus on the process and practice of securing waivers of the DMR from relevant funding agencies.

The authors would express their gratitude to Steven M. Ferguson, CLP and Prof. Adam Mossoff for their critical evaluations and comments on the manuscript.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i Gillian M. Fenton, Esq., CLP is the founder and managing director of LST Strategies LLC, a specialty law practice dedicated to life science transactions (https://lifesciencetransactions.com). She is also a Practitioner in Residence at the Center for Intellectual Property x Innovation Policy (https://cip2.gmu.edu/), hosted by George Mason University.

ii The University and Small Business Patent Procedures Act of 1980, Public Law 96-517 (as amended), codified at title 35 of the United States Code (U.S.C.) 200 et seq.; see also implementing regulations at 37 C.F.R. Parts 401 and 404.
iii Payne, Eric. 2023. “The Critical Importance of the Bayh-Dole Act in the U.S. Energy Transition.” Les Nouvelles. September 2023.
iv 37 C.F.R. § 401.14, Standard Patent Rights Clauses.
v At least one funding agency, the U.S. National Institutes of Health (NIH) refers to Federally Funded Inventions as “extramural inventions” and Federally Owned Inventions as “intramural inventions”. Other agencies may use different nomenclature.
vi University of South Florida Board of Trustees v. United States, 2024 WL 500636 (Fed.Cir. February 9, 2024) (establishing that the government may assert the government use license as a defense to patent infringement suits).
vii Ibid. This government right and exception to licensing exclusivity needs to be understood by licensees and their legal advisors.
viii See Susan B. Cassidy, Alexander B. Hastings, and Jennifer L. Plitsch, What Every Company Should Know about IP Rights When Selling to the US Government, 9 Landslide 6 (July/August 2017).
xix 35 U.S.C. 204.
x 35 USC 209.
xi 35 U.S.C. 204 and 209.
xii See Executive Order No. 14104 on Federal Research and Development in Support of Domestic Manufacturing and United States Jobs | The White House, 88 Fed. Reg. 51203 (July 23, 2023). The E.O. is being implemented in part through the development of a new Common Form for applications for a waiver of the DMR; see Agency Information Collection Activities; Submission to the Office of Management and Budget (OMB) for Review and Approval; Comment Request; Domestic Manufacturing Waiver Request Form 88 Fed, Reg. 85243 (December 7, 2023). Practitioners should monitor the Federal Register and their cognizant funding agencies for additional implementing actions.
xiii 37 C.F.R. § 404.5.
xiv The four sets of circumstances in which “march in” may occur are: (1) the Awardee has not taken effective steps to achieve practical application of the Subject Invention within a reasonable time; (2) such action is necessary to meet health and safety needs that the Awardee  is not meeting; (3) such action is necessary to meet applicable requirements for public use that the Awardee is not meeting; and (4) the Awardee has not bound its exclusive licensee to manufacture products based on the Subject Invention substantially in the United States, or the exclusive licensee is in breach of this requirement.  On December 8, 2023, the National Institute of Standards and Technology (NIST) published a Request for Information Regarding the Draft Interagency Guidance Framework for Considering the Exercise of March-In Rights (88 FR 85593). For purposes of this article, we will address the RFI only as it relates to the Domestic Manufacturing Requirement.
xv A license granted or directed to be granted pursuant to march-in is of course separate from and in addition to the government use license, see note 7.
xvi 37 C.F.R. § 401.14. Note, the exercise of march-in rights is the exclusive remedy available to the government to enforce compliance with the DMR.
xvii Our focus is on the normal framework of the Act with respect to the DMR. However, the Act also authorizes federal agencies to make “determinations of exceptional circumstances” or “DEC” that justify variations from the normal framework; see 35 USC 201 et. seq. and 37 CFR Part 401. For example, DECs have been issued by the Department of Energy that significantly broaden the scope of the DMR for Federally Funded Inventions. See https://www.energy.gov/gc/determination-exceptional-circumstances-decs.
xix NASA previously had a definition at 14 C.F.R. § 1274.911 but it was removed from the Code of Federal Regulations. See 85 Fed. Reg. 72919-01 (November 20, 2020).
xx American Heritage Dictionary, at https://www.ahdictionary.com/word/search.html?q=substantial (accessed on January 18, 2024).
xxi Connecticut National Bank v. Germain, 503 U.S. 249, 253-254 (1992).
xxii> Senate Judiciary Report on S.414, accessed on September 5, 2023 at https://bayhdolecoalition.org/wp-content/uploads/2023/05/S-414-Senate-Judiciary-Committee-Report.pdf
xxiii This issue is also not addressed in the recent related NIST Request for Information Regarding the Draft Interagency Guidance Framework for Considering the Exercise of March-In Rights, see 88 FR 85593 (December 8, 2023).
xxiv 19 U.S.C. § 2518(4)(B).xxv Office of the United States Trade Representative, “Government Procurement”, accessed on November 28, 2023 at https://ustr.gov/issue-areas/government-procurement#:~:text=The%20Trade%20Agreements%20Act%20of,appropriate%20reciprocal%20competitive%20government%20procurement.
xxvi 19 U.S.C. § 2518(4)(B)
xxvii FAR 52.225-5, Trade Agreements.
xviii Federal Acquisition Regulation; Foreign Acquisition (Part 25 Rewrite), 63 Fed. Reg. 51642 (Sept. 28, 1998) (emphasis added). We note that the word “substantially” also appears in the TAA and in the FAR TAA Test, which underscores ambiguities that must be traversed when faced with a need to determine with precision whether the test is satisfied or not.
xxix 949 F.3d 719 (Fed. Cir. 2020)
xxx 19 U.S.C. § 2518(4)(B)
xxxi The Federal Acquisition Regulatory Council provides “direction and coordination of Government-wide procurement policy and Government-wide procurement regulatory activities in the Federal Government.” See https://www.acquisition.gov/far-council.
xxxii American Heritage Dictionary, at https://www.ahdictionary.com/word/search.html?q=substantial (accessed on January 18, 2024).
xxxiii John M. Peterson, Substantial Transformation” – The Worst Rule For Determining Origin Of Goods – Except For All the Rest at https://www.cit.uscourts.gov/sites/cit/files/Substantial%20Transformation.pdf
xxxiv 41 U.S.C. § 8302
xxxv FAR 52.225-1, Buy American-Supplies (Oct 2022). The percentage is set at 65% for 2024 through 2028 and escalates to 75% starting in calendar year 2029.
xxxvi For purposes of BAA compliance, all commercial-off the shelf (“COTS”) items manufactured in the United States that meet the definition in FAR 2.101 are domestic end products regardless of the Component Test. FAR 52.225-1 defines a COTS item as any item of supply that is (i) a “commercial product” as defined in FAR 2.101; (ii) sold in substantial quantities in the commercial marketplace; and (iii) offered to the government without modification in the same form in which it is sold in the commercial marketplace. While compliance with the Component Test is not required for such items in an acquisition context, it could be required for COTS items under Bayh Dole for the purpose of the DMR, to assess the “substantiality” of manufacture in the US. This is a novel question that is not easily answered by the statute, its implementing regulations, or legislative history and in the absence of court decisions.
xxxvii Dynamerica, Inc., B-248237 (Sept. 28, 1992) (citations omitted).
xxxviii The exemption for COTS items under the BAA Test is specific to the BAA and may not apply to determinations of substantial manufacturing under the Bayh-Dole Act.
xxxix In the case of products with a lengthy development path, such as biopharmaceuticals, particularly where the manufacturing process and locations may evolve during development, manufacturers should ensure compliance with the DMR throughout the evolution of the production and manufacturing processes. This is unlike the infringement exception analysis under 35 U.S.C. § 271(e)(1) where a distinction is made between activities during development of products subject to regulatory oversight, versus commercial activities for such products.
xl See, for example, Rathore, A.S., Shereef, F. The influence of domestic manufacturing capabilities on biologic pricing in emerging economies. Nat Biotechnol 37, 498–501 (2019). https://doi.org/10.1038/s41587-019-0116-0. For a more recent specific example, see Pfizer Acquires Abzena’s Biologic Manufacturing Facility (pharmanewsintel.com).
xli This is more easily stated than achieved. Component costs as well as manufacturing costs typically undergo a lengthy period of optimization and are of course subject to efficiencies of scale, preferred supplier agreements, and many other variables.
xlii See FAR 52.227-11, Patent Rights-Ownership by the Government.
xliii The information in the table is illustrative only and is not based on any actual data.
xliv See supra, note 41.

Co-authored with Gillian M. Fentoni

Published in Les Nouvelles, the journal of the Licensing Executives Society International (LESI), June 2024

The Bayh-Dole Act (“Bayh-Dole” or the “Act”)ii governs the licensing of federally funded and federally owned inventions. A key requirement, referred to as the “Domestic Manufacturing Requirement” is that licenses of such inventions to private sector entities should benefit U.S. industry, specifically by requiring manufacture of products that embody or are made through such inventions “substantially in the United States”. If an invention will not be “manufactured substantially in the United States” a waiver must be sought. The Act and its implementing regulations provide two grounds for agencies to grant waivers: (1) if the applicant demonstrates that “reasonable but unsuccessful efforts have been made to grant licenses to potential licensees that would be likely to manufacture substantially in the United States,” or (2) “if domestic manufacture is not commercially feasible.” Waiver requests must granularly address the grounds for the waiver, why a waiver is necessary under the specific circumstances, and why the grant of a waiver would advance the agency’s mission and the policy behind the Act.

This is the second of two articles concerning the Domestic Manufacturing Requirement, codified at 35 U.S.C. § 204. In the first article, we presented an analytical approach to interpreting § 204 and whether it applies to a given invention that arose from U.S. federal funding of research or other activities. In this article, we present a practical approach to securing waivers of the requirement from the cognizant U.S. federal funding agency, including the process, current framework, and practice tips. As with our first article, the topic of this article is of particular concern to recipients of U.S. government funding for inventive activities and their licensee partners. Indeed, the availability of a waiver of the requirement will drive strategic decisions on how to structure manufacturing operations and supply chains for the resulting products for years after the receipt and utilization of the U.S. research funding from which the innovative product arose.

We previously summarized Bayh Dole and explained how it addressed the prior obstacles to development and commercialization of products based on inventions made by either by U.S. government employees or by private sector organizations in the performance of work under grants and other types of government agreements). The Act and its implementing regulations gave recipients of federal grants or contracts (“Awardees”) a path to securing title to the inventions they made (referred to herein as “Federally Funded Inventions”)iii. The Act also imposed certain requirements on the licensing of inventions made by government employed scientists and engineers or Federally Funded Inventions to which the government has obtained title because the Awardees either did not elect to retain title to their inventions, discontinued patenting activities for such inventions, or otherwise failed to comply with the standard patent rights clauses set out in 37 C.F.R. § 401.14 (referred to herein as “Federally-Owned Inventions”). For convenience, where the Act imposes consistent requirements on both Federally Funded and Federally Owned Inventions, we will refer to them collectively as Federal Inventions.

The Domestic Manufacturing Requirement, also referred to herein as the DMR, is the provision in the Act that most clearly reflects the Act’s original policy objective to promote innovation in the United States. It requires that all Federal Inventions that are licensed to private sector entities should benefit U.S. industry, by requiring that products based thereon be manufactured substantially in the United States.  This requirement attaches to licenses of the exclusive right to sell or use a Federally Funded Invention in the United States,iv and to all license grants (non-exclusive and partially exclusive as well as exclusive) of commercial rights in Federally Owned Inventions.v  The DMR attaches to products “embodying” the invention or “produced through the use of” the invention and remains applicable through all tiers of licensing and sublicensing or other transfer of license rights, for the commercial lifetime of the corresponding products.

Enforcement of Bayh Dole, specifically including the DMR, has been utilized by the Biden Administration as a tool to advance national policy priorities.vi In addition, much public attention has focused on recently proposed changes to the “march in” rights provisions of the Act, which are largely outside of the focus of this article.vii There is, however, a connection between the two: exercise of a march-in right through modification or revocation of a license to Federal Inventions embodied in or utilized in making a product is the exclusive remedy for failure to comply with the DMR or for breach of a granted waiver of the DMR.viii For these and other reasons we discuss below, readers should expect further policy developments and a focus on promotion of U.S. manufacturing for at least the remainder of the Biden Administration.

This article is intended as a practical guide for licensees of Federal Inventions who have determined that the Domestic Manufacturing Requirement applies to them and that a waiver is required in order to effectively commercialize their in-licensed products. We believe that an increasing number of licensees will face this situation especially when commercializing highly complex technologies in our current, globally interconnected economy, for which the United States remains a leading commercial marketplace. Thankfully, the Act and its implementing regulations provide that the DMR may be waived in certain circumstances.ix  We turn now to the process for securing waivers, as well as what to expect in a waiver grant. In the forty-plus year history of the Act so far, it is clear that the burdens imposed on those engaged in development and commercialization of Federal Inventions are sufficiently offset by the benefits of private sector access to these taxpayer-funded inventions, producing a strong history of flourishing innovation in the United States across multiple industries.

If an exclusive licensee-developer of a Federally Funded Invention or any licensee of a Federally Owned Invention concludes that a Federal Invention will not be “manufactured substantially in the United States,”x and the Bayh-Dole Act’s Domestic Manufacturing Requirement applies, a waiver must be sought. The Act and its implementing regulations provide two grounds for agencies to grant waivers: (1) if the applicant demonstrates that “reasonable but unsuccessful efforts have been made to grant licenses to potential licensees that would be likely to manufacture substantially in the United States,” or (2) “if domestic manufacture is not commercially feasible.”xi We will now examine in more depth the two eligible grounds for granting waivers, and the paths for applying for waivers of Federally Funded versus Federally Owned Inventions.

• Process for Applying for Waivers
• Federally Funded Inventions

The government-wide regulations on Federally Funded Inventions obligate the original Awardees and certain sub-Awardeesxii to apply for waivers of the Domestic Manufacturing Requirement. However, these regulations do not specify the process that applicants must follow to obtain such waivers. Fortunately, the guidance issued by the National Institutes of Standards and Technology (“NIST”) for its “interagency Edison” (or “iEdison”) portal sets forth such a process for Awardees with agreements with agencies that use the portal.xiii iEdison is an online, relational database designed to enable Awardees to meet all the reporting requirements of the Bayh-Dole Act and its implementing regulations. The system is also used by the funding agencies to receive and review the information and documentation submitted. The guidance requires Awardees to (i) request waivers of the DMR for each Federally Funded Invention; (ii) specify the grounds for the waiver and (iii) to upload supporting documentation providing the rationale for the request.xiv iEdison automatically routes the request to the designated agency official. If approved by that official, the system sends a notice of the approval, with an official approval document that includes terms and conditions of the approval, including any limitations of the waiver to specific time frames, fields of use, countries etc. If the request is denied, the applicant receives a notification indicating the denial. The decision, reason(s) for the denial, and decision date will be displayed in iEdison next to the request in the Invention Report.

 Awardees doing business with agencies that do not participate in iEdison have a more challenging route: the Awardee has to contact the point of contact in the award document to get instructions for filing waiver requests. In many cases, the award document will have a designated contact for patent matters. If there is no such contact, the Awardee will have to contact the individual designated as responsible for administration of the agreement (e.g., for procurement contracts, the Contracting Officer). Then, the Awardee will have to validate information that is provided concerning the process and the addressee for the request, submit the request, confirm receipt, and follow-up until a decision is communicated. Unfortunately, given the consequences of proceeding without a required waiver, the burden is on the applicant to ensure the request is timely processed.

 After submission, applicants should expect that agency review may take as little as 2-4 months or, more commonly, a year or longer until a decision is rendered and communicated to the applicant; however, the Act does not impose any timelines for agency consideration.xv It is important to note also that the decision to grant or deny a waiver is within the discretion of the cognizable Federal agency. The agency may also, in its discretion, impose conditions on the grant of a waiver. Waivers may be structured to advance the goals of the Bayh-Dole Act, and/or the mission of the agency (in the case of the Public Health Services (“PHS”), to advance public health in the United States or globally).

 As mentioned, the original Awardee must file a request for a waiver of the DMR for any of its exclusive licensees who propose not to manufacture products based on a Federally Funded Invention substantially in the United States. Since the exclusive licensee is not the party directly facing the U.S. Government, the licensee must rely upon the licensor (the Awardee, often a University or research institute technology transfer officer) to represent the licensee’s interests. The license agreement between the Awardee/licensor and the exclusive licensee should therefore include a covenant for the licensor to cooperate with the licensee in submitting and timely prosecuting the waiver application.

• Federally Owned Inventions

As with Federally Funded Inventions, there are no government wide regulations that specify the process for obtaining waivers of the Domestic Manufacturing Requirement for Federally Owned Inventions. However, based on our experiences, a waiver that is sought as part of the technology licensing process (i.e., an upfront waiver) is handled by the lead agency negotiating the license. For example, in the case of PHS, the lead agency could be a National Institutes of Health (“NIH”) Institute or Center (e.g., the National Institute of Allergies and Infectious Diseases). In these circumstances, the prospective licensee will raise its desire to secure a waiver during the course of negotiations, and the license document will contain the resulting waiver, if granted. If a waiver is sought subsequent to execution of a license agreement, application must be made to the agency body responsible for license compliance (in the case of NIH, this would be the central NIH Office of Technology Transfer). Thus, different agency officials may be reviewing waiver applications depending on the circumstances. As for Federally Funded Inventions, the Act and its implementing regulations do not set any firm time period by which the cognizant federal agency must complete its review. If and when granted, the waiver will be documented in a separate letter or notice to the applicant (who in the case of Federally Owned Inventions, is the licensee). Each waiver grant should be reviewed carefully to confirm that it is of the requested duration (it should be coterminous with the license grant of rights to make, use, offer for sale, sell, and import licensed products) and has an acceptable scope (as mentioned above, agencies may have a practice of limiting waiver terms to specific geographies, even specific facilities).

• Substance and Rationales for Waivers

As with the waiver process requirements for applicants, there are no government-wide regulations governing the substance and rationales for granting waivers. However, the National Institutes of Health (NIH) provides helpful guidance in its Public Health Service Technology Transfer Manual (Ch. 604 and 604A) (the “PHS Manual”) concerning the information of most interest to agency officials reviewing applications for waivers of the Domestic Manufacturing Requirement. While NIH is not the lead agency responsible for promulgating regulations under the Act, the PHS Manual provides a useful example of how agencies approach the review process. Waiver requests submitted to NIH must include “sufficient and detailed supporting information” that granularly addresses why a waiver is necessary under the specific circumstances, and why the grant of a waiver would advance the agency’s mission and the policy behind the Act (in the case of NIH, these factors center on public health both in the U.S. and globally). It is critical for applicants to provide specific facts in support of the arguments made, which are described more fully below. Finally, applicants should understand that, while applicability of the Act is triggered by the presence of a Federal Invention, Federal agencies such as NIH will review the entire manufacturing process for the product – not just for the active pharmaceutical ingredient (API) or key elements that correspond to patentable or patented subject matter. Overall, applications to NIH or other agencies must include a ‘robust basis’ justifying grant of a waiver.

 Each of the two grounds for granting waivers will now be examined in more detail.

• Reasonable Effort to find a U.S. Licensee

The first acceptable ground, namely that the applicant has made reasonable but unsuccessful effort to secure a licensee willing to manufacture products embodying the Federal Invention substantially on U.S. soil, is usually only made by applicants with licensing programs – i.e., by universities and research institutes. It may also be applicable to Awardees such as start-up and small biotechnology companies who engage in partnering in order to leverage the capabilities of larger organizations in order to access markets that the Awardee cannot serve itself. The licensing argument must be presented with fully developed, relevant and sufficient facts.xvi Following is the guidance from the PHS Manual concerning the information of most interest to the agencies in deciding waivers based on this ground:

a. The nature of the particular market for the subject invention would suggest whether a probable range of companies interested in a license is large or small (e.g., a large range would require greater marketing efforts to be “reasonable”). Potentially relevant information might include: The significance of the technology, the availability of alternative products, size and location of intended patient populations, and the degree of regulatory review needed to bring the product to the U.S. market.
b. Good faith efforts for marketing the technology to companies willing to manufacture in the United States were unsuccessful. Potentially relevant information might include: (i) number of companies contacted; (ii) methods used for marketing and contacting companies; (iii) types of licenses and terms offered to potential licensees; (iv) comparison of terms offered to potential exclusive licensees that will manufacture substantially in the United States versus to licensees that will not; and, (v) responses of companies to marketing efforts.

The facts concerning the nature of the market will provide the required context for the argument on reasonableness of the applicant’s prior unsuccessful efforts to secure a licensee willing to comply with the Domestic Manufacturing Requirement. For example, if the pool of potential licensees is small, the technology has a high significance, there are few or no alternatives to the technology that are available, the market is large and regulatory review complicated, it will be more reasonable for an applicant to have only solicited a limited number of potential licensees. The facts setting out a history of the licensing effort will provide specific support for the arguments that the prior efforts were reasonable.

• Not Commercially Feasible to Manufacture in on U.S. Soil

The second acceptable ground for a waiver of the Domestic Manufacturing Requirement is that manufacture on U.S. soil is not commercially feasible. In the case of Federally Funded Inventions, the licensee will typically take the lead on developing this argument and should expect to collaborate with the Awardee (usually a university or research institute, acting through their technology transfer office) who will be the government-facing party responsible for submitting the application and reporting the outcome to the manufacturer. The commercial infeasibility argument is highly dependent on the specific circumstancesxvii and must be supported by robust facts illustrating a wide range of potential factors. Following is the guidance from the PHS Manual concerning the information of most interest to the agencies in deciding waivers based on this ground:

a. The circumstances that make foreign manufacture necessary;

b. The state of the U.S. market for the potential product, including what companies, if any, make the same or similar products and where such products are manufactured;
c. Whether requiring U.S. manufacture will delay entry of the product into the U.S. market, and the effect such delay may have on the public health;
d. The part or percentage of products arising from the invention that would be manufactured outside the United States;

e. The U.S. manufacturing capabilities of the Awardee’s licensee and the efforts made by the licensee to locate, develop, or subcontract for such U.S. manufacturing capabilities;

f. The factors making domestic manufacture not commercially feasible, including the relative costs of U.S. and foreign manufacturing, the alternative products or therapies available, and the size of the intended patient population;

g. The value or benefit to the United States of permitting foreign manufacture of the technology. Relevant facts may include: (i) the direct or indirect investment in U.S. plants or equipment resulting from foreign manufacturing; (ii) the creation of new or higher quality U.S.-based jobs; (iii) the enhancement of the U.S. skills base in the technology of the subject invention; (iv) the further development within the United States of the technology enabled by foreign manufacture; (v) a positive impact on the U.S. trade balance considering product and service exports as well as foreign licensing royalties and receipts; and (vi) other provisions in the exclusive license that will ensure a correlative benefit to the United States (e.g., U.S. manufacture of another product).

As discussed in part one of this two-part series, a supply chain map and/or manufacturing flow diagram is an important aid to developing these points of argument and sharpening the focus on the specific factors that make U.S. manufacture not commercially feasible. Inputs may be required from a range of functions, including marketing, competitive intelligence, medical affairs and regulatory affairs (in the case of biomedical products), finance and product development as well as supply chain and manufacturing experts.

Throughout, the waiver argument should emphasize the potential value or benefit to the United States of permitting foreign manufacture. This may include an assessment of whether the U.S. will realize a public health benefit more quickly because foreign manufacture enabled a faster path to licensure of the product. Or, permitting foreign manufacture of products based on the Federal Invention may enable the developer to invest in other U.S. based plants, facilities or equipment – for other products or product lines of greater strategic or other potential value. Every waiver argument should address a central policy of the Bayh-Dole Act: would granting the waiver result in the creation of new or higher quality U.S. jobs (e.g., by allowing the contractor to focus on creating more jobs in its core business)? Overall, would the waiver result in an enhancement of the U.S. workforce skills base in the technology (e.g., through collaboration with the experts in the foreign plant)? Finally, if relevant, applicants should describe what effect the waiver would have on the United States balance of trade (e.g., would it enable increased exports of products or services, or yield enhanced licensing revenues coming into the U.S.?).xviii

 If feasible, the waiver rationales and other supporting documents that an applicant uploads to iEdison or otherwise provides to the agency should assert both grounds for a waiver. This should increase the likelihood that the agency will approve the waiver.xix Finally, the applicant should include a brief discussion of any prior waivers granted to it since a reviewer may find such precedent to be helpful in supporting a new waiver grant.

c. What to Expect from the Waiver Application Review Process – Insights from the “Tuesday Licensing Forum”

Since one of the largest funders of research in the United States is the National Institutes of Health, we focus on NIH policy and practices concerning review of applications for waivers of the Bayh-Dole Act Domestic Manufacturing Requirement, as these are germane to Federal Inventions in the field of biomedical research. As noted above, other U.S. agencies may follow different practices; counsel should investigate available information concerning the practices of specific agencies. For NIH, valuable guidance is set out in the PHS Technology Transfer Manual, and additional insights summarized below have been gleaned from topics discussed during meetings of the Tuesday Licensing Forum, a venue for peer-to-peer education of technology transfer professionals hosted by the Federal Laboratories Consortium (FLC | Home (federallabs.org)).xx

• General
• A waiver application will not be considered until sufficient information, as determined by the reviewing agency, is provided by the applicant.
• Specifics of the manufacturing process and the supply chain should be included.
• The agency may defer consideration until the site of proposed manufacture for the U.S. commercial market is known: NIH will not grant a general or blanket waiver.
• Applicants should expect an NIH waiver to specify the exact facility in which manufacture will take place; in the case of a complex supply chain, it is important to cover all facilities in which manufacturing operations will be carried out.
• One factor critical to success of a waiver application is whether the facility or facilities under consideration have been inspected by the U.S. Food and Drug Administration (FDA) and have been approved for the manufacture of human pharmaceutical products.
• Another influential factor is whether the facility is owned by the developer or a contract manufacturing organization (CMO). In the case of a CMO, the applicant should expect to explain what makes an ex-U.S. CMO necessary – is there no CMO on U.S. soil that can provide appropriate manufacturing services? An existing, ex-U.S., developer-owned facility may be considered more favorably than an ex-U.S. CMO, especially if the waiver application describes the circumstances and worker skill sets that make that facility well-suited to serving the U.S. market for the product, assuming of course that the facility is FDA-approved.
• The country in which a facility is situated will also have an influence on whether a waiver is granted; for example, the Department of Energy currently disfavors the grant of waivers for manufacture in China.
• Review of Grounds for a Waiver Based on Reasonable but Unsuccesful Efforts to License to a U.S. manufacturer

For submissions based on the first ground, i.e., that reasonable efforts were expended to secure a licensee willing to manufacture on U.S. soil, but these efforts were unsuccessful, applicants should expect to meet a high threshold of evidence. The agency will evaluate reasonableness of the effort made, including whether inducements or more favorable terms were offered to U.S. based manufacturers. Documentation should be provided showing the number of potential licensees who were contacted, over what period of time, the level of interest expressed by potential licensees, an explanation of any special inducements or more favorable terms offered to U.S. based licensees, and any other factors showing futility of continuing efforts to identify a developer willing to manufacture on U.S. soil.

• Review of Grounds for a Waiver Based on Commercial Infeasibility

Waivers applications based on the second ground, i.e., that manufacture in the United States is not commercially feasible, may be reviewed more favorably where the licensee/developer would have to invest in building new manufacturing capacity, but has an appropriate existing facility abroad. NIH reviewers understand the magnitude of investment required for constructing a new biopharmaceutical manufacturing plant and securing FDA and other approvals for operational readiness, including hiring and training of the necessary skilled manufacturing work force. This factor will be weighed against the benefit of an earlier product introduction into the U.S. market, with corresponding benefits to public health, if the waiver is granted. The same is not necessarily true for an applicant who plans to out-source manufacturing to a CMO: expect to show that the entire U.S. industry of CMOs lacks the capacity and/or functionality required for manufacture of the product. An argument solely based on cost-effectiveness of ex-U.S. manufacture by a CMO may not be well received.

 In all applications – involving either or both of the eligible grounds for issue of a waiver – the application must address the question of how and to what extent granting the waiver will enhance U.S. jobs and/or job quality, since this is a key policy driver of the Bayh-Dole Act. As discussed above, the benefit may arise directly from the product that embodies the Federal Invention, or it may be a collateral benefit arising from investments in other products or other capabilities that entail creation of skilled jobs (preferably but not necessarily in manufacturing) in the United States.

In summary, a waiver of the DMR is likely to be restricted to the sites and activities set out in the application, and should run for the commercial lifetime of the product. It is important to bear in mind there is no well-established process for updating, correcting, or amending a waiver that has been granted. If a supplemental waiver is required for example to cover an alternate manufacturing site (such as a contingent or backup site, a second site, or a successor site), applicants should expect that a more stringent review process will apply since the reviewing agency may question why any new site could not have been planned and constructed in the United States, especially if several years have passed since an original waiver was granted.

Finally, developers of Federal Inventions, including waiver recipients (and as applicable, their licensee-developer partners) should understand that the Act requires ongoing government oversight. The portal on iEdison includes a template for submission of annual invention utilization reports; it is worth browsing this to understand what information is collected concerning compliance with the DMR.xxi

d. What if a Waiver is Denied?

The grant or denial of a manufacturing waiver is within the discretion of the reviewing Federal agency. While the Bayh-Dole Act and its implementing regulations do not address the circumstance where an agency simply does not respond to a waiver application, the implementing regulations do provide some guidance for applicants whose waiver applications are denied. In particular, the regulations provide that each agency must establish and publish procedures under which denial of a waiver application “may be appealed to the head of the agency or designee.”xxii While there appear to be no known publicly available examples, a further appeal from an adverse decision of the agency head might proceed via a claim filed against the Federal agency under the Administrative Procedures Act (APA)xxiii. Not all Federal agency actions can be appealed under the APA, so the availability of this remedy requires careful analysis. If available, this path would require that the denied applicant file suit against the reviewing agency in a Federal District Court of competent jurisdiction. The claim would be reviewed for whether the agency acted in a manner that was arbitrary, capricious or otherwise constituted an abuse of its discretion. Under the APA, the reviewing court must “(1) compel agency action unlawfully withheld or unreasonably delayed; and (2) hold unlawful and set aside agency action, findings, and conclusions found to be–(A) arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; (B) contrary to constitutional right, power, privilege, or immunity; (C) in excess of statutory jurisdiction, authority, or limitations, or short of statutory right; (D) without observance of procedure required by law; (E) unsupported by substantial evidence in [certain cases] or otherwise reviewed on the record of an agency hearing provided by statute; or (F) unwarranted by the facts to the extent that the facts are subject to trial de novo by the reviewing court.”xxiv

e. Penalty for Failure to Comply

Concerning products embodying Federally Funded Inventions, 35 USC 203 provides the applicable penalty for failure to comply with the Bayh-Dole Act’s Domestic Manufacturing Requirement: the federal agency may exercise its march-in rights. More specifically, Section 203 provides that the cognizant federal agency shall have the right to require the contractor, assignee, or exclusive licensee to grant a license to a responsible applicant, upon terms that are reasonable under the circumstances, and if the contractor refuses to grant such license itself, the agency may do so if it determines that such action is necessary because a waiver has not been obtained, or the developer is in breach of its waiver. Implementing regulations are found at 37 CFR 401.14(j). Concerning products embodying Federally Owned Inventions, 35 USC 209 provides for renovation of the license for failure to comply with the DMR. Implementing regulations are found at 37 CFR 404.5. The Act and its implementing regulations (cited above) robustly address the appeals process for an exercise of march-in rights.xxv While the exercise, or even attempted exercise, of march-in rights does not directly entail the imposition of a financial penalty on the developer, it can critically impair the developer’s financial and commercial outlook for the affected product and perhaps for its overall business viability.

There are, however, other potential consequences to failure to secure a manufacturing waiver, or for breach of an existing waiver – and these include potential exposure to significant fines and money damages. For example, the False Claims Actxxvi provides that each invoice submitted by a contractor to the government is an implied certification that the submitting party has complied with all applicable material federal government laws and regulatory requirements.xxvii In the case of a contractor seeking payment by the government for products that embody a Federal Invention, this would include certification that the purchased product was manufactured in compliance with all requirements of the Bayh-Dole Act, including the DMR. Each such invoice could represent a separate FCA violation. It is important for counsel advising business executives to explain fully the risk environment in which decisions are made concerning compliance with the DMR.

Compliance with the Domestic Manufacturing Requirement of the Bayh-Dole Act is an important requirement affecting licenses of inventions made through the investment of U.S. taxpayer funds, throughout the licensing process from due diligence to ongoing compliance with the parties’ obligations, lasting throughout the commercial lifetime of the corresponding products. It is critical that counsel as well as business negotiators understand the implications of the DMR for consequential investments in the relevant products, including the construction and/or enhancement of manufacturing facilities in the United States and globally. This is also the case in mergers and acquisitions of businesses that have acquired license rights to Federal Inventions. The investigation of whether a waiver of the DMR is required is a highly fact specific endeavor, that must be undertaken with a wholistic view of the entire supply chain and manufacturing process for products that embody or are made through the use of Federal Inventions. If a decision is made to pursue a waiver, the applicant should develop and submit granular and robust grounds for the request. We expect continued government scrutiny and focus on strategies to promote U.S. manufacturing competencies and capabilities as an important aspect of national security and U.S. strategic leadership in innovative industries.

The authors express their gratitude to Steven M. Ferguson, CLP and Prof. Adam Mossoff for their critical evaluations and comments on the manuscript.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i Gillian M. Fenton, Esq., CLP is the founder and managing director of LST Strategies LLC, a specialty law practice dedicated to life science transactions (https://lifesciencetransactions.com). She is also a Practitioner in Residence at the Center for Intellectual Property x Innovation Policy (https://cip2.gmu.edu/), hosted by George Mason University.

ii The University and Small Business Patent Procedures Act of 1980, Public Law 96-517 (as amended), codified at title 35 of the United States Code (U.S.C.) 200 et seq.; see also implementing regulations at 37 C.F.R. Parts 401 and 404.

iii These are referred to as “Subject Inventions” in the regulations.

iv 35 U.S.C. 204.

v 35 USC 209.

vi Executive Order No. 14104, issued July 28, 2023. See Executive Order on Federal Research and Development in Support of Domestic Manufacturing and United States Jobs | The White House.

vii See Request for Information Regarding the Draft Interagency Guidance Framework for Considering the Exercise of March-In Rights (88 FR 85593) published by the National Institute of Standards and Technology (NIST) on December 8, 2023, which received over 50,000 comments.

viii 35 U.S.C. 203(a)(4) and 37 C.F.R. § 401.14.

ix This article focuses on the normal framework of the Act with respect to the DMR. However, the Act also authorizes federal agencies to make “determinations of exceptional circumstances” or “DEC” that justify variations from the normal framework; see 35 USC 201 et. seq. and 37 CFR Part 401. For example, DECs have been issued by the Department of Energy that significantly broaden the scope of the DMR for Federally Funded Inventions. See https://www.energy.gov/gc/determination-exceptional-circumstances-decs.

x The analysis leading to such a conclusion is the focus of the first article in this two-part series.

xi 37 CFR § 401.14.(i); 37 CFR § 404.5

xii Under 37 C.F.R. § 401.14(g), Awardees must flow-down the clause to sub-Awardees who will perform research and development activities. The clause provides that the “mutual obligations of the parties created by this clause constitute a contract between the subcontractor and the Federal agency with respect to the matters covered by the clause.”

xiii For a list of these agencies, see https://www.nist.gov/iedison/agency-contact-list.

xiv https://www.nist.gov/iedison/iedison-organization-user-guide/invention-reports/submitting-domestic-manufacturing-waiver.

xv https://autm.net/AUTM/media/Events/Images/AUTM-US-Manufacturing-Waiver-Survey-Results_VF.pdf.

xvi PHS Technology Transfer Policy Manual, Ch. 604A

xvii Id.

xviii For a good overview of waiver arguments, see “Applying for a Waiver from U.S. Manufacturing Requirements for Federally Funded Intellectual Property,” Gadhia et al., Life Sciences Law & Industry Report, 09 LSLR 980, 08/21/2015, available from Bloomberg BNA.

xix Id.

xx Based upon notes of the Tuesday Licensing Forum discussions of 2 August 2022 and 10 January 2023

xxi https://www.nist.gov/iedison/iedison-organization-user-guide/utilization-reports/creating-utilization-report. The template includes specific questions on whether exclusive licenses include a clause stating the Domestic Manufacturing Requirement, and whether all products commercialized under such licenses comply with the DMR. These appear to reflect implementation of the Executive Order issued on July 28, 2023 (https://www.whitehouse.gov/briefing-room/presidential-actions/2023/07/28/executive-order-on-federal-research-and-development-in-support-of-domestic-manufacturing-and-united-states-jobs/)

xxii 37 C.F.R. 401.11(b). Detailed review of jurisdictional and procedural issues involved with such appeals is beyond the scope of this article.

xxiii For further discussion of the APA, see Congressional Research Service Report No. LSB10558.

xxix 5 U.S.C. § 706

xxv See 37 CFR 401.6.

xxvi 31 USC § 3729 – False Claims. See also https://www.law.cornell.edu/wex/false_claims_act and https://www.justice.gov/civil/false-claims-act.

xxvii See Universal Health Servs. v. United States, 579 U.S. 176, 190 (2016).

Under regulations issued by the Small Business Administration (“SBA”) late last year, small veteran owned government contractors can no longer self-certify their eligibility for certain procurement preferences. Instead, to qualify, the contractors will have to obtain formal SBA certifications of their eligibility. All such contractors should be aware that they have until December 31, 2023 to submit applications for the certifications. If a contractor submits the application before the deadline, the contractor can continue to self-certify eligibility until such time as the SBA issues the certification. However, if the contractor misses the deadline, they will no longer be able to self-certify. As a result, they will not be able to qualify for the preferences pending SBA’s certification decision.

In the Small Business Act (the “Act”),i the Congress declared that small businesses are essential to the competitive marketplace that is the essence of the American economic system and thus the economic well-being and security of our nation. In essence, the Congress found that, without strong small business participation in the economy, monopolies and oligopolies would control the economy and ultimately pose a threat to our freedoms. To promote the development of the capacity of small businesses, the Act also declared that the government should award a “fair proportion of the Government’s contracts for goods and services” to small businesses.ii


 To implement this policy, the Act established five government-wide small business contracting goals:iii

Regulations promulgated the Federal Acquisition Regulatory Council and the Small Business Administration give agencies the tools to achieve these the statutory goals. Among other things, the regulations empower agencies to set-aside procurements for qualifying small business concerns and impose requirements on large businesses to take affirmative actions to achieve specified small business subcontracting goals.iv

 Concurrently, the Department of Veterans Affairs (“DVA”) has separate statutory authority to promote awards by the DVA to veteran owned small businesses.v In particular, the DVA statute authorizes the Secretary to set goals for each fiscal year for participation in Department prime contracts and subcontracts by (i) service-disabled veteran owned small business concerns (“SDVOSB”) and (ii) small businesses owned and controlled by veterans who are not veterans with service-connected disabilities (referred to as “veteran owned small businesses” or “VOSBs”). The Secretary may not establish a goal for SDVOSBs that is less than the annual goal set by the President under the Small Business Act, which for 2023 was the minimum authorized goal of 3%.vi However, since that Act does not have a goal for VOSBs, the Secretary has discretion to set the goals according to his priorities for the DVA.vii The DVA each year in its budget submission to Congress provides a table indicating the targets it has set for the coming fiscal year with regard to SDVOSB and VOSB awards and reflecting results vis-à-vis prior year targets. Pertinent data as to FY2023 targets reported by the DVA in its most recent budget submission are as follows:

This article concerns an important regulatory change affecting the eligibility of veteran owned small businesses for procurements set-aside by all federal agencies for SDVOSBs and by the DVA for VOSBs.

In a final rule effective on January 1, 2023 (the “Rule”), the Small Business Administration (“SBA”) changed the process by which veteran owned small businesses can qualify for procurement set-asides.ix Prior to the change, to qualify for DVA set-asides for VOSB and SDVOSBs, offerors had to obtain certification of their eligibility from the DVA’s Center for Verification and Evaluation (“CVE”). To qualify for SDVOSB set-aside procurements by all other federal agencies, SDVOSBs could simply self-certify their eligibility. Under the Rule, the CVE’s eligibility certification responsibilities for DVA procurements were transferred to a new Veteran Small Business Certification Program (“VetCert”) office in the SBA. In addition, all agencies must require offerors to submit proof of certification of their SDVOSB status by the SBA to qualify for a set aside.

 The Rule has three important transition provisions. First, any SDVOSB or VOSB verified by the CVE prior to January 1, 2023 will be deemed SBA-certified for the remainder of the business’ three-year eligibility term provided the business continues to qualify under the criteria set forth in the regulations. Second, SBA intends to grant a one-time, one-year extension to the eligibility term of current CVE certified VOSBs and SDVOSBs. However, any new VOSBs or SDVOSBs applying for SBA certification will receive only a three-year eligibility term. Third, the Rule gives all VOSBs and SDVOSBs that do not have CVE certifications until December 31, 2023 to submit applications for the SBA certifications. If a contractor submits the application to VetCert before the deadline, the contractor can continue to self-certify eligibility until such time as SBA issues the certification. However, if the contractor misses the deadline, they will no longer be able to self-certify. As a result, they will not be able to qualify for the preferences pending SBA’s certification decision.x Nonetheless, any such contractor could continue to self-certify its eligibility as a SDVOSB to prime contractors for purposes of inclusion in their small business subcontracting plans.

 The Rule did not make any major changes to eligibility requirements for set-asides, although it did relax a few requirements.xi In short, to qualify as a VOSB for DVA set-asides, the concern must be (i) a small business concern as defined in 13 CFR Part 121 under the size standard corresponding to any North American Industrial Classification (“NAICS”) code listed in its profile on the System for Award Management (“SAM”); and (ii) not less than 51 percent owned and controlled by one or more veterans. To qualify as a SDVOSB for set-asides by all federal agencies the concern must be (i) a small business concern as defined in 13 CFR Part 121 under the size standard corresponding to any NAICS code listed in its SAM profile and (ii) not less than 51 percent owned and controlled by one or more service disabled veterans or, in the case of a veteran with a disability that is rated by the DVA as permanent and total and is unable to manage the daily business operations of the concern, the spouse or permanent caregiver of such veteran. In addition, applicants must not be suspended or debarred from government contracting, decertified by the SBA due to false statements in a prior application or be if default of any significant financial obligation owed to the federal government, including unresolved tax liens and defaults in federal loans, or other government assisted financing.xii

 The Rule codifies all eligibility and certification requirements in a new Part 128 to the SBA regulations at Title 13 of the Code of Federal Regulations. To prevent “gaming” of the procurement system and fraud, the rules are elaborate and cover a variety of criteria for qualifying as a small business and demonstrating the required ownership and control of the concern. Applicants for certification would be well advised to review all of these rules and associated guidance issued by SBAxiii prior to beginning work on their applications, and to seek legal counsel if and as questions arise.

Before applying for certification, a company must be registered in the SAM and have a Unique Entity Identifier (UEI). During the process, the company’s bank account number will also be needed.

 The SBA, in administering the certification process, will rely upon determinations the VA has made as to an individual’s veteran and service-disability status. The rules and processes by which the VA makes such determinations are beyond the scope of this article.

 Applicants for certification establish an account and login by navigating in a web browser to the Veterans Small Business Certification portal.xv If the preparer is a contractor or consultant, the contract with the business owner will be needed. A preparer who is the surviving spouse of the veteran having not remarried will need a marriage certificate. If the preparer is a permanent caregiver for a veteran with a permanent, total, service-connected disability, that person will need proof of formal appointment as caregiver, as well as the written determination from the Veterans Administration that the veteran has a permanent and total disability.

 The application requires the furnishing of certain business information. If the veteran is not the highest compensated person in the business, required documentation will consist of a written explanation of the situation that details who is highest compensated and the business reasons for such compensation. If the business has a franchise agreement, this will need to be provided. If the business is currently past due on any taxes, liens, federally backed loans, or outstanding tax returns, the preparer must submit a letter of explanation regarding any delinquencies, including amounts and to whom owed. If the owner or any family household member of an owner is a federal employee in a GS-13 (or equivalent) position or above, a letter of non-objection from the federal employee’s ethics official is required. And if the business is owned by a trust, the trust agreement must be provided, and it must demonstrate that the trust is revocable, and that veterans are the grantors, trustees, and current beneficiaries of the trust—other types of trusts are not eligible for the program.

 Different documents are required based upon the entity type of the applicant business:

• A Sole Proprietorship must furnish one of three documents to demonstrate that the business legally exists and is in operation, namely (1) an IRS SS4 TIN issuance letter with correct name and EIN, (2) fictitious name certificate or certificate of trade name, or (3) copy of most recent schedule C.
• A Limited Liability Company (LLC) must furnish (1) copy of articles of organization, or equivalent, including all amendments as filed with the state of formation, (2) certificate, or equivalent, issued by state of formation showing creation of LLC, as available, (3) operating agreement, including all amendments, and (4) minutes demonstrating or establishing the current operating practices and providing evidence of election or appointments of officers, adoption/implementation of operating agreements or voting agreements, business decisions, and voting (should be signed and dated).
• A General Partnership must furnish (1) the partnership agreement, including all amendments, and (2) one of four documents to demonstrate the business legally exists and is in operation, namely (a) copy of most recent Schedule K-1s, (b) copy of most recent Schedule C for proprietorship, (c) IRS SS4 TIN issuance letter with correct name and EIN, or (d) fictitious name certificate or certificate of trade name.
• A Limited Partnership (LP) or Limited Liability Partnership (LLP) must furnish (1) the partnership agreement, including all amendments, (2) certificate, or equivalent, issued by state of formation showing creation of partnership, as available, and (3) minutes demonstrating or establishing the current operating practices and serving as evidence of important partnership actions (should be signed and dated).
• A Corporation must furnish (1) copy of articles of incorporation, or equivalent, including all amendments as filed with the state of formation, (2) all corporate by-laws and all amendments, signed and dated as of their effective date, (3) certificate, or equivalent, issued by state of formation showing creation of corporation, as available, (4) shareholders agreements, including all amendments, (5) minutes demonstrating or establishing the current operating practices and serving as evidence of important partnership actions (should be signed and dated), and (6) copy of the most recent stock ledger adopted in the minutes or by resolution and providing important information about the stockholders of the company, such as stockholder name, stockholder certificate number, date the person became a stockholder, number of shares registered to each stockholder, and class of shares held by the stockholders, e.g., voting shares.

The foregoing items are among the questions and document requirements in the application. The SBA reviewer may ask for additional information based on individual circumstances.

 When an application is deemed by the SBA to be complete, the SBA will review these documents to determine whether the concern meets size, ownership and control requirements of the regulations. It generally takes 90 days for an approval or denial of certification to be issued.

