On Dec. 3, 2018, the Department of Defense (DoD) issued Class Deviation 2019-O0003 – Limitations on Subcontracting for Small Business, which effectively implements the SBA’s Limitations on Subcontracting regulations for DoD procurements. A copy is available here. 

Class Deviation 2019-O0003 should not be a surprise to most small business contractors. In the 2013 National Defense Authorization Act (2013 NDAA), Congress authorized changes to the Small Business Administration’s (SBA) limitations on subcontracting rule. The SBA implemented regulatory changes based on the 2013 NDAA in 2016. Our Sept. 6, 2016 article explaining those changes can be viewed here. The changes created a disconnect between the SBA Regulations and the Federal Acquisition Regulation (FAR) and Defense Acquisition Regulation Supplement (DFARS). This class deviation squares the FAR and DFARS with the existing SBA regulations.

In previous regulatory iterations, the percentage of work that small business contractors could subcontract on contracts set aside for small businesses was limited to essentially 50% for supplies and services, 85% for general construction and 75% for specialty construction. These limitations have created a hardship for many small businesses. Through the 2013 NDAA, Congress allowed for a minor relaxation of the rule, so long as the small business prime contractor subcontracted to small businesses that are “similarly situated” (i.e., in the same size or socioeconomic category as the prime contractor). The class deviation includes the following temporary, formal definition to the FAR:

“Similarly situated entity” means a first-tier subcontractor, including an independent contractor, that has the same small business program status as that which qualified the prime contractor for the award and that is considered small for the NAICS code the prime contractor assigned to the subcontract the subcontractor will perform. An example of a similarly situated entity is a first-tier subcontractor that is a HUBZone small business concern for a HUBZone set-aside or sole source award under the HUBZone Program.

The class deviation also integrates the SBA’s regulatory requirements on the limitations on subcontracting and the nonmanufacturer rule, which provides clarity to small business prime contractors performing DoD contracts.¹ In the case of a contract for services, no more than 50% of the amount the small business prime is paid by the government can be subcontracted to companies that are not similarly situated. For general construction contracts, the amount is 85% and for specialty trade construction contracts, the amount is 75%. The cost of materials on these contracts is excluded and not considered to be subcontracted. In the case of a contract for supplies or products (other than from a nonmanufacturer of such supplies), the small business prime contractor may not pay more than 50% of the amount it is paid by the government, excluding the cost of materials, to companies that are not similarly situated. Small business prime contractors who do not manufacture the items they supply are subject to the nonmanufacturer rule.

The class deviation addressed the nonmanufacturer rule. For those contracts exceeding the simplified acquisition threshold, the small business prime contractor must: (1) provide end items manufactured by a small business in the U.S; (2) be primarily engaged in retail or wholesale trade and normally sell the type of item being supplied; and (3) take ownership or possession of the item with its personnel, equipment or facilities in a manner consistent with industry practice.

Finally, the class deviation clarifies that those small businesses who are in a joint venture may aggregate work performed by all members of the joint venture to reach the minimum percentage.

Class Deviation 2019-O0003 affects all agencies under the Department of Defense. It went into effect immediately upon issuance. There is also a proposed final rule to make these changes to the FAR and DFARS permanent. Comments on the rule are being accepted until Feb. 4, 2019, and more information is available here.

¹13 CFR 124.510, 13 CFR 125.6, 13 CFR 126.700