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outsidelegalguy

Can a Small Business Subcontractor Pass The Work to a Large Business

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A prime contract awarded to a small business on a small business set-aside procurement generally requires the small business prime to perform at least 50% of the work. That’s implemented by the Limitations on Subcontracting clause, 52.219-14. If the prime serves as a "front" for a large business and passes the vast bulk of the work through to the large business, it violates the clause and may find itself the subject of a criminal action based on fraud.

How does it work on the subcontract level? Here’s the scenario: A prime contractor has a small business subcontracting plan, requiring it to make a good faith effort to award some amount of subcontracts to various types of small businesses. Is there any problem (for the prime, the sub, or the sub’s sub) if the prime awards the subcontract to a small business, and that small business then passes the vast bulk of the work through to a large business? Put another way, is there anything wrong with a small business acting as a "front" for a large business with respect to the performance of a subcontract that the prime is awarding as part of satisfying its small business subcontracting plan. There’s no requirement for the prime to include the Limitations on Subcontracting clause in the subcontract – it’s not a required flowdown – so there’s no contract violation.

I’ve certainly heard stories about this happening. Although it’s always made me feel a bit uncomfortable, I’ve never been able to identify anything that makes it illegal, a contract violation, or otherwise improper. Can you?

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No, I can't. I came across this when I was a small business specialist and wondered why this practice wasn't somehow recognized in the regulations.

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I ask this question often in my world, as we supply Commercial of the shelf IT equipment. If a small business is supplying a Dell computer, how can they possible do 50% of the work? Dell makes it, ships it and warranties it, what exaclty does the small buisness do and what percentage is that given?

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Don:

Your last response intrigued me. Looking at 13 CFR 121.406 ©(4), example 2 seems to contradict your response to the Dell scenario:

"Example 2 to paragraph (B)(4). A procuring agency seeks to acquire computer hardware, as well as computer integration and maintenance services. If the procuring agency determines that the principal nature of the procurement is for supplies and classifies the procurement as a supply procurement, the nonmanufacturer rule applies to the computer hardware portion of the requirement. A firm seeking to qualify as a small business nonmanufacturer must supply the computer hardware manufactured by a small business. Because the requirement is classified as a supply contract, the contractor does not have to meet the performance of work requirement set forth in §125.6 for the services portion of the contract."

In lieu of that example, do you think that 52.219-14©(2) only apply to cases where the non-manufacturer rule is waived (below $25,000 or by class waiver), or in the case of kit assemblers?

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Velhammer,

No, I don't think that FAR 52.219-14( c )(2) only applies where the nonmanufacturer rule is waived or in the case of kit assemblers. It applies to supply contracts awarded to manufacturers. If the contractor were a nonmanufacturer, then ( c )(2) would not apply. However, the nonmanufacturer would still have to comply with FAR 52.219-6( d ) if the nonmanufacturer rule had not been waived.

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Note that the question I posed dealt with how much a small business subcontractor could further subcontract, not how much a small business prime could subcontract or, under the nonmanufacturer rule, to whom it could subcontract and/or obtain supplies.

And, the requirements of the non-manufacturer rule don't apply to small business subcontractors, see 13 CFR 121.406(e), so it doesn't limit from whom the subcontractor buys the supplies it provides under its subcontract.

(But, I've also never figured out how a small business prime delivering hardware under a set-aside or an 8(a) could provide a large businesses' equipment, unless the contracting officer characterized it as a "services" contract under which the contractor is also supplying equipment.)

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(But, I've also never figured out how a small business prime delivering hardware under a set-aside or an 8(a) could provide a large businesses' equipment, unless the contracting officer characterized it as a "services" contract under which the contractor is also supplying equipment.)

This could happen if the nonmanufacturer rule has been waived for the required items and the offeror is a nonmanufacturer.

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This could happen if the nonmanufacturer rule has been waived for the required items and the offeror is a nonmanufacturer.

Sure, but I don't think there are any class waivers covering computers & monitors, and it would seem quite a bit of work for the contracting officer to get an individual waiver prepared.