Denial of certification of VOSB or SDVOSB status may be appealed to the SBA’s Office of Hearings and Appeals (OHA). However, the general provisions governing the SBA’s Veteran Small Business Certification Program prominently state that “a denial . . . based on the failure to provide sufficient evidence of the qualifying individual’s status as a veteran or a service-disabled veteran is a final decision, and not subject to appeal to OHA.”xvii While the full meaning of this provision with regard to a particular application will only become clear if and as the matter is litigated, this rule cautions that while an SBA OHA judge can rule on disputes as to eligibility on a given set of facts in an application, the agency itself (that is, the DVA) determines whether an applicant business has furnished sufficient information to establish status as a veteran or service-disabled veteran. Businesses are thus on notice that they must diligently answer all questions presented to them, by DVA officials involved in an individual’s veteran and service-disability status determinations, and then either in the online application or separately by official reviewers of the application. A business whose application for VOSB or SDVOSB certification has been denied must file its appeal within 10 business days of receipt of the denial.

 VOSB or SDVOSB appeals must be in writing. There is no required format for an appeal petition, but it must include (1) a copy of the denial and the date the appellant received it, (2) a statement of why the denial is in error, (3) any other pertinent information the judge should consider, and (4) the name, address, telephone number, and email address, if available, and signature of the appellant or its attorney. The business appealing the denial must serve copies of the entire appeal petition upon the Director, Office of Government Contracting (D/GC) and SBA Counsel at OPLservice@sba.gov. The appellant must attach to the appeal petition a signed certificate of service meeting the requirements of 13 C.F.R. § 134.204(d).

 The appeals process for certification denials does not permit discovery, and oral hearings will not be held. Also, except for good cause shown, evidence beyond the case file will not be admitted. Thus, appellants must submit all of the pertinent evidence and their best arguments with their appeal. The standard of review is whether the denial was based on clear error of fact or law. The appellant has the burden of proof, by a preponderance of the evidence.

 The OHA judge will decide the appeal within 60 calendar days after close of the record, insofar as practicable. The judge will issue a decision containing findings of fact and conclusions of law, reasons for such findings and conclusions, and any relief ordered. The judge’s decision will be based primarily on the evidence in the SBA case file, arguments made on appeal, and any responses, but the judge has discretion to issues beyond those raised in the pleadings and the denial letter. The decision is the final agency decision and becomes effective upon issuance. If the OHA judge dismisses an appeal of a certification denial, the determination remains in effect. If the judge grants the appeal and finds the appellant eligible for inclusion in the SBA certification database, the D/GC must immediately include the prevailing appellant in the SBA certification database. An appellant who receives an adverse decision from the judge may request reconsideration by filing with OHA and serving a petition for reconsideration on all parties to the VOSB or SDVOSB Appeal within twenty (20) calendar days after service of the written decision. The petition must be based upon a clear showing of an error of fact or law material to the decision.xviii

 Whether a final SBA OHA decision upholding denial of a SDVOSB or VOSB certification can be further appealed can raise complex questions regarding the jurisdiction of the court and the extent to which it must defer to matters of agency discretion. Detailed review of these questions is beyond the scope of this article. In short, there are two principal statutes that could provide for judicial review of these decisions. The first is the Administrative Procedure Act (“APA”).xix In general, to obtain review under the APA, the individual, business, or other organization seeking review must have suffered a legal wrong or been otherwise harmed by an agency action. The second is the the Tucker Act.xx Under the Tucker Act, a suit may be brought in the Court of Federal Claims (“COFC”) for a monetary claim against the U.S. government based on a constitutional provision, a statute, or a regulation, and the COFC will find it has jurisdiction if such provision, statute, or regulation is “money-mandating,” meaning that it can fairly be interpreted as mandating compensation for damages as a result of the breach of the duties it imposes and as providing a right of recovery in damages.xxi This means that the business whose certification has been denied, as a Tucker Act claimant, will need to identify a money-mandating source of law, such as a regulation provision governing a specific contract.

 Finally, the SBA rules permit an unsuccessful offeror on a set-aside procurement to file a protest of the SDVOSB or VOBC status of the awardee.xxii Protests are filed with the Contracting Officer who then must forward the protest to the OHA. If the OHA sustains the protest and the awardee loses the contract, the concern may have standing under the Tucker Act’s “bid protest” jurisdictionxxiii to file an action at the COFC to challenge the OHA decision.xxiv Meanwhile, SBA OHA decisions are given deference by the COFC unless an agency regulation, such as that setting forth the SBA’s Veteran Small Business Certification Program, is hopelessly ambiguous, or the COFC finds that it would not be disrupting expert SBA interpretations of its own rules.xxv In light of these and other complexities, businesses considering whether to pursue further appeal of a VOSB or SDVOSB certification denial should seek legal counsel.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i The Small Business Act of 1953, Pub. L. 83-163, Title II, 67 Stat. 232 (codified at 15 U.S.C. ch. 14A).

ii 15 U.S.C. § 631.

iii 15U.S.C.§644(g)(1)(A).

iv See Federal Acquisition Regulation Part 19, Small Business Programs, and the Small Business Administration regulations at Chapter I of Title 13 of the Code of Federal Regulations.

v This authority is the Veterans Benefits, Health Care and Information Technology Act of 2006, Pub. L. No. 109-461, §§ 502–503, 120 Stat. 3403, 3431 (Dec. 22, 2006) (codified at 38 U.S.C.A. §§ 8127–8128).

vi 38 U.S.C. § 8127(a)(3). Congress’s direction to the President in the Small Business Act to set a government-wide goal for procurement contracts to be awarded to SDVOSBs is codified at 15 U.S.C. § 644(g)((a)(A)(ii) (“The Governmentwide goal for participation by small business concerns owned and controlled by service-disabled veterans shall be established at not less than 3 percent of the total value of all prime contract and subcontract awards for each fiscal year.”). The 3% goal for FY2023 is published at Small Business Administration, “Small Business Procurement – FY2023 Small Business Goals – as of 12/15/2022,” available at https://www.sba.gov/sites/sbagov/files/2023-01/FY23_Final_Goals_508_0.pdf (accessed October 13, 2023).

vii 38 U.S.C.§ 8127(a)(1)(A).

viii DVA, FY 2023 Budget Submission: Supplemental Information and Appendices, Vol. 1 of 4, Mar. 2023, at 125, available at https://www.va.gov/budget/docs/summary/archive/fy-2023-va-budget-submission.zip (accessed Oct. 13, 2023). Since 2021, the DVA has not set a separate goal (i.e., other than the not-less-than-3% government-wide goal published by the SBA) for percentage of total procurement to be awarded to SDVOSBs. See DVA, FY 2022 Budget Submission: Supplemental Information and Appendices, Vol. 1 of 4, May 2021, at 25, available at https://www.va.gov/budget/docs/summary/archive/FY-2022-VA-BudgetSubmission.zip (accessed Oct. 13, 2023).
ix 87 Fed. 73400 (November 29, 2022).

xId.

xiA detailed review of these changes is beyond the scope of this article.

xii 87 Fed. 73400

xiii Guidance and further links are available at https://www.sba.gov/brand/assets/sba/resource-partners/Preparing-for-certification-VetCertFactSheet-508c.pdf. Frequently asked questions, with answers, are posted at https://veteranscertify.zendesk.com/hc/en-us/sections/10278762063895-FAQ (accessed Oct. 13, 2023). xiv This section summarizes the regulatory provisions regarding “Certification of VOSB or SDVOSB Status” at 13 C.F.R. Part 128, Subpart C.

xv The portal website is https://www.sba.gov/federal-contracting/contracting-assistance-programs/veteran-contracting-assistance-programs (accessed Oct. 13, 2023).

xvi This section summarizes the new “Rules of Practice for Appeals of Denials of Certification and Decertification in the SBA Veteran Small Business Certification Program (VOSB or SDVOSB Appeals),” at 13 C.F.R. Part 134 (Rules of Procedure Governing Cases Before the Office of Hearings and Appeals), Subpart K, as well as pertinent sections of 13 C.F.R. Part 128 (Veteran Small Business Certification Program).

xvii 13 C.F.R. § 128.304; see also 13 C.F.R. § 134.1103 (“A denial or decertification based on the failure to provide sufficient evidence of the qualifying individual’s status as a veteran or a service-disabled veteran are final VA decisions and not subject to appeal to OHA.).

xviii 13 C.F.R. § 134.1112(g).

xix 5 U.S.C. Chap 7.

xx 28 U.S.C. §1491(a)(1).

xxi Albino v. United States, 104 Fed. Cl. 801, 812-13 (2012).

xxii 13 C.F.R. Part 134, Subpart J.

xxiii 28 U.S.C. §1491(b)(1)

xxi vSwift & Staley, Inc. v. United States, 159 Fed. Cl. 494, 500–01 (2022), aff’d, No. 2022-1601, 2022 WL 17576348 (Fed. Cir. Dec. 12, 2022)

xxvDefense Integrated Solutions, LLC v. United States, 165 Fed. Cl. 352, 371 (2023).

Under regulations issued by the Small Business Administration (“SBA”) late last year, small veteran owned government contractors can no longer self-certify their eligibility for certain procurement preferences. Instead, to qualify, the contractors will have to obtain formal SBA certifications of their eligibility. All such contractors should be aware that they have until December 31, 2023 to submit applications for the certifications. If a contractor submits the application before the deadline, the contractor can continue to self-certify eligibility until such time as the SBA issues the certification. However, if the contractor misses the deadline, they will no longer be able to self-certify. As a result, they will not be able to qualify for the preferences pending SBA’s certification decision.

In the Small Business Act (the “Act”),i the Congress declared that small businesses are essential to the competitive marketplace that is the essence of the American economic system and thus the economic well-being and security of our nation. In essence, the Congress found that, without strong small business participation in the economy, monopolies and oligopolies would control the economy and ultimately pose a threat to our freedoms. To promote the development of the capacity of small businesses, the Act also declared that the government should award a “fair proportion of the Government’s contracts for goods and services” to small businesses.ii

To implement this policy, the Act established five government-wide small business contracting goals:iii

Regulations promulgated the Federal Acquisition Regulatory Council and the Small Business Administration give agencies the tools to achieve these the statutory goals. Among other things, the regulations empower agencies to set-aside procurements for qualifying small business concerns and impose requirements on large businesses to take affirmative actions to achieve specified small business subcontracting goals.iv

Concurrently, the Department of Veterans Affairs (“DVA”) has separate statutory authority to promote awards by the DVA to veteran owned small businesses.v In particular, the DVA statute authorizes the Secretary to set goals for each fiscal year for participation in Department prime contracts and subcontracts by (i) service-disabled veteran owned small business concerns (“SDVOSB”) and (ii) small businesses owned and controlled by veterans who are not veterans with service-connected disabilities (referred to as “veteran owned small businesses” or “VOSBs”). The Secretary may not establish a goal for SDVOSBs that is less than the annual goal set by the President under the Small Business Act, which for 2023 was the minimum authorized goal of 3%.vi However, since that Act does not have a goal for VOSBs, the Secretary has discretion to set the goals according to his priorities for the DVA.vii The DVA each year in its budget submission to Congress provides a table indicating the targets it has set for the coming fiscal year with regard to SDVOSB and VOSB awards and reflecting results vis-à-vis prior year targets. Pertinent data as to FY2023 targets reported by the DVA in its most recent budget submission are as follows:

This article concerns an important regulatory change affecting the eligibility of veteran owned small businesses for procurements set-aside by all federal agencies for SDVOSBs and by the DVA for VOSBs.

In a final rule effective on January 1, 2023 (the “Rule”), the Small Business Administration (“SBA”) changed the process by which veteran owned small businesses can qualify for procurement set-asides.ix Prior to the change, to qualify for DVA set-asides for VOSB and SDVOSBs, offerors had to obtain certification of their eligibility from the DVA’s Center for Verification and Evaluation (“CVE”). To qualify for SDVOSB set-aside procurements by all other federal agencies, SDVOSBs could simply self-certify their eligibility. Under the Rule, the CVE’s eligibility certification responsibilities for DVA procurements were transferred to a new Veteran Small Business Certification Program (“VetCert”) office in the SBA. In addition, all agencies must require offerors to submit proof of certification of their SDVOSB status by the SBA to qualify for a set aside. 

 The Rule has three important transition provisions. First, any SDVOSB or VOSB verified by the CVE prior to January 1, 2023 will be deemed SBA-certified for the remainder of the business’ three-year eligibility term provided the business continues to qualify under the criteria set forth in the regulations. Second, SBA intends to grant a one-time, one-year extension to the eligibility term of current CVE certified VOSBs and SDVOSBs. However, any new VOSBs or SDVOSBs applying for SBA certification will receive only a three-year eligibility term. Third, the Rule gives all VOSBs and SDVOSBs that do not have CVE certifications until December 31, 2023 to submit applications for the SBA certifications. If a contractor submits the application to VetCert before the deadline, the contractor can continue to self-certify eligibility until such time as SBA issues the certification. However, if the contractor misses the deadline, they will no longer be able to self-certify. As a result, they will not be able to qualify for the preferences pending SBA’s certification decision.x Nonetheless, any such contractor could continue to self-certify its eligibility as a SDVOSB to prime contractors for purposes of inclusion in their small business subcontracting plans.

 The Rule did not make any major changes to eligibility requirements for set-asides, although it did relax a few requirements.xi In short, to qualify as a VOSB for DVA set-asides, the concern must be (i) a small business concern as defined in 13 CFR Part 121 under the size standard corresponding to any North American Industrial Classification (“NAICS”) code listed in its profile on the System for Award Management (“SAM”); and (ii) not less than 51 percent owned and controlled by one or more veterans. To qualify as a SDVOSB for set-asides by all federal agencies the concern must be (i) a small business concern as defined in 13 CFR Part 121 under the size standard corresponding to any NAICS code listed in its SAM profile and (ii) not less than 51 percent owned and controlled by one or more service disabled veterans or, in the case of a veteran with a disability that is rated by the DVA as permanent and total and is unable to manage the daily business operations of the concern, the spouse or permanent caregiver of such veteran. In addition, applicants must not be suspended or debarred from government contracting, decertified by the SBA due to false statements in a prior application or be if default of any significant financial obligation owed to the federal government, including unresolved tax liens and defaults in federal loans, or other government assisted financing.xii

The Rule codifies all eligibility and certification requirements in a new Part 128 to the SBA regulations at Title 13 of the Code of Federal Regulations. To prevent “gaming” of the procurement system and fraud, the rules are elaborate and cover a variety of criteria for qualifying as a small business and demonstrating the required ownership and control of the concern. Applicants for certification would be well advised to review all of these rules and associated guidance issued by SBAxiii prior to beginning work on their applications, and to seek legal counsel if and as questions arise.

Before applying for certification, a company must be registered in the SAM and have a Unique Entity Identifier (UEI). During the process, the company’s bank account number will also be needed.

 The SBA, in administering the certification process, will rely upon determinations the VA has made as to an individual’s veteran and service-disability status. The rules and processes by which the VA makes such determinations are beyond the scope of this article.

 Applicants for certification establish an account and login by navigating in a web browser to the Veterans Small Business Certification portal.xv If the preparer is a contractor or consultant, the contract with the business owner will be needed. A preparer who is the surviving spouse of the veteran having not remarried will need a marriage certificate. If the preparer is a permanent caregiver for a veteran with a permanent, total, service-connected disability, that person will need proof of formal appointment as caregiver, as well as the written determination from the Veterans Administration that the veteran has a permanent and total disability.

The application requires the furnishing of certain business information. If the veteran is not the highest compensated person in the business, required documentation will consist of a written explanation of the situation that details who is highest compensated and the business reasons for such compensation. If the business has a franchise agreement, this will need to be provided. If the business is currently past due on any taxes, liens, federally backed loans, or outstanding tax returns, the preparer must submit a letter of explanation regarding any delinquencies, including amounts and to whom owed. If the owner or any family household member of an owner is a federal employee in a GS-13 (or equivalent) position or above, a letter of non-objection from the federal employee’s ethics official is required. And if the business is owned by a trust, the trust agreement must be provided, and it must demonstrate that the trust is revocable, and that veterans are the grantors, trustees, and current beneficiaries of the trust—other types of trusts are not eligible for the program.

 Different documents are required based upon the entity type of the applicant business:

• A Sole Proprietorship must furnish one of three documents to demonstrate that the business legally exists and is in operation, namely (1) an IRS SS4 TIN issuance letter with correct name and EIN, (2) fictitious name certificate or certificate of trade name, or (3) copy of most recent schedule C.
• A Limited Liability Company (LLC) must furnish (1) copy of articles of organization, or equivalent, including all amendments as filed with the state of formation, (2) certificate, or equivalent, issued by state of formation showing creation of LLC, as available, (3) operating agreement, including all amendments, and (4) minutes demonstrating or establishing the current operating practices and providing evidence of election or appointments of officers, adoption/implementation of operating agreements or voting agreements, business decisions, and voting (should be signed and dated).
• A General Partnership must furnish (1) the partnership agreement, including all amendments, and (2) one of four documents to demonstrate the business legally exists and is in operation, namely (a) copy of most recent Schedule K-1s, (b) copy of most recent Schedule C for proprietorship, (c) IRS SS4 TIN issuance letter with correct name and EIN, or (d) fictitious name certificate or certificate of trade name.
• A Limited Partnership (LP) or Limited Liability Partnership (LLP) must furnish (1) the partnership agreement, including all amendments, (2) certificate, or equivalent, issued by state of formation showing creation of partnership, as available, and (3) minutes demonstrating or establishing the current operating practices and serving as evidence of important partnership actions (should be signed and dated).
• A Corporation must furnish (1) copy of articles of incorporation, or equivalent, including all amendments as filed with the state of formation, (2) all corporate by-laws and all amendments, signed and dated as of their effective date, (3) certificate, or equivalent, issued by state of formation showing creation of corporation, as available, (4) shareholders agreements, including all amendments, (5) minutes demonstrating or establishing the current operating practices and serving as evidence of important partnership actions (should be signed and dated), and (6) copy of the most recent stock ledger adopted in the minutes or by resolution and providing important information about the stockholders of the company, such as stockholder name, stockholder certificate number, date the person became a stockholder, number of shares registered to each stockholder, and class of shares held by the stockholders, e.g., voting shares.

The foregoing items are among the questions and document requirements in the application. The SBA reviewer may ask for additional information based on individual circumstances.

 When an application is deemed by the SBA to be complete, the SBA will review these documents to determine whether the concern meets size, ownership and control requirements of the regulations. It generally takes 90 days for an approval or denial of certification to be issued.

Denial of certification of VOSB or SDVOSB status may be appealed to the SBA’s Office of Hearings and Appeals (OHA). However, the general provisions governing the SBA’s Veteran Small Business Certification Program prominently state that “a denial . . . based on the failure to provide sufficient evidence of the qualifying individual’s status as a veteran or a service-disabled veteran is a final decision, and not subject to appeal to OHA.”xvii While the full meaning of this provision with regard to a particular application will only become clear if and as the matter is litigated, this rule cautions that while an SBA OHA judge can rule on disputes as to eligibility on a given set of facts in an application, the agency itself (that is, the DVA) determines whether an applicant business has furnished sufficient information to establish status as a veteran or service-disabled veteran. Businesses are thus on notice that they must diligently answer all questions presented to them, by DVA officials involved in an individual’s veteran and service-disability status determinations, and then either in the online application or separately by official reviewers of the application. A business whose application for VOSB or SDVOSB certification has been denied must file its appeal within 10 business days of receipt of the denial.

 VOSB or SDVOSB appeals must be in writing. There is no required format for an appeal petition, but it must include (1) a copy of the denial and the date the appellant received it, (2) a statement of why the denial is in error, (3) any other pertinent information the judge should consider, and (4) the name, address, telephone number, and email address, if available, and signature of the appellant or its attorney. The business appealing the denial must serve copies of the entire appeal petition upon the Director, Office of Government Contracting (D/GC) and SBA Counsel at OPLservice@sba.gov. The appellant must attach to the appeal petition a signed certificate of service meeting the requirements of 13 C.F.R. § 134.204(d).

 The appeals process for certification denials does not permit discovery, and oral hearings will not be held. Also, except for good cause shown, evidence beyond the case file will not be admitted. Thus, appellants must submit all of the pertinent evidence and their best arguments with their appeal. The standard of review is whether the denial was based on clear error of fact or law. The appellant has the burden of proof, by a preponderance of the evidence.

 The OHA judge will decide the appeal within 60 calendar days after close of the record, insofar as practicable. The judge will issue a decision containing findings of fact and conclusions of law, reasons for such findings and conclusions, and any relief ordered. The judge’s decision will be based primarily on the evidence in the SBA case file, arguments made on appeal, and any responses, but the judge has discretion to issues beyond those raised in the pleadings and the denial letter. The decision is the final agency decision and becomes effective upon issuance. If the OHA judge dismisses an appeal of a certification denial, the determination remains in effect. If the judge grants the appeal and finds the appellant eligible for inclusion in the SBA certification database, the D/GC must immediately include the prevailing appellant in the SBA certification database. An appellant who receives an adverse decision from the judge may request reconsideration by filing with OHA and serving a petition for reconsideration on all parties to the VOSB or SDVOSB Appeal within twenty (20) calendar days after service of the written decision. The petition must be based upon a clear showing of an error of fact or law material to the decision.xviii

 Whether a final SBA OHA decision upholding denial of a SDVOSB or VOSB certification can be further appealed can raise complex questions regarding the jurisdiction of the court and the extent to which it must defer to matters of agency discretion. Detailed review of these questions is beyond the scope of this article. In short, there are two principal statutes that could provide for judicial review of these decisions. The first is the Administrative Procedure Act (“APA”).xix In general, to obtain review under the APA, the individual, business, or other organization seeking review must have suffered a legal wrong or been otherwise harmed by an agency action. The second is the the Tucker Act.xx Under the Tucker Act, a suit may be brought in the Court of Federal Claims (“COFC”) for a monetary claim against the U.S. government based on a constitutional provision, a statute, or a regulation, and the COFC will find it has jurisdiction if such provision, statute, or regulation is “money-mandating,” meaning that it can fairly be interpreted as mandating compensation for damages as a result of the breach of the duties it imposes and as providing a right of recovery in damages.xxi This means that the business whose certification has been denied, as a Tucker Act claimant, will need to identify a money-mandating source of law, such as a regulation provision governing a specific contract.

Finally, the SBA rules permit an unsuccessful offeror on a set-aside procurement to file a protest of the SDVOSB or VOBC status of the awardee.xxii Protests are filed with the Contracting Officer who then must forward the protest to the OHA. If the OHA sustains the protest and the awardee loses the contract, the concern may have standing under the Tucker Act’s “bid protest” jurisdictionxxiii to file an action at the COFC to challenge the OHA decision.xxiv Meanwhile, SBA OHA decisions are given deference by the COFC unless an agency regulation, such as that setting forth the SBA’s Veteran Small Business Certification Program, is hopelessly ambiguous, or the COFC finds that it would not be disrupting expert SBA interpretations of its own rules.xxv In light of these and other complexities, businesses considering whether to pursue further appeal of a VOSB or SDVOSB certification denial should seek legal counsel.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i The Small Business Act of 1953, Pub. L. 83-163, Title II, 67 Stat. 232 (codified at 15 U.S.C. ch. 14A).

ii 15 U.S.C. § 631.

iii 15U.S.C.§644(g)(1)(A).

iv See Federal Acquisition Regulation Part 19, Small Business Programs, and the Small Business Administration regulations at Chapter I of Title 13 of the Code of Federal Regulations.

v This authority is the Veterans Benefits, Health Care and Information Technology Act of 2006, Pub. L. No. 109-461, §§ 502–503, 120 Stat. 3403, 3431 (Dec. 22, 2006) (codified at 38 U.S.C.A. §§ 8127–8128).

vi 38 U.S.C. § 8127(a)(3). Congress’s direction to the President in the Small Business Act to set a government-wide goal for procurement contracts to be awarded to SDVOSBs is codified at 15 U.S.C. § 644(g)((a)(A)(ii) (“The Governmentwide goal for participation by small business concerns owned and controlled by service-disabled veterans shall be established at not less than 3 percent of the total value of all prime contract and subcontract awards for each fiscal year.”). The 3% goal for FY2023 is published at Small Business Administration, “Small Business Procurement – FY2023 Small Business Goals – as of 12/15/2022,” available at https://www.sba.gov/sites/sbagov/files/2023-01/FY23_Final_Goals_508_0.pdf (accessed October 13, 2023).

vii 38 U.S.C.§ 8127(a)(1)(A).

viii DVA, FY 2023 Budget Submission: Supplemental Information and Appendices, Vol. 1 of 4, Mar. 2023, at 125, available at https://www.va.gov/budget/docs/summary/archive/fy-2023-va-budget-submission.zip (accessed Oct. 13, 2023). Since 2021, the DVA has not set a separate goal (i.e., other than the not-less-than-3% government-wide goal published by the SBA) for percentage of total procurement to be awarded to SDVOSBs. See DVA, FY 2022 Budget Submission: Supplemental Information and Appendices, Vol. 1 of 4, May 2021, at 25, available at https://www.va.gov/budget/docs/summary/archive/FY-2022-VA-BudgetSubmission.zip (accessed Oct. 13, 2023).

ix 87 Fed. 73400 (November 29, 2022).

x Id.

xi A detailed review of these changes is beyond the scope of this article.

xii 87 Fed. 73400

xiii Guidance and further links are available at https://www.sba.gov/brand/assets/sba/resource-partners/Preparing-for-certification-VetCertFactSheet-508c.pdf. Frequently asked questions, with answers, are posted at https://veteranscertify.zendesk.com/hc/en-us/sections/10278762063895-FAQ (accessed Oct. 13, 2023).

xiv This section summarizes the regulatory provisions regarding “Certification of VOSB or SDVOSB Status” at 13 C.F.R. Part 128, Subpart C.

xv The portal website is https://www.sba.gov/federal-contracting/contracting-assistance-programs/veteran-contracting-assistance-programs (accessed Oct. 13, 2023).

xvi This section summarizes the new “Rules of Practice for Appeals of Denials of Certification and Decertification in the SBA Veteran Small Business Certification Program (VOSB or SDVOSB Appeals),” at 13 C.F.R. Part 134 (Rules of Procedure Governing Cases Before the Office of Hearings and Appeals), Subpart K, as well as pertinent sections of 13 C.F.R. Part 128 (Veteran Small Business Certification Program).

xvii 13 C.F.R. § 128.304; see also 13 C.F.R. § 134.1103 (“A denial or decertification based on the failure to provide sufficient evidence of the qualifying individual’s status as a veteran or a service-disabled veteran are final VA decisions and not subject to appeal to OHA.).

xviii 13 C.F.R. § 134.1112(g).

xix 5 U.S.C. Chap 7.

xx 28 U.S.C. §1491(a)(1).

xxi Albino v. United States, 104 Fed. Cl. 801, 812-13 (2012).

xxii 13 C.F.R. Part 134, Subpart J.

xxiii 28 U.S.C. §1491(b)(1)

xxivSwift & Staley, Inc. v. United States, 159 Fed. Cl. 494, 500–01 (2022), aff’d, No. 2022-1601, 2022 WL 17576348 (Fed. Cir. Dec. 12, 2022)

xxvDefense Integrated Solutions, LLC v. United States, 165 Fed. Cl. 352, 371 (2023).

President Trump has referred to America’s fight against COVID-19 as a “medical war” and has mobilized the vast resources of the nation to wage this war. One of the more powerful weapons in his arsenal is the Defense Production Act of 1950 (the “DPA”), which authorizes an “array” of actions to mobilize the domestic industrial base for national defense. The DPA defines “national defense” broadly to include “activities and measures designed or undertaken to prepare for or minimize the effects of a hazard upon the civilian population [and] to deal with the immediate emergency conditions which would be created by the hazard.”i Therefore, its authorities are available for use against COVID-19. To date, the President has issued three Executive Orders and three memoranda directing the exercise of DPA authorities in the war against COVID-19. This article provides an overview of these actions.

The “moral” of the story is that companies at all levels of the supply chain for federal orders for the war should educate themselves about the DPA requirements and consequences of non-compliance. In addition, to avoid bad publicity, these companies should adopt a strategy for communications with the government that emphasizes both the company’s patriotic desire to innovate to meet public health needs and transparency about what is achievable.

On March 18, 2020, the President issued Executive Order (“EO”) No. 13909, delegating to the Secretary of the Department of Health and Human Services (“DHHS”) certain authorities under Section 101 of Title I of the DPA.ii As a result, DHHS can exercise the President’s authority to require companies to accept and give priority to orders from the federal government for materials and services necessary to respond to COVID-19.iii This is referred to as the “Prioritization Authority” of the DPA. The EO specifically authorizes DHHS to use the Prioritization Authority for orders of “health and medical resources needed to respond to the spread of COVID-19, including personal protective equipment and ventilators.”iv

 DHHS’ implementing regulations for the DPA delineate the scope of these authorities. In particular:

• A company must accept orders issued pursuant to the DPA, unless a specified ground for rejection applies.v Such orders are referred to as “rated orders.”
• If a company accepts a rated order, the regulations require “flow-down” of the DPA prioritization requirements to “each successive order placed to obtain items or services needed to fill” the order.vi
  No one in this supply chain may discriminate against rated orders “in any manner such as by charging higher prices or by imposing different terms and conditions than for comparable unrated orders.” vii
• A company may reject a rated order if the government or higher-tier supplier does not agree “to meet regularly established terms of sale or payment” or if it is for “an item not supplied or a service not capable of being performed.”viii However, DHHS has authority to countermand the rejection and require the company to perform the order.ix
• A company must reject a rated order for delivery on a specified date “if unable to fill the order by that date.”x However, the company “must inform the customer of the earliest date on which delivery can be made and offer to accept the order on the basis of that date.”xi
  There are two levels of priority for rated orders, identified by the rating symbols “DO” and “DX.” All DO–rated orders have equal priority with each other and take precedence over unrated orders.
• All DX–rated orders have equal priority with each other and take precedence over DO–rated orders and unrated orders.xii
  Recipients of rated orders must give notice of acceptance or rejection of orders within tight deadlines specified in the regulations.xiii

Importantly, DHHS’s Prioritization Authority does not allow DHHS to set the price for an item, unless it has prior authorization from Congress to do so.xiv

 EO No. 13909 also delegated to DHHS the President’s authority under Section 101 of Title I to “allocate materials, services, and facilities in such manner, upon such conditions, and to such extent as he shall deem necessary or appropriate.”xv The government has not used this “Allocation Authority” since the end of the Cold Warxvi and its use is limited to situations where there “is insufficient supply of a material, service, or facility to satisfy national defense supply requirements through the use of the priorities authority or when the use of the priorities authority would cause a severe and prolonged disruption in the supply of materials, services, or facilities available to support normal U.S. economic activities.”xvii However, the delegation of the Allocation Authority gives DHHS vast powers over the industrial base. Indeed, whereas the Prioritization Authority only mandates acceptance and prioritized production of rated orders, the Allocation Authority essentially permits DHHS to commandeer inventories and production processes of private companies and to direct their use for the war against COVID-19.

 Under the DPA’s implementing regulations, there are three types of orders that the government can use to communicate allocation actions:

(a) Set-aside. An official action that requires a person to reserve materials, services, or facilities capacity in anticipation of the receipt of rated orders;

 (b) Directive. An official action that requires a person to take or refrain from taking certain actions in accordance with its provisions. A directive can require a person to: stop or reduce production of an item; prohibit the use of selected materials, services, or facilities; or divert the use of materials, services, or facilities from one purpose to another; and

 (c) Allotment. An official action that specifies the maximum quantity of a material, service, or facility authorized for a specific use.xviii

Following are other highlights of the regulations governing use of the Allocation Authority:

• Acceptance of allocation orders is mandatory.
• If compliance is not possible, the recipient of the order must obtain a special dispensation from the Secretary of DHHS.
• An allocation directive “takes precedence over all DX–rated orders, DO–rated orders, and unrated orders previously or subsequently received, unless a contrary instruction appears in the Directive.”xix
• As with rated orders, the recipient may not discriminate against an allocation order in pricing, terms and conditions or in any other wayxx and the government may not impose a price control without Congressional authorization.xxi

Individuals at any level of the supply chain who willfully fail to perform a rated order or an allocation order or otherwise violate the DPA or its implementing regulations are guilty of a crime that is punishable by up to one year of imprisonment and a fine of up to $10,000.xxii These sanctions give the DPA and its implementing regulations real “teeth” and DHHS a powerful weapon in the fight against COVID-19.

On March 23, 2020, the President issued EO No. 13910, delegating to DHHS his authority under Section 102 of Title I of the DPA to prevent hoarding of health and medical resources necessary to the war against COVID-19.xxiii Under this authority, DHHS may publish a notice in the Federal Register designating certain materials and ancillary services as scarce or threatened by hoarding.xxiv These are referred to as “Designations.” The DPA prohibits the accumulation of designated materials “(1) in excess of the reasonable demands of business, personal, or home consumption, or (2) for the purpose of resale at prices in excess of prevailing market prices.”xxv In making such designations, DHHS may “prescribe such conditions with respect to the accumulation of materials” as it deems necessary to carry out the objectives of the DPA.xxvi

 On March 25, 2020, DHHS issued a Designation covering the following items:

• N-95 Filtering Facepiece Respirators;
• Other Filtering Facepiece Respirators (e.g., those designated as N99, N100, R95, R99, R100, or P95, P99, P100);
• Elastomeric, air-purifying respirators and appropriate particulate filters/cartridges;
• Powered Air Purifying Respirator (PAPR);
• Portable Ventilators;
• Chloroquine phosphate or hydroxychloroquine HCl;
  Sterilization services for certain medical devices and certain sterilizers;
• Disinfecting devices and other sanitizing and disinfecting products suitable for use in a clinical setting;
• Medical gowns or apparel, e.g., surgical gowns or isolation gowns;
• Personal protective equipment (PPE) coveralls, e.g., Tyvek Suits;
• PPE face masks, PPE surgical masks, PPE face shields, PPE gloves or surgical gloves;
• Ventilators, anesthesia gas machines modified for use as ventilators, and positive pressure breathing devices modified for use as ventilators, ventilator tubing connectors, and ventilator accessories.xxvii

EO 13910 also included a delegation to DHHS of certain powers of the President to implement the DPA, referred to herein as “DPA Implementation Authorities.”xxviii In particular, DHHS may now implement the DPA by:

• Promulgating new regulations;
• Issuing and enforcing subpoenas for documents and testimony to perform industry studies assessing the capabilities of the United States industrial base to support the response;
• Obtaining injunctions against individuals who have engaged in or are about to engage in willful violations of the DPA;
• Making special appointments of “persons of outstanding experience and ability without compensation.”xxix

As with rated orders and allocation orders, willful violations of Designations or DHHS subpoenas are crimes that are punishable by up to one year of imprisonment and a fine of up to $10,000.xxx The threat of these sanctions is not theoretical. Indeed, the Department of Justice has established a task force to address hoarding and price gouging associated with COVID-19. Even more ominously for hoarders and price gougers, the Attorney General warned that “[i]f you are sitting on a warehouse with surgical masks, you will be hearing a knock on your door.”xxxi

On March 27, 2020, the President issued EO No. 13911, delegating additional authorities under Titles I, III and VIII of the DPA for use in the war against COVID-19.xxxii Following are highlights of the EO:

• Whereas the other EOs only involved delegations to DHHS, the EO 13911 delegations were to both DHHS and the Secretary of the Department of Homeland Security (“DHS”).
• These agencies may now exercise the President’s authority under Section 107 of Title I to maintain reliable sources of supply for critical items by (i) restricting solicitations for contracts to reliable and/or to domestic sources; (ii) stockpiling; and (iii) developing substitutes for the items.xxxiii
• The EO also provides that these agencies may exercise the President’s authorities under Sections 301 through 303 of Title III of the DPA to provide certain incentives to industry to develop, maintain, modernize and expand the productive capacity of the domestic industrial base for critical items needed to fight the war – e.g, loans, loan guarantees, direct purchases and purchase commitments, and the authority to procure and install equipment in private industrial facilities.xxxiv The agencies were authorized to use the DPA Implementation Authorities as necessary in providing these incentives.
• The EO also delegated to DHHS and DHS the authority under Section 708 of Title VII of the DPA to authorize voluntary agreements or plans of action between competing private industry interests that would otherwise violate anti-trust statutes or contract law.

Whereas the Title I authorities delegated by the other EOs include powerful negative incentives for companies to comply, the additional authorities delegated in EO 13911 permit the government to offer powerful positive incentives to companies to work with the government to fight COVID-19.

The EO included two provisions concerning DHS’ role in administration of the DPA in the war. First, the EO delegated to DHS the same Prioritization Authority, Allocation Authority and anti-hoarding/price gouging authority delegated to DHHS in EOs 13909 and 13910.xxxv Second, the EO included the following statement, which appears to grant DHS primacy in the use of the Prioritization and Allocation Authorities:

The Secretary of Homeland Security may use the authority under section 101 of the Act to determine, in consultation with the heads of other executive departments and agencies as appropriate, the proper nationwide priorities and allocation of health and medical resources, including by controlling the distribution of such materials (including applicable services) in the civilian market, for responding to the spread of COVID-19 within the United States. 

As a result, both DHHS and DHS are now fully armed to use DPA.

Finally, the EO appointed Peter Navarro, the Assistant to the President for Trade and Manufacturing Policy, to serve as National Defense Production Act Policy Coordinator.

As mentioned, to date the President has issued three memoranda directing the exercise of DPA authorities in the war against COVID-19. Following are high level summaries of these actions.

• On March 27, 2020, President Trump issued the a memorandum to the Secretary of DHHS directing him to “use any and all authority available under the Act to require General Motors Company to accept, perform, and prioritize contracts or orders for the number of ventilators that the Secretary determines to be appropriate.”xxxvi The President apparently took the action in response to reports of difficulties in obtaining satisfactory delivery and price commitments from a partnership between General Motors (“GM”) and Ventec Life Systems Inc. (“Ventec”) of Bothell, Washington, under which a GM plant in Kokomo, Indiana will mass produce Ventec’s ventilators. While GM is new to the ventilator business, the plan is to leverage GM’s global supply chain to meet the unprecedented need for this life-saving equipment. It is not clear whether DHHS ultimately issued a rated order or an allocation order or a combination rated/allocation order to GM. However, undoubtedly due to the negative press resulting from the release of the President’s memorandum, GM quickly offered proper assurances to the President and a few days later he said that “General Motors is doing a fantastic job,” and “I don’t think we have to worry about General Motors now.”xxxvii
• On April 2, 2020, the President again took action under the DPA concerning ventilators. On that day, in a memorandum to the Secretaries of DHHS and DHS, he ordered the Secretary of DHHS, in consultation with the Secretary of DHS to “use any and all authority available under the Act to facilitate the supply of materials to the appropriate subsidiary or affiliate of the following entities for the production of ventilators: General Electric Company; Hill-Rom Holdings, Inc.; Medtronic Public Limited Company; ResMed Inc.; Royal Philips N.V.; and Vyaire Medical, Inc.”xxxviii Based on information provided by Mr. Navarro in the President’s Coronavirus Task Force (“Task Force”) briefing of April 2, 2020, it appears that the manufacturers requested this action so that they could “flow-down” DPA requirements (and the prospect of sanctions) through their supply chain and thereby increase the chances for prompt delivery.
• On April 2, 2020, the President issued a memorandum to the Secretary of DHS and the Director of the Federal Emergency Management Agency (a component of DHS) concerning the manufacture by 3M Company of “N-95” Respirators. The memorandum instructed DHS to “use any and all authority available under the Act to acquire, from any appropriate subsidiary or affiliate of 3M Company, the number of N-95 respirators that the Administrator determines to be appropriate.” Based on the Task Force briefing of April 2, it appears that this was a response to reports that 3M was shipping orders for these respirators to foreign customers ahead of orders from the federal government.

Mr. Navarro’s remarks in the April 2nd Task Force briefing cogently summarize the DPA authorities described above and the Administration’s approach to their use in this war: 

When I spoke with you last week, I explained the three points of the compass DPA can be used to hit. The first one is mobilization of the industrial base. This can involve things like re-purposing from say a distiller like Pernod Ricard from liquor to hand sanitizer. It can also involve expansion of production, which is having Honeywell, which makes N95 masks open new factory in Smithfield, Rhode Island.

 With respect to the second point of the compass, allocation of resources, we have two issues there. If you look at the manufacturer itself, . . . what you want to make sure is that the supply chain, which can go seven tiers deep, has enough components in that supply chain so we can actually make what we need and then once it’s made, you also want to make sure that it goes to the right people.

 And then the third point in the compass . . . is basically Bust Them, I call it. Hoarding of critical or threatened materials. So let me walk through what the President did today in terms of a strong action in what we’ve done with the DPA across those three points.

The first order President Trump signed was vigorous, swift. It was the GM order which directed GM to make ventilators in Kokomo, Indiana in Trump time, which is to say as fast as possible. As the President mentioned, he’d spoke to Mary Barr today, the CEO of GM. That is moving forward at the same time as the Ford project [to make GE Healthcare’s ventilators] is moving forward in a Rawsonville, Michigan. And I’ve issued a challenge to those two companies out of Ford versus Ferrari. This is Ford versus GM. Let’s see who gets those ventilators out first.

 Now, the second point of the compass, which these two orders address today is this allocation of resource issues. The ventilator companies themselves express concern that in this rush to build ventilators, there would be pressure on that supply chain. So what they requested that we do and the President do, is to use the DPA to give this gentleman here, is one of the strongest gentleman in the world in terms of applying things, is to give him the ability to prioritize that supply chain for those ventilator manufacturers. And he will do things like give them what’s called a DO rating in the defense procurement, which will allow them to get what they need.

 Now, the second order, which the President signed today has to do with the other part of the equation, which is once they make the stuff, okay, does it go to the right folks? And this is a 3M order. And, to be frank, over the last several days, we’ve had some issues making sure that all of the production that 3M does around the world, enough of it is coming back here to the right places. So what’s going to happen with the signing of that order in Trump time is we’re going to resolve that issue with 3M probably by tomorrow close of business. Because we can’t afford to lose days or hours or even minutes in this crisis.

Now the third part of the compass, this third point there, this gets to the hoarding issue. President stood up here, he’s the Commander In Chief, but we have a sheriff in town too, Attorney General Barr. And he stood up here with Attorney General Barr and Bill Barr said, “I’m going to go out and bust them.” And guess what? Three days ago DOJ went into a warehouse in Jersey, grabbed PPE and the beauty of that was it wasn’t only seized, but within hours it was turned around and given to healthcare professionals in New York and New Jersey. That’s a beautiful thing. That’s a beautiful case of using the DPA.xxxix

Given the gravity of the public health crisis and the aggressive approach of the Administration to date, it seems likely that the Administration will take additional actions to use the powerful weapons of the DPA in pursuit of victory in the war against COVID-19. Therefore, companies at all levels of the supply chain for federal orders should educate themselves about the DPA requirements and consequences of non-compliance. In addition, to avoid bad publicity that can result from imprecise communications or well-intentioned but unrealistic promises, these companies should adopt a strategy for communications with the government that emphasizes both the company’s patriotic desire to innovate to meet public health needs and transparency about what is achievable.

The Federal Acquisition Regulation (“FAR”) requires federal Contracting Officers (“COs”) to “ensure that contractors receive impartial, fair and equitable treatment.”xl This requirement is fundamental to our procurement system. COs have vast powers to “enter into, administer, or terminate contracts and make related determinations and findings”xli and thereby adversely affect the finances of contractors. When COs treat contractors unfairly, the private sector tends to lose faith in the government as a customer. As a result, excellent companies will stop offering needed products and services to the government or will include in the price of their government contracts appropriate contingencies to account for the risks and costs of such inequities. In either case, the taxpayers lose. In my twenty-five years of practicing government contracts law, I have encountered some COs who, with the support of agency lawyers, will take the time to focus on disputed issues and partner with my clients to develop a fair solution that is in the long-term best interests of the taxpayers and the contractor. However, in too many cases, I have seen COs who do not take this approach.

 In particular, some COs, due to overload or other reasons, simply will not take the time to understand and analyze the issues raised by the contractor. Instead, these COs employ delaying tactics to postpone a resolution – e.g., deferring all action until an auditor has reviewed some of the issues or making unnecessary demands for additional information. As a result of the delays, clients are forced to consider incurring the expense of litigating an issue that the parties could, with a few relatively painless consultations, resolve administratively. Other COs seems to have no “stomach” for opposing agency stakeholders such as political appointees, bureaucratic factions, the agency program manager or specialists in law and accounting who have formed adverse opinions of the contractor. Rather than conduct independent fact-finding and analysis to determine whether the stakeholders’ opinions are well founded, the COs are solely focused on acting as advocates of their agency. While this approach is, perhaps, understandable, it is a dereliction of the COs’ duty under the FAR. Fortunately, there are a number of ways contractors can fight and even prevent unfair treatment by COs.

 If the CO’s actions or inactions have become intolerable, the contractor can seek redress under the Contract Disputes Act (“CDA”).xlii The CDA governs the resolution of disputes between contractors and procuring agencies concerning procurement contracts. The contract clause at FAR § 52.233-1, Disputes, implements the CDA. Under this clause, the contractor must initiate a dispute by following detailed procedures for submission of a formal “claim” seeking a CO’s final decision.xliii If the CO denies the claim, the CDA gives the contractor the right to appeal the denial to a Board of Contract Appeals (“BCA”) or to the United States Court of Federal Claims (“COFC”). The contractor may appeal adverse decisions of the BCA or COFC to the United States Court of Appeals for the Federal Circuit. Unfortunately, the general FAR requirement that COs “ensure that contractor receive impartial, fair and equitable treatment” is not specifically set forth in a contract clause. Therefore, contractors tend to sue the government under specific clauses and/or legal doctrines. For example, if the CO improperly interprets a specification in a manner that increases the contractor’s costs and then unfairly refuses to issue a change order giving the contractor additional compensation, the contractor can submit a claim for additional compensation under the “constructive change” doctrine.

 However, where there is evidence of unfair treatment by the CO, contractors will often include in their complaints a count alleging that the government breached its implied contractual duty of “good faith and fair dealing” towards the contractor. According to the seminal case of Centex Corp. v. United Statesxliv , “the covenant of good faith and fair dealing is an implied duty that each party to a contract owes to its contracting partner. The covenant imposes obligations on both contracting parties that include the duty not to interfere with the other party’s performance and not to act so as to destroy the reasonable expectations of the other party regarding the fruits of the contract.” In my view, the FAR requirement that COs “ensure that contractors receive impartial, fair and equitable treatment” is simply a regulatory expression of this line of cases.

 Short of suing the customer, what can contractors do to prevent unfair treatment by their COs? First, contractors should develop comprehensive baseline plans for the performance of the contract, including work breakdown structures, milestone schedules and budgets, and seek to persuade the agency to include key assumptions from these plans in the statement of work for the contract. Then, in the event that the assumptions become invalid and the contractor needs to request additional compensation, the contractor can clearly show the CO the difference between the baseline and the changed requirement. Without a clear baseline, the contractor is more susceptible to arbitrary and unfair action by the CO.