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To original inquiry: Notice also that the [Federal Funding Accountability and Transparency Act] FFATA requirement to report subcontracts only goes to first-tier subcontracts. So the practice is not even required to be disclosed.

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Outsidelegalguy: Sorry, I didn't mean to hijack the thread. I figured the initial question was answered with Don's response, as well as your own point about not having to flow down the limitation on subcontracting requirements. For what its worth, I too ran across this practice while doing SB subcontracting compliance reviews. We couldn't ding them on it because it didn't violate the regulations.

There are currently no class waivers for computers or monitors and I agree that it would be difficult to obtain an individual waiver. The Gov't may not want to buy a computer made in a garage, but I suspect they are probably plenty of folks out there who would claim to do it. So, in my view, unless the supply contract is less than $25K or the 8(a) is providing a product manufactured by a small business; the 8(a) shouldn't be supplying computer hardware.

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This could happen if the nonmanufacturer rule has been waived for the required items and the offeror is a nonmanufacturer. Sure, but I don't think there are any class waivers covering computers & monitors, and it would seem quite a bit of work for the contracting officer to get an individual waiver prepared.
It is not "quite a bit of work." The SBA website has a template class waiver form on it, and all the KO needs to do is fill it in and submit it. Its actually pretty simple, given that they give you a template form to work off of. They provide you with all of the information you need to provide in your waiver request, and it takes a maximum 15 days to process. Edited by dcarver

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An SBA OIG report (from July 2010) says that using the 8(a) program for 'pass through' items is an abuse of the 8(a) program. The report is available here: http://www.sba.gov/office-of-inspector-general/872/5203 Also, I believe that the final words under the final sentence under FAR 19.502-2© - which provides details of the non-manufacturer rule - is often overlooked (my emphasis added): "In both of these cases, the contracting officer’s determination in paragraph (B)(1) of this subsection or the decision not to set aside a procurement reserved for small business under paragraph (a) of this subsection will be based on the expectation of receiving offers from at least two responsible small businesses, including nonmanufacturers, offering the products of different concerns." If it's brand name, there's no competition, thus no set-aside.

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Back to the original question,

1) If providing a service, does 50% of the amount of the prime contract apply to the small business (prime contractor)?

2) If 52.219-14 is not flowed down to the subcontractor (small business to large business), is it implied?

3) Does the small business require consent?

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How does it work on the subcontract level? Here’s the scenario: A prime contractor has a small business subcontracting plan, requiring it to make a good faith effort to award some amount of subcontracts to various types of small businesses. Is there any problem (for the prime, the sub, or the sub’s sub) if the prime awards the subcontract to a small business, and that small business then passes the vast bulk of the work through to a large business? Put another way, is there anything wrong with a small business acting as a "front" for a large business with respect to the performance of a subcontract that the prime is awarding as part of satisfying its small business subcontracting plan. There’s no requirement for the prime to include the Limitations on Subcontracting clause in the subcontract – it’s not a required flowdown – so there’s no contract violation.

I’ve certainly heard stories about this happening. Although it’s always made me feel a bit uncomfortable, I’ve never been able to identify anything that makes it illegal, a contract violation, or otherwise improper. Can you?

Assuming there are no violations of 52.203-7 or other criminal actions involved, there are still some potential disincentives for the prime contractor:

  1. Each subcontractor adds profit and other costs that result in less performance per dollar for the prime’s customer.
  2. Each subcontractor, especially moving from large (prime), to small, and back to large, could add considerable performance risk to the prime.
  3. The prime may be required to obtain consent to subcontract, in which case the Government could request detailed support for the subcontractor costs. The Government could withhold consent to subcontract if they do not approve of the arrangement.
  4. The Government could withhold or withdraw approval for the prime’s purchasing system under FAR 44.305-3.
  5. Indirect costs and profit billed by the small business subcontractor on the lower-tier large business subcontractor costs could be considered excessive pass-through under 52.215-23.

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