 Second, from the contract negotiations phase through the close out of the contract, contractors should proactively cultivate a good working relationship with their COs. To do this, contractors must have regular, routine verbal communication with their COs. In this era of information overload, it is not enough to regularly copy the CO on contract deliverables and e-mail communications with the program team that may have future contractual implications. Rather, to the extent possible the contractor should keep the CO informed of such implications through “old fashioned” conversation, which will “register” with the CO more effectively than an e-mail in a crowded in-box. Ideally, these conversations will occur in the context of regularly scheduled teleconferences (which can be brief) so that the CO views the contractor as a helpful source of information as opposed to just another party asking the CO to take an action. The more conversations between contractors and COs that occur routinely, the better the relationship with the CO and the more likely the contractor will receive fair treatment when the contractor needs to request a change to the contract. If the CO initially refuses to schedule regular talks, the contractor should periodically renew his or her request and then regularly communicate in other ways (eg, periodic “for your information” voice mails and simple, bulleted e-mails).

 Third, through effective communications, contractors should build support on the program team for their requests for contractual relief. The program team has the most informed perspective on the nature of any changes to the program baseline, the importance of the contract work to the agency mission and the availability of funds for a contract modification that will resolve the issue. Therefore, the CO will naturally turn to the program team for their perspectives. If the CO finds that the team is supportive, the chances of a successful resolution will increase significantly.

 Fourth, contractors should organize and simplify the presentation of contract change requests. A disorganized, confusing or overly technical presentation does not support and indeed often impedes prompt resolution of an issue. Most often, the CO and the program team will not read or otherwise engage on such presentations. On the other hand, a tightly organized presentation in “layman’s” terms with an effective Executive Summary and captions that explain the contractor’s position is likely to help the contractor’s case. The key is to make an impression in the first minute or so of the customer’s review of the document that the contractor is organized and ready to pursue its interests in the matter.

 Fifth, contractors should strategically invoke the provisions of the Contract Disputes Act (“CDA”) in communications with the CO.xlv In my experience, a diplomatically crafted and appropriately timed communication to the CO that sets forth a strong contractual and legal position and a resolve to resort to the CDA process if necessary will often bring the CO to the negotiating table.

In conclusion, contractors are not helpless in the face of unfair treatment by COs. Indeed, there are many ways to prevent and fight such treatment.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i50 U.S.C. § 4552 defines “national defense” to include “emergency preparedness activities conducted pursuant to title VI of The Robert T. Stafford Disaster Relief and Emergency Assistance Act and critical infrastructure protection and restoration.” Under that act, “emergency preparedness” means “all those activities and measures designed or undertaken to prepare for or minimize the effects of a hazard upon the civilian population, to deal with the immediate emergency conditions which would be created by the hazard, and to effectuate emergency repairs to, or the emergency restoration of, vital utilities and facilities destroyed or damaged by the hazard.” 42 U.S.C. § 5195a.
ii 85 Fed. Reg. 16227 (March 18, 2020).
iii 50 U.S.C. § 4511.
iv 85 Fed. Reg. 16227 (March 18, 2020).
v 45 C.F.R. § 101.33 (a).
vi Id. at § 101.35.
vii Id. at. § 101.33(a)(1).
viii Id. at. § 101.33(c).
ix Id.
x Id. at § 101.33(b).
xi Id.
xii Id. at § 101.31.
xiii at § 101.33(d) and (e).
xiv 50 U.S.C.§ 4514(a).
xv 85 Fed. Reg. 16227 (March 18, 2020).
xvi Congressional Research Service, “The Defense Production Act of 1950: History, Authorities, and Considerations for Congress” (updated March 2, 2020), at https://fas.org/sgp/crs/natsec/R43767.pdf.
xvii 45 C.F.R. § 101.50.
xviii 45 C.F.R. § 101.53
xix Id. at. § 101.62
xx Id. at § 101.55
xxi 50 U.S.C.§ 4514(a)
xxii Id. at § 4513
xxiii 85 Fed. Reg. 17001 (March 23, 2020)
xxiv 50 U.S.C.§ 4512
xxv Id.
xxvi Id.
xxvii DHHS, Notice of Designation of Scarce Materials or Threatened Materials Subject to COVID-19 Hoarding Prevention Measures Under Executive Order 13910 and Section 102 of the Defense Production Act of 1950, at https://www.hhs.gov/sites/default/files/hhs-dfa-notice-of-scarce-materials-for-hoarding-prevention.pdf.
xxviii 85 Fed. Reg. 17001 (March 23, 2020)
xxix 50 U.S.C.§ 4554,4555, 4556 and 4560.
xxx Id. at § 4513.
xxxi Remarks of Attorney General Barr, March 23, 2020, at https://video.foxbusiness.com/v/6144329476001/#sp=show-clips.
xxxii 85 Fed. Reg. 18403 (March 27, 2020).
xxxiii 50 U.S.C.A. § 4517. The DPA authority to restrict solicitations overlaps other authorities set forth in the procurement laws.
xxxiv Id. at § 4531, 4532 and 4533.
xxxv For some reason, the EO did not grant DHS the DPA Implementation Authorities in connection with this delegation.
xxxvi See https://www.whitehouse.gov/presidential-actions/memorandum-order-defense-production-act-regarding-general-motors-company/.
xxxvii See https://www.nytimes.com/2020/03/30/business/gm-ventilators-coronavirus-trump.html
xxxviii See https://www.whitehouse.gov/presidential-actions/memorandum-order-defense-production-act-regarding-purchase-ventilators/.
xxxix Remarks of Peter Navarro at Task Briefing of April 2, 2020, at https://www.rev.com/blog/transcripts/donald-trump-coronavirus-task-force-briefing-april-2.
xl FAR § 1.602-2(b).
xli Id. at § 1.602-1(a).
xlii 41 U.S.C. § 7101-7109.
xliii There is extensive case law concerning jurisdictional issues under the CDA and FAR 52.233-1. Discussion of this case law is beyond the scope of this article. Contractors should refer to this law and consult with counsel as appropriate prior to filing claims.
xliv Centex Corp. v. United States, 395 F.3d 1283, 1304 (Fed. Cir. 2005).
xlv 41 U.S.C. § 7101-7109.

The government contracting community is awaiting the procurement policies of the Trump Administration with a mixture of excitement and anxiety. The excitement arises from the prospect that he will fulfill his promise to ease the compliance burdens associated with government contracting regulations, which increased markedly under President Obama. For example:

• During his term President Obama issued 11 separate executive orders aimed specifically at regulating contractor behavior.I Nine of these executive orders affected contractor labor practices.
• Mr. Obama also issued two Presidential Memoranda concerning federal procurement policies.
• The words in the Federal Acquisition Regulation (FAR) Part 22, Application of Labor Laws to Government Acquisitions, increased by 64%.II
• The words in FAR Part 23, Environment, Energy and Water Efficiency, Energy, increased by 39% in this period.III

While the new regulations may have advanced some laudable public policies, the increased compliance burdens made it more difficult and risky for contractors to do business with the government, Indeed, in a letter sent to the White House in August 2015, the National Defense Industrial Association, the Aerospace Industries Association, the Professional Services Council and the Information Technology Industry Council asked that “no further presidential directives primarily focused on government contractors be issued for the foreseeable future.” The trade associations stated that “[a]t a time when government budgets are under siege, cost efficiency is essential, and there is a broad agreement about the need for the government to open its aperture to enable access to the full marketplace of capabilities, this rapid growth in compliance requirements is becoming untenable.”IV Therefore, many contractors are eagerly anticipating President Trump’s fulfillment of his promise to eliminate “illegal and overreaching” executive orders and “wasteful and unnecessary” regulationsV imposed by the Obama administration.

 Contractors are also eagerly anticipating new spending on infrastructure, homeland security and national defense. For example:

• In his inaugural address, President Trump promised to “build new roads and highways and bridges and airports and tunnels and railways all across our wonderful nation. We will get our people off of welfare and back to work, rebuilding our country with American hands and American labor.” VI
• Famously (or infamously depending on the perspective), he also proposed a public construction project to build a wall along our Mexican Border.VII
• He has indicated a willingness to increase defense spending, including spending to increase the Navy’s ships to 350, add 100 Air Force fighter planes, increase the size of the Army by 90,000 soldiers and strengthen nuclear and missile defenses.VIII
• Based on his comments about cybersecurity, there is an expectation for increased on cybersecurity contracts.

Despite the excitement, these is also anxiety concerning certain comments the president made during the transition. For example:

• On December 6, 2016, Mr. Trump posted on Twitter that “Boeing is building a brand new 747 Air Force One for future presidents, but costs are out of control, more than $4 billion. Cancel order!”IX
• In an interview on December 7, the President-elect said he would personally negotiate with Boeing the prices of the planes to be used as replacements for Air Force One, promising to block future orders if necessary and to continue using the existing aircraft for the presidential plane.X
• On December 12, 2016, Mr. Trump posted that “the F-35 [fighter jet] program and cost is out of control. Billions of dollars can and will be saved on military (and other) purchases after January 20th.”XI

While the president’s involvement in government contract negotiations would not be illegal per se, there is concern that that it could be counterproductive, For example, Professor Steven Schooner of the George Washington University’s Government Procurement Law Program expressed concern in an interview with Politico that the prospect of an early morning presidential tweet criticizing a procurement would cause Contracting Officers (“COs”) to exercise additional caution in negotiations, thereby slowing down the award process. Likewise, retired Adm. Dave Oliver, who was a top acquisition official in the Defense Department in the 1990s, was quoted as saying presidential comments could frighten “some fifth-level auditor who is going to say ‘goodness gracious, maybe I ought to look at whoever he is attacking at the moment,”XII potentially leading to politically motivated and/or unnecessary audit costs for the government and industry. In addition, a public statement by the president against a government contractor’s pricing without full knowledge of the risks reflected in that pricing could put the contractor in the difficult position of having to choose between bad publicity associated with failing to give in to the president’s demand or risking potentially crippling losses on a government program. Either way, the stakeholders of the contractors would be likely to lose.

 The president’s Executive Order imposing a hiring freeze on civilian agencies is also a source of anxiety. The concern is that if an agency is unable to hire an adequate number of acquisition professionals, the quality and timeliness of procurements will be degraded.XIII

 Of course, only the passage of time and analysis of the Trump Administration’s behavior will reveal whether or not these emotions are justified. In the meantime, contractors are well advised to keep a close eye on the government contracts policy environment and to prepare plans to take advantage of the changes that are on the horizon.

Background. The Privacy Act of 1974 (the “Act”) establishes controls over the collection and maintenance by federal agencies of information about individuals. In particular, it applies to any agency “system of records” containing personally identifiable information – i.e., a collection of information about individuals that contains individual names or other identifying information, such as social security number, driver’s license number or phone number, from which information is retrieved by the name of the individual or by other identifying information. For example, the Privacy Act would apply to the Department of Education’s databases of student loan information, the Department of Justice’s criminal history records, the Office of Personnel Management’s records of the employment history of federal employees and clinical research records of the National Institutes of Health, to the extent agencies retrieve information from these records by the name or other identifying information of an individual.XIV

The key provisions of the Act require agencies to:XV

• Maintain only such information that is both relevant and necessary to accomplish a purpose of the agency required to be accomplished by Federal statute or by Executive Order;
• Collect information to the greatest extent practicable directly from the subject individual;
• Inform each individual whom it asks to supply information with a Privacy Act Statement;
• Limit disclosures of information to authorized purposes set forth in the Act;
• Maintain all records used by the agency about an individual with such accuracy, relevance, timeliness, and completeness to assure fairness to the individual;
• Maintain no record describing how any individual exercises their First Amendment rights, unless authorized by law.
• Establish “rules of conduct” for persons involved in the design, development, operation, or maintenance of any system of records; and the consequences of non-compliance.
• Establish appropriate physical, technical, and administrative safeguards for the security and accuracy of records to prevent substantial harm, embarrassment, inconvenience, or unfairness to any individual on whom information is maintained.
• Publish in the Federal Register a Systems of Records Notice (“SORN”) XVI, which includes detailed information about the system, policies and practices of the agency regarding storage, retrievability, access controls, retention, and disposal of the records and the agency procedures whereby an individual can be notified at his request if the system of records contains a record pertaining to him/her

The Act states that “when an agency provides by a contract for the operation by or on behalf of the agency of a system of records to accomplish an agency function” the agency must apply the requirements of the act to such system. XVII Agencies tend to do this in two ways. First, agencies will often include a special contract clause requiring the contractor to comply with the SORN issued by the agency for the system. Second, agencies will include in the contract FAR § 52.224-2, Privacy Act, which requires the contractor to comply with the Act and the agency’s implementing regulations. Notably, that clause does not require contractors to conduct training of their employees on the Privacy Act.

 Contractors can face civil or criminal penalties for violations of the Act.

 The New Rule. On December 20, 2016, the FAR Council issued a final rule adding new FAR § 52.224-3, Privacy Training, which requires contractors to conduct initial and annual Privacy Act training for employees who— (1) have access to a system of records; (2) create, collect, use, process, store, maintain, disseminate, disclose, dispose, or otherwise handle personally identifiable information on behalf of an agency; or (3) design, develop, maintain, or operate a system of records. The training must be “role-based, provide foundational as well as more advanced levels of training, and have measures in place to test the knowledge level of users.

At a minimum, the training must cover:

• The provisions of the Privacy Act of 1974 (5 U.S.C. 552a), including penalties for violations of the Act;
• The appropriate handling and safeguarding of personally identifiable information;
• The authorized and official use of a system of records or any other personally identifiable information;
• The restriction on the use of unauthorized equipment to create, collect, use, process, store, maintain, disseminate, disclose, dispose or otherwise access personally identifiable information;
• The prohibition against the unauthorized use of a system of records or unauthorized disclosure, access, handling, or use of personally identifiable information; and
• The procedures to be followed in the event of a suspected or confirmed breach of a system of records or the unauthorized disclosure, access, handling, or use of personally identifiable information

In addition:

• The new clause requires contractors to maintain records reflecting that its employees have completed the requisite training and to provide these records to the CO upon request.
• The Contractor may not allow any employee access to a system of records, or permit any employee to create, collect, use, process, store, maintain, disseminate, disclose, dispose or otherwise handle personally identifiable information, or to design, develop, maintain, or operate a system of records unless the employee has completed privacy training, as required by the clause.
• The prime contractor must flow-down these requirements to all applicable subcontracts.XVIII

While the rule is effective January 19, 2017, the contract clause will not apply to current contracts until and unless the CO issues a modification adding the clause to the contract. If a CO attempts to do this, contractors should consult with counsel about whether to demand consideration from the government for the change. In any case, contractors submitting proposals for new contracts that involve systems of records should expect to see the new clause in the request for proposal and make plans to comply with its requirements.

To date, DoD has issued three final rules to implement various provisions in the National Defense Authorization Acts for fiscal years 2012, 2013, 2015 and 2016 intended to combat counterfeiting in DoD supply chains for electronic parts. The first rule, issued on May 6, 2014, imposed three major new requirements:

1. It required inclusion of a new contract clause in prime contracts subject to the Cost Accounting Standards (“CAS”) that involve supply of electronics parts, either as end items or in assemblies.  The new clause, Defense Federal Acquisition Regulation Supplement (“DFARS”) § 252.246-7007, Contractor Counterfeit Electronic Parts Detection and Avoidance System, requires contractors to “establish and maintain an acceptable counterfeit electronic part avoidance and detection system.”  To be considered acceptable, contractor systems must include risk-based policies and procedures addressing twelve specific criteria.  Contractors must “flow down” the clause to all subcontracts in all tiers of the supply chain that are for electronic parts.  There are no exceptions for subcontracts for commercial items or with small businesses.
2. The rule revised DFARS § 252.244-7001, Contractor Purchasing System Administration, to provide that a CAS covered contractor’s failure to maintain an acceptable counterfeit electronics detection and avoidance system can result in government disapproval of the contractor’s purchasing system and withholding of up to 5% of contract payments pending correction of significant deficiencies.
3. The rule added DFARS § 231.205-71, Cost of Remedy for Use or Inclusion of Counterfeit Electronic Parts and Suspect Counterfeit Electronic Parts, which made unallowable the cost of counterfeit and suspect counterfeit electronic parts and the cost of rework or corrective action to remedy use or inclusion of such for all contractors unless: (1) the parts were provided to the contractor as “government furnished property” in accordance with FAR Part 45.101; (2) the contractor has an operational system to detect and avoid counterfeit parts and suspect counterfeit electronic parts that has been reviewed and approved by DoD; and (3) the contractor provides timely notice to the government.XIX

The second rule, which was effective on August 2, 2016, has a broader reach than the first rule. Whereas the first rule focused on imposing requirements for counterfeit avoidance systems in large CAS covered contractors, the second rule imposes sourcing requirements on all contractors and subcontractors that supply electronic parts to promote the supply of authentic parts. The requirements are set forth in a new clause – DFARS § 252.246-7008, Sources of Electronic Parts – that covers three different sourcing scenarios:

1. If the required electronic parts are still in production by the original manufacturer or an authorized aftermarket manufacturer or currently available in stock, the contractor/subcontractor must obtain the parts from (i) the original manufacturers of the parts; (ii) their authorized suppliers (including aftermarket manufacturers); or (iii) suppliers that obtain such parts exclusively from the original manufacturers of the parts or their authorized suppliers.  These are referred to as “Category One Sources.”
2. If electronic parts are not available from a Category One Source, the contractor/subcontractor must obtain the part from a “contractor approved supplier” that “has been identified as trustworthy by a contractor or subcontractor” based on “established counterfeit prevention industry standards and processes (including inspection, testing and authentication).”  These are referred to as “Category Two Sources.”  Notably, the new clause makes the contractor/subcontractor responsible for the authenticity of parts obtained from Category Two Sources and gives the CO the right to review and audit the selection decisions for such sources.
3. If the part is not available from a Category One or Two Source, the contractor/subcontractor may procure the part from another source (referred to as a “Category Three Source”) but must promptly notify the CO and take responsibility for and document the inspection, testing and authentication of the part in accordance with industry standards.  According to the promulgation comments, “the notice originates with whatever entity (prime contractor or subcontractor) is making the purchase, and is passed up to the contracting officer through the intervening subcontract tiers and the prime contractor. Documentation of inspection, testing, and authentication of such electronic parts is only required to be furnished to the Government upon request . . . The rule does not require approval for use of Category 3 sources.”

The new clause also requires inspection, testing and authentication of electronic parts when: (1) a contractor/subcontractor cannot confirm that a part from a Category One or Category Two Source is new and has not been comingled with used, refurbished, reclaimed or returned parts; (2) the contractor/subcontractor cannot establish traceability from the original manufacturer for the part, or; (3) a subcontractor refuses flow down of the clause. The contractor/subcontractor must maintain documentation of all inspection, testing, authentication and traceability information and make such information available to the CO upon request. Flow down of the clause is required at all tiers in “all subcontracts, including subcontracts for commercial items that are for electronic parts or assemblies containing electronic parts, unless the subcontractor is the original manufacturer.”

 The second rule also includes changes to the policy guidance in DFARS § 246.870, Contractors’ Counterfeit Electronic Part Detection and Avoidance, and a new version of DFARS § 252.246-7007 that cross references and coordinates with the new sourcing requirements set forth in DFARS § 252.246-7008. Finally, the rule includes guidance concerning the applicability of the new clause to purchases form the Federal Supply Schedule, Defense Microelectronics Activity or from government stock.XX

The third rule, which was effective on August 30, 2016, changed the cost allowability provisions promulgated in the first rule. In particular, the rule added to DFARS § 231.205-71 additional exceptions to the general rule that the costs of counterfeit electronic parts and suspect counterfeit electronic parts and the costs of rework or corrective action that may be required to remedy the use or inclusion of such parts are unallowable. Under the new exceptions, such costs are allowable (subject to the general rules on allowability in FAR Subpart 31.2) if:

1. The parts were obtained by the contractor in accordance with new DFARS § 252.246-7008, Sources of Electronic Parts; or
2. The contractor—
3. Becomes aware of the counterfeit electronic parts or suspect counterfeit electronic parts through inspection, testing, and authentication efforts of the contractor or its subcontractors; through a Government Industry Data Exchange Program (“GIDEP”) alert; or by other means; and
4. Provides timely (i.e., within 60 days after the contractor becomes aware) written notice to—(A) The cognizant contracting officer(s); and (B) GIDEP (unless the contractor is a foreign corporation or partnership that does not have an office, place of business, or fiscal paying agent in the United States; or the counterfeit electronic part or suspect counterfeit electronic part is the subject of an on-going criminal investigation).XXI

Additional rule making is expected in the coming months.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

I Jones Day, “Government Contracts Ramifications of the Trump Election” at http://www.jonesday.com/government-contracts-ramifications-of-the-trump-election-12-12-2016/

II This is based on a comparison of words in Part 22 as of October 1, 2008 (35,593) and as of January 18, 2017 (58,522).

III This is based on a comparison of words in Part 23 as of October 1, 2008 (7,051) and as of January 18, 2017 (9,817.)

IV Lydia Wheeler, “Trade Groups Ask White House to Stop Creating Regs for Contractors”; The Hill (August 12, 2015) at http://thehill.com/regulation/250946-trade-groups-ask-wh-to-hold-up-on-executive-orders /

V See https://www.donaldjtrump.com/policies/regulations

VI “America First’: Full Transcript and Video of Donald Trump’s Inaugural Address”; The Wall Street Journal (January 21, 2016) at http://blogs.wsj.com/washwire/2017/01/20/america-first-full-text-of-donald-trumps-inaugural-address/

VII Peter Andreas, “Yes, Trump will build his border wall. Most of it is already built”; Washington Post” (November 21, 2016) at https://www.washingtonpost.com/news/monkey-cage/wp/2016/11/21/yes-trump-will-build-his-border-wall-most-of-it-is-already-built/?utm_term=.82793a012679

VIII Charles Tiefer, “President Trump Is Likely To Boost U.S. Military Spending By $500 Billion To $1 Trillion”; Forbes (November 9, 2016) at http://www.forbes.com/sites/charlestiefer/2016/11/09/president-trump-is-likely-to-boost-u-s-military-spending-by-500-billion-to-1-trillion/#503d41834108

IX Donald Trump at https://twitter.com/realDonaldTrump/status/806134244384899072.

X Damian Paletta and Daniel Nasaw, “Donald Trump Says He Will Personally Negotiate Air Force One Price With Boeing”; The Wall Street Journal (December 7, 2016); http://www.wsj.com/articles/trump-says-he-will-personally-negotiate-air-force-one-price-with-boeing-1481120870,

XI Donald J. Trump at https://twitter.com/realDonaldTrump/status/808301935728230404?ref_src=twsrc%5Etfw.

XII Danny Vinik, “Trumps $400 Billion Weapon: The President-Elect Appears Set on Becoming Personally Involved in the Contracting Process: How Far Can He Actually Go?”; Politco (December 22, 2016) at http://www.politico.com/agenda/story/2016/12/trump-federal-contracts-weapon-000262,

XIII See .https://www.washingtonpost.com/apps/g/page/politics/executive-order-on-federal-hiring-freeze/2157/?tid=a_inl.

XIV 5 U.S.C.A. § 552a

XV This list is based on Defense Logistics Agency, “Privacy Act 101:Privacy Awareness Training” at www.dla.mil/LinkClick.aspx?fileticket=vfav84q9SSM%3D&tabid=18088

XVI For a collection of Privacy Act SORNs, see https://www.gpo.gov/fdsys/browse/collection.action?collectionCode=PAI&browsePath=2015&isCollapsed=false&leafLevelBrowse=false&isDocumentResults=true&ycord=0 XVII 5 U.S.C.A. § 552a(m)(1)

XVIII 81 Fed. Reg. 93481 (December 20, 2016)

XIX See 79 Fed. Reg. 26092 (May 6, 2014)

XX 81 Fed. Reg. 50635 (August 2, 2016).

XXI 81 Fed. Reg. 59510 (August 30, 2016)

On May 7, 2015, the Federal Acquisition Regulatory Council (the “FAR Council”) finalized changes to the Federal Acquisition Regulation (“FAR”) implementing new Department of Labor (“DOL”) rules regarding federal contractors’ employment of veterans. The major changes in the new rules involve: 

• New mandatory benchmarks for hiring of veterans;

• Changes to affirmative action program content;

• Amendments of rules relating to job listings;

• Expanded DOL access to contractor records; and

• Requirements for pre-award compliance evaluations.

Federal contractors should be familiar with these new rules and implement necessary changes to ensure compliance. The purpose of this article is to provide an overview of the new rules. Background. In 1974, Congress enacted the Vietnam Era Veterans’ Readjustment Assistance Act—commonly known as VEVRAA—for the purpose of expanding civilian employment opportunities for military veterans.II Despite its name, the scope of VEVRAA is not limited to Vietnam veterans, but applies to other veterans as well, including veterans who may be classified as “disabled veterans,” “recently separated veterans,” “active duty wartime or campaign badge veterans,” or “Armed Forces service medal veterans.”III Generally, VEVRAA prohibits federal contractors and subcontractors from discriminating against veterans in hiring and employment, and requires contractors to take certain affirmative steps to employ and advance veterans. The Department of Labor’s Office of Federal Contract Compliance Programs (OFCCP) is responsible for adopting regulations to implement and enforce the requirements of VEVRAA. The FAR Council is responsible for implementing the OFCCP rules in the Federal Acquisition Regulation.

On September 24, 2013, OFCCP published new rules relating to VEVRAA (the “New DOL Rules”).IV On July 25, 2014, the FAR Council issued an interim rule to amend the FAR to implement these changes. The interim rule included a new version of FAR § 52.222–35, Equal Opportunity for Veterans, dated July 2014. However, the revised clause did not repeat the entirety of the New DOL Rules. Rather, the FAR clause provided a citation to the prescribed clause in the DOL regulations and included a high level statement that summarizes the contractor’s obligations under that clause.V On May 7, 2015, the FAR Council issued a final rule adopting without change the interim rule.VI

Hiring benchmarks. The New DOL Rules include a new section of Title 41 of the Code of Federal Regulations, 41 C.F.R. § 60-300.45, which requires federal contractors to establish benchmarks for hiring veterans. Contractors may either use the national percentage of veterans in the civilian labor force as a benchmark or establish their own hiring benchmark.VII The simpler option is to use the national percentage of veterans in the workforce, which is published by OFCCP on its website. The percentage is currently 7.2%. Alternatively, if a contractor wishes to establish its own benchmark, it must do so based on the following factors that are outlined in the regulation:

• The average percentage of veterans in the civilian labor force in the State(s) where the contractor is located over the preceding three years, as calculated by the Bureau of Labor Statistics and published on the OFCCP Web site;
• The number of veterans, over the previous four quarters, who were participants in the employment service delivery system in the State where the contractor is located, as tabulated by the Veterans’ Employment and Training Service and published on the OFCCP Web site;
• The applicant ratio and hiring ratio for the previous year, based on the data collected pursuant to [41 C.F.R.] § 60–300.44(k);
• The contractor’s recent assessments of the effectiveness of its external outreach and recruitment efforts, as set forth in [41 C.F.R.] § 60–300.44(f)(3); and
• Any other factors, including but not limited to the nature of the contractor’s job openings and/or its location, which would tend to affect the availability of qualified protected veterans.VIII

Contractors must “document” the hiring benchmarks they set each year and keep records relating to the benchmarks for a three-year period.IX If a contractor elects to devise its own benchmark, it must “document” its consideration of each of the above factors.X

These benchmarks are not considered “quotas,” and contractors may not use them as quotas.XI Nor are they to be considered “a ceiling or a floor” for hiring of veterans.XII “The purpose of establishing benchmarks is to create a quantifiable method by which the contractor can measure its progress toward achieving equal employment opportunity for protected veterans.”XIII According to OFCCP, “contractors have significant flexibility to set their own benchmarks, and will not be cited for violations solely for failing to meet the benchmarks.”XIV Essentially, the regulation requires contractors to establish a “yardstick” by which to measure their hiring of veterans and requires them to keep and maintain records of their success or failure in meeting the benchmarks.

Affirmative Action Program Content. Contractors with contracts valued at $100,000 or more and 50 or more employees must continue under the New DOL Rules to prepare written affirmative action programs (“AAPs”) for the employment of veterans. However, the New DOL Rules include significant changes to the requirements concerning the content of AAPs. For example:

• The AAP must now indicate the support of the contractor’s top United States executive for the affirmative actions required by the AAP.
• The notice to employees required by the AAP concerning the contractor’s affirmative action commitment must be in a form that is understandable to the disabled veteran (e.g., in Braille or large print and/or posted to enable visual accessibility to persons in wheelchairs).
• Contractors must include in the AAP additional language concerning internal procedures they will use to communicate to employees their obligation to engage in affirmative action efforts to employ and advance in employment qualified protected veterans.XV

Job listings. The New DOL Rules do not change the previous requirement that contractors list all employment openings at the time of execution of the contract with the state workforce agency job bank or local employment service delivery system where the opening exists. However, the rules add a new requirement that the contractor inform such establishments that: “(a) it is a Federal contractor, so that the employment service delivery systems are able to identify them as such; and (b) it desires priority referrals from the state of protected veterans for job openings at all locations within the state.” The contractor must also provide to the employment service delivery system the name and location of each hiring location within the state and the contact information for the contractor official responsible for hiring at each location.XVI

Access to Records. The New DOL Rules change requirements for contractors to provide access to OFCCP to records documenting compliance with VEVRAA and its implementing regulations. Whereas the previous rules required contractors to give access to records to OFCCP at the contractor’s facilities, under the New DOL Rules contractors must also provide OFCCP electronic access to these materials. In addition, upon request, the contractor must provide OFCCP information concerning all format(s), including specific electronic formats, in which the contractor maintains its records and other information. The contractor must provide records and other information in any of the formats in which they are maintained, as selected by OFCCP.XVII

Pre-Award Compliance Evaluations. The New DOL Rule adds a new requirement that OFCCP conduct pre-award VEVRAA compliance evaluations for each contract and subcontract valued at $10 million or more “unless OFCCP has conducted an evaluation and found them to be in compliance with VEVRAA within the preceding 24 months.”XVIII The procedures for these evaluations are as follows:

The awarding agency will notify OFCCP and request appropriate action and findings in accordance with this subsection. Within 15 days of the notice OFCCP will inform the awarding agency of its intention to conduct a pre-award compliance evaluation. If OFCCP does not inform the awarding agency within that period of its intention to conduct a pre-award compliance evaluation, clearance shall be presumed and the awarding agency is authorized to proceed with the award. If OFCCP informs the awarding agency of its intention to conduct a pre-award compliance evaluation, OFCCP will be allowed an additional 20 days after the date that it so informs the awarding agency to provide its conclusions. If OFCCP does not provide the awarding agency with its conclusions within that period, clearance will be presumed and the awarding agency is authorized to proceed with the award.xix

“Flow Down” to Subcontracts. There was no change to the previous requirement that contractors include FAR § 52.222-35 in all subcontracts of $100,000 or more, including subcontracts for “commercial items” as defined in FAR 2.101. However, the changes to the FAR clarified that flow down of the companion clause at FAR § 52.222-37, Employment Reports on Veterans, is mandatory for commercial item subcontracts.

Effectivity. The New DOL Rules took effect on March 24, 2014. Contractors should note that the New DOL Rules include the following provision:

(e) Incorporation by operation of the Act [VEVRAA]. By operation of the Act, the equal opportunity clause shall be considered to be a part of every contract and subcontract required by the Act and the regulations in this part to include such a clause, whether or not it is physically incorporated in such contract and whether or not there is a written contract between the agency and the contractor.xx

Thus, it appears that DOL believes that the changes apply to federal contracts and subcontracts whether or not the agreement is modified to include the new version of FAR § 52.222-35.

Conclusion. The New DOL Rules as implemented in the FAR make significant changes to the obligations of contractors and subcontractors to take affirmative action to offer equal employment opportunities to veterans. The discussion above is only a summary of some of the major changes. To ensure full compliance, contractors should engage their human resource departments and external resources as necessary to fully understand and implement the changes.

Cost reimbursement type government contracts include a clause stipulating that the government will only reimburse costs that are allowable under the “Cost Principles” set forth in FAR Subpart § 31.2. See Federal Acquisition Regulation (“FAR”) § 52.216-7, Allowable Cost and Payment. Under FAR § 52.242-3, Penalties for Unallowable Costs, the government can penalize contractors that include expressly unallowable costs in final indirect cost rate proposals for completed fiscal years. On January 7, 2015, the DCAA issued an audit alert “enhancing” previously issued guidance to auditors regarding how to identify expressly unallowable costs (the “Alert”).XXI


The Alert notes that Cost Principles tend to fall into one of three groups. The first group consists of those principles that provide broad and general criteria for assessing the allowability of costs. For example, FAR § 31.205-6, Compensation for Personal Services, provides that compensation for individual employees is allowable only if it is “reasonable for the work performed.” The second group has principles that specifically and expressly make certain costs unallowable. For example, FAR § 31.205-51, Costs of Alcoholic Beverages, states that “alcoholic beverages are unallowable.” The third group of Cost Principles includes those principles that do not expressly state that a cost is unallowable but provide criteria that leave little room for interpretation concerning allowability determinations. For example, paragraph (d)(1) of FAR § 31.205-13, Employee Morale, Health, Welfare, Food Service and Dormitory Costs, provides that losses for operating food services for employees are allowable “only if the contractor’s objective is to operate such services on a break even basis” (emphasis added).

Under the guidance in the Alert DCAA auditors must treat costs covered by the second and third group of Cost Principles as expressly unallowable:

In order for a cost to be expressly unallowable, the Government must show that it was unreasonable under all the circumstances for a person in the contractor’s position to conclude that the costs were allowable. Thus, a cost principle makes costs expressly unallowable if: 1. It states in direct terms that the costs are unallowable, or leaves little room for differences of opinion as to whether the particular cost meets the allowability criteria; and 2. It identifies the specific cost or type of costs in a way that leaves little room for interpretation.xxii

The Alert also includes a set of examples applying the above tests. The earlier guidance issued by FCAA includes other examples.xxiii

 Commentary on the Alert has been mixed. One commentator stated that the Alert “should help the parties navigate the murky waters of unallowable costs and penalties thereon.”xxiv Another commentator questioned the need for DCAA to issue any guidance on the subject at all. In his view, the definition in Cost Accounting Standard (“CAS”) No. 405, Unallowable Costs, provides sufficient guidance. That definition states that “expressly unallowable cost” means “a particular item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable.”XXV

On May 6, 2014, DoD issued a final rule that imposes significant new anti-counterfeiting requirements on the DoD supply chain for electronic parts.

First, the rule, which implements certain requirements of the National Defense Authorization Acts (“NDAAs”) for fiscal years 2012 and 2013, requires inclusion of a new contract clause in prime contracts subject to the Cost Accounting Standards (“CAS”) set forth at 48 C.F.R.§ 9903.201-1. The new clause prescribed by the rule, Defense Federal Acquisition Supplement (“DFARS”) 252.246-7007, Contractor Counterfeit Electronic Parts Detection and Avoidance System, requires contractors to “establish and maintain an acceptable counterfeit electronic part avoidance and detection system.” To be considered acceptable, contractor systems must include risk-based policies and procedures addressing: 

• training;
• inspection and testing of electronic parts, including criteria for
• acceptance and rejection;
• processes to abolish counterfeit parts proliferation;
• processes to maintain electronics parts traceability;
• use of suppliers that are the original manufacturer, or sources with the express written authority of the original manufacturer or current design activity;
• quarantining and reporting to the CO and Government Industry Data Exchange Program (“GIDEP”) of counterfeit electronic parts and suspect counterfeit electronic parts;
• methodologies to identify suspect counterfeit parts and to rapidly determine if a suspect counterfeit part is, in fact, counterfeit;
• design, operation, and maintenance of systems to detect and avoid counterfeit electronic parts and suspect counterfeit electronic parts;
• the flow down of counterfeit avoidance and detection requirements to subcontractors;
• process for keeping continually informed of current counterfeiting information and trends;
• process for screening GIDEP reports and other credible sources of counterfeiting information to avoid the purchase or use of counterfeit electronic parts; and
• control of obsolete electronic parts in order to maximize the availability and use of authentic, originally designed, and qualified electronic parts throughout the product’s life cycle.

The new clause contains guidance for compliance with each of these criterion. Following are key definitions set forth in the clause: 

Electronic part means an integrated circuit, a discrete electronic component (including, but not limited to, a transistor, capacitor, resistor, or diode), or a circuit assembly . . . . The term ‘‘electronic part’’ includes any embedded software or firmware.

Counterfeit electronic part means an unlawful or unauthorized reproduction, substitution, or alteration that has been knowingly mismarked, misidentified, or otherwise misrepresented to be an authentic, unmodified electronic part from the original manufacturer, or a source with the express written authority of the original manufacturer or current design activity, including an authorized aftermarket manufacturer. Unlawful or unauthorized substitution includes used electronic parts represented as new, or the false identification of grade, serial number, lot number, date code, or performance characteristics.

Suspect counterfeit electronic part means an electronic part for which credible evidence (including, but not limited to, visual inspection or testing) provides reasonable doubt that the electronic part is authentic.

Importantly, while DoD COs will only include the new clause in CAS covered contracts, covered prime contractors must “flow down” the clause to all subcontracts in all tiers of the supply chain that are for electronic parts or assemblies containing electronic parts regardless of whether the subcontracts are CAS covered. There are no exception for subcontracts for commercial items or with small businesses.XXVI

Second, the rule revises DFARS 252.244-7001, Contractor Purchasing System Administration, to provide that a contractor’s failure to maintain an acceptable counterfeit electronics detection and avoidance system can result in government disapproval of the contractor’s purchasing system and withholding of up to 5% of contract payments pending correction of significant deficiencies.XXVII

Third, the rule makes unallowable the cost of counterfeit and suspect counterfeit electronic parts and the cost of rework or corrective action to remedy use or inclusion of such parts unless: (1) the parts were provided to the contractor as “government furnished property” in accordance with FAR Part 45.101; (2) the contractor has an operational system to detect and avoid counterfeit parts and suspect counterfeit electronic parts that has been reviewed and approved by DoD; and (3) the contractor provides timely notice to the government.XXVIII

Since DoD issued the new rule, anti-counterfeiting experts have been busy helping contractors to meet compliance challenges of the rule, including especially the challenges associated with acquiring parts from suppliers who are not authorized distributors of the original component manufacturer’s (“OCM’s”). To address those circumstances, the organization must establish systems and procedures to obtain and evaluate the integrity of supply chain traceability information back to the OCM or perform testing necessary to determine whether the parts are genuine.XXIX

The foregoing reflections were prepared for the general information of clients and other friends of the Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

I This article was jointly authored by Christopher C. Bouquet of the Law Office of Christopher C. Bouquet, PLLC and Joseph Creed of Joseph, Greenwald & Laake, PA.

II VEVRAA was amended by the Jobs for Veterans Act of 2002.
III 41 C.F.R. § 60-300.2
IV Fed. Reg. 58614-01 (Sept. 24, 2013).
V 79 Fed. Reg. 43575 (July 25, 2014)
VI 80 Fed. Reg. 26423 (May 7, 2015).
VII 41 C.F.R. § 60-300.45(b).
VIII 41 C.F.R. § 60-300.45(b)(2).
IX 41 C.F.R. § 60-300.45(c).
X 41 C.F.R. § 60-300.45(c).
XI Under the new regulation, “[q]uotas are expressly forbidden.” 41 C.F.R. § 60-300.45.
XII 41 C.F.R. § 60-300.45.
XIII 41 C.F.R. § 60-300.45(a)
XIV 78 Fed. Reg. 58614-01.
XV 41 C.F.R. § 60-300.44
XVI 41 C.F.R. § 60–300.5
XVII 41 C.F.R. § 60–300.81
XVIII 41 CFR § 60-300.61
XIX 41 CFR § 60-300.61
XX 41 C.F.R. § 60–300.5
XXI See http://www.dcaa.mil/mmr/14-PAC-022.pdf.
XXII Id.
XXIII Id.
XXIV See http://www.apogeeconsulting.biz/index.php?option=com_content&view=article&id=1015:dcaa-continues-to-issue-good-audit-guidance-on-expressly-unallowable-costs&catid=1:latest-news&Itemid=55
XXV See http://www.crowell.com/NewsEvents/All/DCAA-Issues-MisGuidance-on-Expressly-Unallowable-Costs.
XXVI See 79 Fed. Reg. 26092 (May 6, 2014).
XXVII Id.
XXVIII Id.
XXIX See http://counterfeitparts.sae.org/articles/ 

On September 3, 2013, new rules concerning past performance evaluations took effect. The new rules, which amend FAR Part 42.15, Contractor Performance Information, establish standardized Government-wide processes, evaluation factors and rating scales. I


The new rules do not change the requirement that agencies perform evaluations for each contract and order under a multi-agency contract that exceeds the simplified acquisition threshold or the rules governing the process by which contractors can rebut adverse past performance evaluations.. However, the new rules make two major changes to the processes for completing evaluations. First, while the old rules required the Contracting Officer (“CO”) to complete interim evaluations “as specified by the agency”, the new rules require the CO to complete such evaluations “at least annually”. Second, COs must now enter past performance information into the Contractor Performance Assessment Reporting System (“CPARS”), the single Government – wide past performance reporting system.

Following are the new standardized past performance evaluation factors that COs must use to evaluate contractors:

• technical;

• cost control (not applicable to firm fixed price and fixed price

• contracts with economic price adjustment);

• schedule/timeliness;

• management or business relations; and

• small business subcontracting.

COs have latitude to evaluate contractors based on other factors such as terminations, suspensions, debarments and late payment or nonpayment of subcontractors. II
 
COs must rate contractor performance for each factor in accordance with a standardized five scale rating system – i.e., exceptional, very good, satisfactory, marginal and unsatisfactory – and provide a supporting narrative for each rating. The new rules include tables providing detailed definitions of each of these ratings. If the contract provides for incentive or award fees, the CO must also enter the fee evaluation into CPARS. III

 Given the importance of past performance information to winning new contracts, contractors should undertake a thorough review of the new rules.

On August 27, 2013, a significant new Small Business Administration (“SBA”) rule concerning program eligibility representations took effect. IV The rule, which implements provisions of the Small Business Jobs Act of 2010 (the “Act”), will make it easier for the government to punish small businesses that willfully misrepresent their eligibility for such programs. In addition, the rule imposes new requirements on the process for making these representations.

Background. Procuring agencies are responsible for administering SBA programs that provide procurement preferences to small businesses – i.e., the “Section 8(a)” business development program for socially and economically disadvantaged small businesses, the small disadvantaged business “evaluation preference” program, service disabled veteran owned small business set asides; historically underutilized business zone set asides, woman owned small business (“WOSB”) set asides, economically disadvantaged WOSB set asides, general small business set asides open to any type of small business and the “Section 8(d) small business subcontracting program . However, these agencies do not have the resources to verify independently whether a concern qualifies as a small business for these programs. Applicant concerns, therefore, must submit representations to the procuring agency of their eligibility for the programs. The Government, in turn, relies on the veracity of these representations when making contract awards under these programs.

Punishment of Contractors for Misrepresentations. The government has always had the power to take action against contractors for knowing misrepresentations of program eligibility. Indeed, the law has long authorized the imposition of severe criminal penalties for such statements. V In addition, contractors that knowingly misrepresent their size status have been subject to significant civil penalties under the civil False Claims Act and the Program Fraud Civil Remedies Act. VI Furthermore, the SBA and procuring agencies have been authorized to initiate suspension or debarment proceedings against a contractor for making a false certification regarding size status. VII However, the government has faced two major difficulties in punishing contractors under these authorities. First, it was difficult for the government to prove that the contractor acted knowingly in making the misrepresentation. Second, where the contractor under false pretenses received an award under a SBA program and then provided the government with a superior product or service, it was difficult for the government to prove and recover damages from the contractor. As a result, the government seldom pursued such cases. The Act and the new implementing regulations seek to remedy this problem. In particular:

• The new rule deems a wide variety of actions by a contractor as “knowing” misrepresentations of program eligibility.  In particular, the mere submission of a bid, proposal, application or offer for a federal grant, contract, subcontract, cooperative agreement, or cooperative research and development agreement set aside or otherwise classified as intended for award to small business concerns is deemed an “affirmative, willful and intentional” certification of eligibility.  Furthermore, any submission which encourages an agency to classify the bid or proposal as an award to a small business concern shall likewise be deemed affirmative, willful and intentional certifications.  Finally, the simple act of registering on an electronic database for the purpose of being considered as a small business concern for an award under an SBA program is also deemed an affirmative, willful and intentional certification. As a result, it will be much easier for the government prove that contractors have violated the laws prohibiting misrepresentations of program eligibility.
• The new rule also establishes a rebuttable presumption of loss to the Government equal to the value of the contract when a firm willfully misrepresents its program eligibility. VIII   As a result, it will be much easier for the government to prove damages in cases brought against contractors for misrepresenting their program eligibility.

Limitations of Liability. The rule provides that contractors will not face liability in the case of “unintentional errors, technical malfunctions, and other similar situations that demonstrate that a misrepresentation of size was not affirmative, intentional, willful or actionable under the False Claims Act, 31 U.S.C. §§ 3729, et seq.” Furthermore, prime contractors acting in good faith are not liable for misrepresentations made by subcontractors regarding their size. The regulation outlines various relevant factors that the Government will consider in assessing whether a misrepresentation was unintentional – i.e.:

• the contractor’s internal management procedures governing size representations/certifications;
• the clarity or ambiguity of the representation or certification requirement, and
• the efforts made by the concern to correct an incorrect or invalid representation or certification in a timely manner. IX

The Eligibility Representation Process. The new rule imposes two new requirements on the process by which contractors make representations of their program eligibility. First, each proposal must contain on a single page a certification concerning the small business size and status of the applicant concern that is signed by an authorized official. Second, concerns that fail to annually update their size or status certifications in the government’s System for Award Management data base will no longer be identified in the data base as qualifying for SBA’s small business programs until the concern recertifies its eligibility. X

Conclusions. As a result of the Act and the new rule, contractors should expect increased government scrutiny of their representations of eligibility for the various SBA programs. To prepare for such scrutiny and limit liability for errors, contractors should develop, implement and follow internal management procedures that ensure their representations are accurate.

On May 16, 2013, the Department of Defense (“DoD”) issued a proposed rule that would impose three significant new anti-counterfeiting requirements on the Department of Defense (“DoD”) supply chain for electronic parts. XI

First, the proposed rule, which implements certain requirements of the National Defense Authorization Acts (“NDAAs”) for fiscal years 2012 and 2013, requires inclusion of a new contract clause in prime contracts subject to the Cost Accounting Standards (“CAS”) set forth at 48 C.F.R.§ 9903.201-1. The clause requires contractors to “establish and maintain an acceptable counterfeit electronic part avoidance and detection system” that includes policies and procedures addressing: (1) training; (2) inspection and testing of electronic parts, including criteria for acceptance and rejection; (3) processes to abolish counterfeit parts proliferation; (4) mechanisms to enable traceability of parts to suppliers; (5) use and qualification of trusted suppliers; (6) reporting and quarantining of counterfeit electronic parts and suspect counterfeit electronic parts; (7) methodologies to identify suspect counterfeit parts and to determine rapidly if a suspect counterfeit part is, in fact, counterfeit; (8) design, operation, and maintenance of systems to detect and avoid counterfeit electronic parts and suspect counterfeit electronic parts; (9) the flow down of counterfeit avoidance and detection requirements to subcontractors. XII

Second, the proposed rule revises DFARS 252.244-7001, Contractor Purchasing System Administration, to provide that a contractor’s failure to maintain an acceptable counterfeit electronics detection and avoidance system can result in government disapproval of the contractor’s purchasing system and withholding of up to 5% of contract payments pending correction of significant deficiencies. XIII

Third, the proposed rule makes unallowable the cost of counterfeit and suspect counterfeit electronic parts and the cost of rework or corrective action to remedy use or inclusion of such parts unless: (1) the parts were provided to the contractor as “government furnished property” in accordance with FAR Part 45.101; (2) the contractor has an operational system to detect and avoid counterfeit parts and suspect counterfeit electronic parts that has been reviewed and approved by DoD; and (3) the contractor provides timely notice to the government. See 78 Fed. Reg. 28780 (May 16, 2013). XIV

Industry reaction to the proposed rule was sharply critical. XV One of the major criticisms concerned the definitions used in the proposed rule. The American Bar Association’s (“ABA’s”) comments explain the importance of these definitions:

DoD’s proposed definitions of the operative terms are critical because Section 818(c)(2)(A) [of the FY 12 NDAA] makes contractors subject to this rule responsible “for detecting and avoiding the use or inclusion of counterfeit electronic parts or suspect counterfeit electronic parts in such products and for any rework or corrective action that may be required to remedy the use or inclusion of such parts.” Thus, many obligations that arise under the proposed rule turn on whether a part is a “counterfeit” or a “suspect counterfeit” electronic part, as these terms are defined. Because Section 818(c)(2)(B) provides that “the cost of counterfeit electronic parts and suspect counterfeit electronic parts and the cost of rework or corrective action that may be required to remedy the use or inclusion of such parts are not allowable costs under [DoD] contracts,” these definitions may also have a cost impact. Reporting and quarantining obligations apply to “counterfeit parts and suspect counterfeit electronic parts” under Section 818(c)(4). Under Section 818(e)(2), contractors are obligated to improve systems to detect and avoid “counterfeit electronic parts and suspect counterfeit electronic parts.” Under Section 818(b)(4), contractors are potentially exposed to suspension or debarment should they repeatedly fail “to detect and avoid counterfeit electronic parts.” For these reasons, the definitions of “counterfeit electronic part” and “suspect counterfeit electronic part” have overarching importance to the operation of the rule. XVI

Under the proposed rule, a part is “counterfeit” if that part is: “(1) an unauthorized copy or substitute part that has been identified, marked, and/or altered by a source other than the part’s legally authorized source and has been misrepresented to be from a legally authorized source; (2) an item misrepresented to be an authorized item of the legally authorized source; or (3) a new, used, outdated, or expired item from a legally authorized source that is misrepresented by any source to the end-user as meeting the performance requirements for the intended use.” A “suspect counterfeit part” is defined as: “a part for which visual inspection, testing, or other information provide reason to believe that a part may be a counterfeit part.” The ABA, the Semiconductor Industry Association (“SIA”) and the Electronics Component Industry Association (“ECIA”) all raised a number of objections to these definitions. One common theme of the objections is that the definitions in the proposed rule do not include an element of intent. As a result, under the proposed rule, if a contractor inadvertently delivers an unauthorized part the contractor could be liable even if the contractor did not intend to mislead, defraud or deceive the government. Another theme is that the definitions are not aligned with industry standards expressed in various SAE International documents. XVII

Another major criticism concerns the “safe harbor” provisions of the rule that allow the cost of re-work in certain limited circumstances. A common theme of these criticisms is that the safe harbor should be expanded. For example, according to SIA: “DoD has missed an ideal – and key – opportunity to incentivize contractors and subcontractors by not including a ―safe harbor from the express unallowability of costs of rework and corrective action for contractors or subcontractors that purchase the counterfeit part or suspect counterfeit part from the OM or sources authorized by the OM.” Likewise, the ECIA states:

There is no provision within the proposed DFARS that provides a “safe harbor” for those contractors and subcontracts that have industry standard processes and procedures in place to detect and avoid counterfeit parts. This safe harbor would include an exemption for purchases of electronic parts obtained from “legally authorized sources.” Under the DFARS proposal’s definition of counterfeit, without a safe harbor test, legally authorized sources would be exposed to penalties for such things as manufacturing defects, picking the wrong item or fully disclosing that a part requested by and sold to the customer was from an unauthorized source.

In short, the contents of the proposed rule did not assure industry that DoD will implement the NDAA anti-counterfeiting provisions in a manner that limits contractor liabilities to the minimum required by the law. However, contractors are hoping that DoD will make significant changes in preparing the final rules and/or that Congress will legislate further practical revisions to the laws.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

I 75 Fed. Reg. 46783 (August 1, 2013).

II Id.

III Id.

IV 78 Fed. Reg. 38811 (June 26, 2013).

V 15 U.S.C.A. § 645(a), (d) and 18 USC 1001, 18 USC 287. Criminal punishments can include a fine of not more than $500,000 and/or imprisonment for not more than 10 years for knowingly misrepresenting small business size status or making false statements or misrepresentations to the SBA.

VI 31 U.S.C.A. § 3729 et seq.; 31 U.S.C.A. §§ 3801-3812.

VIII See13 C.F.R. § 125.29; FAR subpt. 9.4.

VIII 78 Fed. Reg. 38811.

IX Id.

X Id.

XI 78 Fed. Reg. 28780 (May 16, 2013).

XII Id.

XIII Id.

XIV Id.

XV Industry comments are at the following link: http://www.regulations.gov/#!docketDetail;D=DARS-2013-0014.

XVI Id.

XVII Id.

The Department of Defense (“DoD”) is working on new regulations to prevent the use of counterfeit electronic parts in DoD systems. The regulations are required by Section 818 of the National Defense Authorization Act for Fiscal Year 2012 (the “Act”).I Under the Act, DoD must issue changes to the Department of Defense Supplement to the Federal Acquisition Regulation (“DFARS”) that will impose significant new supply chain management requirements on contractors.II To highlight the importance of preventing counterfeiting, the Act imposes severe new criminal penalties for the intentional trafficking in counterfeit military goods or services. Therefore, contractors that supply electronics to DoD have significant incentives to implement robust compliance programs to avoid even an appearance of intentional trafficking in counterfeits.

 The Act specifies that the DFARS changes, which will apply to contractors that are subject to the cost accounting standards under section 26 of the Office of Federal Procurement Policy Act, 41 U.S.C. 422, (i.e., “covered contractors”), must:

• Assign responsibility to prime contractors and subcontractors for detection and avoidance of the use of counterfeit electronic parts and for any rework or corrective action that may be required to remedy the use of such part;
• Make unallowable the cost of counterfeit and suspect counterfeit parts and the cost of corrective action to remedy use of such parts;
• Establish qualification requirements, under which DoD can identify “trusted suppliers” that have appropriate policies and procedures in place to detect and avoid counterfeit electronic parts and suspect counterfeit electronic parts;
• Require that, whenever possible, contractors and subcontractors obtain electronic parts that are in production or currently available in stock from (i) the original manufacturers of the parts or (ii) their authorized dealers, or (iii) trusted suppliers who obtain such parts exclusively from the original manufacturers of the parts or their authorized dealers;
• Require that, whenever possible, contractors and subcontractors obtain from trusted suppliers electronic parts that are not in production or currently available in stock;
• Establish requirements for the inspection, testing, authentication and reporting to DoD of electronic parts that a contractor obtains from sources other than the original manufacturer, authorized dealers or trusted suppliers;
• Require contractors to report to the Government when the contractor becomes aware, or has reason to suspect, that a component, or part or material supplied to the DoD contains counterfeit electronic parts. Under the Act, contractors or subcontractors who do so are immune from civil liability based on the reporting. III

In addition, the Act also requires DoD to “implement a program to enhance contractor detection and avoidance of counterfeit electronic parts”. The program must have two major elements. First, the program must require covered contractors that supply electronic parts or systems that contain electronic parts to establish policies and procedures addressing the following subjects:

• training of personnel;

• inspection and testing of electronic parts;

• processes to abolish the proliferation of counterfeit parts;

• mechanisms to enable traceability of parts;

• use of trusted suppliers;

• the reporting and quarantining of counterfeit electronic parts and suspect counterfeit electronic parts;

• methodologies to identify suspect counterfeit parts and to rapidly determine if a suspect counterfeit part is, in fact, counterfeit;

• the design, operation, and maintenance of systems to detect and avoid counterfeit electronic parts and suspect counterfeit electronic parts; and

• the flow down of counterfeit avoidance and detection requirements to subcontractors.

Second, the program must “establish processes for the review and approval of contractor systems for the detection and avoidance of counterfeit electronic parts and suspect counterfeit electronic parts” that are comparable to the processes established for contractor business systems under section 893 of the Ike Skelton National Defense Authorization Act for Fiscal Year 2011 (Public Law 111-383; 124 Stat. 4311; 10 U.S.C. 2302 note).IV These processes establish specific criteria for various business systems and authorize the Government’s withholding of payment to contractors if audits reveal significant deficiencies in the contractors’ compliance with these criteria.

 The Act required DoD to issue the DFARS changes and regulations implementing the anti-counterfeiting program on or before September 26, 2012. However, DoD missed that deadline. This delay is a blessing to industry because it allows for more time for to prepare for these sweeping new rules. Companies that have not done so already should start their preparations by reviewing existing policies and procedures against SAE Aerospace Standard AS5553, Counterfeit Electronic Parts; Avoidance, Detection, Mitigation, and Disposition. It is likely the regulations will use many of the concepts from this industry standard – e.g., the Counterfeit Electronics Control Plan elements in Section 4.1, guidance for addressing life cycle parts availability in the design process in Appendix A, purchasing process guidance in Appendices B and D, supply chain traceability requirements in Appendix C and the methods for counterfeit detection set forth in Appendix E. Contractors should assume that DoD will at any time issue “interim” regulations that will be effective upon issuance.V

On November 13, 2102, the Government Accountability Office (GAO) released its annual report to Congress concerning government contracts bid protests.VI Two of the statistics included in the report are particularly noteworthy. The first is the fiscal year (FY) 2012 protest “sustain rate”. This is the percentage of cases decided in favor of the protester. In FY 2012, the sustain rate was 18.6%. This is consistent with the average sustain rate for FY 2008 through FY 2011, which was 18.5%. This statistic shows that bid protests continue to be relatively difficult to win. However, the second significant statistic – the protest “effectiveness rate” – offers more hope to protesters. This is the percentage of cases in which the protester received some form of relief from the contracting agency, frequently a re-opening of the competition. In FY 2012, the effectiveness rate was 42%. This is consistent with the average effectiveness rate for FY 2008 through FY 2011, which was 42.75%. This statistic shows that agencies are continuing to take voluntary corrective action in response to a significant number of protests. While the statistics offer valuable high level insights to contractors about the bid protest process, they need to be viewed in the proper context. Obviously, prospects for success in a protest action vary considerably based on the circumstances of the procurement.

Earlier this year, DoD finalized changes to the Defense Federal Acquisition Regulation Supplement (“DFARS”) that authorize the Government’s withholding of payment to contractors for significant deficiencies relating to six contractor business systems: (1) accounting systems; (2) estimating systems; (3) purchasing systems; (4) earned value management systems; (5) material management and accounting systems; and (6) property management systems. The rules apply to contracts that are “subject to” the Cost Accounting Standards (“CAS”) (under 41 U.S.C. chapter 15).VII On April 24, 2012, DCAA issued guidance concerning audits of contractors’ compliance with these new rules (the “Guidance”).VIII The Guidance has both general and specific elements.

The general elements of the Guidance outline DCAA’s new approach and revised policy for auditing business systems of large contractors. The new approach focuses on “contractor system demonstrations and walk-throughs by the applicable contractor personnel of the various processes that ensure compliance with the DFARS business system criteria.” According to the Guidance, these demonstrations “are an essential element for obtaining and documenting the understanding” of the contractors’ systems. Under the revised policy, while DCAA will continue to test internal controls, the auditors will no longer opine on the general adequacy of the system or general effectiveness of the contractor’s internal controls. Instead, auditors will focus on the contractor’s compliance with the specific criteria set forth in the new business systems rules. In addition, DCAA will no longer make specific recommendations to the CO concerning whether to disapprove a system. The Guidance anticipates that the CO will make an independent determination of whether he should act to withhold payments based on an audit finding.

The specific elements of the Guidance concern auditing of contractor accounting systems for compliance with the criteria at DFARS 252.242-7006, Accounting System Administration. The DFARS requires DoD Contracting Officers to include this clause in cost reimbursement, incentive type, time and materials and labor hour contracts and in contracts with progress payments made on the basis of contractor costs incurred or on a percentage or stage of completion. The clause requires contractors to maintain an “acceptable accounting system” that complies with 18 specified criteria. If a CO issues a final determination that a contractor has a “significant deficiency” in its accounting system, he may then withhold five percent of payments due to the contractor under covered contracts pending correction of the deficiency. The clause defines a “significant deficiency” as a “shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes”. The Guidance provides the following additional detail:

• “A material noncompliance with any one of the 18 criteria indicates a significant deficiency/material weakness exists and that the contractor has not complied in all material respects with the DFARS criteria.
• Materiality levels in such cases should generally be lower than when Government funds and programs are not involved. . . In addition, it is not necessary to demonstrate an actual monetary impact to the Government (e.g., unallowable or unallocable costs, or that the price the Government negotiated for a contract was unreasonable) to report a significant deficiency/material weakness.
• If there is a reasonable possibility that the identified noncompliance with the DFARS criteria will result in a material non-compliance with other applicable Government contract laws and regulations, either individually or in combination, it is a significant deficiency/material weakness.” 

The Guidance indicates that auditors should consider the following factors in assessing whether a deficiency is “significant”:

• “A material noncompliance with any one of the 18 criteria indicates a significant deficiency/material weakness exists and that the contractor has not complied in all material respects with the DFARS criteria.
• Materiality levels in such cases should generally be lower than when Government funds and programs are not involved. . . In addition, it is not necessary to demonstrate an actual monetary impact to the Government (e.g., unallowable or unallocable costs, or that the price the Government negotiated for a contract was unreasonable) to report a significant deficiency/material weakness.
• If there is a reasonable possibility that the identified noncompliance with the DFARS criteria will result in a material non-compliance with other applicable Government contract laws and regulations, either individually or in combination, it is a significant deficiency/material weakness.” 

The Guidance also requires auditors to consider the following “indicators of a significant deficiency”:

• History of noncompliances found in contractor assertions (e.g., public vouchers, incurred cost submissions, proposals) requiring correction.
• Identification of material noncompliances with applicable Government contract laws and regulations (e.g., with FAR Subpart 31.2, CAS, or applicable requirements in FAR Part 15) either in the business system audit or another audit.

The following example illustrates the application of the Guidance:

• ABC Corporation (“ABC”) has government contracts that include DFARS 252.242-7006.
• In an audit of ABC’s compliance with this clause, DCAA finds that ABC’s system complies with 17 of the 18 criteria set forth in clause.
• However, DCAA finds that ABC’s system does not comply with criterion no. 12 of DFARS 252.242-7006(c), which requires contractors’ accounting systems to provide for the exclusion from costs charged to Government contracts of amounts which are not allowable under FAR Part 31, Contract Cost Principles.
• The problem with ABC’s system is that it fails to exclude borrowing costs that are unallowable under FAR 31.205-20, Interest and Other Financial Costs, from the calculation of ABC’s general and administrative costs.
• DCAA’s testing reveals that ABC has recently incurred some modest borrowing costs but the extent of its borrowing costs in prior years is not known.
• Under the Guidance, there is a reasonable possibility that the identified noncompliance with the DFARS criteria will result in a material non-compliance with other applicable Government contract laws and regulations – ie, FAR 31.205-20.
• Therefore, even though ABC complies with 17 of the 18 criteria in the DFARS and the monetary impact of the problem is not known, DCAA’s report will state that there is a significant deficiency in ABC’s system.

In conclusion, the Guidance provides valuable insights to contractors concerning the direction that DCAA intends to take in future audits of accounting systems. The new approach involving contractor demonstrations and new policy of focusing on specific system criteria should reduce misunderstandings. However, contractors will need to communicate effectively with the auditors to promote an environment in which audit findings stay within the scope of the DFARS clause and the Guidance. 

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

I Pub. Law No. 112-081.

II Id. at Sec. 818(c).

III Id.

IV Id. at Sec. 818(e).

V On October 5. 2012, a subcommittee of the American Bar Association issued a thoughtful paper concerning implementation of the Act. See http://www.americanbar.org/content/dam/aba/administrative/public_contract_law/aba_pcl_taskforce_on_counterfeit_part_white_paper.authcheckdam.pdf.

VI B-158766 (November 13, 2012), http://www.gao.gov/assets/650/649957.pdf.

VII See 77 Fed. Reg. 37 (February 24, 2012).

VIII http://www.dcaa.mil/mmr/12-PAS-012.pdf

The Department of Defense (“DoD”) is working on new regulations that will have a significant impact on many contractors that supply electronic parts to DoD. The regulations are required by Section 818 of the National Defense Authorization Act for Fiscal Year 2012 (the “Act”).i Under the Act, DoD must issue on or before September 26, 2012, changes to the Department of Defense Supplement to the Federal Acquisition Regulation (“DFARS”) that will impose significant new requirements on contractors to prevent the use of counterfeit electronic parts in DoD systems.ii To highlight the importance of preventing counterfeiting and compliance with the new regulations, the Act imposes severe new criminal penalties for the intentional trafficking in counterfeit military goods or services. Therefore, contractors that supply electronics to DoD have significant incentives to implement robust compliance programs to avoid even an appearance of intentional trafficking in counterfeits.

Under the Act, the DFARS changes, which will apply to contractors that are subject to the cost accounting standards under section 26 of the Office of Federal Procurement Policy Act, 41 U.S.C. 422, (i.e., “covered contractors”), must:

• Assign responsibility to prime contractors and subcontractors for detection and avoidance of the use of counterfeit electronic parts and for any rework or corrective action that may be required to remedy the use of such part;
• Make unallowable the cost of counterfeit parts and the cost of corrective action to remedy use of such parts;
• Establish qualification requirements, under which DoD can identify “trusted suppliers” that have appropriate policies and procedures in place to detect and avoid counterfeit electronic parts and suspect counterfeit electronic parts;
• Require that, whenever possible, contractors and subcontractors obtain electronic parts that are in production or currently available in stock from (i) the original manufacturers of the parts or (ii) their authorized dealers, or (iii) trusted suppliers who obtain such parts exclusively from the original manufacturers of the parts or their authorized dealers;
• Require that, whenever possible, contractors and subcontractors obtain from trusted suppliers electronic parts that are not in production or currently available in stock;
• Establish requirements for the inspection, testing, authentication and reporting to DoD of electronic parts that a contractor obtains from sources other than the original manufacturer, authorized dealers or trusted suppliers;
• Require contractors to report to the Government when the contractor becomes aware, or has reason to suspect, that a component, or part or material supplied to the DoD contains counterfeit electronic parts. Under the Act, contractors or subcontractors who do so are immune from civil liability based on the reporting.iii

In addition, the Act also requires DoD to “implement a program to enhance contractor detection and avoidance of counterfeit electronic parts”. The program must have two major elements. First, the program must require covered contractors that supply electronic parts or systems that contain electronic parts to establish policies and procedures addressing the following subjects:

• training of personnel;

• inspection and testing of electronic parts;

• processes to abolish the proliferation of counterfeit parts;

• mechanisms to enable traceability of parts;

• use of trusted suppliers;

• the reporting and quarantining of counterfeit electronic parts and suspect counterfeit electronic parts;

• methodologies to identify suspect counterfeit parts and to rapidly determine if a suspect counterfeit part is, in fact, counterfeit;

• the design, operation, and maintenance of systems to detect and avoid counterfeit electronic parts and suspect counterfeit electronic parts; and

• the flow down of counterfeit avoidance and detection requirements to subcontractors.

Second, the program must “establish processes for the review and approval of contractor systems for the detection and avoidance of counterfeit electronic parts and suspect counterfeit electronic parts” that are comparable to the processes established for contractor business systems under section 893 of the Ike Skelton National Defense Authorization Act for Fiscal Year 2011 (Public Law 111-383; 124 Stat. 4311; 10 U.S.C. 2302 note).iv These processes establish specific criteria for various business systems and authorize the Government’s withholding of payment to contractors if audits reveal significant deficiencies in the contractors’ compliance with these criteria.

To prepare for the forthcoming DFARS rules, contractors should immediately undertake a thorough review of existing policies for preventing acquisition of counterfeit electronic parts and identify required improvements. As part of this review, contractors should assess current compliance against industry standards such as SAE Standard No. AS 5553, Counterfeit Electronic Parts; Avoidance, Detection, Mitigation and Disposition.

After August 24, 2012, new financial conflict of interest (“FCOI”) rules will apply to entities or organizations (“Institutions”) that receive grants, cooperative agreements and contracts from the Public Health Service (“PHS”) of the U.S. Department of Health and Human Services (“DHHS”).v The PHS consists of the following components: 1) Office of the Assistant Secretary for Health; 2) Food and Drug Administration; 3) Health Resources and Services Administration; 4) Indian Health Service; 5) National Institutes of Health; 6) Substance Abuse and Mental Health Services Administration; 7) Office of Global Affairs; and 8) Office of the Assistant Secretary for Preparedness and Response, which includes the Biomedical Advanced Research and Development Authority (“BARDA”).vi In promulgating the new rules, DHHS made the following comments concerning awards to which the new rules apply:

We note that many PHS grants, cooperative agreements, and contracts continue for several years and, particularly in the case of grants and cooperative agreements, a new award can be made every year. Therefore, the revised regulations will apply to each grant or cooperative agreement with an issue date of the Notice of Award that is subsequent to [August 24, 2012] (including noncompeting continuations) and to solicitations issued and contracts awarded subsequent to [August 24, 2012] that are for research. Through their policies, Institutions may choose to apply the revised regulations to all active PHS awards. For example, Institutions may choose, in their FCOI policy, to implement the regulations on a single date on all PHS-funded awards rather than implementing the regulations sequentially on the specific award date of each individual project.vii

The new rules do not change certain longstanding requirements. In particular:

• Individuals, regardless of title or position, who are responsible for the design, conduct, or reporting of research funded by the PHS (“Investigators”) must continue to disclose “significant financial interests” to their Institutions.
• The new rules continue to exclude from the definition of “significant financial interests” remuneration paid by the Institution to Investigators employed by the Institution.
• Institutions must still review the disclosures of their Investigators to determine whether a reported significant financial interest rises to the level of an FCOI.
• The determination of whether there is a FCOI continues to depend on whether the reported significant financial interest “could directly and significantly affect the design, conduct or reporting of PHS-funded research”.
• If it does, Institutions must continue to take steps to report and mitigate the conflict.

However, the new rules do impose significant new requirements for: 1) the content of financial disclosures that investigators must make to their Institutions; 2) publication of certain FCOI information; 3) training of investigators concerning applicable FCOI policies; and 4) “flow down” of FCOI requirements to sub-awards. Major aspects of the new requirements are reviewed below.

Financial Disclosure Requirements. Under the old rules, Investigators only had to report to their Institutions those significant financial interests (hereinafter “SFIs”) that the Investigator deemed were related to PHS funded research. Under the new rules, Investigators have to report all SFIs related to the Investigator’s Institutional responsibilities. In addition, the definition of SFI has changed in two fundamental ways. First, while remuneration paid to the Investigator by his or her employer is still not considered an SFI, the “de minimis” threshold for classification of remuneration from other organizations has changed. Whereas under the old rules the definition of SFI excluded payments or equity interests from such organizations of $10,000 or less, under the new rules the definition excludes payments of $5,000 or less. For equity interests in publicly held companies, the threshold is also $5,000. However, any equity interest in a privately held company other than the Investigator’s employer is now considered a significant financial interest. The second major change in the definition of SFIs is the level of detail. Considerable detail previously found only in “questions and answers” on DHHS websites, is now included in the definition. Following is the new definition:

     Significant financial interest means

(1) A financial interest consisting of one or more of the following interests of the Investigator (and those of the Investigator’s spouse and dependent children) that reasonably appears to be related to the Investigator’s institutional responsibilities:

(i) With regard to any publicly traded entity, a significant financial interest exists if the value of any remuneration received from the entity in the twelve months preceding the disclosure and the value of any equity interest in the entity as of the date of disclosure, when aggregated, exceeds $5,000. For purposes of this definition, remuneration includes salary and any payment for services not otherwise identified as salary (e.g., consulting fees, honoraria, paid authorship); equity interest includes any stock, stock option, or other ownership interest, as determined through reference to public prices or other reasonable measures of fair market value;

(ii) With regard to any non-publicly traded entity, a significant financial interest exists if the value of any remuneration received from the entity in the twelve months preceding the disclosure, when aggregated, exceeds $5,000, or when the Investigator (or the Investigator’s spouse or dependent children) holds any equity interest (e.g., stock, stock option, or other ownership interest); or

(iii) Intellectual property rights and interests (e.g., patents, copyrights), upon receipt of income related to such rights and interests.

(2) Investigators also must disclose the occurrence of any reimbursed or sponsored travel (i.e., that which is paid on behalf of the Investigator and not reimbursed to the Investigator so that the exact monetary value may not be readily available), related to their Institutional responsibilities; provided, however, that this disclosure requirement does not apply to travel that is reimbursed or sponsored by a Federal, state, or local government agency, an Institution of higher education as defined at 20 U.S.C. 1001(a), an academic teaching hospital, a medical center, or a research institute that is affiliated with an Institution of higher education. The Institution’s FCOI policy will specify the details of this disclosure, which will include, at a minimum, the purpose of the trip, the identity of the sponsor/organizer, the destination, and the duration. In accordance with the Institution’s FCOI policy, the Institutional official(s) will determine if further information is needed, including a determination or disclosure of monetary value, in order to determine whether the travel constitutes an FCOI with the PHS-funded research.

(3) The term significant financial interest does not include the following types of financial interests: salary, royalties, or other remuneration paid by the Institution to the Investigator if the Investigator is currently employed or otherwise appointed by the Institution, including intellectual property rights assigned to the Institution and agreements to share in royalties related to such rights; any ownership interest in the Institution held by the Investigator, if the Institution is a commercial or for-profit organization; income from investment vehicles, such as mutual funds and retirement accounts, as long as the Investigator does not directly control the investment decisions made in these vehicles; income from seminars, lectures, or teaching engagements sponsored by a Federal, state, or local government agency, an Institution of higher education as defined at 20 U.S.C. 1001(a), an academic teaching hospital, a medical center, or a research institute that is affiliated with an Institution of higher education; or income from service on advisory committees or review panels for a Federal, state, or local government agency, an Institution of higher education as defined at 20 U.S.C. 1001(a), an academic teaching hospital, a medical center, or a research institute that is affiliated with an Institution of higher education.,viii

Example SFI Disclosure and FCOI Review. The following example illustrates the application of the new SFI definitions. 

• On August 25, 2012, BARDA awarded a contract to ABC Pharma (the “Contract”) for advanced development of medical countermeasure (“MCM”) against a variety of bioterrorism threats.
• Since BARDA is part of PHS and the award date of the contract is after August 24, 2012, the new FCOI rules apply to the contract.
• ABC Pharma’s Chief Scientific Officer assigned to Marcus Welby, M.D. responsibility for the design of a protocol for a Phase I clinical trial that will be funded by the Contract. Dr. Welby also has responsibilities to support research and marketing of the potential commercial indications for the MCM. Unless significant safety concerns arise from the Phase I trials, ABC Pharma intends to pursue the commercial indications for the MCM using venture capital funding. Dr. Welby joined ABC Pharma on January 1, 2012.
• As part of its compliance program for the new rules, ABC Pharma’s Chief Financial Officer has assigned to Mr. Argent the responsibility for collecting and reviewing financial disclosure forms from all of ABC Pharma’s Investigators.
• Because Dr. Welby is responsible for the Phase I protocol design under the Contract, he qualifies as an Investigator and must disclose his SFIs to Mr. Argent.^ix
• Under the ABC Pharma policy implementing the new rules, Dr. Welby must update his SFI disclosures each year on or before September 30.^x
• Following is a discussion of his report dated September 30, 2013:
  • In the period from October 1, 2012 through September 30, 2013, he earned a salary from ABC Pharma of $200,000 per year. He does not have to include this salary on the disclosure form he files with Mr. Argent because salary from the employing Institution is not part of the definition of an SFI.
  • Prior to joining ABC Pharma, Dr. Welby served as a clinical researcher in Global Pharma LLC’s (“Global’s”) bio-defense business unit, earning a salary of $150,000 per year and Global stock options currently valued at $25,000. In his work with Global, a multi-national company with $20 billion in revenue per year, Dr. Welby researched a counter measure that use a different technology than the technology under the development under the Contract. However, the Global and ABC Pharma countermeasures target some of the same bioterrorism threats. Therefore, Dr. Welby’s stock options in Global “reasonably appear to be related to” his institutional responsibilities at ABC Pharma and qualify as SFIs. However, since he earned the Global salary more than 12 months prior to the report it is not an SFI.
  • In the reporting period, Dr. Welby maintained his appointment and privileges at Boston University (“BU”) Hospital. This required that he perform two weeks of clinical rotations at the hospital. BU Hospital paid him $10,000 for this work. ABC Pharma has permitted Dr. Welby to maintain his appointment at BU Hospital because it will assist his research and marketing of the commercial uses of the MCM. Therefore, the compensation from BU reasonably appears related to his institutional responsibilities and should be listed as an SFI on the disclosure form he files with Mr. Argent.
  • In the reporting period, XYZ Venture Capital Corporation (“XYZ Venture”) gave Dr. Welby two all expenses paid trips to their corporate facilities to give presentations and answer questions about the commercial indications of the MCM. XYZ Venture made all the travel arrangements and paid the airlines and hotels directly for his expenses. Dr. Welby should list XYZ Venture’s reimbursement of these expenses on his SFI disclosure form in accordance with ABC Pharma’s policies.
  • Dr. Welby’s wife, Dr. Wendy Smith, works a researcher in Global’s bio-defense unit, earning a salary of $200,000 per year. Dr. Smith currently owns Global stock options valued at $50,000. Since Global and Pharma’s MCM target some of the same bioterrorism threats, Dr. Smith’s salary and stock options in Global “reasonably appear to be related to” Dr. Welby’s institutional responsibilities at ABC Pharma and qualify as SFIs.

As noted above, the new rules don’t change longstanding requirements that Institutions must review the disclosures of their Investigators to determine whether a reported significant financial interest rises to the level of a FCOI. Following is the definition of an FCOI:

Financial conflict of interest (FCOI) means a significant financial interest that could directly and significantly affect the design, conduct, or reporting of PHS-funded research.xi

The rules require the designated Institutional official to first assess whether an Investigator’s SFI is “related” to PHS-funded research. To do this, the official must determine whether a reported SFI “could be affected by the PHS-funded research; or is in an entity whose financial interest could be affected by the research.” If the SFI meets this test, then the official(s) must determine whether the SFI “could directly and significantly affect the design, conduct, or reporting of the PHS-funded research”.xii

Thus, in the example above, Mr. Argent must first assess whether Dr. Welby’s SFIs are related to the research under the Contract. He makes the following conclusions.

• As indicated above, Drs. Welby and Smith have SFIs in Global. Since Global and ABC Pharma’s MCMs counter some of the same biothreats, it is possible that the SFIs of Dr. Welby and Dr. Smith in Global could be adversely affected by success under the Contract and/or that Global’s financial interest could be adversely affected by the research. In particular, in the event that ABC Pharma’s MCM shows greater promise than Global’s, the government market prospects for ABC Pharma’s MCM would be improved and the prospects for Global’s MCM could be decreased. Therefore, Mr. Argent concludes that Dr. Welby’s SFI in Global is related to PHS funded research.
• If the Phase I clinical trials show significant safety concerns, Dr. Welby’s SFI in BU and XYZ Ventures could be affected by PHS-funded research. In that event, the prospects for successful commercialization of the MCM would be diminished and the purpose of the relationships with these entities would no longer be as viable. Therefore, Mr. Argent concludes that these SFIs are also related to PHS funded research.

Moving to the next step in the analysis, Mr. Argent concludes for the following reasons that although Dr. Welby’s SFIs are “related” to the research under the Contract, they cannot “directly and significantly affect the design, conduct, or reporting” of the research:

• Even if ABC Pharma’s research succeeds beyond expectations, the prospects of a direct and significant adverse impact on his SFI in Global and/or Global’s interests are minimal. While Global and ABC Pharma’s MCMs counter some of the same biothreats, Global’s MCM uses a different technology and also addresses biothreats that ABC Pharma’s does not. Therefore, it is highly likely that Global would experience no impact at all from the success of ABC Pharma’s research. In addition, given Global’s vast revenues, even if Global experienced a severe impact in the government market for bio-terror MCMs, there is almost no chance that the impact would directly and significantly affect Dr. Welby’s SFIs in Global – e.g., his stock options. Based on these probabilities and Dr. Welby’s obvious self interest in serving the interests of ABC Pharma, there is likewise almost no chance that his SFI’s in Global would provide any motivation to deviate from scientific and professional standards and take a biased overly negative approach in his analysis of the research under the Contract.
• Even if ABC Pharma’s research succeeds beyond expectations, the prospects of a direct and significant adverse impact on his SFI in Global and/or Global’s interests are minimal. While Global and ABC Pharma’s MCMs counter some of the same biothreats, Global’s MCM uses a different technology and also addresses biothreats that ABC Pharma’s does not. Therefore, it is highly likely that Global would experience no impact at all from the success of ABC Pharma’s research. In addition, given Global’s vast revenues, even if Global experienced a severe impact in the government market for bio-terror MCMs, there is almost no chance that the impact would directly and significantly affect Dr. Welby’s SFIs in Global – e.g., his stock options. Based on these probabilities and Dr. Welby’s obvious self interest in serving the interests of ABC Pharma, there is likewise almost no chance that his SFI’s in Global would provide any motivation to deviate from scientific and professional standards and take a biased overly negative approach in his analysis of the research under the Contract.

Since Mr. Argent concluded that there was no FCOI, no report to BARDA was necessary.xiii If he had concluded that there was an FCOI, ABC Pharma would have had to develop a plan for managing the FCOI to avoid bias in the research. In addition, ABC Pharma would have to submit an initial and annual FCOI reports to the awarding PHS component during the period of performance of the Contract.xiv

Public Accessibility. As mentioned above, the new rules impose significant new requirements for publication of certain Institutional FCOI information. First, the rules require covered Institutions to “maintain an up-to-date, written, enforced policy on financial conflicts of interest that complies with this part, and make such policy available via a publicly accessible Web site.”xv Second, if the Institution does determine that there is an FCOI, the Institution must ensure public accessibility, via a publicly accessible Web site or written response to any requestor within five business days of a request, the following information concerning the SFI that led to the FCOI.

The Investigator’s name; the Investigator’s title and role with respect to the research project; the name of the entity in which the significant financial interest is held; the nature of the significant financial interest; and the approximate dollar value of the significant financial interest (dollar ranges are permissible: $0-$4,999; $5,000-$9,999; $10,000-$19,999; amounts between $20,000-$100,000 by increments of $20,000; amounts above $100,000 by increments of $50,000), or a statement that the interest is one whose value cannot be readily determined through reference to public prices or other reasonable measures of fair market value.xvi

These transparency requirements were not included in the old rules.

Training. The new rules require each Institution to: 

Inform each Investigator of the Institution’s policy on financial conflicts of interest, the Investigator’s responsibilities regarding disclosure of significant financial interests, and of these regulations, and require each Investigator to complete training regarding the same prior to engaging in research related to any PHS-funded contract and at least every four years, and immediately when any of the following circumstances apply:

(1) The Institution revises its financial conflict of interest policies or procedures in any manner that affects the requirements of Investigators;

(2) An Investigator is new to an Institution; or

(3) An Institution finds that an Investigator is not in compliance with the Institution’s financial conflict of interest policy or management plan.xvii

The old rules had no such requirement.

Flow Down to Subrecipients. Whereas the old rules merely required Institutions generally to take “reasonable steps” to ensure that Investigators working for subrecipients comply with the regulations, the new rules affirmatively require the Institutions to incorporate as part of a written agreement with the subrecipient “terms that establish whether the financial conflicts of interest policy of the awardee Institution or that of the subrecipient will apply to the subrecipient’s Investigators.” If the agreement specifies that the subrecipient’s Investigators must comply with the subrecipient’s FCOI policy, the subrecipient must certify in the agreement that its policy complies with the regulations. If the subrecipient cannot provide such certification, the agreement must state that subrecipient Investigators are subject to the financial conflicts of interest policy of the awardee Institution for disclosing SFIs that are directly related to the subrecipient’s work for the awardee Institution. In that case, the parties have two options for handling reporting and disclosures. Under Option One, the sub agreement will specify that subrecipient will collect SFIs from its Investigators and assess FCOIs and the time period(s) for the subrecipient to report all identified FCOIs to the awardee Institution. Under Option Two, the agreement will specify time period(s) for the subrecipient to submit all Investigator disclosures of SFIs to the prime awardee Institution for an FCOI assessment. In either case, the reporting time periods in the sub-agreement must be sufficient to enable the awardee Institution to comply timely with its review, management, and reporting obligations under the rule.xviii

The Importance of Compliance With the New Rules. In each contract proposal subject to the new rules, contractors must certify that they will comply with the new rules and that they have up to date and compliant policies and processes for doing so.xix Contractors can be liable under the civil False Claims Act for submitting such a certification with “reckless disregard” or “deliberate ignorance” of its accuracy.xx Contractors and their certifying officials could even be subject to criminal penalties for knowingly and willfully submitting a false certification.xxi Therefore, contractors performing PHS-funded research have significant incentives to implement robust compliance programs to avoid even an appearance of non-compliance with the new rules. Fortunately, NIH has published valuable resource material for contractors and their counsel to use in planning and implementing changes to their FCOI compliance programs. The resources included presentation materials, answers to numerous “frequently asked questions” and a checklist for development of required policies. Following is a link to these resources:

http://grants.nih.gov/grants/policy/coi/

Conclusion. The foregoing is only an overview of major changes to the DHHS FCOI rules. Contractors expecting to receive awards from PHS organizations after August 24th will need to thoroughly familiarize themselves with the new rules and take affirmative actions to comply. It is particularly important that contractors come into compliance with the new rules prior to making the required certifications concerning their FCOI policies and processes.

Earlier this year, DoD finalized changes to the Defense Federal Acquisition Regulation Supplement (“DFARS”) that authorize the Government’s withholding of payment to contractors for significant deficiencies relating to six contractor business systems: (1) accounting systems; (2) estimating systems; (3) purchasing systems; (4) earned value management systems; (5) material management and accounting systems; and (6) property management systems. The rules apply to contracts that are “subject to” the Cost Accounting Standards (“CAS”) (under 41 U.S.C. chapter 15).xxii On April 24, 2012, DCAA issued guidance concerning audits of contractors’ compliance with these new rules (the “Guidance”).xxiii The Guidance has both general and specific elements.

The general elements of the Guidance outline DCAA’s new approach and revised policy for auditing business systems of large contractors. The new approach focuses on “contractor system demonstrations and walk-throughs by the applicable contractor personnel of the various processes that ensure compliance with the DFARS business system criteria.” According to the Guidance, these demonstrations “are an essential element for obtaining and documenting the understanding” of the contractors’ systems. Under the revised policy, while DCAA will continue to test internal controls, the auditors will no longer opine on the general adequacy of the system or general effectiveness of the contractor’s internal controls. Instead, auditors will focus on the contractor’s compliance with the specific criteria set forth in the new business systems rules. In addition, DCAA will no longer make specific recommendations to the CO concerning whether to disapprove a system. The Guidance anticipates that the CO will make an independent determination of whether he should act to withhold payments based on an audit finding.

The specific elements of the Guidance concern auditing of contractor accounting systems for compliance with the criteria at DFARS 252.242-7006, Accounting System Administration. The DFARS requires DoD Contracting Officers to include this clause in cost reimbursement, incentive type, time and materials and labor hour contracts and in contracts with progress payments made on the basis of contractor costs incurred or on a percentage or stage of completion. The clause requires contractors to maintain an “acceptable accounting system” that complies with 18 specified criteria. If a CO issues a final determination that a contractor has a “significant deficiency” in its accounting system, he may then withhold five percent of payments due to the contractor under covered contracts pending correction of the deficiency. The clause defines a “significant deficiency” as a “shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes”. The Guidance provides the following additional detail: 

• “A material noncompliance with any one of the 18 criteria indicates a significant deficiency/material weakness exists and that the contractor has not complied in all material respects with the DFARS criteria.
• Materiality levels in such cases should generally be lower than when Government funds and programs are not involved. . . In addition, it is not necessary to demonstrate an actual monetary impact to the Government (e.g., unallowable or unallocable costs, or that the price the Government negotiated for a contract was unreasonable) to report a significant deficiency/material weakness.
• If there is a reasonable possibility that the identified noncompliance with the DFARS criteria will result in a material non-compliance with other applicable Government contract laws and regulations, either individually or in combination, it is a significant deficiency/material weakness.”

The Guidance indicates that auditors should consider the following factors in assessing whether a deficiency is “significant”:

• “The nature and frequency of the noncompliance with the DFARS criteria identified with appropriate consideration of sampling risk (i.e., the risk that the conclusion based on the sample is different than it would be had the entire population been tested).
• Whether the noncompliance with the DFARS criteria is material considering the nature of the compliance requirements.
• The root cause of the noncompliance. (Understanding why the noncompliance occurred will help to determine if it is systemic and significant.)
• The effect of compensating controls.
• The possible future consequences of the noncompliance with the DFARS criteria.
• Qualitative considerations, including the needs and expectations of the report’s users. For Government contract cost issues, qualitative considerations also include serving the public interest and honoring the public trust.”

The Guidance also requires auditors to consider the following “indicators of a significant deficiency”:

• History of noncompliances found in contractor assertions (e.g., public vouchers, incurred cost submissions, proposals) requiring correction.
• Identification of material noncompliances with applicable Government contract laws and regulations (e.g., with FAR Subpart 31.2, CAS, or applicable requirements in FAR Part 15) either in the business system audit or another audit.

The following example illustrates the application of the Guidance:

• ABC Corporation (“ABC”) has government contracts that include DFARS 252.242-7006.
• In an audit of ABC’s compliance with this clause, DCAA finds that ABC’s system complies with 17 of the 18 criteria set forth in clause.
• However, DCAA finds that ABC’s system does not comply with criterion no. 12 of DFARS 252.242-7006(c), which requires contractors’ accounting systems to provide for the exclusion from costs charged to Government contracts of amounts which are not allowable under FAR Part 31, Contract Cost Principles.
• The problem with ABC’s system is that it fails to exclude borrowing costs that are unallowable under FAR 31.205-20, Interest and Other Financial Costs, from the calculation of ABC’s general and administrative costs.
• DCAA’s testing reveals that ABC has recently incurred some modest borrowing costs but the extent of its borrowing costs in prior years is not known.
• Under the Guidance, there is a reasonable possibility that the identified noncompliance with the DFARS criteria will result in a material non-compliance with other applicable Government contract laws and regulations – ie, FAR 31.205-20.
• Therefore, even though ABC complies with 17 of the 18 criteria in the DFARS and the monetary impact of the problem is not known, DCAA’s report will state that there is a significant deficiency in ABC’s system.

In conclusion, the Guidance provides valuable insights to contractors concerning the direction that DCAA intends to take in future audits of accounting systems. The new approach involving contractor demonstrations and new policy of focusing on specific system criteria should reduce misunderstandings. However, contractors will need to communicate effectively with the auditors to promote an environment in which audit findings stay within the scope of the DFARS clause and the Guidance. 

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

iPub. Law No. 112-081.

iiId. at Sec. 818(c).

iiiId.

ivId. at Sec. 818(e).

v76 Fed. Reg. 53256 (August 25, 2011). The new rules are in two places in the Code of Federal Regulations: 42 CFR Part 50 (which applies to grants and cooperative agreements) and 45 CFR Part 94 (which applies to contracts). For ease of reference, this article cites to the provisions in 45 CFR Part 94. However, the rules applicable to grants and cooperative agreements are substantially similar to those applicable to contracts. The new rules do not apply to Phase I awards under the Small Business Innovation Research Program.

vi http://www.hhs.gov/about/orgchart/.

vii76 Fed. Reg. 53256.

viii45 CFR 94.3.

ixPrior to the submission of ABC Pharma’s proposal to BARDA, Dr. Welby made a disclosure of his SFIs to Mr. Argent under the old rules. Mr. Argent concluded that Dr. Welby did not have an FCOI.

xUnder 45 CFR 94.4(e) Investigators who plan to participate in PHS funded research have to submit SFI disclosures before the date of submission of any proposal for the research. Investigators participating in the research then have to submit updated disclosures at least annually and within thirty days of acquiring a new SFI (e.g., through purchase, marriage or inheritance). In addition, under 45 CFR 94.5(b)(2), new Investigators that join PHS funded research projects must immediately submit their SFI disclosures to the Institution’s designated official. Such Investigators should be cleared for FCOIs before charging time to the project.

xi45 CFR 94.3.

xii45 CFR. 94.4(f).

xiiiThe new rules require Institutions to maintain records relating to all Investigator disclosures and the Institution’s review and response to the disclosures and other actions under the Institution’s FCOI policy for at least three years from the date of final payment unless a different period is specified in FAR 4.7. See id.

xivDiscussion of the reporting requirements of the new rules is beyond the scope of this article. See 45 CFR 94.5(b) for details.

xvId. at 94.4(a)

xvi45 CFR 94.5(a)(5).

xvii45 CFR 94.4(b).

xviii45 CFR 94.4(c).

xix45 CFR 94.4(k).

xx31 U.S.C. § 3729 et. seq.

xxiSee 18 U.S.C. § 287 and 18 U.S.C. § 1001.

xxiiSee 77 Fed. Reg. 37 (February 24, 2012).

xxiii http://www.dcaa.mil/mmr/12-PAS-012.pdf.

In an opinion issued on June 6, 2011, the Supreme Court of the United States held that the Bayh-Dole Act (the “Act”), a key federal statute allocating patent rights under government contracts, does not automatically grant title to contractors in inventions made in the performance of their contract. Instead, to obtain title under the Act, contractors must first obtain from the inventor an assignment of his or her legal rights to the invention. The Court’s decision in Board of Trustees of Leland Stanford Junior University v. Roche Molecular Systems, Inc.ii is important because it clears up significant uncertainty about whether the Act has precedence over longstanding principles of U.S. patent law providing that rights in an invention belong to the individual inventor.iii It also highlights to contractors the importance of obtaining from all employees involved in creative processes an effective, current assignment of their rights, title and interest in inventions resulting from their employment.

Overview of the Bayh-Dole Act. Enacted in 1980, the Act allocates rights in federally funded “subject invention[s]” between the Government and certain contractors. Under the Act, a “subject invention” is “any invention of the contractor conceived or first actually reduced to practice in the performance of work under a funding agreement,” (emphasis added). A “funding agreement” means any “contract, grant, or cooperative agreement entered into between any Federal agency, other than the Tennessee Valley Authority, and any contractor for the performance of experimental, developmental, or research work funded in whole or in part by the Federal Government.” The Act provides that contractors may “elect to retain title to any subject invention” (emphasis added). To retain title, a contractor must discharge various duties imposed by the statute. In particular, the contractor must

1.     “disclose each subject invention to the [relevant] Federal agency within a reasonable time”;
2.     “make a written election within two years after disclosure” stating that the contractor opts to retain title to the invention; and
3.     “file a patent application prior to any statutory bar date.”

If a contractor fails to comply with any of these duties, the “Federal Government may receive title” to a subject invention.iv

When the contractor retains title, the agency that granted the federal funds receives from the contractor “a nonexclusive, nontransferable, irrevocable, paid-up license to practice … [the] subject invention.”v The agency also obtains “[m]arch-in rights,” which permit the agency to grant a license to a responsible third party under certain circumstances, such as when the contractor fails to take “effective steps to achieve practical application” of the invention.vi

The Act applies only to small businesses, universities, and other nonprofit organizations.vii However, a Presidential Memorandum issued to the executive branch agencies on February 18, 1983 extended the provisions of the Act to large businesses.

Facts and Procedural History of the Case. The Stanford University case concerned the invention of a human immunodeficiency virus (HIV) blood testing technique by Dr. Mark Holodniy of Stanford University and employees of Cetus, a small research company. When he joined Stanford in 1988, Dr. Holodniy signed a Copyright and Patent Agreement (“CPA”) under which he “agreed to assign” to Stanford his “right, title and interest” in inventions resulting from his employment. Shortly thereafter, his supervisor arranged for him to conduct research at the offices of Cetus. Stanford and Cetus were collaborating to test the efficacy of new HIV drugs. Prior to gaining access to Cetus personnel and facilities, Dr. Holodniy had to sign a Visitor’s Confidentiality Agreement (“VCA”) stating that “he will assign and do[es] hereby assign” to Cetus his “right, title and interest in . . . the ideas, inventions and improvements” made “as a consequence of [his] access” to Cetus. Working with Cetus employees, Dr. Holodniy devised a new procedure for measuring the amount of HIV in a patient’s blood. Following his return to Stanford, Stanford then secured patents to this measurement process.

In 1991 Roche Molecular Systems (“Roche”) acquired certain Cetus assets, including all the patent rights Cetus obtained in the VCA signed by Dr. Holodniy. Roche then commercialized the testing procedure invented by Dr. Holodniy and the Cetus employees. Roche’s HIV test kits are now in use in hospitals and clinics around the world.

In 2005, the Board of Trustees of Stanford University filed suit against Roche in a federal district court, asserting that Roche’s HIV test kits infringed Stanford’s patents. Roche contended in response that it was a co-owner of the HIV quantification procedure, based on Dr. Holodniy’s assignment of his rights in the VCA. Therefore, Roche argued, Stanford had no standing to sue Roche for patent infringement.viii Stanford argued that Holodniy had no rights to assign to Roche because Stanford’s HIV research was federally funded, giving the university superior rights in the invention under the Act.ix

The District Court ruled that the “VCA effectively assigned any rights that Holodniy had in the patented invention to Cetus,” and thus to Roche.x However, the district court also ruled that as a result of the operation of the Act, “Holodniy had no interest to assign.”xi The court held that the Act “provides that the individual inventor may obtain title” to a federally funded invention “only after the government and the contracting party have declined to do so.”xii

Stanford appealed to the Court of Appeals for the Federal Circuit (“CAFC”), which reversed the district court. The CAFC first held that Dr. Holodniy’s initial agreement with Stanford in the CPA was a mere promise to assign rights in the future, unlike Dr. Holodniy’s agreement with Cetus in the VCA, which itself affected a present assignment of Dr. Holodniy’s rights in the invention to Cetus.xiii Thus, under contract law, Cetus obtained Dr, Holodniy’s rights in the HIV measurement technique when he signed the VCA. The CAFC next explained that the Act “does not automatically void ab initio the inventors’ rights in government-funded inventions” and that the “statutory scheme did not automatically void the patent rights that Cetus received from Holodniy.”xiv In conclusion, the court held that “Roche possesse[d] an ownership interest in the patents-in-suit” by virtue of the VCA that was not extinguished by the Act and that Stanford had no standing to sue Roche for patent infringement. Stanford appealed this ruling to the Supreme Court.

The Supreme Court Decision. At the Supreme Court, the sole issue was whether the Bayh Dole Act automatically vests title to federally funded inventions in contractors, thus displacing the longstanding principle of U.S. patent law that rights in an invention belong to the inventor. The CAFC’s interpretation of the two assignment agreements was not at issue.

The Supreme Court began its analysis of the issue with the following statement concerning U.S. patent law:

Although much in intellectual property law has changed in the 220 years since the first Patent Act, the basic idea that inventors have the right to patent their inventions has not. Under the law in its current form, “[w]hoever invents or discovers any new and useful process, machine, manufacture, or composition of matter … may obtain a patent therefor.” 35 U.S.C. § 101. The inventor must attest that “he believes himself to be the original and first inventor of the [invention] for which he solicits a patent.” § 115. In most cases, a patent may be issued only to an applying inventor, or—because an inventor’s interest in his invention is “assignable in law by an instrument in writing”—an inventor’s assignee. §§ 151, 152, 261.

Our precedents confirm the general rule that rights in an invention belong to the inventor. See, e.g., Gayler v. Wilder, 51 U.S.(10 How. 477), 493, 13 L.Ed. 504 (1851) (“the discoverer of a new and useful improvement is vested by law with an inchoate right to its exclusive use, which he may perfect and make absolute by proceeding in the manner which the law requires”); Solomons v. United States, 137 U.S. 342, 346, 26 Ct.Cl. 620, 11 S.Ct. 88, 34 L.Ed. 667 (1890) (“whatever invention [an inventor] may thus conceive and perfect is his individual property”); United States v. Dubilier Condenser Corp., 289 U.S. 178, 188, 53 S.Ct. 554, 77 L.Ed. 1114 (1933) (an inventor owns “the product of [his] original thought”). The treatises are to the same effect. See, e.g., 8 Chisum on Patents § 22.01, p. 22–2 (2011) (“The presumptive owner of the property right in a patentable invention is the single human inventor”).

It is equally well established that an inventor can assign his rights in an invention to a third party. See Dubilier Condenser Corp., supra, at 187, 53 S.Ct. 554 (“A patent is property and title to it can pass only by assignment”); 8 Chisum on Patents, supra, § 22.01, at 22–2 (“The inventor … [may] transfer ownership interests by written assignment to anyone”). Thus, although others may acquire an interest in an invention, any such interest—as a general rule—must trace back to the inventor.

In accordance with these principles, we have recognized that unless there is an agreement to the contrary, an employer does not have rights in an invention “which is the original conception of the employee alone.” Dubilier Condenser Corp., 289 U.S., at 189, 53 S.Ct. 554. Such an invention “remains the property of him who conceived it.” Ibid. In most circumstances, an inventor must expressly grant his rights in an invention to his employer if the employer is to obtain those rights. See id., at 187, 53 S.Ct. 554 (“The respective rights and obligations of employer and employee, touching an invention conceived by the latter, spring from the contract of employment”).xvi

The Court then assessed whether the Act “reorders the normal priority of rights in an invention when the invention is conceived or first reduced to practice with the support of federal funds.”xvii Stanford, supported by the U.S. in an amicus curiae brief, made the following argument. First, the Act defines a “subject invention” as “any invention of the contractor conceived or first actually reduced to practice in the performance of work under a funding agreement”. The term “invention of the contractor” encompasses all inventions made by the contractor’s employees with the aid of federal funding.xviii Second, the Act’s provision allowing contractors to “retain” title to subject inventions means that the contractors have a priority right to “acquire” and “receive” title to all inventions made by their employees in the performance of federal funding agreements.xix

  The Court recognized the superficial appeal of Stanford’s arguments:

Stanford’s reading of the phrase “invention of the contractor” to mean “all inventions made by the contractor’s employees” is plausible enough in the abstract; it is often the case that whatever an employee produces in the course of his employment belongs to his employer. No one would claim that an autoworker who builds a car while working in a factory owns that car.

However, the Court rejected these arguments and affirmed the decision of the CAFC:

[A]s noted, patent law has always been different: We have rejected the idea that mere employment is sufficient to vest title to an employee’s invention in the employer. Against this background, a contractor’s invention—an “invention of the contractor”—does not automatically include inventions made by the contractor’s employees.xx . . .
Congress has in the past divested inventors of their rights in inventions by providing unambiguously that inventions created pursuant to specified federal contracts become the property of the United States. . . . Such language is notably absent from the Bayh–Dole Act. Nowhere in the Act is title expressly vested in contractors or anyone else; nowhere in the Act are inventors expressly deprived of their interest in federally funded inventions. Instead, the Act provides that contractors may “elect to retain title to any subject invention.” 35 U.S.C. § 202(a). . . .xxi

[Stanford’s] reading assumes that Congress subtly set aside two centuries of patent law in a statutory definition. It also renders the phrase “of the contractor” superfluous. If the phrase “of the contractor” were deleted from the definition of “subject invention,” the definition would cover “any invention … conceived or first actually reduced to practice in the performance of work under a funding agreement.” Reading “of the contractor” to mean “all inventions made by the contractor’s employees with the aid of federal funding,” as Stanford would, adds nothing that is not already in the definition, since the definition already covers inventions made under the funding agreement. That is contrary to our general “reluctan[ce] to treat statutory terms as surplusage.” Duncan v. Walker, 533 U.S. 167, 174, 121 S.Ct. 2120, 150 L.Ed.2d 251 (2001) (internal quotation marks omitted). Construing the phrase to refer instead to a particular category of inventions conceived or reduced to practice under a funding agreement—inventions “of the contractor,” that is, those owned by or belonging to the contractor—makes the phrase meaningful in the statutory definition. . . .

The Bayh–Dole Act’s provision stating that contractors may “elect to retain title” confirms that the Act does not vest title. 35 U.S.C. § 202(a) (emphasis added). Stanford reaches the opposite conclusion, but only because it reads “retain” to mean “acquire” and “receive.” . . . . That is certainly not the common meaning of “retain.” . . . The Bayh–Dole Act does not confer title to federally funded inventions on contractors or authorize contractors to unilaterally take title to those inventions; it simply assures contractors that they may keep title to whatever it is they already have. Such a provision makes sense in a statute specifying the respective rights and responsibilities of federal contractors and the Government.

The Bayh–Dole Act states that it “take[s] precedence over any other Act which would require a disposition of rights in subject inventions … that is inconsistent with” the Act. 35 U.S.C. § 210(a). The United States as amicus curiae argues that this provision operates to displace the basic principle, codified in the Patent Act, that an inventor owns the rights to his invention. See Brief for United States 21. But because the Bayh–Dole Act, including § 210(a), applies only to “subject inventions”—”inventions of the contractor”—it does not displace an inventor’s antecedent title to his invention. Only when an invention belongs to the contractor does the Bayh–Dole Act come into play. The Act’s disposition of rights—like much of the rest of the Bayh–Dole Act—serves to clarify the order of priority of rights between the Federal Government and a federal contractor in a federally funded invention that already belongs to the contractor. Nothing more. xxii

As a result of this decision, Stanford’s patent infringement suit was dismissed, Roche’s patent rights are secure and the uncertainty concerning the interaction of fundamental principles of U.S. patent law and the Act has been resolved.

Implications for Contractors. Following are key implications of the Stanford University case for contractors:

1. Contractors should request patent counsel to review their existing policies and program for obtaining assignments of patent rights from employees involved in creative processes. To preserve their rights in subject inventions, contractors should require such employees to execute assignment agreements as a condition of employment. If such agreements have not been obtained in the past, contractors should involve labor counsel in the development of corrective action plans.
2. Contractor patent counsel should review the current employee assignment agreement forms that are in use to ensure that the language makes effective, current assignments of the employees’ rights, title and interest in inventions resulting from their employment in accordance with the latest case law from the Federal Circuit and the Supreme Court.
3. The contractor’s invention disclosure and patent prosecution files/databases should include copies of the applicable employee assignment agreements. In the event of sale of the contractor or a contractor patent, this will enable the purchaser to establish that the inventor does not have a claim to title to the patent.

On August 29, 2011, the United States Court of Appeals for the Federal Circuit (the “Federal Circuit”) affirmed the right of contractors to file judicial challenges against negative performance evaluations. The case, Todd Construction, L.P. v. United Statesxxiii , arose after a government engineer rated as “unsatisfactory” a construction contractor’s performance on two projects, largely due to significant delays in completion of the projects. The contractor requested a review by the Contracting Officer (CO), who issued a final decision concluding that the rating was justified. The contractor then filed a complaint in the Court of Federal Claims (the “Claims Court”) essentially requesting a declaratory judgment that the evaluations were unfair and inaccurate.xxiv

The Claims Court found that it had jurisdiction over the contractor’s complaint but dismissed the complaint due to defects in the contractor’s pleadings. The contractor appealed and the Federal Circuit examined the jurisdictional issue de novo. The court first reviewed the Tucker’s Act grant of jurisdiction to the Claims Court over any “claims” made by contractors under the Contract Disputes Act (“CDA”) on which a CO has issued a final decision. The court then noted that under the CDA’s implementing regulations at Federal Acquisition Regulation (“FAR”) § 2.101, a “claim” is a “written demand or written assertion by one of the contracting parties seeking, as a matter of, the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to the contract.” There was no dispute that the contractor has submitted a written demand seeking relief or that the CO had issued a final decision on that demand. Rather, the sole jurisdictional dispute was whether the demand “related” to the contract. The government argued that it did not relate to any of the contracts at issue because the contracts did not include a clause requiring the government to prepare accurate and fair performance evaluations. Therefore, the government asserted that the contractor’s demand was not a claim over which the court had jurisdiction.xxv

The Federal Circuit refused to adopt the government’s restrictive view of jurisdiction, holding as follows:

Congress’ overall purpose to confer comprehensive jurisdiction under the CDA confirms that we should read the definition of “claim” broadly. We have previously recognized that “[i]n defining the jurisdiction of the [Claims Court] over CDA disputes, Congress has chosen expansive, not restrictive, language.” Alliant Techsystems, Inc. v. United States, 178 F.3d 1260, 1268 (Fed.Cir.1999). The Tucker Act provides jurisdiction to “render judgment upon any claim by or against … a contractor arising under section 10(a)(1) of the [CDA], including … nonmonetary disputes on which a decision of the contracting officer has been issued under section 6 of the [CDA].” 28 U.S.C. § 1491(a)(2) (emphases added). In Alliant, the government argued that “nonmonetary disputes” should be read narrowly to exclude “disputes arising prior to the completion of work on a contract” and “disputes that have not yet ripened into a monetary dispute but … could” if the contractor “could convert the claim into one for monetary relief” by its own actions. 178 F.3d at 1268 (internal quotation marks omitted). We rejected this narrow reading, emphasizing that the provision “begins by broadly granting the court jurisdiction over ‘any claims,’ ” uses the “nonrestrictive term (‘including’),” and ends the provision with “equally nonrestrictive language” concerning “nonmonetary disputes.” Id. We also explicitly recognized that “[t]he FAR has … ensured that review of contract claims will be relatively easy to obtain, by defining the term ‘claim’ broadly, to include a demand or assertion seeking … relief arising under or relating to the contract.” Id. at 1271. Therefore, the broad language of the statute and FAR provision supports a broad reading of the term “claim.”

In line with this authority, we have previously held that to be a claim “relating to the contract” under the CDA, the claim “must have some relationship to the terms or performance of a government contract.” Applied Cos. v. United States, 144 F.3d 1470, 1478 (Fed.Cir.1998). The performance evaluations at issue have a direct connection and association with Todd’s government contracts and, under this “ordinarily broad understanding of the phrase,” Tyco, 587 F.3d at 1379, appear to be “relat[ed] to the contract .” While the unsatisfactory performance evaluations may not relate to the terms of the contract itself, they relate to Todd’s performance under the contract. As the Claims Court recognized:”The subject of the evaluations is the quality of the contractor’s performance under the terms of the contract…. As a matter of logic, a performance evaluation relates to the contractor’s performance under the contract, in the same way that any evaluation relates to the thing evaluated.” BLR Grp. of Am., Inc. v. United States, 94 Fed.Cl. 354, 373 (2010) (quoting Todd I, 85 Fed.Cl. at 44–45).xxvi

Thus, even though the contractor failed to allege that the evaluation breached a particular contract term or implied duty, the courts nonetheless had jurisdiction over the contractor’s demand because it related to the performance of a government contract. Interestingly, the court noted that it was not reading the regulation governing performance evaluations into the contract. Rather, the court stated that the “regulation applies of its own force and directly governs the parties’ performance under the contract.”xxvii

At the end, the Federal Circuit agreed with the Court of Claims’ dismissal of the contractor’s suit due to defects in the pleadings – i.e., failure to establish standing by alleging prejudice resulting from procedural irregularities and failure to state a claim by alleging that the substantial delays were excusable.xxviii However, the decision is important because it upholds contractors’ rights to make judicial challenges to negative performance evaluations.

In recent industry meetings and articles, members of the government contracting community have been discussing the challenges that agency Contracting Officers (“COs”) face in discharging the duties assigned to them by the Federal Acquisition Regulation (“FAR”).xxix One part of this discussion has concerned certain difficulties associated with the discharge of the CO’s duty to exercise independent judgment in the administration of contracts. The FAR and the case law, including a May 27, 2010 decision of the Court of Federal Claims, require the CO to “put his own mind to the problems and render his own decisions”. However, in today’s environment the CO tends to simply “rubber stamp” the recommendations of his legal, accounting and technical advisors. This article discusses problems created by this tendency, the governing law and some actions that agency policy makers and contractors alike can take to ensure that COs exercise independent judgment.

COs have a critical role in the federal procurement system. Under the Contract Disputes Act, contractors must submit all of their claims for contractual relief to the CO for decision. Until the CO issues a decision on the claim or the claim is “deemed denied” under the governing regulations, the contractor cannot appeal to a judicial body. In deciding contractor claims, FAR 1.602-2 requires COs to “ensure that contractors receive impartial, fair and equitable treatment.” From a procurement policy perspective, the FAR’s imposition of this “duty of impartiality” makes sense. The massive federal bureaucracy that is necessary to meet our nation’s challenges is not by nature particularly inclined to nimble, creative, cost effective problem solving. However, as a result of their struggle for survival in sometimes brutal free markets, contractors are able to offer this type of problem solving to the government. In short, the government desperately needs the support of good contractors. When COs treat contractors unfairly, the private sector tends to lose faith in the government as a customer. As a result, excellent companies will stop offering their services to the government or will include in the price of their government contracts appropriate contingencies to account for the risks and costs of such inequities. In either case, the taxpayers lose.

To discharge the duty of impartiality, COs must act independently. If COs merely concern themselves with meeting needs or addressing issues of federal agency stakeholders such as political appointees, bureaucratic factions, the agency program manager or specialists in law and accounting, then CO decisions will tend to be unfair to contractors. If, on the other hand, COs are independent of these influences, then their decisions will tend to be more equitable. Of course, it would be unrealistic to expect COs to be completely free from all influence by the agency that employs them. However, discharge of their duty to exercise independent judgment does not require such freedom. Rather, it simply requires the COs to take conscious account of contractor arguments, positions and concerns.

A long line of cases recognizes that the CO has a duty to exercise independent judgment in administering contracts and deciding claims. The case of Fireman’s Fund Ins. Co. v. United States, which was decided by the Court of Federal Claims on May 26, 2010, is the most recent in this line.xxx In that case, the CO asserted a claim against the contractor for a reduction in the price of the contract. The CO alleged that a predecessor CO had waived a key testing requirement, making performance of the contract less expensive for the contractor. Agency counsel drafted the claim for the CO but the CO made no changes to the draft. Furthermore, while the CO made an effort to understand the claim, the CO made no effort to verify the technical inputs or to review and analyze its substantive merits of the claim. The court summarized the law as follows:

While there is no “implied prohibition against [the contracting officer’s] first obtaining or even agreeing with the views of others,” Pac. Architects & Eng’rs, Inc. v. United States, 203 Ct.Cl. 499, 491 F.2d 734, 744 (Ct.Cl.1974), a contracting officer must still ” ‘put his own mind to the problems and render his own decisions,’ ” id. (quoting N.Y. Shipbuilding Corp. v. United States, 180 Ct.Cl. 446, 385 F.2d 427, 435 (Ct.Cl.1967)). “Consultation is one thing, however; abdication, quite another.” N. Star Ala. Hous. Corp. v. United States, 76 Fed.Cl. 158, 209 (2007). The contracting officer must “take ownership of all determinations included in the final contracting officer’s opinion,” CEMS, Inc. v. United States, 65 Fed.Cl. 473, 479 (2005), and, if other government officials are consulted, including government attorneys, “a contracting officer may not forsake his duties, but rather must ensure that his decisions are the product of his personal and independent judgment,” N. Star Ala. Hous., 76 Fed.Cl. at 209 (emphasis added). A contractor is entitled to a determination by the contracting officer, and therefore “a decision by someone else is a nullity.” N.Y. Shipbuilding, 385 F.2d at 436.xxxi

Applying this law to the facts of the case, the court held as follows:

Plaintiffs were entitled to a fair and impartial final decision by the contracting officer. FAR 1.602-2(b). . . .[The CO’s] testimony portrayed an orphan decision that she signed because her legal team recommended it. The claim was entirely developed by counsel, with some information from [individuals other than the CO]. What attention she gave the final decision was not a substantive review and analysis of the claim’s merits or a review of the technical input; rather, she merely understood the nature of the claim asserted in the decision. Such a decision hardly can be elevated to the product of the exercise of the contract[ing] officer’s independent judgment.xxxii

Because the CO did not put her own mind to the decision, the court ruled that the decision supporting the government claim was invalid.xxxiii Where the contractor submits a claim and the CO fails to exercise independent judgment in deciding the claim, the contractor has a cause of action against the government for breach of contract.xxxiv

 It is clear that the CO’s lack of specialized expertise in the legal, accounting and technical issues associated with a contract administration issue is not an excuse for abdicating the duty to exercise independent judgment. In New York Shipbuilding, the court stated:

Nor can we agree that insistence on a decision by the contractual official is hypertechnical or unrealistic. It may be that, in some instances, the “reality” is that the designated individual merely rubber-stamps a subordinate’s or superior’s findings, but we must presume that the parties intend otherwise that they desire that in the end he put his own mind to the problems and render his own decisions. That has been the consistent teaching of this court in the past … and we shall not today sanction an erosion of responsibility by holding that it makes no difference whether or not the chosen officer does his work.xxxv

Thus, regardless of the complexity of a matter or demands on the COs time, a CO may not simply accept a Defense Contract Audit Agency recommendation to disallow a cost without making an effort to analyze the positions of both DCAA and the contractor on the issue. Similarly, the CO may not simply adopt without any thought the recommendations of his lawyer on an issue. Rather, the CO has a duty under the law to ask questions of his advisors, review key documents and to do whatever else is necessary to understand and fully consider the positions of both sides. In addition to fulfilling a legal duty, this approach would improve the quality of the government’s decision making process by making the advisors, who are not always perfect, accountable for producing thorough and complete analyses that produce the right answer to a question, not just the answer that protects the agency’s programmatic interests.

As mentioned, the procurement system and U.S. taxpayers benefit when COs exercise independent judgment. To promote this benefit, agency procurement policymakers should emphasize in their training and other communications with COs their duty to do so. In addition, agency counsel should remind COs of this duty when developing documents for the signature of COs. Furthermore, while lack of resources is not an excuse for failing to follow the law, agencies should redouble efforts to hire additional COs so that the COs have adequate time to exercise independent judgment in their decision making on contractor issues. These steps are not only necessary to fundamental fairness, but will also help the agencies to avoid wasting taxpayer resources on decision processes that are later ruled illegal by the courts and boards of contract appeals. At appropriate times, contractors should also remind COs of their duty to exercise independent judgment. If COs fail to exercise this duty in reviewing well supported contractor submissions and the stakes are high enough for the contractor, contractors can challenge CO decisions in litigation.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i 35 U.S.C. § 200 et. seq.

ii 131 S.Ct. 2188 (2011).

iii 35 U.S.C. §101.

iv Id. at §§ 201(e), (c), 202(a), (c)(1)-(3).

v Id. at § 202(c)(4).

vi Id. at § 203.

vii Id. at § 202(a).

viii 487 F.Supp.2d 1099, 1111, 1115 (N.D.Cal.2007).

ix Id.

x Id. at 1117.

xiId. at 1117, 1119.

xii Id at 1118.

xiii See 583 F.3d 832, 841–842 (2009).

xiv Id. at 844–845.

xvId. at 836–837.

xvi 131 S.Ct. at 2194-2195.

xvii Id. at 2195.

xviii Id. at 2196.

xix Id. at 2197.

xx Id. at 2196-2197.

xxi Id. at 2196.

xxii Id. at 2196-2197.

xxiii —F.3d— (Fed. Cir. 2011), 2011 WL 3796259.

xxiv Id.

xxv Id.

xxvi Id.

xxvii Id.

xxviii Id.

xxix See e.g., American Bar Association, 16th Annual Federal Procurement Institute, March 4, 2010, Contracting Officers: The Journey from Autonomy to 24/7 Oversight; Vernon. J. Edwards & Ralph C. Nash, Postscript II: The Role Of The Contracting Officer, 24 N&CR ¶ 14 (March 2010); Buchanan, Ingersoll & Rooney, Changes in the Rules Government Contracting Officers, DCAA Auditors and DCMA Administrators May Have a Serious Adverse Impact on Government Contractors, Government Contracts Advisory (March 2010).

xxxFireman’s Fund Ins. Co. v. United States, —-Fed. Cl.—-, 2010 WL 2197532 (Fed. Cl., May 26, 2010).

xxxi Id.

xxxii Id.

xxxiii Id.

xxxiv N. Star Ala. Hous. Corp. v. United States, 76 Fed.Cl. 158, 209 (2007).

xxxv New York Shipbuilding Corp. v. United States, 180 Ct.Cl. 446, 385 F.2d 427, 435 (1967).

In recent industry meetings and articles, members of the government contracting community have been discussing the challenges that agency Contracting Officers (“COs”) face in discharging the duties assigned to them by the Federal Acquisition Regulation (“FAR”).i One part of this discussion has concerned certain difficulties associated with the discharge of the CO’s duty to exercise independent judgment in the administration of contracts. The FAR and the case law, including a May 27, 2010 decision of the Court of Federal Claims, require the CO to “put his own mind to the problems and render his own decisions”. However, in today’s environment the CO tends to simply “rubber stamp” the recommendations of his legal, accounting and technical advisors. This article discusses problems created by this tendency, the governing law and some actions that agency policy makers and contractors alike can take to ensure that COs exercise independent judgment.

COs have a critical role in the federal procurement system. Under the Contract Disputes Act, contractors must submit all of their claims for contractual relief to the CO for decision. Until the CO issues a decision on the claim or the claim is “deemed denied” under the governing regulations, the contractor cannot appeal to a judicial body. In deciding contractor claims, FAR 1.602-2 requires COs to “ensure that contractors receive impartial, fair and equitable treatment.” From a procurement policy perspective, the FAR’s imposition of this “duty of impartiality” makes sense. The massive federal bureaucracy that is necessary to meet our nation’s challenges is not by nature particularly inclined to nimble, creative, cost effective problem solving. However, as a result of their struggle for survival in sometimes brutal free markets, contractors are able to offer this type of problem solving to the government. In short, the government desperately needs the support of good contractors. When COs treat contractors unfairly, the private sector tends to lose faith in the government as a customer. As a result, excellent companies will stop offering their services to the government or will include in the price of their government contracts appropriate contingencies to account for the risks and costs of such inequities. In either case, the taxpayers lose.

To discharge the duty of impartiality, COs must act independently. If COs merely concern themselves with meeting needs or addressing issues of federal agency stakeholders such as political appointees, bureaucratic factions, the agency program manager or specialists in law and accounting, then CO decisions will tend to be unfair to contractors. If, on the other hand, COs are independent of these influences, then their decisions will tend to be more equitable. Of course, it would be unrealistic to expect COs to be completely free from all influence by the agency that employs them. However, discharge of their duty to exercise independent judgment does not require such freedom. Rather, it simply requires the COs to take conscious account of contractor arguments, positions and concerns.

A long line of cases recognizes that the CO has a duty to exercise independent judgment in administering contracts and deciding claims. The case of Fireman’s Fund Ins. Co. v. United States, which was decided by the Court of Federal Claims on May 26, 2010, is the most recent in this line.ii In that case, the CO asserted a claim against the contractor for a reduction in the price of the contract. The CO alleged that a predecessor CO had waived a key testing requirement, making performance of the contract less expensive for the contractor. Agency counsel drafted the claim for the CO, but the CO made no changes to the draft. Furthermore, while the CO made an effort to understand the claim, the CO made no effort to verify the technical inputs or to review and analyze its substantive merits of the claim. The court summarized the law as follows:

While there is no “implied prohibition against [the contracting officer’s] first obtaining or even agreeing with the views of others,” Pac. Architects & Eng’rs, Inc. v. United States, 203 Ct.Cl. 499, 491 F.2d 734, 744 (Ct.Cl.1974), a contracting officer must still “ ‘put his own mind to the problems and render his own decisions,’ “ id. (quoting N.Y. Shipbuilding Corp. v. United States, 180 Ct.Cl. 446, 385 F.2d 427, 435 (Ct.Cl.1967)). “Consultation is one thing, however; abdication, quite another.” N. Star Ala. Hous. Corp. v. United States, 76 Fed.Cl. 158, 209 (2007). The contracting officer must “take ownership of all determinations included in the final contracting officer’s opinion,” CEMS, Inc. v. United States, 65 Fed.Cl. 473, 479 (2005), and, if other government officials are consulted, including government attorneys, “a contracting officer may not forsake his duties, but rather must ensure that his decisions are the product of his personal and independent judgment,” N. Star Ala. Hous., 76 Fed.Cl. at 209 (emphasis added). A contractor is entitled to a determination by the contracting officer, and therefore “a decision by someone else is a nullity.” N.Y. Shipbuilding, 385 F.2d at 436.iii

Applying this law to the facts of the case, the court held as follows: 

Plaintiffs were entitled to a fair and impartial final decision by the contracting officer. FAR 1.602-2(b). . . .[The CO’s] testimony portrayed an orphan decision that she signed because her legal team recommended it. The claim was entirely developed by counsel, with some information from [individuals other than the CO]. What attention she gave the final decision was not a substantive review and analysis of the claim’s merits or a review of the technical input; rather, she merely understood the nature of the claim asserted in the decision. Such a decision hardly can be elevated to the product of the exercise of the contract[ing] officer’s independent judgment.iv

Because the CO did not put her own mind to the decision, the court ruled that the decision supporting the government claim was invalid.v Where the contractor submits a claim and the CO fails to exercise independent judgment in deciding the claim, the contractor has a cause of action against the government for breach of contract.vi

It is clear that the CO’s lack of specialized expertise in the legal, accounting and technical issues associated with a contract administration issue is not an excuse for abdicating the duty to exercise independent judgment. In New York Shipbuilding, the court stated:

Nor can we agree that insistence on a decision by the contractual official is hypertechnical or unrealistic. It may be that, in some instances, the “reality” is that the designated individual merely rubber-stamps a subordinate’s or superior’s findings, but we must presume that the parties intend otherwise that they desire that in the end he put his own mind to the problems and render his own decisions. That has been the consistent teaching of this court in the past … and we shall not today sanction an erosion of responsibility by holding that it makes no difference whether or not the chosen officer does his work.vii

Thus, regardless of the complexity of a matter or demands on the COs time, a CO may not simply accept a Defense Contract Audit Agency recommendation to disallow a cost without making an effort to analyze the positions of both DCAA and the contractor on the issue. Similarly, the CO may not simply adopt without any thought the recommendations of his lawyer on an issue. Rather, the CO has a duty under the law to ask questions of his advisors, review key documents and to do whatever else is necessary to understand and fully consider the positions of both sides. In addition to fulfilling a legal duty, this approach would improve the quality of the government’s decision making process by making the advisors, who are not always perfect, accountable for producing thorough and complete analyses that produce the right answer to a question, not just the answer that protects the agency’s programmatic interests.

As mentioned, the procurement system and U.S. taxpayers benefit when COs exercise independent judgment. To promote this benefit, agency procurement policymakers should emphasize in their training and other communications with COs their duty to do so. In addition, agency counsel should remind COs of this duty when developing documents for the signature of COs. Furthermore, while lack of resources is not an excuse for failing to follow the law, agencies should redouble efforts to hire additional COs so that the COs have adequate time to exercise independent judgment in their decision making on contractor issues. These steps are not only necessary to fundamental fairness, but will also help the agencies to avoid wasting taxpayer resources on decision processes that are later ruled illegal by the courts and boards of contract appeals. At appropriate times, contractors should also remind COs of their duty to exercise independent judgment. If COs fail to exercise this duty in reviewing well supported contractor submissions and the stakes are high enough for the contractor, contractors can challenge CO decisions in litigation.

On May 19, 2010, the Department of Defense (“DoD”) issued a new interim rule that restricts contractors from entering into or enforcing agreements with their employees to arbitrate certain claims.viii The rule implements Section 8116 of the DoD Appropriations Act for Fiscal Year (“FY”) 2010 (the “Act”)ix, which prohibits the use of FY 10 funds for any contract exceeding $1 million, if the contractor restricts its employees to arbitration of claims arising out of sexual harassment or assault. The impetus for the Act and the interim rule was a case involving the alleged rape of a contractor employee by her co-workers. In that case, the employee had a mandatory arbitration agreement with the company and the company asserted that this agreement precluded the employee from bringing a case against the company in the courts and obtaining a trial before a jury. The case got the attention of Sen, Al Franken, who sponsored the Act based on his belief that contractor employees should be able to have their day court in such circumstances.x

  The rule requires use of a new Defense Federal Acquisition Regulation Supplement (“DFARS”) clause in all solicitations and contracts valued in excess of $1 million that use funds appropriated or “otherwise made available” by the Act, except in contracts for the acquisition of commercial items.xi Under the clause, DFARS 252.222-7006 Restrictions on the Use of Mandatory Arbitration Agreements, contractors agree not to enter into or enforce agreements with employees or independent contractors to resolve through arbitration: (1) any claim under title VII of the Civil Rights Act of 1964, including sexual harassment and discrimination claims; or (2) any tort related to or arising out of sexual assault or harassment, including assault and battery, intentional infliction of emotional distress, false imprisonment, or negligent hiring, supervision, or retention (collectively the “Covered Areas”). In addition, contractors agree that their signature on any contract awarded after June 17, 2010 is a certification that the contractor requires each “covered subcontractor” to agree not to enter into, and not to take any action to enforce, any provision of any agreements to arbitrate claims for the Covered Areas with respect to any employee or independent contractor performing work related to such subcontract. “Covered subcontractors” are any entities that have a subcontract valued in excess of $1 million, except for subcontracts for commercial items.xii

  The preamble to the rule contains the following helpful guidance concerning the applicability of the clause:

• A new order that exceeds $1 million using funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act, placed against an indefinite-delivery/indefinite-quantity contract for an applicable item or service, is covered by the restriction in the new DFARS clause, regardless of whether the basic indefinite-delivery/indefinite-quantity contract was covered.
• A funding modification adding more than $1 million of funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act to a contract that does not contain the clause at 252.222-7006 or 252.222-7999 (Deviation), is not covered.
• A bilateral modification adding new work that uses funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act in excess of $1 million is covered.
• The award of a new order using funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act with a value of $700,000 is not covered, since the value is under $1 million.
• A contract valued at $1.5 million awarded today but with only $10,000 in funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act (with the remaining balance coming from FY 11 funding), is not covered because the total value of funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act is less than $1 million.
• An entity or firm that does not have a contract in excess of $1 million appropriated or otherwise made available by the FY 10 DoD Appropriations Act is not affected by the clause.
• Unless a parent or subsidiary corporation is a party to the contract, it is not affected. The term “contractor” in the new DFARS clause is narrowly applied only to the entity that has the contract.
• When using funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act for bilateral modifications adding new work or orders that exceed $1 million that are issued after the effective date of this interim rule [May 19, 2010], Contracting Officers must modify existing contracts (on a bilateral basis) to include the new DFARS clause.
• In the event that a contractor refuses to accept such a modification, the contractor will not be eligible for receipt of funds appropriated or otherwise made available by the FY 10 DoD Appropriations Act on such modifications or orders.^xiii

The Federal Circuit’s recent decision in the case of ATK Thiokol, Inc. v. United Statesxiv clarifies the rules that govern accounting for independent research and development (“IR&D”) costs. Under these rules, contractors may allocate across all of their contracts the costs of IR&D, but must allocate to a particular benefiting contract or group of contracts the costs of research and development that does not qualify as IR&D. To qualify as IR&D, the effort must not be “required in the performance of a contract”.xv The ATK Thiokol decision resolves longstanding uncertainty concerning how to discern when an effort is “required” by a contract. The decision is important because it enables contractors to allocate research and development costs across a larger base and thereby to maintain competitive pricing and profitability in the contracts and product lines that will initially benefit from the investment.

Over the years, the government has argued that research and development is “required in the performance of a contract” if the effort was either explicitly or implicitly required in the performance of the contract. In the civil False Claims Act (“FCA”) case of United States v. Newport News Shipbuilding Inc., 276 F. Supp 2d 539 (E.D. Va 2003), the court agreed with this position and held that the costs of any work that is an implied precondition to performance of a contract may not be charged as IR&D if the work is done concurrently with contract performance. Furthermore, contractors who did allocate such costs to IR&D could be held liable to the government for submission of false claims on the government contracts to which the costs were allocated. Under the rationale of this opinion, contractors would have to charge all such concurrent research and development costs that are impliedly necessary to the performance of a contract to the first contract that will benefit from the costs. On such contracts, contractors would be faced with the “Hobson’s choice” of pricing themselves out of the market or available funds for the contract or accepting a loss contract.

Whereas the Newport News opinion came from a district court in a FCA context, the ATK Thiokol case arose out of an audit of a contractor’s incurred costs. The auditors and the Contracting Officer held that the contractor’s disclosed IR&D accounting practice violated the regulations because the practice treated as IR&D certain research that were impliedly necessary to their performance. The contractor appealed to the Court of Federal Claims (“COFC”), which specializes in handling government contract cases. The COFC held as follows:

• Only development that is specifically required by the contract is excluded from the definition of IR&D.
• Whether development is specifically required depends on the parties’ intent. To determine the parties’ intent, the court reviewed: (1) whether the contract language required the development; and (2) whether the cost of the development work was included in the contract price.
• The court also approved the contractor’s practice that if there is no specific requirement for the effort and it is reasonably foreseeable that the work will benefit more than one contract, the project could be classified as IR&D.
• The court rejected the proposition in Newport News that development work that was an implied precondition to performance was necessarily “required in the performance of the contract”.
• The court also rejected the proposition that development work that is conducted concurrently with a contract and that benefits the contract must be charged to the contract.^xvi

On appeal, the Federal Circuit agreed with the COFC’s finding that the meaning of the phrase “required in the performance of a contract” in the regulations on accounting for bid and proposal (“B&P”) costs should be applied to the same phrase in the IR&D cost accounting regulations. In particular, the Federal Circuit said: 

CAS 402-61(c) . . . Interpretation No. 1 distinguishes proposal costs that are “specifically required by” an existing contract from those that “do not result from such specific requirements.” The former costs “relate only to [a particular] contract,” while the latter costs “relate to all work of the contractor” and thus qualify as B&P. The effect of Interpretation No. 1 is to equate the B&P definitional exclusion of proposal costs that are “required in the performance of a contract” with the category of costs that are “specifically required by the provisions of a contract.”

The same analysis applies to the closely analogous category of IR&D costs. Although Interpretation No. 1 does not by its terms address IR&D, the government’s suggestion that the approach employed in Interpretation No. 1 should be limited to B&P costs, and that IR&D costs should be treated differently, would result in a construction in which identical regulatory language-“required in the performance of a contract”-would be interpreted differently for IR&D than for B&P. There is no support anywhere in the text or history of the regulations for treating that identical regulatory formulation differently. We therefore construe the reference to costs “required in the performance of a contract” to mean, in both contexts, costs that are specifically required by the contract. xvii

The Federal Circuit also made the following statement concerning the Newport News type approach to IR&D accounting: 

[T]he result of requiring IR&D costs to be borne by a contract for which the research and development work in question is deemed necessary could have the perverse effect of charging all of the research and development costs for a proposed product line against the first contract for the products in that line, whether the contract is governmental or commercial. That approach would either disproportionately burden the contract that happened to be first in line or ensure that the first contract would be a losing one. For research that, by hypothesis, benefits multiple potential contracts, both commercial and governmental, allocating general research and development costs in that manner is not sensible as a policy matter.

Because the Federal Circuit has affirmed the expert opinion of the COFC, there is good reason to hope that the debate and uncertainty concerning the IR&D cost accounting regulations is over. However, there is a risk that auditors, whistleblowers and even district courts will continue to misunderstand this issue. To mitigate this risk, contractors should take care to fully disclose their IR&D cost accounting practices. xviii

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i See e.g., American Bar Association, 16th Annual Federal Procurement Institute, March 4, 2010, Contracting Officers: The Journey from Autonomy to 24/7 Oversight; Vernon. J. Edwards & Ralph C. Nash, Postscript II: The Role Of The Contracting Officer, 24 N&CR ¶ 14 (March 2010); Buchanan, Ingersoll & Rooney, Changes in the Rules Government Contracting Officers, DCAA Auditors and DCMA Administrators May Have a Serious Adverse Impact on Government Contractors, Government Contracts Advisory (March 2010).

ii Fireman’s Fund Ins. Co. v. United States, —-Fed. Cl.—-, 2010 WL 2197532 (Fed. Cl., May 26, 2010).

iii Id.

iv Id.

v Id.

vi N. Star Ala. Hous. Corp. v. United States, 76 Fed.Cl. 158, 209 (2007).

vii New York Shipbuilding Corp. v. United States, 180 Ct.Cl. 446, 385 F.2d 427, 435 (1967).

viii 75 Fed. Reg. 27946 (May 19, 2010).

ix Public Law No. 111-118.

x See Cynthia Dizikes, Senate Passes Franken Amendment Aimed at Defense Contractors, www.MinnPost.com (October 6, 2009).

xi 75 Fed. Reg. 27946.

xii Id.

xiii Id.

xiv ATK Thiokol v. United States, 598 F.3d 1329 (Fed. Cir. 2010).

xv The rules concerning allocability of IR&D costs to contracts are set forth in Cost Accounting Standard 420. The parallel rules concerning allowability (i.e., recoverability) of IR&D costs are set forth in FAR 31.205-18.

xviATK Thiokol v. United States, 68 Fed. Cl. 612 (2005) aff’d 598 F.3d 1329 (Fed. Cir. 2010).

xvii ATK Thiokol v. United States, 598 F.3d 1329 (Fed. Cir. 2010).

xviii Analysis of the procedures and challenges associated with changing from a Newport News to an ATK Thiokol type approach is beyond the scope of this article. Contractors should consult legal and/or accounting experts before making such a change.

On January 10, 2010, recipients of American Recovery and Reinvestment Act (“Recovery Act”) funds filed the second of a series of required reports concerning the use and impact of the funds. These reports, which covered the three month period from October 1 through December 31, 2009, showed that the Recovery Act funded 32,695 government contractor jobs in that period. By contrast, Recovery Act grants funded 560,618 jobs in that period. See www.recovery.gov. As mentioned in the Summer 2009 edition of “Reflections on Government Contracts”, Recovery Act spending on grants will significantly exceed spending on contracts. Indeed, the government will ultimately spend approximately $214 billion in grants but “only” $60 billion in contracts.

To implement Recovery Act reporting requirements, the Acquisition Councils promulgated a new Federal Acquisition Regulation (“FAR”) clause – FAR § 52.204-11, American Recovery and Reinvestment Act- Reporting Requirements. As mentioned, one of the major new reporting requirements of the clause involves reporting of “jobs created” and “jobs retained” by the prime contractor as a result of Recovery Act funding. Jobs data must be expressed in “full-time equivalents”, calculated cumulatively as all hours worked on the project divided by the total number of hours in a full-time schedule. Another major reporting requirement concerns executive compensation. If the contractor in the preceding fiscal year received (a) 80 percent or more of its annual gross revenues from Federal contracts; and (b) $25,000,000 or more in annual gross revenues from Federal contracts, the contractor must report on the total compensation of the prime contractor’s five most highly compensated officers for the calendar year in which the Recovery Act award was made. In addition, prime contractors must obtain and report data concerning certain first tier subcontractors –ie, the DUNS number, location (including congressional district), date and amount of subcontract, description of products and services and, for certain large subcontractors meeting the specified criteria, executive compensation data. FAR § 52.204-11 requires that prime contractors receiving Recovery Act funds file their reports at www.FederalReporting.gov by the 10th day after the end of each calendar quarter. Contractors should be aware that the False Statements Act provides for criminal penalties for anyone who, in providing information to the government, knowingly and willfully falsifies or conceals a material fact, makes a materially false statement or representation, or uses a document known to contain materially false information. Therefore, contractors should have a strong commitment to accuracy in information presented in Recovery Act reports.

On October 10, 2009, recipients of American Recovery and Reinvestment Act (“Recovery Act”) funds filed the first of a series of required reports concerning the use and impact of the funds. On October 15, 2009, the government published the reported data concerning contracts awarded with Recovery Act funds. That data showed that the Recovery Act has created or saved 30,383 government contractor jobs. The government plans to publish data concerning jobs created or saved by Recovery Act funded grants and loans by October 30, 2009. As mentioned in the Summer 2009 edition of “Reflections on Government Contracts”, Recovery Act grant spending on grants will significantly exceed spending on contracts. Indeed, the government will ultimately spend approximately $214 billion in grants but “only” $60 billion in contracts. Therefore, the data released on October 30, 2009 should show significantly more jobs created or saved by Recovery Act funds.

To implement Recovery Act reporting requirements, the Acquisition Councils promulgated a new Federal Acquisition Regulation (“FAR”) clause – FAR § 52.204-11, American Recovery and Reinvestment Act- Reporting Requirements. As mentioned, one of the major new reporting requirements of the clause involves reporting of “jobs created” and “jobs retained” by the prime contractor as a result of Recovery Act funding. Jobs data must be expressed in “full-time equivalents”, calculated cumulatively as all hours worked on the project divided by the total number of hours in a full-time schedule. Another major reporting requirement concerns executive compensation. If the contractor in the preceding fiscal year received (a) 80 percent or more of its annual gross revenues from Federal contracts; and (b) $25,000,000 or more in annual gross revenues from Federal contracts, the contractor must report on the total compensation of the prime contractor’s five most highly compensated officers for the calendar year in which the Recovery Act award was made. In addition, prime contractors must obtain and report data concerning certain first tier subcontractors –ie, the DUNS number, location (including congressional district), date and amount of subcontract, description of products and services and, for certain large subcontractors meeting the specified criteria, executive compensation data. FAR § 52.204-11 requires that prime contractors receiving Recovery Act funds file their reports at www.FederalReporting.gov by the 10th day after the end of each calendar quarter. Contractors should be aware that the False Statements Act provides for criminal penalties for anyone who, in providing information to the government, knowingly and willfully falsifies or conceals a material fact, makes a materially false statement or representation, or uses a document known to contain materially false information. Therefore, contractors should have a strong commitment to accuracy in information presented in Recovery Act reports.

On September 14, 2009, a federal district court issued a decision that highlights the perils to government contractors of organizational conflicts of interests (“OCIs”). In general terms, an OCI arises when there is a risk that a contractor might: (1) have an unfair advantage in a competition for a contract because of prior work for the government or (2) be unable to render impartial assistance to the government on a contract because of other business interests. The recent decision concerns the latter type of OCI – i.e., an “impaired objectivity” OCI. The case involved a contract between Science Applications International Corporation (“SAIC”) and the Nuclear Regulatory Commission (“NRC”) under which SAIC advised NRC about rulemaking concerning recycling and reuse of certain radioactive materials with low levels of contamination. At a public meeting, a private citizen brought to light certain relationships between SAIC and businesses that stood to benefit from this rulemaking. NRC shortly thereafter terminated SAIC’s contract. The government then filed suit against SAIC under the civil False Claims Act (“FCA”) on the grounds that these relationship created OCIs and that each and every invoice submitted under the contract contained a false implied certification that SAIC complied with contractual provisions prohibiting OCIs and prior representations that no OCIs existed.

On July 31, 2008 , a federal jury sitting in the District of Columbia found that SAIC had violated the civil FCA by failing to disclose and avoid OCIs that had the potential to bias its work under the contract. The jury also found that SAIC submitted these claims with the requisite knowledge for liability under the FCA- i.e., that SAIC either actually knew the claims were false, acted in deliberate ignorance of the truth or falsity of the claims or acted in reckless disregard of the truth or falsity of the information. The jury awarded the United States $5.92 million in triple damages under the FCA and civil penalties of $577,500 for the 77 false claims and statements that it submitted to the NRC. This award is consistent with prior judicial opinions holding that “a government contractor’s failure to disclose an organizational conflict of interest constitutes a false claim under the False Claims Act.” Following the award, SAIC moved for judgment as a matter of law under Federal Rule of Civil Procedure (“FRCP”) 50(b) or, in the alternative, for a new trial under FRCP Rule 59. SAIC’s motion attacked the jury verdict from numerous angles. However, the district court found that SAIC had not shown that the instructions given to the jury were “erroneous or that any other error was committed at trial such that it would be a clear miscarriage of justice not to grant SAIC a new trial.” Furthermore, the court found that there “was sufficient evidence upon which a reasonable jury could find for the United States . . . “ Therefore, the court denied SAIC’s motion. This verdict against SAIC, whether justified or not, highlights the perils to contractors of failing to identify, disclose and properly manage OCIs. The only way to mitigate these risks is to fully train the responsible employees on the OCI rules and maintain a comprehensive OCI compliance system. These rules are notoriously vague and ambiguous. Therefore, contractor compliance officials must make extensive use of the interpretative case law in the development of OCI training materials and systems.

On September 8, 2009, a new rule that will require contractors to make significant changes to their employment eligibility verification processes took effect. The new rule was originally scheduled to take effect on January 15, 2009. In response to a lawsuit challenging the rule, the outgoing Bush Administration delayed the implementation until February 20, 2009. The Obama Administration then issued three Federal Register Notices delaying implementation of the rule.

The rule requires Contracting Officers to include a new FAR clause governing employment eligibility verification in all new solicitations and contracts that exceed the simplified acquisition threshold ($100,000 for most acquisitions) and have a period of performance of 120 days or more, except for contracts for: 

• commercially available-off-the shelf (“COTS”) items;
• certain minor modifications of COTS items;
• certain “bulk cargo” items; or
• certain commercial services that are related to COTS items.

Contracts that do not involve any work in the United States are also exempt.

The new FAR clause, FAR 52.222-54, Employment Eligibility Verification, requires the use of the Department of Homeland Security’s (DHS’) E-Verify system to verify the employment eligibility of:

• all persons hired after November 6, 1986 and assigned by the contractor to “directly” perform work within the United States on the contract (“Assigned Employees”); AND
• all persons hired during the contract term by the contractor to perform ANY employment duties within the United States (“New Hires”).

Employees are not considered to be directly performing work under a contract if they normally perform support work, such as overhead activities, and do not perform any substantial duties applicable to the contract. To prevent duplication of effort, the new contract clause makes clear that contractors are not required to perform additional employment verification using E-verify for any employee who has (1) previously been verified through E-Verify; (2) been granted and holds an active US government security clearance; or (3) has undergone a complete investigation under Homeland Security Presidential Directive No. 12.

In the preamble to the new rule, the Councils stated that agencies should amend certain existing indefinite-delivery indefinite quantity contracts (“IDIQ”) to include the new clause for future orders. In particular, IDIQ contracts would be amended if the remaining period of performance extends for at least six months after the effective date of the rule and the agency expects the remaining amount of work or number of orders to be substantial. In addition, Prime Contractors must flow the clause down to all subcontracts for services or construction that exceed $3,000 and include work performed in the United States, except for subcontracts for services related to certain COTS items. The rule does not require flow down of the clause to subcontracts for materials.

Importantly, the new FAR clause requires compliance with requirements of the E-Verify program as expressed in a memorandum of understanding (MOU) between the contractor and DHS. The E-Verify program is an internet-based system operated by DHS’ U.S. Citizenship and Immigration Service (“USCIS”) in partnership with the Social Security Administration (“SSA”). Contractors will input pertinent information about an employee in the E-Verify database and receive back either a confirmation or a “non-confirmation” of the employee’s eligibility to work. To protect the rights of the employee, contractors must send certain notices to employees who are not confirmed and afford them the opportunity to contact USCIS and SSA to correct their databases.

In accordance with current law, contractors will still complete an Employment Eligibility Verification Form (Form I-9) for each newly hired employee. Following completion of the Form I-9, the contractor will enter the worker’s personal and employment eligibility information into the E-Verify website. That website then checks the information against information contained in SSA and USCIS databases. The SSA database first verifies that the name, social security number and date of birth of the employee are correct and, if the employee has stated that he or she is a U.S. citizen, confirms whether this is in fact the case through its databases. If the employee is a U.S. citizen, SSA’s database will establish that the employee is employment-eligible. USCIS also verifies through database checks that any non-U.S. citizen employee is in an employment-authorized immigration status.

If the information provided by the worker matches the information in the SSA and USCIS records, no further action generally is necessary, and the contractor may continue to employ the worker. If SSA cannot verify the information presented by the worker, the employer will receive an “SSA Tentative Non-confirmation” notice. Similarly, if USCIS cannot verify the information presented by the worker, the employer will receive a “DHS Tentative Non-confirmation” notice. Contractors may receive a tentative non-confirmation notice for a variety of reasons, including inaccurate entry of information into the E-Verify Web site, name changes, or changes in immigration status that are not reflected in the database. If the individual’s information does not match the SSA or USCIS records, the contractor must provide the employee with a written notice, which is referred to as a “Notice to Employee of Tentative Non-confirmation.” The worker must then state on the notice whether he or she contests or chooses not to contest the tentative non-confirmation. The worker and the employer must sign the notice.

If the worker chooses to contest the tentative non-confirmation, the contractor is required to print a second notice, called a “Referral Letter,” which sets forth information about how to resolve the tentative non-confirmation, as well as the contact information for SSA or USCIS, depending on which agency was the source of the tentative non-confirmation. The worker then has eight Federal Government work days to visit an SSA office or call USCIS to try to resolve the discrepancy in the information. Under the E-Verify MOU, if the worker contests the tentative non-confirmation, the employer is prohibited from terminating or otherwise taking adverse action against the worker while he or she awaits a final resolution from the Federal Government agency. Failure to follow this rule could lead to wrongful dismissal lawsuits, e.g., on the grounds of national origin discrimination. If the worker fails to contest the tentative non-confirmation, or if SSA or USCIS was unable to resolve the discrepancy, the employer will receive a notice of final non-confirmation and the employee may be terminated.

As mentioned above, participation in E-Verify does not exempt the contractor from its responsibility under the immigration laws to complete, retain, and make available for inspection Forms I-9 that relate to its employees, or from other requirements of applicable regulations or laws. However, the following special requirements arise due to the contractor’s participation in the E-Verify program: 

• identity documents used for verification purposes must have photos;
• if a contractor obtains confirmation of the identity and employment eligibility of an individual in compliance with the terms and conditions of E-Verify, a rebuttable presumption is established that the contractor has not violated the INA in the hiring of the individual;
• the contractor must notify DHS if it continues to employ any employee after receiving a final non-confirmation, and is subject to a civil money penalty between $500 and $1,000 for each failure to provide such notice;
• if a contractor continues to employ an employee after receiving a final non-confirmation and that employee is subsequently found to be an unauthorized alien, the contractor is subject to a rebuttable presumption that it has knowingly employed an unauthorized alien in violation of the immigration laws; and
• no person or entity participating in E-Verify may be held civilly or criminally liable under any law for any action taken in good faith based on information provided through the confirmation system.

See the January 2009 edition of “Reflections on Government Contracts” for additional details concerning the new rule and the E-Verify program.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

[i] Pub. Law No. 111-5.

[ii] www.recovery.gov.

[iii] Id.

[iv] Id. A breakdown of the Recovery Act at www.recovery.gov shows $288 billion in tax relief, $144 billion in state and local fiscal relief and $81 billion in individual aid to “protect the vulnerable”. These amounts total $513 billion. Adding the $60 billion in contracts (see note below) yields a subtotal of $573 billion. It appears that the balance of $214 billion ($787 billion less $573 billion) is for grants –e.g., for highways, education, research and housing.

[v] Director, Office of Management and Budget, Memorandum for the Heads of Departments and Agencies (April 3, 2009) at p. 24.

[vi] See FAR 52.204-11 for the full set of requirements and the helpful responses to “frequently asked questions” at www.FederalReporting.gov.

[vii] 18 U.S.C. § 1001.

[viii] United States v. Science Applications Int’l Corp., 2009 WL 2929250 (D.D.C. 2009).

[ix] FAR 9.505. The regulations at issue in the case varied slightly from this FAR provision.

[x] Press Release, Nuclear Regulatory Commission, Government Prevails in Conflict of Interest Case Against Science Applications International Corporation, at www.nrc.gov/reading-rm/doc-collections/news/2008/08-142.html.

[xi] Press Release, Nuclear Regulatory Commission, supra.

[xii] United States v. Science Applications Int’l Corp., 2009 WL 2929250 (D.D.C. 2009).

[xiii] Press Release, Nuclear Regulatory Commission, supra.

[xiv] United States v. Science Applications Int’l Corp., 2009 WL 2929250 (D.D.C. 2009).

[xv] Id.

[xvi] See e.g., United States ex. rel. Ervin & Assocs. v. Hamilton Secs. Group, 370 F. Supp.2d 18 (D.D.C. 2005).

[xvii] United States v. Science Applications Int’l Corp., 2009 WL 2929250 (D.D.C. 2009).

[xviii] 73 Fed. Reg. 67064 (November 12, 2008).

[xix] Elise Castelli, Contractor Groups Sue to Abolish New Immigration Checks, at www.federaltimes.com (December 30, 2008).

[xx] 74 Fed. Reg. 1937 (January 14, 2009).

[xxi] 74 Fed. Reg. 5621 (January 30, 2009); 74 Fed. Reg. 17793 (April 17, 2009); 74 Fed. Reg. 26981 (June 5, 2009).

[xxii] 73 Fed. Reg. 67064.

[xxiii] Id.

[xxiv] Id.

[xxv] 73 Fed. Reg. 33374.

The government plans to spend less than 8% of the funds appropriated in the American Recovery and Reinvestment Act of 2009 i (“Recovery Act”) on federal contracts – i.e., approximately $60 billionii out of $787 billion.iii The remainder of this money will be used for tax cuts, state and local fiscal relief, individual assistance and various grants for education, housing, highway/transit and other purposes.iv While the amount planned for contracts is relatively small, many contractors are nonetheless keenly interested in the opportunities presented by Recovery Act procurements. On May 17, 2009, when the government published detailed Recovery Act spending plans, the scope of these opportunities came into sharper focus.

Congress enacted the Recovery Act on February 13, 2009 in response to a serious economic crisis sparked by the near meltdown of America’s financial markets. The main purposes of the Recovery Act are to: (1) promote economic recovery by preserving and creating jobs; (2) assist those most impacted by the recession; (3) provide investments to spur technological advances in science and health to increase economic efficiency; (4) invest in transportation, environmental and other infrastructure projects that will yield long term economic benefits; and (5) stabilize State and local government budgets to avoid reduction in services and state and local tax increases that might stall the recovery. There is an ongoing political discussion concerning whether the nation can afford the high price of this legislation.v However, in the boardrooms of many contractors, discussion about the Recovery Act undoubtedly is focusing on how to identify and take advantage of new opportunities created by the law.

On May 15, 2009, agencies receiving Recovery Act funds submitted to the Office of Management and Budget formal documented plans for how the funds will be applied and managed (the “Agency Plans”). The Agency Plans set forth broad Recovery Act goals and describe the coordination efforts among different parts of the agency towards their successful implementation and monitoring. The government published these plans on May 17, 2009 on the Recovery Act website – www.recovery,gov. The plans do not always delineate clearly whether spending will be through a contract or a grant. However, in many cases, it is possible to discern agency plans for contracting actions. Following are some highlights from these plans:

Agencies will post specific notices of most Recovery Act procurements at www.fedbizopps.gov. Contractors should be aware that special rules apply to these procurements.vi The rules cover publicizing of contract actions, reporting on use of funds and jobs created, whistleblower protections, General Accounting Office and Inspector General audit and access rights and Buy American requirements for construction materials. Coverage of these rules is beyond the scope of this article. However, an excellent summary of the rules can be found at the American Bar Association website www.abanet.org/contract/admin/recoveryact0509.ppt.

As mentioned above, Recovery Act spending on federal contracts is only a small fraction of the total spending. There are numerous other opportunities for industry, including responding to federal grant announcements and State and local procurements funded by Recovery Act grants. Due to information overload on the internet and the bureaucratic jargon associated with some program descriptions, identifying such opportunities can be challenging. However, with a sustained effort, the opportunities can be found.

It appears that the Office of Management and Budget (OMB) missed a July 1, 2009 deadline to issue government-wide guidance that will assist federal agencies to identify and take corrective action concerning contracts that are wasteful, inefficient, or not otherwise likely to meet agency needs. The deadline was set by President Obama himself in his Memorandum on Government Contracts dated March 4, 2009 (the “Memorandum”).vii However, as of July 9, 2009, there was no indication in press reports that the guidance had been issued. Presumably, work on the guidance is continuing. The requirement to issue the guidance was only one of the actions required by the far-reaching Memorandum. Key language from the Memorandum is set forth below.

It is the policy of the Federal Government that executive agencies shall not engage in noncompetitive contracts except in those circumstances where their use can be fully justified and where appropriate safeguards have been put in place to protect the taxpayer. In addition, there shall be a preference for fixed-price type contracts. Cost-reimbursement contracts shall be used only when circumstances do not allow the agency to define its requirements sufficiently to allow for a fixed-price type contract. Moreover, the Federal Government shall ensure that taxpayer dollars are not spent on contracts that are wasteful, inefficient, subject to misuse, or otherwise not well designed to serve the Federal Government’s needs and to manage the risk associated with the goods and services being procured. The Federal Government must have sufficient capacity to manage and oversee the contracting process from start to finish, so as to ensure that taxpayer funds are spent wisely and are not subject to excessive risk. Finally, the Federal Government must ensure that those functions that are inherently governmental in nature are performed by executive agencies and are not outsourced.

I hereby direct the Director of the Office of Management and Budget (OMB), in collaboration with the Secretary of Defense, the Administrator of the National Aeronautics and Space Administration, the Administrator of General Services, the Director of the Office of Personnel Management, and the heads of such other agencies as the Director of OMB determines to be appropriate, and with the participation of appropriate management councils and program management officials, to develop and issue by July 1, 2009, Government-wide guidance to assist agencies in reviewing, and creating processes for ongoing review of, existing contracts in order to identify contracts that are wasteful, inefficient, or not otherwise likely to meet the agency’s needs, and to formulate appropriate corrective action in a timely manner. Such corrective action may include modifying or canceling such contracts in a manner and to the extent consistent with applicable laws, regulations, and policy.

I further direct the Director of OMB, in collaboration with the aforementioned officials and councils, and with input from the public, to develop and issue by September 30, 2009, Government-wide guidance to:

1. govern the appropriate use and oversight of sole-source and other types of noncompetitive contracts and to maximize the use of full and open competition and other competitive procurement processes;
2. govern the appropriate use and oversight of all contract types, in full consideration of the agency’s needs, and to minimize risk and maximize the value of Government contracts generally, consistent with the regulations to be promulgated pursuant to section 864 of Public Law 110-417;
3. assist agencies in assessing the capacity and ability of the Federal acquisition workforce to develop, manage, and oversee acquisitions appropriately; and
4. clarify when governmental outsourcing for services is and is not appropriate, consistent with section 321 of Public Law 110-417 (31 U.S.C. 501 note).

One reason for the delay in issuing the guidance may be the difficulty of defining when a contract is wasteful and inefficient. Presumably, cost and schedule overruns will be one measure of efficiency. However, any assessment tools and benchmarks promulgated by OMB will have to take into account the nature of the effort required by the contract and legitimate changes in requirements. For example, in research and development contracts the contractor is attempting to advance the state of the art or to use scientific or technical knowledge to design, develop, test or evaluate a potential new product or service. By their nature, these activities are subject to risk and uncertainty. Therefore, actual budgets and schedules may vary considerably from original budgets and schedules for these contracts. However, this does not necessarily mean that the contract is inefficient.

Ideally, the guidance will be based on some input from industry. For example, industry can point to the waste and inefficiency that result when Contracting Officers (COs) populate their contracts with excessive FAR clauses. In many cases, the flexibilities built into the FAR to minimize the burdens of government contracts regulations are not fully used by COs. Moreover, the guidance should include a process of consultation between contractors and government concerning corrective actions if a contract is identified as wasteful and inefficient. The government contracting community is eagerly waiting to see if the guidance will truly serve the taxpayers’ interests by empowering the agencies to improve their contracting processes in partnership with the private sector.

On June 5, 2009, the Federal Acquisition Regulation Council again delayed the implementation date of a controversial new rule that would require contractors to make significant changes to their employment eligibility verification processes.viii The new rule was originally scheduled to take effect on January 15, 2009.ix In response to a lawsuit challenging the rule,x the outgoing Bush Administration delayed the implementation until February 20, 2009.xi The Obama Administration has now issued three Federal Register Notices delaying implementation of the rule.xii The new rule will now apply to solicitations and contracts issued on or after September 8, 2009.xiii It appears that the latest delay results from an ongoing Administration legal review of the rule in connection with the lawsuit.xiv

The rule requires Contracting Officers to include a new FAR clause governing employment eligibility verification in all new solicitations and contracts that exceed the simplified acquisition threshold ($100,000 for most acquisitions) and have a period of performance of 120 days or more, except for contracts for:

• commercially available-off-the shelf (“COTS”) items;
• certain minor modifications of COTS items;
• certain “bulk cargo” items; or
• certain commercial services that are related to COTS items.

Contracts that do not involve any work in the United States are also exempt.xv


The new FAR clause, FAR 52.222-54, Employment Eligibility Verification, requires the use of the Department of Homeland Security’s (DHS’) E-Verify system to verify the employment eligibility of:

• all persons hired after November 6, 1986 and assigned by the contractor to “directly” perform work within the United States on the contract (“Assigned Employees”); AND
• all persons hired during the contract term by the contractor to perform ANY employment duties within the United States (“New Hires”).

Employees are not considered to be directly performing work under a contract if they normally perform support work, such as overhead activities, and do not perform any substantial duties applicable to the contract. To prevent duplication of effort, the new contract clause makes clear that contractors are not required to perform additional employment verification using E-verify for any employee who has (1) previously been verified through E-Verify; (2) been granted and holds an active US government security clearance; or (3) has undergone a complete investigation under Homeland Security Presidential Directive No. 12.xvi

In the preamble to the new rule, the Councils stated that agencies should amend certain existing indefinite-delivery indefinite quantity contracts (“IDIQ”) to include the new clause for future orders. In particular, IDIQ contracts would be amended if the remaining period of performance extends for at least six months after the effective date of the rule and the agency expects the remaining amount of work or number of orders to be substantial. In addition, Prime Contractors must flow the clause down to all subcontracts for services or construction that exceed $3,000 and include work performed in the United States, except for subcontracts for services related to certain COTS items. The rule does not require flow down of the clause to subcontracts for materials.xvii

Importantly, the new FAR clause requires compliance with requirements of the E-Verify program as expressed in a memorandum of understanding between the contractor and DHS. The E-Verify program is an internet-based system operated by DHS’ U.S. Citizenship and Immigration Service (“USCIS”) in partnership with the Social Security Administration (“SSA”). Contractors will input pertinent information about an employee in the E-Verify database and receive back either a confirmation or a “non-confirmation” of the employee’s eligibility to work. To protect the rights of the employee, contractors must send certain notices to employees who are not confirmed and afford them the opportunity to contact USCIS and SSA to correct their databases.

In accordance with current law, contractors will still complete an Employment Eligibility Verification Form (Form I-9) for each newly hired employee. Following completion of the Form I-9, the contractor will enter the worker’s personal and employment eligibility information into the E-Verify website. That website then checks the information against information contained in SSA and USCIS databases. The SSA database first verifies that the name, social security number and date of birth of the employee are correct and, if the employee has stated that he or she is a U.S. citizen, confirms whether this is in fact the case through its databases. If the employee is a U.S. citizen, SSA’s database will establish that the employee is employment-eligible. USCIS also verifies through database checks that any non-U.S. citizen employee is in an employment-authorized immigration status.

If the information provided by the worker matches the information in the SSA and USCIS records, no further action generally is necessary, and the contractor may continue to employ the worker. If SSA cannot verify the information presented by the worker, the employer will receive an “SSA Tentative Non-confirmation” notice. Similarly, if USCIS cannot verify the information presented by the worker, the employer will receive a “DHS Tentative Non-confirmation” notice. Contractors may receive a tentative non-confirmation notice for a variety of reasons, including inaccurate entry of information into the E-Verify Web site, name changes, or changes in immigration status that are not reflected in the database. If the individual’s information does not match the SSA or USCIS records, the contractor must provide the employee with a written notice, which is referred to as a “Notice to Employee of Tentative Non-confirmation.” The worker must then state on the notice whether he or she contests or chooses not to contest the tentative non-confirmation. The worker and the employer must sign the notice.

If the worker chooses to contest the tentative non-confirmation, the contractor is required to print a second notice, called a “Referral Letter,” which sets forth information about how to resolve the tentative non-confirmation, as well as the contact information for SSA or USCIS, depending on which agency was the source of the tentative non-confirmation. The worker then has eight Federal Government work days to visit an SSA office or call USCIS to try to resolve the discrepancy in the information. Under the E-Verify MOU, if the worker contests the tentative non-confirmation, the employer is prohibited from terminating or otherwise taking adverse action against the worker while he or she awaits a final resolution from the Federal Government agency. Failure to follow this rule could lead to wrongful dismissal lawsuits, e.g., on the grounds of national origin discrimination. If the worker fails to contest the tentative non-confirmation, or if SSA or USCIS was unable to resolve the discrepancy, the employer will receive a notice of final non-confirmation and the employee may be terminated.
As mentioned above, participation in E-Verify does not exempt the contractor from its responsibility under the INA to complete, retain, and make available for inspection Forms I-9 that relate to its employees, or from other requirements of applicable regulations or laws. However, the following special requirements arise due to the contractor’s participation in the E-Verify program:

• identity documents used for verification purposes must have photos;
• if a contractor obtains confirmation of the identity and employment eligibility of an individual in compliance with the terms and conditions of E-Verify, a rebuttable presumption is established that the contractor has not violated the INA in the hiring of the individual;
• the contractor must notify DHS if it continues to employ any employee after receiving a final non-confirmation, and is subject to a civil money penalty between $500 and $1,000 for each failure to provide such notice;
• if a contractor continues to employ an employee after receiving a final non-confirmation and that employee is subsequently found to be an unauthorized alien, the contractor is subject to a rebuttable presumption that it has knowingly employed an unauthorized alien in violation of the immigration laws; and
• no person or entity participating in E-Verify may be held civilly or criminally liable under any law for any action taken in good faith based on information provided through the confirmation system.

See the January 2009 edition of “Reflections on Government Contracts” for additional details concerning the new rule and the E-Verify program.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

iPub. Law No. 111-5.

iiDirector, Office of Management and Budget, Memorandum for the Heads of Departments and Agencies (April 3, 2009) at p. 24. This memorandum also states that the government will award approximately $300 billion in grants of discretionary appropriations. OMB estimates that $85 billion of this amount will be for competitive grants. The non-competitive discretionary appropriations grants will be for education, housing and highway/transit purposes.

iiiwww.recovery.gov.

ivId. A breakdown of the Recovery Act at www.recovery.gov shows $288 billion in tax relief, $144 billion in state and local fiscal relief and $81 billion in individual aid to “protect the vulnerable”. These amounts total $513 billion. Adding the $60 billion in contracts yields a subtotal of $573 billion. It appears that the balance of $214 billion ($787 billion less $573 billion) is for grants –e.g., for highways, education, research and housing. The reason that this number is lower than the $300 billion in grants in the OMB Memorandum of April 3, 2009 is not entirely clear. However, it is likely that the $300 billion number includes grants in the category of “state and local fiscal relief.”

vPub. Law No. 111-5, §2.

viSee 74 Fed. Reg. 14622 (March 31, 2009).

vii74 Fed. Reg. 9755 (March 6, 2009).

viii74 Fed. Reg. 26981 (June 5, 2009)

ix73 Fed. Reg. 67064 (November 12, 2008).

xElise Castelli, Contractor Groups Sue to Abolish New Immigration Checks, at www.federaltimes.com (December 30, 2008).

xi74 Fed. Reg. 1937 (January 14, 2009)

xii74 Fed. Reg. 5621 (January 30, 2009); 74 Fed. Reg. 17793 (April 17, 2009); 74 Fed. Reg. 26981 (June 5, 2009)

xiii74 Fed. Reg. 26981 (June 5, 2009)

xivBill Leonard, E-Verify Rules for Federal Contractors Delayed, Again, at www.shrm.org (June 2, 2009).

xv73 Fed. Reg. 67064.

xviId.

xviiId.

xviii73 Fed. Reg. 33374.

The January 30, 2009 deadline for Defense Contract Audit Agency (DCAA) field audit office managers to complete briefings to staff concerning newly issued audit guidance on access to contractor records has passed.i Contractors are now bracing themselves for possible adverse impacts of the guidance. This article examines two key aspects of the guidance and its potential repercussions.

First, the guidance mandates that auditors set strict deadlines for the submission of documentation, including that contractors provide data supporting proposals on the same day it is requested. While the guidance states that the auditor should give the contractor a “reasonable time period to provide the data given the specific circumstances”, it goes on to state that support for proposed costs or prices “should be provided the same day requested, given the information would have been generated by the contractor prior to submitting the proposal.” If response to a request requires analysis or if extenuating circumstances exist, then the auditor will allow additional time “deemed necessary” to provide the requested information. If the contractor does not provide the information by the deadline and has not provided an “appropriate” explanation for the delay, auditors must make a formal demand to contractor management imposing a new deadline that is not later than one week from the date of the demand. If the contractor misses the new deadline, the auditor will report the contractor to DCAA management on a Denial of Access to Contractor Records form and initiate suspensions of cost recoveries on cost reimbursement contracts for costs that DCAA considers unsupported due to the alleged denial of access. In addition, the auditor may involve the Administrative Contracting Officer in an attempt to resolve the issue. If these further efforts to obtain the information fail, then the guidance requires a review to determine whether DCAA should use its subpoena authority to obtain the information. The guidance even calls for DCAA to work with the Department of Defense Inspector General (IG) to use the IG’s broad subpoena authority if DCAA believes it needs information that cannot be obtained under its more limited subpoena authority.ii While the guidance recognizes that “extenuating circumstances” may require longer periods to respond to auditor requests, it does not explicitly permit auditors to take into account the real problem of competing government demands for the time of contractor audit liaison personnel. In addition, it appears to contemplate that DCAA will unilaterally impose deadlines on contractor personnel. While the contracting community is hoping that auditors will apply this aspect of the guidance with prudence, there is widespread concern that the new process will lead to inequitable allegations of denial of access and disputes over the resulting suspension of costs.

Second, the guidance states that DCAA expects direct access to the contractor personnel responsible for generating the information requested. In particular, the guidance states that: “support [for assertions in contractor proposals/claims] includes access to personnel, in addition to the documentation/data supporting the contractor’s assertion (e.g., cost records, policies and procedures, management reports). Auditors should generally obtain supporting documentation directly from the person responsible for the information. The contractor’s use of a liaison for requests from DCAA should not result in delays in providing requested documentation or inhibit the auditor’s access to contractor personnel needed to conduct the audit. Such delays and/or restrictions should be addressed in writing to senior management of the company.” This guidance is consistent with a November 2008 presentation of the DCAA Director to the National Defense Industrial Association, in which she stated that DCAA is seeking “real time access to the right contractor personnel.iii The problem with this guidance is that DCAA does not have legal authority to interview company employees, except concerning time records under time and materials and labor hour contracts. Notwithstanding this problem, many contractors likely will allow DCAA access to their employees. Otherwise, these contractors may be reported by DCAA for “denial of access” and may face suspension of “unsupported” costs on cost reimbursement contracts.iv The trouble with providing access to employees, of course, is that they may not understand the full picture of an issue and may create misunderstandings in the auditor’s mind, leading to unwarranted questioning of costs and the resulting cost and disruption of disputes concerning the costs. Therefore, contractors will need to develop/refine procedures for DCAA liason activities so that the central point of contact stays involved with and ensures the accuracy of all communications between DCAA and the company. If DCAA gets too aggressive –e.g., asking to interview employees about their expense reports – DCAA’s authority may need to be formally challenged under the Contract Disputes Act.

In corporate offices throughout the world, government contractors and their lawyers are struggling mightily to assess the fallout from a new rule (the “New Rule”) that the drafters described as a “sea change” to the government’s longstanding approach of encouraging contractors to make voluntary disclosures of violations of the procurement laws.v The New Rule, which was effective on December 12, 2008, mandates that contractors notify the pertinent agency Inspector General whenever they have “credible evidence” of certain violations of the criminal laws or the civil False Claims Act. The New Rule also provides that contractors can be suspended and/or debarred in certain circumstances for failing to turn themselves in. Furthermore, the New Rule imposes strict new internal control requirements for contractor ethics and compliance programs. This article reviews major issues facing contractors as they begin their efforts to comply with the New Rule.

The New Rule’s mandatory disclosure requirement is set forth in a revision to FAR 52.203-13, Contractor Code of Business Ethics and Conduct. That clause now requires contractors to:

. . . timely disclose, in writing, to the agency Office of the Inspector General (OIG), with a copy to the Contracting Officer, whenever, in connection with the award, performance, or closeout of this contract or any subcontract thereunder, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed–(A) a violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code; or (B) a violation of the civil False Claims Act (31 U.S.C. 3729–3733).vi

Under the New Rule, FAR 52.203-13, which previously did not apply to contracts for commercial items or contracts performed entirely outside the US, must now be included in ALL prime contracts with a performance period of 120 days or more that are expected to exceed $5,000,000 in value. The clause must also be “flowed down” to all subcontracts that meet these thresholds. However, subcontractors must turn themselves in directly to the government and not to the prime contractor.

The New Rule does not define “credible evidence”. However, in the preamble to the New Rule, the drafters stated that the term “credible evidence” should be interpreted as a “higher standard” than the “reasonable grounds to believe a violation has occurred” standard in the proposed rule. The drafters stated, further, that use of the credible evidence standard “impl[ies] that the contractor will have the opportunity to take some time for preliminary examination of the evidence to determine its credibility before deciding to disclose it to the government.”vii Contractors and their lawyers are struggling to assess this sparse and ambiguous guidance and to develop practical guidance for inclusion in compliance program policies and procedures. One task that will help develop such guidance involves analysis of differences between “reasonable grounds” and “credible evidence”. For example, whereas under the proposed rule contractors likely would have had to self report following an employee’s ethics hot line call if the allegations were facially reasonable under the circumstances, under the New Rule contractors only need to self report if preliminary examination of the allegation reveals credible evidence of a violation. Obviously, a preliminary examination is something short of a full scale internal investigation. The challenge involves defining the precise boundaries of such an examination. Another task involves defining the “credible evidence” standard itself. One way to approach this is to compare different definitions of standards of evidence in the case law and regulations to the expressed intent of the drafters of the New Rule. For example, is “credible evidence” less evidence than the “adequate evidence” required to suspend a contractor under FAR 9.407?viii If so, how much less? At this early stage in the implementation of the New Rule, there are more questions than there are answers about the credible evidence standard in the New Rule.

Under revisions to FAR 9.406, contractors can now be suspended and/or debarred for: a “[k]nowing failure by a principal, until 3 years after final payment on any Government contract awarded to the contractor, to timely disclose to the Government, in connection with the award, performance, or closeout of the contract or a subcontract thereunder, credible evidence of– (A) [v]iolation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code; (B) [v]iolation of the civil False Claims Act (31 U.S.C. 3729-3733); or (C) [s]ignificant overpayment(s) on the contract, other than overpayments resulting from contract financing payments as defined in 32.001.”ix Thus, even if a contractor does not have contracts that are subject to FAR 52.203-13, it can be debarred from government contracts for a knowing failure to self report in the specified circumstances. In effect, this aspect of the New Rule applies the mandatory disclosure requirements to all government contractors on the effective date of the rule. A key issue in the implementation of this aspect of the New Rule involves the definition of “principals”. Under the revised definition in FAR 2.101, principal means an “officer, director, owner, partner, or a person having primary management or supervisory responsibilities within a business entity (e.g., general manager, plant manager, head of a subsidiary, division or business segment; and similar positions).” One commentator has suggested that this definition will be read broadly to include compliance officers and directors of internal audits. He also suggested that contractors should provide written guidance to principals concerning their disclosure obligations and require regular central reporting from them, even if they are not aware of any violations.x

As mentioned above, the New Rule sets forth new internal control system requirements. These requirements, also imposed through revisions to FAR 52.203-13, are more onerous than the previous internal control system requirements. However, they will not apply to small business concerns or to contractors who only have contracts for commercial items as defined in FAR 2.101. Under the New Rule, covered contractors’ internal control systems must provide for the following:

• Assignment of responsibility at a sufficiently high level and adequate resources to ensure effectiveness of the business ethics awareness and compliance program and internal control system.
• Reasonable efforts not to include an individual as a principal, whom due diligence would have exposed as having engaged in conduct that is in conflict with the Contractor’s code of business ethics and conduct.
• Periodic reviews of company business practices, procedures, policies, and internal controls for compliance with the Contractor’s code of business ethics and conduct and the special requirements of Government contracting, including–

• • Monitoring and auditing to detect criminal conduct;
  • Periodic evaluation of the effectiveness of the business ethics awareness and compliance program and internal control system, especially if criminal conduct has been detected; and
  • Periodic assessment of the risk of criminal conduct, with appropriate steps to design, implement, or modify the business ethics awareness and compliance program and the internal control system as necessary to reduce the risk of criminal conduct identified through this process.

• An internal reporting mechanism, such as a hotline, which allows for anonymity or confidentiality, by which employees may report suspected instances of improper conduct, and instructions that encourage employees to make such reports.
• Disciplinary action for improper conduct or for failing to take reasonable steps to prevent or detect improper conduct.”^xi

In addition, contractor internal control systems must provide for “[t]imely disclosure, in writing, to the agency OIG, with a copy to the Contracting Officer, whenever, in connection with the award, performance, or closeout of any Government contract performed by the Contractor or a subcontractor thereunder, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed a violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 U.S.C. or a violation of the civil False Claims Act (31 U.S.C. 3729-3733)” (emphasis added).”xii Thus, whereas contractors are required by the revised FAR 52.203-13 to disclose violations of the law that have occurred in connection with the award, performance, or closeout of contracts that include the clause (and subcontracts thereunder), contractor internal control systems must provide for disclosure of violations on any government contract performed by the contractor (and subcontracts thereunder). Importantly, the New Rule provides that the disclosure requirement for an individual contract continues until at least 3 years after final payment on the contract.xiii One issue that has arisen in the implementation of this aspect of the New Rule is whether prime contractor internal control systems must provide for the modification of existing subcontracts to require reporting of violations. As mentioned above, FAR 52.203-13 applies to new prime contracts and subcontracts with a performance period of 120 days or more that are expected to exceed $5,000,000 in value. However, the suspension and debarment and internal control requirements of the New Rule apply across the board to all existing and new contracts. If prime contractors do not impose disclosure requirements on existing subcontracts, are they at risk of termination for default, suspension or debarment?

Finally, internal control systems must provide for “full cooperation with any Government agencies responsible for audits, investigations, or corrective actions.” The New Rule makes clear that the “full cooperation” requirement “does not require– (i) a Contractor to waive its attorney-client privilege or the protections afforded by the attorney work product doctrine; or (ii) any officer, director, owner, or employee of the Contractor, including a sole proprietor, to waive his or her attorney client privilege or Fifth Amendment rights; and . . . [d]oes not restrict a Contractor from– (i) conducting an internal investigation; or (ii) defending a proceeding or dispute arising under the contract or related to a potential or disclosed violation.”xiv Notwithstanding this assurance, contractors will need to ensure that any disclosures made do not include privileged information.

In conclusion, contractors and their lawyers have a “full plate” of new compliance requirements and issues to swallow and digest in the New Year.

On January 30, 2009, the Federal Acquisition Regulation Council delayed the implementation date of a controversial new rule that would require contractors to make significant changes to their employment eligibility verification processes.xv The new rule was originally scheduled to take effect on January 15, 2009.xvi In response to a lawsuit challenging the rule,xvii the outgoing Bush Administration delayed the implementation until February 20, 2009.xviii Then, after a review by the incoming Obama Administration, the implementation was delayed again. The rule will now apply to solicitations and contracts issued on or after May 21, 2009.xix

 The rule requires Contracting Officers to include a new FAR clause governing employment eligibility verification in all new solicitations and contracts that exceed the simplified acquisition threshold ($100,000 for most acquisitions) and have a period of performance of 120 days or more, except for contracts for:

Contracts that do not involve any work in the United States are also exempt.xx

The new FAR clause, FAR 52.222-54, Employment Eligibility Verification (Jan 2009), requires the use of the Department of Homeland Security’s (DHS’) E-Verify system to verify the employment eligibility of:

Employees are not considered to be directly performing work under a contract if they normally perform support work, such as overhead activities, and do not perform any substantial duties applicable to the contract. To prevent duplication of effort, the new contract clause makes clear that contractors are not required to perform additional employment verification using E-verify for any employee who has (1) previously been verified through E-Verify; (2) been granted and holds an active US government security clearance; or (3) has undergone a complete investigation under Homeland Security Presidential Directive No. 12.xxi

In the preamble to the new rule, the Councils stated that agencies should amend certain existing indefinite-delivery indefinite quantity contracts (“IDIQ”) to include the new clause for future orders. In particular, IDIQ contracts would be amended if the remaining period of performance extends for at least six months after the effective date of the rule and the agency expects the remaining amount of work or number of orders to be substantial. In addition, Prime Contractors must flow the clause down to all subcontracts for services or construction that exceed $3,000 and include work performed in the United States, except for subcontracts for services related to certain COTS items. The rule does not require flow down of the clause to subcontracts for materials.xxii See the January 2009 editions of “Reflections on Government Contracts” for a detailed discussion of the rule and the E-Verify program.

DHS Secretary Janet Napolitano reportedly explained that the latest delay is to permit the government to assess what needs to be done to increase the E-Verify system capacity to handle the increased demand that will result from the implementation of the rule.xxiii During the period of the delay, however, it is likely that immigrant rights groups will renew their previously expressed concerns that false non-confirmations from the systems will threaten the livelihood of lawfully present immigrants who may be wrongfully dismissed from or refused employment.xxiv Moreover, the contracting community is likely to press its complaint that the rule will needlesslyxxv add another layer of complex regulation to the already heavily regulated enterprise of government contracts. Ultimately, the taxpayers will pay for the costs of this regulation when contractors include the cost of compliance into the prices of their contracts. The question that policymakers should answer during this interregnum is whether the benefit of the regulation will outweigh these costs.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i Memorandum No. 08-PAS-042(R) from Assistant Director, Policy and Plans, DCAA, for Regional Directors, Audit Guidance on Denial of Access to Records Due to Contractor Delays (December 19, 2008).

ii Id.

iii Id.

iv See FAR 52.212-4(i)(4)(ii)(D) (Alt. 1).

v 73 Fed. Reg. 67064 (November 12, 2008).

vi Id.

vii Id.

viii See Rand Allen and John Burd, New FAR “Mandatory Disclosure” Rule: Best Practices for Day One, 90 Federal Contracts Report 43 (December 9, 2008).

ix 73 Fed. Reg. 67064.

x Allen and Burd, 90 Federal Contracts Report 43.

xi 73 Fed. Reg. 67064.

xii Id.

xiii Id.

xiv Id.

xv 74 Fed. Reg. 5621 (January 30, 2009).

xvi 73 Fed. Reg. 67064 (November 12, 2008).

xvii Elise Castelli, Contractor Groups Sue to Abolish New Immigration Checks, at www.federaltimes.com (December 30, 2088).

xviii 74 Fed. Reg. 1937 (January 14, 2009)

xix 74 Fed. Reg. 5621.

xx 73 Fed. Reg. 67064.

xxi Id.

xxii Id.

xxiii Spencer Hsu, System to Verify Worker Legality is Delayed Again, at www.washingtonpost.com (January 30, 2009). xxivSee e.g., How Errors in Basic Pilot/E-verify Databases Impact U.S. Citizens and Lawfully Present Immigrants, National Immigration Law Center, www.nilc.org.

xxv Well before issuing the Proposed Rule, the government took steps to require personal identity verification for contractor personnel with access to federal installations and information systems. See FAR 52.204-9, Personal Identity Verification of Contractor Personnel.

Government contractors, already challenged by a bewildering array of procurement laws and regulations, now face yet another set of regulations. These new rules, which are effective on January 15, 2009, will require contractors to make significant changes to their employment eligibility verification processes. Industry groups have filed suit challenging the rules. However, it is not yet clear whether the suit will delay implementation of the rules.

President Bush fired the opening shot in the rulemaking process on June 6, 2008, when he issued Executive Order 13645 (the “Executive Order”) . That order requires executive agencies to include in their contracts a requirement that contractors use a Department of Homeland Security (“DHS”) designated system to verify whether certain employees meet the eligibility requirements of the Immigration and Naturalization Act (“INA”). On June 9, 2008, DHS designated its controversial “E-Verify” system as the system that the departments and agencies must impose on government contractors. Then, on June 12, 2008, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council (the “Councils”) proposed changes to the Federal Acquisition Regulation (“FAR”) that would implement the Executive Order and DHS’ instruction (the “Proposed Rule”). On November 14, 2008, after considering public comments, the Councils published a final rule (the “Final Rule”).iv

The Final Rule requires Contracting Officers to include a new FAR clause governing employment eligibility verification in all new solicitations and contracts that exceed the simplified acquisition threshold ($100,000 for most acquisitions) and have a period of performance of 120 days or more, except for contracts for:

Contracts that do not involve any work in the United States are also exempt. v

 The new FAR clause, FAR 52.222-54, Employment Eligibility Verification (Jan 2009), requires the use of E-Verify to verify the employment eligibility of:

• all persons hired after November 6, 1986 and assigned by the contractor to “directly” perform work within the United States on the contract (“Assigned Employees”); AND

• all persons hired during the contract term by the contractor to perform ANY employment duties within the United States (“New Hires”).

Employees are not considered to be directly performing work under a contract if they normally perform support work, such as overhead activities, and do not perform any substantial duties applicable to the contract. To prevent duplication of effort, the new contract clause makes clear that contractors are not required to perform additional employment verification using E-verify for any employee who has (1) previously been verified through E-Verify; (2) been granted and holds an active US government security clearance; or (3) has undergone a complete investigation under Homeland Security Presidential Directive No. 12.vi


In the preamble to the Final Rule, the Councils stated that agencies should amend certain existing indefinite-delivery indefinite quantity contracts (“IDIQ”) to include the new clause for future orders. In particular, IDIQ contracts would be amended if the remaining period of performance extends for at least six months after the effective date of the Final Rule and the agency expects the remaining amount of work or number of orders to be substantial. In addition, Prime Contractors must flow the clause down to all subcontracts for services or construction that exceed $3,000 and include work performed in the United States, except for subcontracts for services related to certain COTS items. The Final Rule does not require flow down of the clause to subcontracts for materials.vii

Importantly, the new FAR clause requires compliance with the E-Verify program rules as expressed in a memorandum of understanding between the contractor and DHS. The E-Verify program is an internet-based system operated by DHS’ U.S. Citizenship and Immigration Service (“USCIS”) in partnership with the Social Security Administration (“SSA”). Contractors will input pertinent information about an employee in the E-Verify database and receive back either a confirmation or a “non-confirmation” of the employee’s eligibility to work. To protect the rights of the employee, contractors must send certain notices to employees who are not confirmed and afford them the opportunity to contact USCIS and SSA to correct their databases.

In accordance with current law, contractors will still complete an Employment Eligibility Verification Form (Form I-9) for each newly hired employee. Following completion of the Form I-9, the contractor will enter the worker’s personal and employment eligibility information into the E-Verify website. That website then checks the information against information contained in SSA and USCIS databases. The SSA database first verifies that the name, social security number and date of birth of the employee are correct and, if the employee has stated that he or she is a U.S. citizen, confirms whether this is in fact the case through its databases. If the employee is a U.S. citizen, SSA’s database will establish that the employee is employment-eligible. USCIS also verifies through database checks that any non-U.S. citizen employee is in an employment-authorized immigration status.

If the information provided by the worker matches the information in the SSA and USCIS records, no further action generally is necessary, and the contractor may continue to employ the worker. If SSA cannot verify the information presented by the worker, the employer will receive an “SSA Tentative Non-confirmation” notice. Similarly, if USCIS cannot verify the information presented by the worker, the employer will receive a “DHS Tentative Non-confirmation” notice. Contractors may receive a tentative non-confirmation notice for a variety of reasons, including inaccurate entry of information into the E-Verify Web site, name changes, or changes in immigration status that are not reflected in the database. If the individual’s information does not match the SSA or USCIS records, the contractor must provide the employee with a written notice, which is referred to as a “Notice to Employee of Tentative Non-confirmation.” The worker must then state on the notice whether he or she contests or chooses not to contest the tentative non-confirmation. The worker and the employer must sign the notice.

If the worker chooses to contest the tentative non-confirmation, the contractor is required to print a second notice, called a “Referral Letter,” which sets forth information about how to resolve the tentative non-confirmation, as well as the contact information for SSA or USCIS, depending on which agency was the source of the tentative non-confirmation. The worker then has eight Federal Government work days to visit an SSA office or call USCIS to try to resolve the discrepancy in the information. Under the E-Verify MOU, if the worker contests the tentative non-confirmation, the employer is prohibited from terminating or otherwise taking adverse action against the worker while he or she awaits a final resolution from the Federal Government agency. Failure to follow this rule could lead to wrongful dismissal lawsuits, e.g., on the grounds of national origin discrimination. If the worker fails to contest the tentative non-confirmation, or if SSA or USCIS was unable to resolve the discrepancy, the employer will receive a notice of final non-confirmation and the employee may be terminated.

As mentioned above, participation in E-Verify does not exempt the contractor from its responsibility under the INA to complete, retain, and make available for inspection Forms I-9 that relate to its employees, or from other requirements of applicable regulations or laws. However, the following special requirements arise due to the contractor’s participation in the E-Verify program:

• identity documents used for verification purposes must have photos;
• if a contractor obtains confirmation of the identity and employment eligibility of an individual in compliance with the terms and conditions of E-Verify, a rebuttable presumption is established that the contractor has not violated the INA in the hiring of the individual;
• the contractor must notify DHS if it continues to employ any employee after receiving a final non-confirmation, and is subject to a civil money penalty between $500 and $1,000 for each failure to provide such notice;
• if a contractor continues to employ an employee after receiving a final non-confirmation and that employee is subsequently found to be an unauthorized alien, the contractor is subject to a rebuttable presumption that it has knowingly employed an unauthorized alien in violation of the INA; and
• no person or entity participating in E-Verify may be held civilly or criminally liable under any law for any action taken in good faith based on information provided through the confirmation system.viii

As mentioned above, the New Rule sets forth new internal control system requirements. These requirements, also imposed through revisions to FAR 52.203-13, are more onerous than the previous internal control system requirements. However, they will not apply to small business concerns or to contractors who only have contracts for commercial items as defined in FAR 2.101. Under the New Rule, covered contractors’ internal control systems must provide for the following:

For convenience, contractors may elect to verify all persons hired after November 6, 1986 rather than just Assigned Employees. Contractors who make this election must initiate eligibility verifications within 180 calendar days of (1) enrollment in the program or (2) submission of a specified notification of the election.ix

The Final Rule likely will create headaches and increased costs for contractors who will have to develop, implement and staff the new processes required to submit verification queries and administer the non-confirmation process not only for Assigned Employees but also for all New Hires during the contract term. Of course, contractors will include the costs of compliance with the rule in the prices proposed for new contracts and in requests for equitable adjustment submitted in response to modifications of IDIQ contracts issued to include the new clause, thereby resulting in an increase in the prices of government contracts. Large companies with a small number of government contracts will face added challenges. The “hassle factor” of compliance with E-Verify requirements in conjunction with numerous other government contracts compliance requirements may lead these companies to conclude that doing business with the government is not worth the trouble, thereby depriving the government of valuable expertise and/or products. For these companies, there is an “opportunity cost” of spending time on government contracts compliance activities. That cost is equal to the value of other, more profitable activities that could not be undertaken due to the requirements.

Of course, the costs of compliance will be greater if the E-Verify database is not accurate and contractors have to deal with the paperwork and employee complaints associated with numerous false non-confirmations. Importantly, a study prepared for USCIS in the fall of 2007 found that the database was “not sufficiently up to date” at that point to meet current legal requirements for accurate verification, especially for naturalized citizens. Moreover, immigrant rights groups have expressed concern that false non-confirmations will threaten the livelihood of lawfully present immigrants who may be wrongfully dismissed from or refused employment. Contractors will need to account for the possibility of the extra work associated with database problems when pricing compliance with the Final Rule. Anticipating these problems, human resources and contractor groups have filed suit challenging the Final Rule on the grounds that it is contrary to the statute authorizing the E-Verify program. At present, it is not possible to predict whether the lawsuit will delay or stop the implementation of the Final Rule.

In conclusion, the Final Rule will add another layer of complex regulation to the already heavily regulated enterprise of government contracts. Implementation of the requirements will not be a trivial exercise. Indeed, the government’s own Regulatory Impact Analysis estimates the cost of implementation at over $550 million. Ultimately, the taxpayers will pay for the costs of this regulation when contractors include the cost of compliance into the prices of their contracts. While the enforcement of the immigration laws of the United States likely will improve , federal procurement policy makers should prepare for the possibility that the rules will deter more companies from bringing needed products and services to the government marketplace. The question is whether the benefit of the regulation will outweigh these costs.

In corporate offices throughout the world, government contractors and their lawyers are struggling mightily to assess the fallout from a new rule (the “New Rule”) that the drafters described as a “sea change” to the government’s longstanding approach of encouraging contractors to make voluntary disclosures of violations of the procurement laws. The New Rule, which took effect on December 12, 2008, mandates that contractors notify the pertinent agency Inspector General whenever they have “credible evidence” of certain violations of the criminal laws or the civil False Claims Act. The New Rule also provides that contractors can be suspended and/or debarred in certain circumstances for failing to turn themselves in. Furthermore, the New Rule imposes strict new internal control requirements for contractor ethics and compliance programs. This article reviews major issues facing contractors as they begin their efforts to comply with the New Rule.

The New Rule’s mandatory disclosure requirement is set forth in a revision to FAR 52.203-13, Contractor Code of Business Ethics and Conduct. That clause now requires contractors to:

. . . timely disclose, in writing, to the agency Office of the Inspector General (OIG), with a copy to the Contracting Officer, whenever, in connection with the award, performance, or closeout of this contract or any subcontract thereunder, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed–(A) a violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code; or (B) a violation of the civil False Claims Act (31 U.S.C. 3729–3733).vi

Under the New Rule, FAR 52.203-13, which previously did not apply to contracts for commercial items or contracts performed entirely outside the US, must now be included in ALL prime contracts with a performance period of 120 days or more that are expected to exceed $5,000,000 in value. The clause must also be “flowed down” to all subcontracts that meet these thresholds. However, subcontractors must turn themselves in directly to the government and not to the prime contractor.

The New Rule does not define “credible evidence”. However, in the preamble to the New Rule, the drafters stated that the term “credible evidence” should be interpreted as a “higher standard” than the “reasonable grounds to believe a violation has occurred” standard in the proposed rule. The drafters stated, further, that use of the credible evidence standard “impl[ies] that the contractor will have the opportunity to take some time for preliminary examination of the evidence to determine its credibility before deciding to disclose it to the government.” Contractors and their lawyers are struggling to assess this sparse and ambiguous guidance and to develop practical guidance for inclusion in compliance program policies and procedures. One task that will help develop such guidance involves analysis of differences between “reasonable grounds” and “credible evidence”. For example, whereas under the proposed rule contractors likely would have had to self report following an employee’s ethics hot line call if the allegations were facially reasonable under the circumstances, under the New Rule contractors only need to self report if preliminary examination of the allegation reveals credible evidence of a violation. Obviously, a preliminary examination is something short of a full scale internal investigation. The challenge involves defining the precise boundaries of such an examination. Another task involves defining the “credible evidence” standard itself. One way to approach this is to compare different definitions of standards of evidence in the case law and regulations to the expressed intent of the drafters of the New Rule. For example, is “credible evidence” less evidence than the “adequate evidence” required to suspend a contractor under FAR 9.407? If so, by how much less? At this early stage in the implementation of the New Rule, there are more questions than there are answers about the credible evidence standard in the New Rule. 

Under revisions to FAR 9.406, contractors can now be suspended and/or debarred for: a “[k]nowing failure by a principal, until 3 years after final payment on any Government contract awarded to the contractor, to timely disclose to the Government, in connection with the award, performance, or closeout of the contract or a subcontract thereunder, credible evidence of– (A) [v]iolation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code; (B) [v]iolation of the civil False Claims Act (31 U.S.C. 3729-3733); or (C) [s]ignificant overpayment(s) on the contract, other than overpayments resulting from contract financing payments as defined in 32.001.” Thus, even if a contractor does not have contracts that are subject to FAR 52.203-13, it can be debarred from government contracts for a knowing failure to self report in the specified circumstances. In effect, this aspect of the New Rule applies the mandatory disclosure requirements to all government contractors on the effective date of the rule. A key issue in the implementation of this aspect of the New Rule involves the definition of “principals”. Under the revised definition in FAR 2.101, principal means an “officer, director, owner, partner, or a person having primary management or supervisory responsibilities within a business entity (e.g., general manager, plant manager, head of a subsidiary, division or business segment; and similar positions).” One commentator has suggested that this definition will be read broadly to include compliance officers and directors of internal audits. He also suggested that contractors should provide written guidance to principals concerning their disclosure obligations and require regular central reporting from them, even if they are not aware of any violations.xx

As mentioned above, the New Rule sets forth new internal control system requirements. These requirements, also imposed through revisions to FAR 52.203-13, are more onerous than the previous internal control system requirements. However, they will not apply to small business concerns or to contractors who only have contracts for commercial items as defined in FAR 2.101. Under the New Rule, covered contractors’ internal control systems must provide for the following:

• “Assignment of responsibility at a sufficiently high level and adequate resources to ensure effectiveness of the business ethics awareness and compliance program and internal control system.
• Reasonable efforts not to include an individual as a principal, whom due diligence would have exposed as having engaged in conduct that is in conflict with the Contractor’s code of business ethics and conduct.
• Periodic reviews of company business practices, procedures, policies, and internal controls for compliance with the Contractor’s code of business ethics and conduct and the special requirements of Government contracting, including–

• • Monitoring and auditing to detect criminal conduct;
  • Periodic evaluation of the effectiveness of the business ethics awareness and compliance program and internal control system, especially if criminal conduct has been detected; and
  • Periodic assessment of the risk of criminal conduct, with appropriate steps to design, implement, or modify the business ethics awareness and compliance program and the internal control system as necessary to reduce the risk of criminal conduct identified through this process.

• An internal reporting mechanism, such as a hotline, which allows for anonymity or confidentiality, by which employees may report suspected instances of improper conduct, and instructions that encourage employees to make such reports.
• Disciplinary action for improper conduct or for failing to take reasonable steps to prevent or detect improper conduct.”^xxi

In addition, contractor internal control systems must provide for “[t]imely disclosure, in writing, to the agency OIG, with a copy to the Contracting Officer, whenever, in connection with the award, performance, or closeout of any Government contract performed by the Contractor or a subcontractor thereunder, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed a violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 U.S.C. or a violation of the civil False Claims Act (31 U.S.C. 3729-3733)” (emphasis added)xxii. Thus, whereas contractors are required by the revised FAR 52.203-13 to disclose violations of the law that have occurred in connection with the award, performance, or closeout of contracts that include the clause (and subcontracts thereunder), contractor internal control systems must provide for disclosure of violations on any government contract performed by the contractor (and subcontracts thereunder). Importantly, the New Rule provides that the disclosure requirement for an individual contract continues until at least 3 years after final payment on the contract. One issue that has arisen in the implementation of this aspect of the New Rule is whether prime contractor internal control systems must provide for the modification of existing subcontracts to require reporting of violations. As mentioned above, FAR 52.203-13 applies to new prime contracts and subcontracts with a performance period of 120 days or more that are expected to exceed $5,000,000 in value. However, the suspension and debarment and internal control requirements of the New Rule apply across the board to all existing and new contracts. If prime contractors do not impose disclosure requirements on existing subcontracts, are they at risk of termination for default, suspension or debarment?

Finally, internal control systems must provide for “full cooperation with any Government agencies responsible for audits, investigations, or corrective actions.” The New Rule makes clear that the “full cooperation” requirement “does not require– (i) a Contractor to waive its attorney-client privilege or the protections afforded by the attorney work product doctrine; or (ii) any officer, director, owner, or employee of the Contractor, including a sole proprietor, to waive his or her attorney client privilege or Fifth Amendment rights; and . . . [d]oes not restrict a Contractor from– (i) conducting an internal investigation; or (ii) defending a proceeding or dispute arising under the contract or related to a potential or disclosed violation.”xxiv Notwithstanding this assurance, contractors will need to ensure that any disclosures made do not include privileged information.

In conclusion, contractors and their lawyers have a “full plate” of new compliance requirements and issues to swallow and digest in the New Year.

On December 22, 2008, the Government Accountability Office (GAO) released its annual report to Congress concerning government contracts bid protests.xxvTwo of the statistics included in the report are particularly noteworthy. The first is the fiscal year (FY) 2008 protest “sustain rate”. This is the percentage of cases decided in favor of the protester. In FY 2008, the sustain rate was 21%. By contrast, the average sustain rate for FY 2004 through FY 2007 was 25%. This statistic shows that bid protests continue to be relatively difficult to win. However, the second significant statistic – the protest “effectiveness rate” – offers more hope to protesters. This is the percentage of cases in which the protester received some form of relief from the contracting agency, frequently a re-opening of the competition.xxvi In FY 2008, the effectiveness rate was 42%. By contrast, the average effectiveness rate for FY 2004 through FY 2007 was 37%. This statistic shows that agencies are increasingly taking voluntary corrective action in response to protests. While the statistics offer valuable high level insights to contractors about the bid protest process, they need to be viewed in the proper context. Obviously, prospects for success in a protest action vary considerably based on the circumstances of the procurement.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

i 73 Fed. Reg. 33285 (June 11, 2008).

ii 8 U.S.C. § 1324a.

ii 73 Fed. Reg. 33374 (June 12, 2008).

iv 73 Fed. Reg. 67651 (November 14, 2008).

v Id.

vi Id.

vii Id.

viii 73 Fed. Reg. 33374.

xi 73 Fed. Reg. 67651.

x Findings of the Web Basic Pilot Evaluation (Westat, Sep. 2007), www.uscis.gov/files/articleWebBasicPilotRprtSept2007.pdf, at xxi.

xi See e.g., How Errors in Basic Pilot/E-verify Databases Impact U.S. Citizens and Lawfully Present Immigrants, National Immigration Law Center, www.nilc.org.

xii Elise Castelli, Contractor Groups Sue to Abolish New Immigration Checks, at www.federaltimes.com (December 30, 2008).

xiii 73 Fed. Reg. 33374.

xiv Well before issuing the Proposed Rule, the government took steps to require personal identity verification for contractor personnel with access to federal installations and information systems. See FAR 52.204-9, Personal Identity Verification of Contractor Personnel. Therefore, the main benefit of the new employment eligibility verification rules will be improved enforcement of the immigration laws of the United States.

xv 73 Fed. Reg. 67064 (November 12, 2008).

xvi Id.

xvii Id.

xviii See Rand Allen and John Burd, New FAR “Mandatory Disclosure” Rule: Best Practices for Day One, 90 Federal Contracts Report 43 (December 9, 2008).

xix 73 Fed. Reg. 67064.

xx Allen and Burd, 90 Federal Contracts Report 43.

xxi 73 Fed. Reg. 67064.

xxii Id.

xxiii Id.

xxiv Id.

xxv Letter from General Counsel, GAO, to Hon. Nancy Pelosi (December 22, 2008), B-158766, available at www.gao.gov.

xxvi Robert Brodsky, Bid Protests Reach 10 Year High, govexec.com (January 5, 2009).

The election of Senator Barack Obama as President has caused many government contractors to wonder whether the “righteous winds” that brought him to that high office will buffet or benefit their businesses in years to come. Of course, only time will tell. However, one thing is clear: contractors need to prepare for significant changes to federal procurement policy. While he has not yet offered detailed proposals, his campaign statements offer a preview of these changes. In particular, he promised to:

In addition to these changes, the Federal Times has reported that President-elect Obama intends to audit 25% of all “large contracts” each year, beginning with cost-based contracts. The audits reportedly “would focus on work performance, cost savings, whether the work should have been outsourced, whether it was subject to adequate competition and whether the contractor treats its workers fairly.”3

The promise to introduce positive incentives to reward good performance may ultimately benefit both contractors and the public. However, the other changes mentioned above are not likely to benefit contractors, at the least in the short term. At this early stage, all that contractors can do is to begin to work on plans to closely monitor and react to legislative and regulatory developments. In addition, contractors should work aggressively to ensure that they are prepared to withstand additional scrutiny of their compliance with the sometimes byzantine rules of government contracting. Attention to the new Federal Acquisition Regulation rule on contractor compliance programs discussed below is a necessary part of these preparations.

On November 12, 2008, the Civilian Agency Acquisition Council and the Defense Acquisition Regulation Council (the “Councils”) issued a final rule (the “Final Rule”) that the drafters described as a “sea change” to the government’s longstanding approach of offering incentives to contractors to make voluntary disclosures of violations of the procurement laws. In accordance with the Supplemental Appropriations Act of 2008 (the “Act”), the Final Rule mandates that contractors notify the pertinent agency Inspector General whenever they have “credible evidence” of certain violations of the criminal laws or the civil False Claims Act. The Final Rule also provides that contractors can be suspended and/or debarred in certain circumstances for failing to turn themselves in. Furthermore, the Final Rule imposes strict new internal control requirements for contractor ethics and compliance programs. The effective date of the Final Rule is December 12, 2008. This article provides some background information on the Final Rule, a description of its key features and some reflections on potential consequences of the new rule.

Section 6102 of the Act, which was signed into law by the President on June 30, 2008, requires the following:

The Federal Acquisition Regulation shall be amended within 180 days after the date of the enactment of this Act pursuant to FAR Case 2007-006 (as published at 72 Fed Reg. 64019, November 14, 2007) or any follow-on FAR case to include provisions that require timely notification by Federal contractors of violations of Federal criminal law or overpayments in connection with the award or performance of covered contracts or subcontracts, including those performed outside the United States and those for commercial items.

Section 6103 of the Act defines “covered contract” as any contract in an amount greater than $5,000,000 and more than 120 days in duration.

In the FAR case referenced in the Act, the Councils had, prior to enactment of the Act, issued and then amended a proposed rule (the “Proposed Rule”) that is similar in many ways to the Final Rule. A key difference between the Proposed Rule and the Final Rule, however, is the criteria for self-reporting. The Proposed Rule would have required that contractors notify the agency Inspector General in writing whenever the contractor had “reasonable grounds” to believe that a violation of federal criminal law or of the civil False Claims Act had occurred in connection with the award or performance of government contracts performed by the contractor (or a subcontract thereunder). Government contractors and their representatives roundly criticized this aspect of the Proposed Rule as overly vague. For example, in comments submitted to the Councils on July 15, 2008, the Professional Services Council (“PSC”) argued that the Act did not require that the FAR regulations include the vague “reasonable grounds to believe” standard for reporting violations. Thus, PSC asserted that the Proposed Rule should be revised to require reporting only when “there has actually been a criminal indictment, information, a plea agreement with an admission of liability or similar definitive action.” The drafters of the Final Rule responded to this comment as follows: “[t]his rule was initiated as a matter of policy. Although the new statute reinforces and provides a statutory basis for some aspects of the rule, the fact that any part of the rule is not required by statute does not alter the rationale that provided the underpinning for those aspects of the rule. Each aspect of the rule not required by statute must be considered on its own merits.” In the Final Rule, the drafters did not adopt industry’s recommendation that the FAR only require self-reporting when there has been “definitive action” indicative of a violation of law. However, as described below, the Councils did abandon the “reasonable grounds” standard for self-reporting, replacing it with a “credible evidence” standard.

The Final Rule has three key features. First, the Final Rule has a new mandatory disclosure requirement, which is set forth in a revision to FAR 52.203-13, Contractor Code of Business Ethics and Conduct. That clause now requires contractors to:

. . . timely disclose, in writing, to the agency Office of the Inspector General (OIG), with a copy to the Contracting Officer, whenever, in connection with the award, performance, or closeout of this contract or any subcontract thereunder, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed–(A) a violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code; or (B) a violation of the civil False Claims Act (31 U.S.C. 3729-3733). 11

In the preamble to the Final Rule, the drafters stated that the term “credible evidence” should be interpreted as a “higher standard” than the “reasonable grounds to believe” standard in the Proposed Rule. The drafters stated, further, that use of the credible evidence standard “impl[ies] that the contractor will have the opportunity to take some time for preliminary examination of the evidence to determine its credibility before deciding to disclose it to the government.” Under the Final Rule, FAR 52.203-13, which previously did not apply to contracts for commercial items or contracts performed entirely outside the US, must now be included in ALL prime contracts with a performance period of 120 days or more that are expected to exceed $5,000,000 in value. The clause must also be “flowed down” to all subcontracts that meet these thresholds. However, subcontractors must turn themselves in directly to the government and not to the prime contractor.

Second, the Final Rule includes new grounds for suspension and debarment. Under revisions to FAR 9.406, contractors can now be suspended and/or debarred for : a “[k]nowing failure by a principal, until 3 years after final payment on any Government contract awarded to the contractor, to timely disclose to the Government, in connection with the award, performance, or closeout of the contract or a subcontract thereunder, credible evidence of– (A) [v]iolation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code; (B) [v]iolation of the civil False Claims Act (31 U.S.C. 3729-3733); or (C) [s]ignificant overpayment(s) on the contract, other than overpayments resulting from contract financing payments as defined in 32.001.” Thus, even if a contractor does not have contracts that are subject to FAR 52.203-13, it can be debarred from government contracts for a knowing failure to self-report in the specified circumstances. In effect, this feature of the Final Rule applies the mandatory disclosure requirements to all government contractors on the effective date of the rule.

Third, the Final Rule sets forth new internal control system requirements. These requirements, also imposed through revisions to FAR 52.203-13, are more onerous than the previous internal control system requirements. However, they will not apply to small business concerns or to contractors who only have contracts for commercial items as defined in FAR 2.101. Under the Final Rule, covered contractors’ internal control systems must provide for the following:

• “Assignment of responsibility at a sufficiently high level and adequate resources to ensure effectiveness of the business ethics awareness and compliance program and internal control system.
• Reasonable efforts not to include an individual as a principal, whom due diligence would have exposed as having engaged in conduct that is in conflict with the Contractor’s code of business ethics and conduct.
• Periodic reviews of company business practices, procedures, policies, and internal controls for compliance with the Contractor’s code of business ethics and conduct and the special requirements of Government contracting, including–

• •  Monitoring and auditing to detect criminal conduct;
  • Periodic evaluation of the effectiveness of the business ethics awareness and compliance program and internal control system, especially if criminal conduct has been detected; and
  • Periodic assessment of the risk of criminal conduct, with appropriate steps to design, implement, or modify the business ethics awareness and compliance program and the internal control system as necessary to reduce the risk of criminal conduct identified through this process.

• An internal reporting mechanism, such as a hotline, which allows for anonymity or confidentiality, by which employees may report suspected instances of improper conduct, and instructions that encourage employees to make such reports.
• Disciplinary action for improper conduct or for failing to take reasonable steps to prevent or detect improper conduct.” 13

In addition, contractor internal control systems must provide for “[t]timely disclosure, in writing, to the agency OIG, with a copy to the Contracting Officer, whenever, in connection with the award, performance, or closeout of any Government contract performed by the Contractor or a subcontractor there under, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed a violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 U.S.C. or a violation of the civil False Claims Act (31 U.S.C. 3729-3733)” (emphasis added).” Thus, whereas contractors are required by the revised FAR 52.203-13 to disclose violations of the law that have occurred in connection with the award, performance, or closeout of contracts that include the clause (and subcontracts there under), contractor internal control systems must provide for disclosure of violations on any government contract performed by the contractor (and subcontracts there under). Importantly, the Final Rule provides that the disclosure requirement for an individual contract continues until at least 3 years after final payment on the contract. 15


Finally, internal control systems must provide for “full cooperation with any Government agencies responsible for audits, investigations, or corrective actions.” The Final Rule makes clear that the “full cooperation” requirement “does not require– (i) a Contractor to waive its attorney-client privilege or the protections afforded by the attorney work product doctrine; or (ii) any officer, director, owner, or employee of the Contractor, including a sole proprietor, to waive his or her attorney client privilege or Fifth Amendment rights; and . . . [d]oes not restrict a Contractor from– (i) conducting an internal investigation; or (ii) defending a proceeding or dispute arising under the contract or related to a potential or disclosed violation.” 16

In response the Final Rule, contractors will need to make significant changes in their compliance programs. For example, contractors will need to

• Develop or refine policies and procedures that ensure that information concerning possible violations or overpayments is brought to the attention of company officials who are responsible for investigating and deciding whether to self-report;
• Develop standards for deciding when there is “credible evidence” that a violation of law or significant overpayment has occurred and documenting the bases for decisions to self-report and not to self-report;
• Revise purchasing/procurement policies and templates to include flow down of new requirements to subcontractors;
• Determine how to meet the “full cooperation” requirements without waiving privileged communications between employees and company lawyers; and
• Ensure that compliance program policies and plans include all the required internal control system elements.

Needless to say, the regulation writers have given government contractors a “full plate” of compliance program development activities for the end of 2008 and the New Year.

Although the demands of federal customers will require many government contracts professionals to work during the upcoming religious and secular holidays, all of us will have some time to contemplate the “reason for the season” and to give thanks for our many blessings. For our part, we are thanking God for the opportunity to serve Him through our law office. We are also grateful to our clients and other friends who helped to make this a successful year. To these dear people and all who visit this website, we wish you a Merry Christmas and a Happy New Year! May 2009 bring prosperity and good health to you and yours.

To Life-

L’chaim

Chris Bouquet, Esq.

Mrs. Angela Bouquet

The foregoing reflections were prepared for the general information of clients and other friends of the Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

It probably goes without saying that federal procurement policy likely will not be a “game changing” issue in this or any future presidential election. Nonetheless, in his first debate with Sen. Barack Obama, Sen. John McCain weighed in on the subject, decrying defense systems costs that “are completely out of control” and calling for the federal government to “do away with cost-plus contracts.”1 Sen. McCain made this statement in response to a question from Moderator Jim Lehrer concerning the priorities Sen. McCain would adjust because of the cost of the financial rescue package. Following is the full text of his statement:

MCCAIN: Look, we, no matter what, we’ve got to cut spending. We have — as I said, we’ve let government get completely out of control.

Senator Obama has the most liberal voting record in the United States Senate. It’s hard to reach across the aisle from that far to the left.

The point — the point is — the point is, we need to examine every agency of government.

First of all, by the way, I’d eliminate ethanol subsidies. I oppose ethanol subsidies.

I think that we have to return — particularly in defense spending, which is the largest part of our appropriations — we have to do away with cost-plus contracts. We now have defense systems that the costs are completely out of control.

We tried to build a little ship called the Littoral Combat Ship that was supposed to cost $140 million, ended up costing $400 million, and we still haven’t done it.

So we need to have fixed-cost contracts. We need very badly to understand that defense spending is very important and vital, particularly in the new challenges we face in the world, but we have to get a lot of the cost overruns under control.

I know how to do that.2

By way of background, cost-reimbursement types of contracts provide for payment of incurred costs that are “allowable” under detailed regulations set forth in the Federal Acquisition Regulation (“FAR”) to the extent prescribed in the contract. These contracts establish an estimate of total contract costs for the purpose of obligating funds and a ceiling that the contractor may not exceed (except at the contractor’s own risk) without the approval of the contracting officer.3 Cost-reimbursement contracts are suitable for use only when:

• uncertainties involved in contract performance do not allow the estimation of costs sufficient accuracy to use any type of fixed-price contract4;
• the contractor has an accounting system that is adequate for determining applicable contract costs; and
• appropriate government surveillance during performance will provide reasonable assurance that the contractor uses efficient methods and effective cost controls.5

In addition, cost reimbursement contracts may not be used for the acquisition of commercial items.6 On major defense acquisition programs, use of a cost reimbursement contract must be justified by specific written determinations, including a determination that the program is “so complex and technically challenging that it would not be practicable to reduce program risk to a level that would permit the use of a fixed price type contract”. 7


Federal procurement policy permits agencies to use three types of cost-reimbursement contracts: (1) “cost contracts”, under which the contractor receives no fee8; (2) “cost sharing” contracts, under which the contractor receives no fee and is reimbursed for an agreed-upon share of its allowable costs,9 and; (3) the “cost plus” contracts that Sen. McCain referred to in the debate, under which the contractor receives a fee.10 Cost-plus-incentive-fee contracts stipulate an initially negotiated fee that will be adjusted later by a formula based on the relationship of total allowable costs to total target costs.11 Cost-plus-award-fee contracts provide for a fee that consists of (a) a base amount (which may be zero) fixed at inception of the contract and (b) an award amount, based upon a judgmental evaluation by the Government, sufficient to motivate the contractor to excel in performance of the contract (including cost control).12 Cost-plus-fixed-fee contracts provide for payment to the contractor of a negotiated fee that is fixed at the inception of the contract. The fixed fee does not vary with actual cost, but may be changed as a result of changes in the work to be performed under the contract.13 The FAR states that cost-plus-fixed-fee contracts “normally” should not be used in development of major systems when there is a “high degree of probability that the development is achievable and the Government has established reasonably firm performance objectives and schedules”.14


In summary, existing procurement policy recognizes the reality that programs, especially those requiring the development of a new technology, pass through periods of uncertainty when the government lacks a full understanding of its own requirements and may make overly optimistic assumptions. The policy recognizes, further, that use of fixed price contracts in such situations inevitably results in contractor claims and disputes concerning changes to the baseline for the contract. Thus, use of cost plus contracts serves the public interest by enabling the government to avoid the expense and disruption of contract litigation. As mentioned above, cost plus contracts may also include fee provisions that incentivize cost control and quality.

At various times in history, there have been attempts to do away with cost plus contracts. As one esteemed commentator has said:

The use of fixed-price type contracts to force the services and its contractors to limit the technological risk in the development of a weapon system is not a new idea. It has been tried repeatedly starting in the 1960s with Secretary of Defense Robert McNamara. It has never worked and it will not work until defense officials at the highest level impose full discipline on the system. If they don’t, all that these fixed-price contracts accomplish is to breed litigation and trauma during the administration of the contract.15

Should the people elect Sen. McCain as President, it will be interesting to see whether his Secretary of Defense can impose the necessary discipline to do away with cost plus contracts.

In a memorandum to all Defense Contract Audit Agency (“DCAA”) employees issued on September 30, 2008, the Director of DCAA announced dramatic changes in the way in which DCAA measures its own performance.16 The changes are part of DCAA’s response to a Government Accountability Organization (“GAO”) report that criticized DCAA for failing to follow Generally Accepted Government Auditing Standards (“GAGAS”).17 In that report, GAO made numerous allegations that DCAA had failed to comply with GAGAS. For example, GAO alleged that DCAA violated GAGAS independence standards by allowing contractor officials and the DoD contracting community to influence improperly the audit scope, conclusions, and opinions of DCAA audits. In addition, GAO alleged that pressures to meet DCAA performance measures were causing auditors to take “inappropriate short cuts-ultimately resulting in noncompliance with GAGAS . . . “18 In response, DCAA initiated a project to review and assess its use of performance measures. As a result of that project, DCAA eliminated 18 of the 19 performance measures that were in use at the time GAO was preparing its report and implemented 8 new performance measures.19 It appears that, with the new measures, DCAA is attempting to achieve a better balance between the sometimes competing goals of timeliness, efficiency and quality.

 Unfortunately, however, some of the changes may not improve the quality of DCAA’s audits. DCAA’s new goal that 45% of all audit reports should include findings against contractors is particularly troublesome. Due to the complexity of the facts and the regulations, auditors’ initial impressions of contractor accounting practices are often wrong. Rather than encouraging auditors to come to correct conclusions, the new goal encourages auditors to make allegations against contractors without the proper regard for their substantive merit. Thus, the new goal is likely to increase the number of incorrect audit findings and decrease the overall quality of DCAA’s product. Moreover, rather than incentivizing auditors to use independent judgment, the new goal incentivizes auditors to issue findings to meet the expectations of DCAA management. In the end, the new goal will not serve the taxpayers well. The correction of audit errors made in pursuit of the goal will require the government and contractors to expend significant resources that could have been employed more productively in partnering to meet the needs of the taxpayer. Finally, the stated purpose of this goal is “to measure the percentage of audit reports issued with findings as an indication of the tangible value of the audit work performed by DCAA”.20 While meritorious audit findings on material issues are indicative of valuable audit work, incomplete or erroneous findings are not. Contractors can only hope that individual DCAA auditors will not sacrifice their professional independence and judgment in the interests of achieving an arbitrary goal set by DCAA management.

On September 17, 2008, the Civilian and Defense Acquisition Councils issued an interim rule that requires enhanced competition for orders issued under task and delivery order type contracts.21 A “task order contract” is a contract for services that does not require a performance of a firm quantity of services (other than a minimum or maximum quantity) and that provides for the issuance of orders for the performance of tasks during the term of the contract.22 A “delivery order contract” is a contract for supplies that does not require delivery of a firm quantity of supplies (other than a minimum or maximum quantity) and that provides for the issuance of orders for the delivery of supplies during the term of the contract.23 The new rule, which implements Section 843 of the Fiscal Year 2008 National Defense Authorization Act, does not apply to orders issued under GSA Multiple Award Schedule contracts.24 The purpose of the statute and the new rule is “to improve opportunities for competition through fair opportunity, transparency and accountability in contracting”.25


The new rule makes three major changes to the Federal Acquisition Regulation. First, the rule prohibits the award of a task or delivery order contract in an amount estimated to exceed $100 million (including all options) to a single source unless the head of the agency makes certain written findings.26 According to the drafters, this provision is intended “to place greater emphasis on awarding multiple award contracts and enhancing the fair opportunity provisions within FAR Subpart 16.5. Competition of orders leads to improved contractor performance, stimulation of technological solutions, and reduction of costs over time. The tenets of this provision strike at the core of enhancing competition and ensuring competition continues to exist even after award of the initial contract vehicles.”27


Second, the rule imposes new “fair opportunity” procedures that will govern the competitive placement of task or delivery orders with an expected value in excess of $5 million (including options) placed under multiple award task or delivery order contracts. In particular, all contract awardees must receive, at a minimum:

• notice of the agency’s intent to place an order with a clear statement of requirements;
• a reasonable period in which to submit a proposal;
• disclosure of the significant evaluation factors and subfactors that the agency plans to consider in evaluating proposals and their relative importance;
• where award of the order is made on a best value basis, a statement concerning the basis for award and the relative importance of quality and price or cost factors; and
• an opportunity for a postaward debriefing in accordance with procedures set forth in FAR 15.506.28

The purpose of these changes is to “improve the transparency and accountability of agency award decisions”.29 The new requirements apply to orders on existing contracts, as well as on new contracts.30

  Third, the rule includes a new right to protest the issuance of task or delivery orders if the order is valued in excess of $10 million (including options). The Comptroller General has exclusive jurisdiction over such protests.31 According to the drafters, this provision “provides for greater accountability, oversight and discipline within the Federal acquisition framework, when coupled with the requirement of post award debriefings”.32 The protest authority applies to orders on existing contracts, as well as to orders on new contracts.33

  The interim rule was effective September 17, 2008. Comments are due on or before November 17, 2008.34

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

1 Commission on Presidential Debates, The First McCain-Obama Presidential Debate (September 26, 2008), available at http://www.debates.org/pages/debtrans.html.

2 Id.

3 FAR § 16.301-1.

4 Id. at § 16.301-2.

5 Id. at § 16.303-1.

6 Id. The definition of “commercial items” is set forth in FAR § 2.101.

7 DFARS § 234.004.

8 FAR § 16.302.

9 Id. at §16.303.

10 “Cost plus percentage of cost” contracts providing for the contractor to be paid costs incurred plus a percentage of these costs are strictly prohibited. FAR § 16.102(c).

11 Id. at § 16.304.

12 Id. at § 16.305. Cost-plus-award fee contracts may not be awarded unless the contract amount, performance period, and expected benefits are sufficient to warrant the additional administrative effort and cost involved.

13 Id. at § 16.306.

14 Id. at § 16.306(b)(2). Limitations on the amount of the fee are set forth at FAR § 15.404-4(c)(4)(i).

15 Ralph C. Nash, Selecting the Type of Contract for Development Work: A New Twist, 21 Nash & Cibinic Rep. 2, ¶1 (February 2007).

16 Memorandum from Director, Defense Contract Audit Agency, to All Employees (September 30, 2008).

17 U.S. Government Accountability Office, DCAA Audits: Allegations That Certain Audits at Three Locations Did Not Meet Professional Standards Were Substantiated, GAO-08-857 (2008).

18 Id.

19 Memorandum from Director, Defense Contract Audit Agency, supra note 1.

20 Id.

21 73 Fed. Reg. 54008 (September 17, 2008).

22 FAR § 16.501-1.

23 Id.

24 See FAR § 16.500(c).

25 73 Fed. Reg. 54008 (September 17, 2008).

26 Id.

27 Id.

28 Id.

29 Id.

30 Id.

31 Id. This new protest right and the existing right to protest if an order increases the scope, period, or maximum value of the contract under which the order is issued expire May 27, 2011, unless extended by a new statute.

32 Id.

33 Id. Discussion of complexities associated with the interaction of the new and existing protest rules is beyond the scope of this Reflection. Counsel should be consulted as soon as a company starts to consider a protest of an order under this new authority.

34 Id.

On July 31, 2008, after a four week trial, a federal jury sitting in the District of Columbia found that Science Applications International Corporation (“SAIC”) had violated the civil False Claims Act (“FCA”)1 by failing to disclose and avoid organizational conflicts of interests that had the potential to bias its work under a contract with the Nuclear Regulatory Commission (“NRC”).2 In general terms, an OCI arises when there is a risk that a contractor might: (1) have an unfair advantage in a competition for a contract because of prior work for the government or (2) be unable to render impartial assistance to the government on a contract because of other business interests.3 In the SAIC case, the jury found that SAIC’s work with the NRC to write a rule that would govern whether radioactive materials from nuclear facilities could be released or recycled was not impartial because it conflicted with SAIC’s business relationships with private corporations that stood to benefit from the rule. SAIC’s conflicting relationships were brought to light by a private citizen at a public meeting held in November of 1999 and the NRC shortly therafter terminated SAIC’s contract.4


This verdict came six weeks after the district court issued an opinion denying SAIC’s motion for summary judgment on the FCA counts in the government’s complaint.5Based on the court’s opinion, it appears that the jury found that each and every invoice submitted under the contract contained a false implied certification that SAIC complied with contractual provisions prohibiting OCIs and prior representations that no OCIs existed.6 Obviously, the jury also found that SAIC submitted these claims with the requisite knowledge for liability under the FCA- i.e., that SAIC either actually knew the claims were false, acted in deliberate ignorance of the truth or falsity of the claims or acted in reckless disregard of the truth or falsity of the information.7 The jury awarded the United States $5.91 million in triple damages under the FCA. SAIC will also have to pay penalties of between $5,000 and $10,000 for each of the 77 false claims and statements that it submitted to the NRC.8 This award is consistent with prior judicial opinions holding that “a government contractor’s failure to disclose an organizational conflict of interest constitutes a false claim under the False Claims Act.”9


This verdict against SAIC, whether justified or not, highlights the perils to contractors of failing to identify, disclose and properly manage OCIs. The only way to mitigate these risks is to fully train the responsible employees on the OCI rules. These rules are notoriously vague and ambiguous. Therefore, contractor compliance officials must make extensive use of the interpretative case law in the development of OCI training materials.

In a recent interview with Defense News, Robert Stevens, the Chairman of the Board, Chief Executive Officer and President of Lockheed Martin Corporation, made some important observations about the contract award process of the Department of Defense (“DoD”). When asked how that process should be fixed so that award protests are not sustained, he replied:

I think the best way to improve it is for us to spend more time at the front end of the process in a fundamental immersion in the concept of operations that we need to achieve the mission. When we get that fundamental grounding in place, when it is well understood, when we try to wring out some of the uncertainty and do that early, then industry is in a much better position to put a schedule against those requirements, to put a cost against those requirements, to analyze a risk environment, and to put forward a much better-balanced proposal that is closer to being realistic because the risks have been better understood early.10

A “concept of operations” is a statement that clearly and concisely expresses what a military commander intends to accomplish and how it will be done using available resources. It is intended to provide an overall picture of an operation.11 Mr. Stevens’ response to this question indicates that he believes that, prior to releasing a solicitation, DoD should spend more time determining what it intends to accomplish with available resources and working on effectively communicating its requirements to industry. Further, it appears that he believes that this increased DoD attention to the concept of operations will result in better proposals from industry and that better proposals will reduce the risks of errors in the award process.

Mr. Stevens made clear, however, that improving the award process is not solely the responsibility of DoD. In fact, he stated that:

This is a shared responsibility that the more we in industry can meet with those in the Pentagon-not only who are chartered with buying the systems, but who will also use the systems in their operational domain-the more we can get convergence there about what needs to be done, how that mission will be accomplished, then industry can bring forward the better system engineering, better-refined risk assessments, better costs and better schedule.12

Mr. Stevens’s comments highlight the need for contractors and the government to work together early in the procurement process to ensure the development of proper baselines for the performance of government contracts. The Federal Acquisition Regulation (“FAR”) explicitly encourages the types of exchanges that Mr. Stevens referred to in his comments, even before the release of a solicitation. Indeed, FAR 15.201(c) states:

Agencies are encouraged to promote early exchanges of information about future acquisitions. An early exchange of information among industry and the program manager, contracting officer, and other participants in the acquisition process can identify and resolve concerns regarding the acquisition strategy, including proposed contract type, terms and conditions, and acquisition planning schedules; the feasibility of the requirement, including performance requirements, statements of work, and data requirements; the suitability of the proposal instructions and evaluation criteria, including the approach for assessing past performance information; the availability of reference documents; and any other industry concerns or questions. Some techniques to promote early exchanges of information are— (1) industry or small business conferences; (2) public hearings; (3) market research . . .(4) one-on-one meetings with potential offerors . . . ; (5) presolicitation notices; (6) draft RFPs; (7) RFIs; (8) presolicitation or preproposal conferences; and (9) site visits.

After the release of a solicitation, the Contracting Officer becomes the focal point for all contractor communications.13 However, even then, contractors are typically provided an opportunity to submit questions about the solicitation. Of course, throughout the procurement process, contractors must comply with the provisions of the Procurement Integrity Act (“PIA”) governing the contents of their communications with the government.14 The PIA strictly forbids contractors and their agents from soliciting or obtaining from a government employee: 1) any confidential information submitted by a competitor to the government in connection with a government procurement (i.e., “contractor bid or proposal information”); and 2) any non-public information concerning the government’s actions, plans or processes with respect to a procurement (i.e., “source selection information”).

Mr. Stevens’ comments are important because they highlight the urgent need for a commitment to thorough pre-contractual baselining. Too often, due to resource constraints and/or schedule pressures, the government and contractors take short cuts in the procurement process and do not immerse themselves in the fundamental concept of operations of a procurement. This leads not only to problems in the award process but also to performance problems-e.g., claims and terminations. Increased attention to pre-contractual baselining will help the government obtain the products and services that it needs and will also help contractors perform their government contracts without resorting to costly dispute processes.

In a Federal Register notice issued on August 26, 2008 (the “Notice”), the Multiple Award Schedule (“MAS”) Advisory Panel (“Panel”) of the General Services Administration (“GSA”), which has already held six meetings this year, announced that it will hold four additional public meetings in September and October 2008.15 Under the MAS program, GSA’s Federal Acquisition Service (“FAS”) negotiates and awards contracts to multiple suppliers for similar or comparable “commercial” supplies and services, at varying prices.16 MAS contracts are indefinite delivery, indefinite quantity contracts for base periods of five years, plus (3) five-year options. Federal government agencies and other authorized users issue task and delivery orders against the MAS contracts.17 To comply with the Competition in Contracting Act (“CICA”), GSA must open participation in the MAS program to “all responsible sources”. In addition, MAS contracts and orders must result in the “lowest cost alternative to meet the needs of the government.”18

GSA has described current MAS contract pricing policy as follows:

. . . [CICA] requires that MAS contracts and orders result in the lowest overall cost alternative. Historically, to meet this requirement, the goal of the MAS price negotiation has been to obtain government prices that are comparable to the firm’s “most favored commercial customer.” Prior to award, the MAS contracting officer determines that the negotiated prices are fair and reasonable. After award, the contractor may for various reasons, reduce its prices to commercial customers. Based upon price reduction provisions of the negotiated MAS contract, the government may also be entitled to the reduced prices.19

In the MAS contract award process, the government’s announced intention to award multiple contracts for a single item should produce competitive forces that will motivate offerors to lower their proposed prices. Moreover, under the current policy, the Contracting Officer should obtain during this process a significant amount of data concerning the offeror’s commercial sales practices (“CSP”) and use this data to determine whether the price offered to the government is comparable to the prices at which the offeror’s items are sold to its “most favored customer”.20 Furthermore, before placing an order that exceeds the micro-purchase threshold but does not exceed the contractually specified maximum order threshold, an ordering activity should consider reasonably available information about the supply or service offered under MAS contracts by surveying at least three schedule contractors through the GSA Advantage! on-line shopping service, or by reviewing the catalogs or pricelists of at least three schedule contractors.21 Agencies will seek price reductions from contractors if the order exceeds the maximum order threshold.22 For orders of services exceeding the micro-purchase threshold and involving a statement of work, the agency should conduct a “mini-competition” and issue Requests for Quotes to MAS contractors that offer services that will meet the agency’s needs and evaluate responses.23 Award should be to the contractor offering the “best value” to the government.24

The Panel is empowered to review this policy, associated contract provisions and current commercial pricing practices and recommend to the GSA Administrator any changes that the Panel considers “required or advisable to ensure that FAS negotiates prices that enable federal customers to award orders that represent ‘best value’ and result in the lowest overall cost alternative.”25 The focus of the upcoming meetings of the Panel will be on developing recommendations for changes to MAS program pricing provisions for acquisition of professional services, products, total solutions involving professional services and products and non-professional services. The Notice indicates that, for each of these types of acquisitions, the Panel will assess whether competition amongst offerors of similar or comparable items for government business occurs primarily in the MAS contract award process or in the process for issuance of orders under these contracts.26 It appears that, if the Panel finds that competitive forces do not significantly affect MAS contract pricing, it will assess whether competition for orders and the current CSP data submission requirements adequately ensure that the government receives the lowest overall cost alternative to meet its needs.27 It is entirely possible that the Panel will recommend additional competition requirements at the task or delivery order award level. The dates of the next meetings are September 19 and 22, 2008 and October 6 and 27, 2008. Instructions for submitting comments are set forth in the Notice.28

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

131 U.S.C. § 3729 et. seq.

2 Press Release, Nuclear Regulatory Commission, Government Prevails in Conflict of Interest Case Against Science Applications International Corporation, at www.nrc.gov/reading-rm/doc-collections/news/2008/08-142.html.

3 FAR 9.505. NRC regulations at issue in the case varied slightly from this formulation.

4 Press Release, Nuclear Regulatory Commission, supra at note 2.

5 United States v. Science Applications International Corp., 555 F. Supp. 2d 40 (D.D.C. 2008).

6 Id.

7 See 31 U.S.C. § 3729(b).

8 Press Release, Nuclear Regulatory Commission, supra at note 2.

9 See e.g., United States ex. rel. Ervin & Assocs. v. Hamilton Secs. Group, 370 F. Supp.2d 18 (D.D.C. 2005).

10 Antonie Boessenkool, Interview: Robert Stevens, Chairman, President and CEO, Lockheed Martin, Defense News, Defense News, August 4, 2008, at 78.

11 US Department of Defense, Dictionary of Military and Associated Terms, http://www.dtic.mil/doctrine/jel/doddict/data/c/index.html.

12 Boessenkool, supra note 1, at 78.

13 FAR 15.201(f).

14 See FAR 3.104.

15 73 Fed. Reg. 50329 (August 26, 2008).

16 FAR 8.401. Items are considered “commercial” if they meet the definition of “commercial item” set forth in FAR 2.101.

17 General Services Administration, Multiple Awards Schedule Advisory Panel, at http://www.gsa.gov/Portal/gsa/ep/channelView.do?pageTypeId=8203&channelPage=%252Fep%252Fchannel%252FgsaOverview.jsp&channelId=-19486.

18 41 U.S.C. § 259(b)(3).

19 General Services Administration, Multiple Awards Schedule Advisory Panel, supra note 8.

20 GSAR 515.408.

21 FAR 8.405-1(c).

22 FAR 8.405-1(d).

23 FAR 8.405-2.

24 FAR 8.405-1(c)(1) and 8.405-2(d).

25 General Services Administration, Multiple Awards Schedule Advisory Panel, supra note 8.

26 Id.

27 73 Fed. Reg. 50329.

28 Id.

In a scathing report issued on July 22, 2008 (the “Report”), the Government Accountability Office (“GAO”) criticized the Defense Contract Audit Agency’s (“DCAA’s”) auditing practices at three DCAA locations.1 GAO’s investigation began as a response to complaints lodged with GAO’s FraudNET hotline and then expanded based on additional allegations raised during GAO’s fact finding. Key findings were as follows:

Although DCAA policy states that its audits are performed according to [Generally Accepted Government Auditing Standards (“GAGAS”)], GAO found numerous examples where DCAA failed to comply with GAGAS. For example, contractor officials and the DoD contracting community improperly influenced the audit scope, conclusions, and opinions of three audits-a serious independence issue. At two DCAA locations, GAO found evidence that (1) working papers did not support reported opinions, (2) DCAA supervisors dropped findings and changed audit opinions without adequate evidence for their changes, and (3) sufficient audit work was not performed to support audit opinions and conclusions. GAO also substantiated allegations of inadequate supervision of certain audits at a third DCAA location. . . . Moreover, during GAO’s investigation, DCAA managers took actions against staff at two locations, attempting to intimidate auditors, prevent them from speaking with investigators, and creating a generally abusive work environment.

Reaction from Congress to the Report was swift and severe. On July 23, 2008, U.S. Senator Claire McCaskill fired off letters to Secretary of Defense Robert Gates and April Stephenson, the Director of DCAA. In her letter to Secretary Gates, Senator McCaskill said” “I am sorry to say this, but you have another mess on your hands.”2 In her letter to Director Stephenson, the Senator called for disciplinary actions against the supervisors who changed audit findings and the firings off the manager who allegedly retaliated against the staff. She also said:

These findings in this audit do not just cast a cloud over three of your offices. It casts a deep, dark cloud over your entire agency. It calls into question the reliability of every audit your agency performs. Your response to GAO is wholly inadequate. You state that the agency does not agree with the “totality” of their findings, but do agree that “shortcomings” existed in the working paper documentation. The fact that the GAO found that none of the audits investigated had adequate work paper documentation is not a shortcoming. It’s a debacle and embarrassment. Zero percent of the audits reviewed were found to comply with government auditing standards. Employees reported to GAO that they were threatened and made to change their findings to favor contractors, and felt intimidated and harassed concerning their cooperation with GAO. Yet, DCAA states that they believe all the offices where this investigation took place are currently operating at a satisfactory level of compliance. That defies explanation.3

To add fuel to the fire, on July 25, 2008, a DCAA Senior Auditor wrote a letter to Senator McCaskill, Secretary Gates and others vigorously defending DCAA and roundly criticizing the professionalism of GAO’s investigation. Concerning Senator McCaskill’s comments, the auditor said:

You made horrible comments about DCAA and honestly, although I realize your actions and comments may be well meaning, you over-reacted based on a lack of facts. Since you are an auditor, you know that one of the fundamentals of auditing is to get the facts, all the pertinent facts, not just the facts that you want to see and hear, but all the facts that exist.4

Concerning the changing of audit findings by supervisory auditors, the Senior Auditor said as follows:

As DCAA explained in its 19 page rebuttal-the auditor’s findings were removed because they were not good findings. What is wrong with that? . . . The GAO concluded management actions were inappropriate and that supervisors should not have removed the findings. How can GAO make this conclusion if it did not determine whether the audit findings were good? DCAA in its rebuttal stated that in each case, the supervisor removed findings that were not supported . . . DCAA has a strict policy of only reporting findings based on sufficient evidential matter as required by GAGAS. That shows in the GAO review. There is nothing wrong with a supervisor removing unsupported findings from a report.5

Contractors and their representatives likely will find themselves in agreement with this comment of the Senior Auditor. When DCAA issues critical audit reports that are not well supported by the Federal Acquisition Regulations and/or the Cost Accounting Standards, contractors must assemble a team (often including outside experts) to respond, the government must then assess the response and decide whether to withdraw the critical report. If the report is not withdrawn, a dispute may arise that could even lead to litigation. Thus, supervisory changes to incorrect audit findings actually serve the public interest by reducing the expense and disruption of the auditing process for both the government and its contractors. Indeed, supervisors would be derelict in their duties if they did not make such changes. Unfortunately, it is entirely likely that GAO’s Report will have a “chilling effect” on such interventions and give more rein to lower level auditors to make poorly informed conclusions about contractor internal control systems.

Concerning the competency of GAO’s investigators, the Senior Auditor said:

You should ask the GAO whether its investigators are experienced in auditing contractor internal controls. I can guarantee that they were not. . . . These people visited [my] office last year and I guarantee you they knew nothing about audit[ing] contractor internal controls. We spent hour explaining contractor internal controls and then spent hours explaining the GAGAS requirements for internal control audits. It was a horrible waste of our time. And definitely qualifies as wasteful auditing.6

On July 25, 2008, bowing to the pressure of GAO and Senator McCaskill, DCAA announced that it had asked the DoD Inspector general to review the allegations in the GAO Report. DCAA also informed the public that its leaders had “initiated an agency-wide reinforcement of professional expectations and assembled a team to conduct its own internal assessment.”7 Contractors and their representatives can only hope that these initiatives will not lead to more wasteful auditing.

The Supplemental Appropriations Act of 2008 (the “Act”), which the President signed into law on June 30, 2008, mandates certain changes to the Federal Acquisition Regulation (“FAR”) concerning contractor compliance programs.8 In particular, Section 6102 of the Act requires the following:

The Federal Acquisition Regulation shall be amended within 180 days after the date of the enactment of this Act pursuant to FAR Case 2007-006 (as published at 72 Fed Reg. 64019, November 14, 2007) or any follow-on FAR case to include provisions that require timely notification by Federal contractors of violations of Federal criminal law or overpayments in connection with the award or performance of covered contracts or subcontracts, including those performed outside the United States and those for commercial items. 

Section 6103 of the Act defines “Covered contact” as any contract in an amount greater than $5,000,000 and more than 120 days in duration.

In the referenced FAR case, the Civilian Agency Acquisition Council and the Defense Acquisition Regulation Council (the “Councils”) issued a Proposed Rule that requires that contractors notify the agency Inspector General and the Contracting Officer in writing whenever the contractor has “reasonable grounds” to believe that a principal, employee, agent, or subcontractor of the contractor has committed a violation of the civil False Claims Act or a violation of federal criminal law in connection with the award or performance of any government contract performed by the contractor (or a subcontract thereunder).9 The Proposed Rule also stipulates that contractors may be suspended and debarred for a knowing failure to report in a timely manner such violations or an overpayment on a government contract. Further, contractors must have internal control systems that mandate these disclosures and require “full cooperation” with any government investigation. Government contractors and their representatives have roundly criticized the Proposed Rule as overly vague, unnecessary and overbearing.10


In comments submitted to the Councils on July 15, 2008 concerning the Proposed Rule, the Professional Services Council (“PSC”) argued that the Proposed Rule should be revised to reflect the terms of the Act.11 The PSC noted that the Act did not require that the FAR regulations include the vague “reasonable grounds to believe” standard for reporting violations. Thus, PSC believes the Proposed Rule should be revised to require reporting only when “there has actually been a criminal indictment, information, a plea agreement with an admission of liability or similar definitive action.” PSC argued, further, that the Act does not include language stating that a knowing failure to report a violation should be listed in the regulations as a cause for debarment or suspension. PSC believes that, since a violation itself is sufficient grounds for suspension or debarment, listing it in the regulations as an independent basis is unnecessary. Finally, PSC argued that the Act did not mandate that the regulations require reporting of violations to the IG. PSC believes that Contracting Officers are best suited to “make a judgment about whether a matter should be resolved through the contract administration process or referred to the Inspector General.” It is entirely possible that the regulation writers will not agree with this argument. As mentioned above, the Act requires amendments to the FAR “pursuant to” the FAR Case under which the Councils issued the Proposed Rule. The regulation writers may very well will interpret this language as a “green light” or even a mandate to issue a final rule that closely resembles the Proposed Rule.

In the event that the Councils continue down the path reflected in the Proposed Rule, contractors will need to make significant changes in their compliance programs. For example, contractors will need to develop standards for deciding when there are “reasonable grounds” to believe a violation or overpayment has occurred. In addition, contractors will need to develop or refine policies and procedures that ensure that information concerning possible violations or overpayments is brought to the attention of company officials who are responsible for investigating and deciding whether to self report. Further, companies will need to determine how to meet the “full cooperation” requirements without waiving privileged communications between employees and company lawyers. Needless to say, government contractors will be interested in the content of the final rules that are required by the Act.

In this election year, scrutiny of special interest lobbying of the Congress has become fashionable. Despite the old adage that “there are two things you don’t want to see being made—sausage and legislation”12 , the media, government watchdog organizations and both presidential campaigns seem determined to shine a spotlight on this process.13 These groups appear particularly concerned about legislative “earmarking” – i.e., the process by which legislators insert language in funding bills or reports that curtails the ability of the Executive Branch to control critical aspects of the funds allocation process.14 For government contracts, earmarks typically direct a specified amount of money to a particular contractor or project in a legislator’s home state or district. The critics complain that, by circumventing established merit-based or competitive funding allocation processes, such earmarks serve special interests and not the public interest. One critic has even alleged that earmarks for contracts associated with the War on Terror have damaged national security.15


The various laws and regulations that govern the enterprise of lobbying the government fall into two broad categories: 1) rules requiring public disclosure of lobbying activities;16 and 2) government contracting rules governing accounting for the costs of lobbying.17 Not surprisingly, the current scrutiny of special interest lobbying in the “public square” has led to increased auditing of contractor compliance with these rules. Indeed, the Defense Contract Audit Agency (“DCAA”) has recently stepped up its auditing of contractors’ compliance with the lobbying cost accounting rules. To assist contractors’ preparations to withstand such audits, this article provides an overview of the lobbying cost accounting rules and discusses a recent DCAA audit alert instructing auditors to pay special attention to contractors’ accounting for the costs of lobbying for earmarks.

There are two major sets of government contracting rules applicable to accounting for lobbying costs: 1) the so-called “Byrd Amendment” rules governing accounting for the funds used to pay for lobbying for government contract awards18 (the “Byrd Amendment Rules”); and 2) the principles set forth in Federal Acquisition Regulation (“FAR”) Part 31 concerning accounting for lobbying costs (the “Cost Principles”).19

The Byrd Amendment Rules prohibit recipients of appropriated federal funds from using those funds to pay persons or organizations to lobby Congress or an executive agency in connection with the award, extension or modification of a contract, grant or other funding instrument (“Covered Federal Action”).20 In short, the Byrd Amendment Rules require contractors to track separately and to pay for the costs of covered lobbying activities out of funds that are not considered “federal”. Fortunately, the implementing regulations specify that profits and fees from government contracts are not considered federal funds and may be used to pay for covered lobbying.21 Moreover, as long as a contractor can demonstrate that it has sufficient funds, other than federal funds, to cover the costs of its lobbying, there is a presumption that the contractor used these other monies.22

 The Byrd Amendment Rules are far-reaching. In particular:

• • They preclude the use of federal funds to pay for the making, with the intent to influence, of ANY communication to or appearance before an officer or employee of any executive agency, a Member of Congress, an officer or employee of Congress, or an employee of a Member of Congress in connection with any Covered Federal Action.²³
  • The “making” of a communication includes all activities preparatory to the communication, including development of strategy and tactics and the preparation of position papers and presentation slides.  It also includes follow up activities, such as the development of conference notes or debriefings of individuals who were not in attendance at a meeting. 
  • The rules cover not only the costs of activities of outside consultants and lobbyists, but also cover the costs of efforts by a contractor’s officers, directors or employees to influence a transaction. 
  • The rules cover the costs of activities to influence the earmarking of funds.

The Byrd Amendment prohibitions do not apply to reasonable compensation paid to employees of the contractor for providing information specifically requested by Congress or an agency or for agency and legislative liaison activities not directly related to a Covered Federal Action, such as holding discussions with an agency regarding product qualities or adaptation of products for particular uses that occur prior to the issuance of a solicitation.24 The Act also does not prohibit using appropriated funds to pay persons, including consultants, for “professional and technical services” provided directly in connection with the preparation, submission or negotiation of any proposal for an award or for meeting requirements of the law pertaining to the award. Such services are limited to advice and analysis directly applying a professional or technical discipline to the proposal effort. If the services involve lobbying, then their costs are not allowable.25


Solicitations for contracts expected to exceed $100,000 include FAR provisions stating that, by signing or submitting its offer, the contractor is certifying to the best of its knowledge and belief that no federal appropriated funds have been paid or will be paid for covered lobbying activities in connection with the contract.26 Prime contractors and subcontractors must obtain this certification from subcontractors that will receive subcontracts expected to exceed $100,000.27 Moreover, all prime government contracts expected to exceed this amount include FAR provisions requiring compliance with the Byrd Amendment Rules during the term of the contract, including the rules prohibiting use of federal funds to influence the extension or other modification of the contract.28 These provisions must be flowed down to subcontracts exceeding $100,000 at all tiers.29


To meet the requirement to demonstrate that they have sufficient funds, other than appropriated federal funds, to cover the costs of their lobbying activities, contractors must identify and segregate these costs. Moreover, the costs must be excluded from contractor invoices under cost reimbursable type contracts or other claims for payment based on costs incurred. Such costs must also be excluded from cost estimates used to develop or support proposed prices for fixed price contracts. In other words, the costs of covered lobbying activities must be treated as “unallowable costs” under government contracts. If they are not treated in this manner, then federal funds will, in fact, be used to pay for the costs in violation of the Byrd Amendment Rules. Failure to comply with the Byrd Amendment Rules can lead to significant legal liability. Under the Act, civil penalties between $10,000 and $100,000 for each violation may be imposed. Moreover, contractors who are not compliant with the Byrd Amendment Rules risk significant liability under the False Statements and False Claims Acts simply by submitting their proposals because each such submission carries with it a certification of compliance with the rules.30

The principles in FAR Part 31 govern the allowability (i.e., recoverability) of costs under cost reimbursable type contracts.31 They are also used in the pricing of fixed price contracts when (a) the procurement involves government analysis of estimated costs submitted by the contractor in support of the reasonableness of the fixed price or (b) a contract clause requires the determination or negotiation of costs (e.g., when the fixed price is re-determined during or after performance based on costs incurred).32 When a cost is unallowable under FAR Part 31, its “directly associated” costs are also unallowable. In this context, a directly associated cost is any cost that a contractor incurs solely as a result of incurring an unallowable cost, and that would not have been incurred had the unallowable cost not been incurred.33

The Cost Principles make unallowable the costs of lobbying concerning the introduction, enactment or modification of Federal, state, or local legislation on any topic, including taxes, environmental regulations and particular government contract awards.34 Under the Cost Principles, the costs of legislative liaison activities, including attendance at legislative sessions or committee hearings, gathering information regarding legislation, and analyzing the effect of legislation, when carried on in preparation for or support of lobbying for legislation, are also unallowable.35 There are exceptions to the Cost Principles on lobbying costs. In particular, costs of the following activities are allowable (if they are reasonable):

• • providing certain technical and factual presentations on topics directly related to the performance of a contract to the Congress or a state legislature in response to a documented request;
  • state/local legislative lobbying to directly reduce contract costs or to avoid material impairment of the contractor’s ability to perform the contract; and
  • any activity specifically authorized by statute to be undertaken with funds from the contract.³⁶

As with the Byrd Amendment Rules, failure to comply with the Cost Principles can lead to significant legal liability. Inclusion of unallowable costs in proposals or claims can result in the imposition of administrative penalties under the FAR.37 Moreover, contractors who are not compliant with the Cost Principles risk significant liability under the False Statements and False Claims Acts simply by submitting their proposals or invoices because each such submission might be considered to include a material falsity- i.e., a claim of entitlement to payment of amounts that are not recoverable under the regulations.38

Some lobbying costs that are unallowable under the Byrd Amendment Rules, such as lobbying for earmarks in legislation, are also unallowable under the Cost Principles on lobbying costs. In addition, some lobbying costs that are unallowable under the Byrd Amendment Rules, such as the costs of lobbying that strictly concerns executive branch decision making on contracting matters, are not made unallowable by the Cost Principles. Furthermore, some lobbying costs that are not made unallowable by the Byrd Amendment Rules, such as lobbying concerning the tax laws, are made unallowable by the Cost Principles. Compliance with both sets of rules requires design and implementation of a comprehensive internal control system that identifies and segregates unallowable lobbying costs and directly associated costs. A key task in implementing such a system is the inclusion in all lobbying and consulting agreements of provisions requiring the maintenance of adequate records concerning the amount of effort spent on unallowable lobbying activities in each month that the lobbyist or consultant does any work for the company, in relation to the total effort spent by the lobbyist or consultant on all company activities in that month. It also requires training and educating of employees to identify and separately record the time they spend on lobbying activities covered by the rules.

Through its stepped up auditing activities, including the recently issued Audit Alert, DCAA is shining a spotlight on contractors’ lobbying costs. Contractors should prepare themselves to withstand DCAA audits of these by designing and implementing robust internal control systems that identify and segregate unallowable lobbying costs and directly associated costs.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

1 U.S. Government Accountability Office, DCAA Audits: Allegations That Certain Audits at Three Locations Did Not Meet Professional Standards Were Substantiated, GAO-08-857 (2008).

2 Letter from U.S. Senator Claire McCaskill to Defense Secretary Robert Gates (July 23, 2008)(available at www.mccaskill.senate.gov).

3 Letter from U.S. Senator Claire McCaskill to DCAA Director April Stephenson (July 23, 2008)(available at www.mccaskill.senate.gov).

4 Letter from DCAA Senior Auditor “Dan Hawkins” to U.S. Senator Claire McCaskill (July 25, 2008)(on file with author)(it appears that the name “Dan Hawkins” is a nom de plume adopted by the auditor to protect himself from retaliation).

5 Id.

6 Id.

7 U.S. Department of Defense, Office of the Assistant Secretary of Defense (Public Affairs), News Release (July 25, 2008)(available at www.defenselink.mil).

8 Public Law No. 110-252.

9 72 Fed. Reg. 64019 (Nov. 14, 2007) amended 73 Fed. Reg. 28407 (May 16, 2008).

10 See comments on FAR Case 2007-06 at www.regulations.gov.

11 Letter from Colleen Preston, Executive Vice President, Policy and Operations, Professional Services Council, to Laurieann Duarte, Regulatory Secretariat, General Services Administration (July 15, 2008) available at www.regulations.gov.

12 This adage has been attributed to German Chancellor Otto Von Bismark (1815-1898). See e.g., Alan Rosenthal, “The Legislature as Sausage Factory: It’s About Time We Examine This Metaphor,” American Political Science Association Legislative Studies Section Newsletter, Vol. 25 No. 1 (Jan. 2002) at www.apsanet.org/~lss/Newsletter/Jan02/sausage.htm.

13 See e.g., Marilyn W. Thompson and Ron Nixon, “Even Cut 50 Percent, Earmarks Clog Military Bill,” The New York Times, (Nov. 4, 2007) at http://www.nytimes.com/2007/11/04/washington/04earmarks.html ; Citizens Against Government Waste, 2008 Congressional Pig Book Summary at www.cagw.org; John McCain 2008, “Ethics Reform” at www.johnmccain.com/Informing/issues/; Obama’08, “Shine the Light on Washington Lobbying” at http://www.barackobama.com/issues/ethics/.

14 See Office of Management and Budget, “OMB Guidance to Agencies on Definition of Earmarks” at http://earmarks.omb.gov/earmarks_definition.html.

15 Eric Egland, “Earmark Folly: Damaging U.S. National Security,” The Washington Times (July 2, 2008) at www.washingtontimes.com/news/2008/jul/02/earmark-folly.

16 See e.g., Lobbying Disclosure Act as amended by the Honest Leadership and Open Government Act of 2007, 2 U.S.C. § 1601 et. seq. (Cornell Univ. Law School, Legal Information Institution through 2008). Examination of these rules in beyond the scope of this article.

17 See e.g., 31 USC § 1352; 48 C.F.R. § 52.203-12 (2007); 48 C.F.R. § 31.205-22.

18 31 USC §1352; 48 C.F.R. § 52.203-12. These rules also mandate that contractors make certain disclosures of lobbying contacts. The disclosure aspects of the Byrd Amendment Rules are beyond the scope of this article.

19 48 C.F.R. § 31.205-22.

20 31 U.S.C. § 1352(a)(1); 48 C.F.R. § 52.203-12(b).

21 48 C.F.R. § 52.203-12(b)(1).

22 Id. at § 52.203-12(b)(2).

23 Id. at § 52.203-12(a) and (b).

24 Id. at § 52.203-12(c)(1).

25 Id. at § 52.203-12(c)(2).

26 48 C.F.R. § 3.808(a); 48 C.F.R. § 52.203-11; 48 C.F.R. § 52.212-3(e).

27 48 C.F.R § 52.203-12(g).

28 48 C.F.R. § 3.808(b); 48 C.F.R § 52.203-12; 48 C.F.R § 52.212-4(r).

29 48 C.F.R § 52.203-12(g). FAR § 52.203-12 is not listed in FAR § 52.244-6, Subcontracts for Commercial Items, or FAR § 52.212-5(e), Terms and Conditions Required to Implement Statutes or Executive Orders-Commercial Items, as a mandatory flow down to subcontracts for “commercial items”. However, it should nonetheless be flowed down to all subcontracts exceeding $100,000 because the statute applies to all such subcontracts.

30 18 U.S.C. § 287; 18 U.S.C. § 1001; 31 U.S.C § 3729 et. seq.

31 48 C.F.R. § 31.103(b)(1).

32 48 C.F.R. § 31.102.

33 48 C.F.R § 31.201-6.

34 48 C.F.R § 31.205-22(a)(3). FAR § 31.205-22(a)(1), (2), (4) and (6) also make unallowable the costs of certain political activities and attempts to influence Executive Branch employees to act regarding a contract on any basis other than the merits. Discussion of these costs is beyond the scope of this article.

35 Id. at § 31.205-22(a)(5). When a contractor seeks reimbursement for indirect costs, total unallowable lobbying costs must be separately identified in the indirect cost rate proposal and thereafter treated as other unallowable activity costs. Id. at § 31.205-22(c).

36Id. at § 31.205-22(b). To be allowable, these costs must meet the general allowability criteria in FAR § 31.201-2.

37 FAR § 52.215-10, Price Reduction for Defective Cost or Pricing Data and FAR § 52.242-3, Penalties for Unallowable Costs.

38 18 U.S.C. § 287; 18 U.S.C. § 1001; 31 U.S.C § 3729 et. seq.

39 Memorandum from Assistant Director of Policy and Plans, Defense Contract Audit Agency, to Regional Directors and Director, Field Detachment (April 24, 2008) (available at www.dcaa.mil).

40 Whether DCAA has contractual authority to interview contractor personnel has been the subject of considerable debate. Discussion of this issue is beyond the scope of this article.

41Memorandum from Assistant Director of Policy and Plans, supra note 29.

Government contractors, already challenged by a bewildering array of procurement laws and regulations, will soon face yet another set of burdensome regulations. These new rules will require contractors to make dramatic changes in their employment eligibility verification processes. President Bush fired the opening shot in the rulemaking process on June 6, 2008, when he issued Executive Order 13645 (the “Executive Order”)1. That order requires executive agencies to include in their contracts a requirement that contractors use a Department of Homeland Security (“DHS”) designated system to verify whether certain employees meet the eligibility requirements of the Immigration and Naturalization Act (“INA”)2. On June 9, 2008, DHS designated its controversial “E-Verify” system as the system that the departments and agencies must impose on government contractors. Then, on June 12, 2008, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council (the “Councils”) proposed changes to the Federal Acquisition Regulation (“FAR”) that would implement the Executive Order and DHS’ instruction (the “Proposed Rule”)3.

 The Proposed Rule requires Contracting Officers to include a new FAR clause governing employment eligibility verification in all new solicitations and contracts except those that:

• • are for commercially available-off-the shelf (“COTS”) items and certain minor modifications of COTS items;
  • are under the micro-purchase threshold (typically $3,000); or
  • do not include any work that will be performed in the United States.

In the preamble to the Proposed Rule, the Councils stated that agencies should also amend certain existing indefinite-delivery indefinite quantity contracts (“IDIQ”) to include the new clause for future orders. In particular, IDIQ contracts would be amended if the remaining period of performance extends for at least six months after the effective date of the final rule and the agency expects the remaining amount of work or number of orders to be substantial.

The proposed new FAR clause requires the use of E-Verify to verify the employment eligibility of:

• • all persons hired after November 6, 1986 and assigned by the contractor to “directly” perform work within the United States on the contract (“Assigned Employees”); AND
  • all persons hired during the contract term by the contractor to perform ANY employment duties within the United States following the date of the contractor’s enrollment in E-Verify (“New Hires”).

Prime Contractors must flow the clause down to all subcontracts for services or construction that exceed $3,000 and include work performed in the United States. The Proposed Rule does not require flow down of the clause to subcontracts for materials.

The E-Verify program is an internet-based system operated by DHS’ U.S. Citizenship and Immigration Service (“USCIS”) in partnership with the Social Security Administration (“SSA”). Contractors will input pertinent information about an employee in the E-Verify database and receive back either a confirmation or a “non-confirmation” of the employee’s eligibility to work. To protect the rights of the employee, contractors must send certain notices to employees who are not confirmed and afford them the opportunity to contact USCIS and SSA to correct their databases. The Proposed Rule likely will create headaches and increased costs for contractors who will have to develop, implement and staff the new processes required to submit verification queries and administer the non-confirmation process not only for Assigned Employees but also for all New Hires during the contract term. Of course, contractors will include the costs of compliance with the rule in the prices proposed for new contracts, thereby resulting in an increase in the prices of government contracts.

Large companies with a small number of government contracts will face added challenges. The “hassle factor” of compliance with E-Verify requirements in conjunction with numerous other government contracts compliance requirements may lead these companies to conclude that doing business with the government is not worth the trouble, thereby depriving the government of valuable expertise and/or products. For these companies, there is an “opportunity cost” of spending time on government contracts compliance activities. That cost is equal to the value of other, more profitable activities that could not be undertaken due to the requirements. Hopefully, the regulation writers will address this problem in drafting the final rule. One solution would be to define “contractor” to include only the business unit responsible for the performance of the contract.

Of course, the costs of compliance will be greater if the E-Verify database is not accurate and contractors have to deal with the paperwork and employee complaints associated with numerous false non-confirmations. Importantly, a study prepared for USCIS last fall found that the database was “not sufficiently up to date” at that point to meet current legal requirements for accurate verification, especially for naturalized citizens.4 Moreover, immigrant rights groups have expressed concern that false non-confirmations will threaten the livelihood of lawfully present immigrants who may be wrongfully dismissed from or refused employment.5 Contractors will need to account for the possibility of the extra work associated with database problems when pricing compliance with the final rule.

Under the Proposed Rule, contractors must enroll in the program within 30 calendar days of contract award and comply with all program requirements. In the enrollment process, the contractor must enter into a Memorandum of Understanding (“MOU”) with DHS and SSA that requires the contractor to maintain legal hiring procedures, take training on E-Verify and ensure that no employee is unfairly discriminated against as a result of the contractor’s use of the program. The Proposed Rule requires contractors to initiate verification queries to E-Verify for Assigned Employees within 30 days after enrollment. Contractors must initiate queries for Assigned Employees who are assigned after the enrollment date within three business days of the assignment to the contract or 30 days of award, whichever is greater. Contractors must initiate queries for New Hires within three business days of the date of employment.

In accordance with current law, contractors will still complete an Employment Eligibility Verification Form (Form I-9) for each newly hired employee. Following completion of the Form I-9, the contractor will enter the worker’s personal and employment eligibility information into the E-Verify website. That website then checks the information against information contained in SSA and USCIS databases. The SSA database first verifies that the name, social security number and date of birth of the employee are correct and, if the employee has stated that he or she is a U.S. citizen, confirms whether this is in fact the case through its databases. If the employee is a U.S. citizen, SSA’s database will establish that the employee is employment-eligible. USCIS also verifies through database checks that any non-U.S. citizen employee is in an employment-authorized immigration status.

If the information provided by the worker matches the information in the SSA and USCIS records, no further action generally is necessary, and the contractor may continue to employ the worker. If SSA cannot verify the information presented by the worker, the employer will receive an “SSA Tentative Non-confirmation” notice. Similarly, if USCIS cannot verify the information presented by the worker, the employer will receive a “DHS Tentative Non-confirmation” notice. Contractors may receive a tentative non-confirmation notice for a variety of reasons, including inaccurate entry of information into the E-Verify Web site, name changes, or changes in immigration status that are not reflected in the database. If the individual’s information does not match the SSA or USCIS records, the contractor must provide the employee with a written notice, which is referred to as a “Notice to Employee of Tentative Non-confirmation.” The worker must then state on the notice whether he or she contests or chooses not to contest the tentative non-confirmation. The worker and the employer must sign the notice.

If the worker chooses to contest the tentative non-confirmation, the contractor is required to print a second notice, called a “Referral Letter,” which sets forth information about how to resolve the tentative non-confirmation, as well as the contact information for SSA or USCIS, depending on which agency was the source of the tentative non-confirmation. The worker then has eight Federal Government work days to visit an SSA office or call USCIS to try to resolve the discrepancy in the information. Under the E-Verify MOU, if the worker contests the tentative non-confirmation, the employer is prohibited from terminating or otherwise taking adverse action against the worker while he or she awaits a final resolution from the Federal Government agency. Failure to follow this rule could lead to wrongful dismissal lawsuits, e.g., on the grounds of national origin discrimination. If the worker fails to contest the tentative non-confirmation, or if SSA or USCIS was unable to resolve the discrepancy, the employer will receive a notice of final non-confirmation and the employee may be terminated.

As mentioned above, participation in E-Verify does not exempt the contractor from its responsibility under the INA to complete, retain, and make available for inspection Forms I-9 that relate to its employees, or from other requirements of applicable regulations or laws. However, the following special requirements arise due to the contractor’s participation in E-Verify:

• • identity documents used for verification purposes must have photos;
  • if a contractor obtains confirmation of the identity and employment eligibility of an individual in compliance with the terms and conditions of E-Verify, a rebuttable presumption is established that the contractor has not violated the INA in the hiring of the individual;
  • the contractor must notify DHS if it continues to employ any employee after receiving a final non-confirmation, and is subject to a civil money penalty between $500 and $1,000 for each failure to provide such notice;
  • if a contractor continues to employ an employee after receiving a final non-confirmation and that employee is subsequently found to be an unauthorized alien, the contractor is subject to a rebuttable presumption that it has knowingly employed an unauthorized alien in violation of the INA; and
  • no person or entity participating in E-Verify may be held civilly or criminally liable under any law for any action taken in good faith based on information provided through the confirmation system.

In conclusion, the Proposed Rule would add another layer of complex regulation to the already heavily regulated enterprise of government contracts. Implementation of the requirements will not be a trivial exercise. Indeed, the government’s own Regulatory Impact Analysis estimates the cost of implementation at over $550 million. Ultimately, the taxpayers will pay for the costs of this regulation when contractors include the cost of compliance into the prices of their contracts. While the enforcement of the immigration laws of the United States likely will improve6, federal procurement policy makers should prepare for the possibility that the rules will deter more companies from bringing needed products and services to the government marketplace. The question is whether the benefit of the regulation will outweigh these costs.

The Court of Federal Claims (“COFC”) and the Government Accountability Office (“GAO”) are at odds about a key rule governing the acquisition of foreign made supplies. The rule at issue is the “substantial transformation” test of the regulations implementing the Trade Agreements Act (“TAA”)7. Under these regulations, which apply to acquisitions valued at $194,000 or more, contractors must supply items “substantially transformed” in the U.S. or a “designated country” into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was transformed.8 By contrast, on lower dollar valued acquisitions, the Buy American Act (“BAA”)9 applies. The BAA, a depression-era statute, generally requires that agencies only procure “domestic end products”, subject to certain exceptions.10 Under the BAA, an item qualifies as a domestic end product if: (1) it is manufactured in the United States; and (2) the cost of its components manufactured in the United States exceeds 50 percent of the cost of all its components.11


In Klinge Corp., a disappointed bidder protested to GAO the award to Sea Box, Ltd. (“Sea Box”) of a contract for large field refrigeration systems (“LFRS”). The TAA applied to the procurement. The protester alleged that Sea Box’s LFRS was substantially transformed in the People’s Republic of China, which is not a designated country.12 The GAO denied the protest, finding that the agency reasonably determined that Sea Box’s LFRS was substantially transformed in the U.S. Importantly, the GAO credited as reasonable the agency’s analysis that the costs of the manufacturing processes performed in the U.S. “accounted for a significant portion of the overall cost of the LFRS.” This decision was consistent with prior GAO decisions upholding agency substantial transformation determinations that were based on cost data.13


After losing at GAO, the disappointed bidder filed a protest at the COFC. In a decision issued on June 10, 2008, the COFC sustained the protest.14 Among other errors, the court found that the agency “should have realized” that the “significant portion of the overall cost” test “was not drawn from the TAA.” Indeed, the court found that this test was “drawn from the BAA” and was the “wrong inquiry”. In lieu of a cost based test, the court simply used a logical analysis of whether the operations performed in the U.S. on the LFRS were “transformative”. The court found that the work on painting, installation of an interior light and associated transformers and bolting of skids that occurred in the U.S. was “simply finishing work” and not substantial transformation. The court found, further, that the fact that the unit did not meet all contract requirements when it arrived in the U.S. from China was not controlling. Thus, at the GAO finishing work that constitutes a significant portion of the overall cost of the end product may be transformative whereas at the COFC it may not be. These differing decisions are further evidence of the need for constant vigilance over compliance with the rules on acquisitions of foreign made supplies. To properly mitigate risks, contractors will need to ensure they comply with the stricter standard of the COFC.

The U.S. Court of Appeals for the Fifth Circuit recently decided a key issue in a suit arising out of an attack by Iraqi insurgents on a convoy of fuel trucks operated by Kellog Brown & Root, Inc. (“KBR”) under a U.S. government contract.15 Unfortunately, the attack injured and killed U.S. civilian truck drivers who were working for KBR. In the suit, the injured employees and survivors of the dead alleged that KBR was liable for damages under various state law theories.16 In particular, plaintiffs asserted fraud based claims that the company used intentionally misleading and false advertisements and recruiting materials to induce the plaintiffs to accept employment and relocate to Iraq. The plaintiffs also alleged intentional infliction of emotional distress, negligence and gross negligence. Plaintiffs alleged further that, as a result of these torts, they suffered damages. The issue decided by the Fifth Circuit was whether the “political question” doctrine required dismissal of the suit.

Under the “political question” doctrine, “questions, in their nature political, or which are, by the constitution and laws, submitted to the executive” may not be decided by the courts.17 One of the key functions of the political question doctrine is to preclude judicial review of the Executive’s decisions concerning the conduct of war.18 The doctrine is based on the judiciary’s respect for the unique competence of the Executive branch to make such decisions and the recognition that the courts are incompetent to second guess them. Most importantly, the political question doctrine upholds the separation of powers design of the federal government by preventing judicial intrusions into the powers of the Executive and Legislature to wage war. At the district court, KBR’s excellent lawyers argued that judicial review of KBR’s decisions would necessarily involve questioning the Army’s decisions concerning the information that would be provided to KBR and the force levels used to protect the convoys. Moreover, defendants argued, the courts would have to determine whether the military personnel assigned to protect the convoys performed properly. The district court agreed that these are political questions and dismissed the case.19 Plaintiffs appealed to the Fifth Circuit.

The Fifth Circuit reversed and remanded the case to the district court, finding that the court “will not inevitably be drawn into a reconsideration of military decisions or be forced to announce its opposition to an Executive or Congressional policy”.20 In making this decision, the court relied on a theory of tort law that permits recovery even if another actor or cause intervenes to be the direct cause of the damages. The court found that, under this theory, plaintiffs may be able to recover against KBR even if the insurgent attack and inadequate Army protection are found to be the direct causes of their damages. Plaintiffs would recover if they proved that KBR misrepresentations and/or negligence were the “cause in fact” of the damages – i.e., a substantial factor in bringing about the injury and without which no harm would have been incurred. The court held that, under this approach, it is possible that the case could be decided by examining KBR’s actions and NOT the actions of the Army. The court recognized, however, that further factual development, especially on the negligence claims, may implicate the political question doctrine.

War related liability suits against government contractors will be a part of the landscape of government contracts law for many years to come. Contractors involved in supporting the war and their attorneys should stay abreast of developments in these cases.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

1 73 Fed. Reg. 33285 (June 11, 2008).

2 8 U.S.C. § 1324a.

3 73 Fed. Reg. 33374 (June 12, 2008).

4 Findings of the Web Basic Pilot Evaluation (Westat, Sep. 2007), www.uscis.gov/files/article/WebBasicPilotRprtSept2007.pdf, at xxi.

5 See e.g., How Errors in Basic Pilot/E-verify Databases Impact U.S. Citizens and Lawfully Present Immigrants, National Immigration Law Center, www.nilc.org.

6 Well before issuing the Proposed Rule, the government took steps to require personal identity verification for contractor personnel with access to federal installations and information systems. See FAR 52.204-9, Personal Identity Verification of Contractor Personnel. Therefore, the main benefit of the new employment eligibility verification rules will be improved enforcement of the immigration laws of the United States.

7 19 U.S.C. §§ 2501 et.seq.

8 FAR § 25.1101(c)(1) and § 52.225-5; DFARS § 225.1101 and §252.225-7021.

9 41 U.S.C. § 10a to 10d.

10 FAR § 25.102. The main exceptions are for items that: (1) are for use outside the U.S.; (2) are unreasonable in cost; (3) qualify as information technology “commercial items” under FAR § 2.101 and (4) are not made in sufficient and reasonably available commercial quantities of satisfactory quality. The agency head can also issue “public interest” exemptions under certain circumstances. FAR 25.103.

11 FAR 25.101(b).

12 Klinge Corp., B-309930.2, 2008 WL 2264491 (February 13, 2008).

13 See e.g., Pacific Lock Co., B-309982, 2007 CPD 191 (October 25, 2007).

14 Klinge Corp. v. United States, —Fed. Cl.—, 2008 WL 2461487, June 10, 2008 (No. 08-134C).

15 Lane ex. rel. Lane v. Halliburton, —F.3d—. 2008 WL 2191200, (5th Cir.) (May 28, 2008)

16 Plaintiffs also asserted federal law theories but they were not at issue in the decision.

17 Marbury v. Madison, 5 U.S. 137, 170 (1803).

18 Lane, supra.

19 Fisher v. Halliburton, 454 F.Supp.2d 637, 639-45 (S.D.Tex.2006).

20 Lane, supra..

As you know, selling to the U.S. government, either directly or through another company, presents great opportunities and challenges. The opportunities result from the large size and relative stability of federal procurement spending. In 2007, the government spent $430.1 billion on contracts for goods and services.>1 This amount exceeded the entire gross domestic product of 190 nations, including Venezuela, Switzerland, Taiwan and Austria!2 Moreover, due to the demands of the global war on terror and numerous domestic needs, it is likely that federal procurement spending will continue to be high for the foreseeable future.

With these opportunities, though, come challenges. Managing a government contract is unlike any other contract management undertaking. Work under such a contract is governed by numerous complex federal statutes, regulations and contract clauses that do not apply in commercial contracts. To take just one example of many, under the civil False Claims Act (FCA), representations made to the government in “reckless disregard” or “deliberate ignorance” of the truth are considered procurement fraud.3 Under this statute, acts that would be treated as accidents or oversights when dealing with a commercial customer can unexpectedly trigger investigations, allegations, triple damages and penalties.

The civil FCA was enacted to combat fraud committed by government contractors against the Union Army during the Civil War. Congressional hearings held during the war had “revealed instances of the same horses being sold twice to the army, sand being substituted for gunpowder, and crates full of sawdust being shipped to the front lines labeled as muskets.”4,/ Heightened congressional scrutiny and an increase in procurement fraud investigations and prosecutions also followed increased defense spending to support subsequent wars. The current increase in defense and homeland security spending similarly is focusing attention on how procurement dollars are spent.

Unfortunately in the current climate, it is very easy to get into trouble with the government for making representations that are less than accurate. Therefore, contractors should assume that every representation they make about their government work, whether it is in a proposal, on a time sheet, in a progress report or otherwise, can or will become a representation to the government in the normal course of business. To mitigate the legal risks of doing business with the government, contractors should invest in the development of effective compliance systems that will detect and deter non-compliant conduct that could lead to the financial ruin of the company. Indeed, investment in such systems is critical to a company’s ability to survive and thrive in today’s government marketplace.

The Federal Acquisition Regulation (FAR), which governs the formation and performance of executive agency contracts, has important new provisions concerning contractor compliance and ethics programs. These provisions, which were effective on December 24, 2007, mandate the inclusion of a new contract clause in contracts that meet the following criteria:

• • the product or service provided by the contractor does not meet the definition of a “commercial item” set forth in FAR 2.101
  • the expected value is $5,000,000 or more
  • the performance period is 120 days or more
  • any part of the performance will take place in the United States.⁵

The clause, FAR § 52.203-13, Contractor Code of Business Ethics and Conduct, requires contractors to produce within 30 days of contract award a Code of Ethics and Business Conduct (“Code”) and to distribute it to all employees engaged in the performance of the contract. In addition, such contractors (if they are other than small businesses) must, within 90 days of contract award, conduct business ethics and compliance program training and establish and maintain internal controls to prevent and detect improper conduct in connection with government contracts. The Contracting Officer may extend the deadlines for taking these actions.

The internal control system must “facilitate timely discovery of improper conduct in connection with Government contracts; and ensure corrective measures are promptly instituted and carried out.” The clause states, further, that internal control systems should provide for:

• • periodic reviews of company business practices, procedures, policies, and internal controls for compliance with the Code and the unique requirements of Government contracting
  • a hotline or other internal reporting mechanism, by which employees may report suspected instances of improper conduct
  • guidance that encourage employees to make hotline reports
  • internal and/or external audits of compliance with government contracts requirements, as appropriate
  • disciplinary action for improper conduct.

In the midst of the daily challenges associated with the dynamic and complex business of government contracting, it is easy to lose sight of the big picture. It may seem that we are running in a “gerbil wheel” of endless meetings, phone calls, paperwork and crisis management and/or that our time is consumed with satisfying powerful people. However, our work as government contracts lawyers and managers is, in fact, an enterprise –i.e., a “systematic, purposeful activity.”7 The late Lon L. Fuller, professor of general jurisprudence at the Harvard Law School, defined law as the “enterprise of subjecting human conduct to the governance of rules.” In his view, law is an activity and a legal system is “the product of a sustained and purposive effort.”8 Applying Professor Fuller’s concept, we can see that the broader purpose of our work is to subject the conduct of our clients to the governance of the government contracting rules. In doing so, we benefit our clients by keeping them out of trouble. We also benefit society as a whole by promoting integrity in public procurement.

We can also benefit society by working to improve government contracts law. Professor Fuller identified various “routes to disaster” in legal systems. One of these is “a failure to make rules understandable.”9 All of us can point to government contracts laws and regulations that are not models of clarity. The rules in Federal Acquisition Regulation (FAR) Part 25 governing the foreign content of supplies and in FAR Part 30 governing the administration of the cost accounting standards are good examples. To the extent we can, we should work towards simplification of these and other confusing regulatory regimes. However, until such changes are made, the burden is on us to obtain an understanding of these rules and to explain them to our clients in a way that makes sense to them and helps to shape their conduct to conform to the rules.

In the press of daily events, we are often unable to stop and consider basic questions, such as-what are we doing and why are we doing it? Of course, we are aware that we are working for the salutary purposes of caring for ourselves, our families and our communities. However, we are also serving other broad and important purposes, such as the enterprise of government contracts law.

Endnotes

The foregoing reflections were prepared for the general information of clients and other friends of The Law Office of Christopher C. Bouquet, PLLC. They are not meant as legal advice with respect to any specific matter and should not be acted upon without counsel from an attorney. If you have any questions or require any further information regarding these or other related matters, please contact us. This material is considered Attorney Advertising.

1 www.usaspending.gov

2 Central Intelligence Agency, The World Factbook, https://www.cia.gov/library/publications/the-world-factbook/geos/xx.html.

3 31 U.S.C. 3729 et. seq.

4 See 144 Cong. Rec. S7675-76 (daily ed. July 8, 1998) (statement of Sen. Grassley).

5 72 Fed. Reg. 65873 (November 23, 2007).

6 72 Fed. Reg. 64019 (Nov. 14, 2007) amended 73 Fed. Reg. 28407 (May 16, 2008).

7 Webster’s Collegiate Dictionary, p. 386 (10th ed.).

8 Lon L. Fuller, The Morality of Law, p. 106 (Yale University 1969).

9 Id., p. 39.