There's No I in Team! - Strategies for Maintaining and Managing a Diverse and Complex Federal Supply Chain in an Ever Changing Compliance Environment
In today’s complex world of federal procurement, many times the government’s desired “solution” cannot always be met by one contractor. Teaming, subcontracting and the utilization of contractors that make up the federal supply chain can become a necessity for a winning bid in response to a solicitation. Managing those relationships can be challenging but also critically important. The ultimate success or failure of contract performance likely will depend not only on the performance of a federal prime contractor, but also the performance of the entire team of subcontractors and other supply chain contractors. In this course, we will explore a wide range of federal supply chain issues including basic compliance issues related to the scope of subcontracting and flowdown obligations to more complex issues concerning Contractor Purchasing System Reviews (CPSRs) and ever-evolving cybersecurity requirements that can affect the entire supply chain. We will also suggest strategies for establishing and maintaining a fully compliant supply chain.
Eric Leonard: Welcome everyone to strategies for maintaining and managing diverse and complex federal supply chain in an ever-changing compliance environment. This presentation is brought to you by Quimby. My name is Eric Leonard, and I look forward to spending the next 60 minutes with you surveying and analyzing the ins and outs of federal subcontracting and supply chain management. This includes front-end analysis, such as whether a company is a subcontractor or not, and what if any federal prime contract clauses need to be flowed down to lower tier contractors, to strategies for monitoring lower tier contractor compliance during performance, and other related what I call hot topic issues.
We will also highlight some of the cutting edge challenges in this area, including new DOD cybersecurity requirements, nuances associated with the use of other transaction agreements, OTAs, and the recent efforts to exclude the use of certain foreign companies to support the performance of US government contracts. Selection of subcontractors, lower tiered contractors, suppliers, vendors, and the like, can really make or break whether performance under a federal contract is successful and profitable for a prime contractor. Perhaps even more importantly, whether the contract achieves the mission and delivers the product or service that the government bargain for through the award of the contract. From any large federal contracts, no one company can provide the entire solution sought in RFP, making it necessary to form a team to prepare a proposal.
How to form that team, how to select teammates, and on what basis, are all complex inquiries that require knowledge of the relevant laws and regulations governing subcontracting and teaming arrangements. In this presentation, we will seek to walk through that process and suggest strategies from the perspective of prime contractors and their lower tier counterparts on how to navigate successfully for all parties involved. As I noted earlier, we're going to start and talk a little bit about subcontracts 101. I want to start there because it's really critically important to ensure that all parties involved understand whether they are considered and being treated as a subcontractor or not for purposes of performance under a contract. And we'll walk through some examples of types of arrangements that typically would be subcontracts versus ones that likely don't rise to the level of subcontract relationship. And then we're going to spend some time talking about flow-down obligations.
Flow-down obligations can take many different forms, and we'll talk about the different ways flow-down clauses can appear in a contract, where they appear, where they come from, the sources of those obligations, and the scope of those obligations. And then I'll spend a little bit of time talking about mandatory versus recommended flow-downs. Certain clauses that are flowed down by prime contractors from their prime contract are required flow-downs. And scope of that required flow-down is going to depend on a number of factors, including the size of the contract, the type of subcontract, and others. But in addition to those required flow-downs, there are a whole set of non-mandatory or recommended flow-downs that I want to spend some time talking about. These are the type of flow-down clauses that, well, maybe not required by the letter of the law are critical for the prime contractor to flow down to their subcontractor to ensure that the subcontractor and prime contractor both can meet the performance requirements to the government.
I'll spend a little bit of time talking about, from my experience at least, the flow-down negotiation dynamics, some of the challenges and strategies, probably we'll highlight a few of my pet peeves when it comes to flow-down negotiations, because this can be a somewhat contentious debate. But nevertheless, it's critically important to understand the structure of that negotiation. And hopefully I can provide a few pointers from my experience on how to make it as successful and I guess least cumbersome as possible. And then we'll talk about some current developments and areas of emphasis for flow-down obligations for all contractors throughout the supply chain. Cybersecurity, banning of certain Russian and Chinese companies, these are all recent developments by America Act I'll talk about, is also another recent development where we see a lot of activity. And it's really important, I think, to stay on the forefront of this so that not only you ensure that you as, let's say, the higher tiered contractor are compliant, but that you're making sure that your lower tier contractors and suppliers and others also are compliant with these obligations.
So with that, let's get rolling. First, I want to take a minute or two just to describe the current contracting environment that contractors and subcontractors are facing. Federal procurement and the underlying policies driving the federal procurement process change over time, much like a pendulum. Heavy regulation swings to streamline procurement and everywhere in between. And as I'm sure you can expect, many outside forces and stakeholders can drive this process, Congress, executive branch, outside investigatory authorities. Just now we're seeing the [SIPA 000531] for pandemic response that's been stood up. A whole nother investigative authority that again can push the pendulum toward regulation as opposed to streamline procurement.
We're probably going in that direction now based on developments and based on the different initiatives we've seen at least advanced thus far in the current administration. But as we'll talk about, there are ways to manage that risk. Supply chain issues also have really started to receive attention from the highest levels of government. For instance, in February, 2021, President Biden issued executive order 14017 directing agencies to assess vulnerabilities, to strengthen the resilience of critical supply chains. And this follows in a line of different supply chain orders by America direction that came even from the prior administration, focusing on the critical nature of supply chains.
The assessment, in response to this February, 2021 order, was published in June, and it revealed a number of supply chain vulnerabilities in areas such as semiconductors, critical minerals, large capacity batteries, and critical medicines and pharmaceuticals. That assessment also proposed six new strategies to address these shortcomings and prevent supply chain disruptions. One of these suggestions was increased use of the Defense Production Act. Defense Production Act is a somewhat unique government power to prioritize production in a federal contract to support critical federal missions over any commercial production. We'll talk a little bit more about Defense Production Act and some of the regulations that follow from the Defense Production Act.
But let's just say that right now that the Defense Production Act can really significantly impact and arguably disrupt the orderly operation of your federal supply chain. We've seen increased use of this act, even outside the scope of this report, in the pandemic response and in other areas where for a long time Defense Production Act was solely used in a very narrow area of military missions. But with that expansion, I think there's now a need to understand better how is that going to impact my supply chain.
And that's not all. Just this July, 2021, a proposed rule was issued to gradually increase the domestic content threshold for the Buy American Act from the current requirement of 55% domestic components to 60% and ultimately to 75% total. This rule could have a huge impact on the supply chain, likely to the benefit of domestic producers and to the detriment of entities that rely on foreign suppliers or production to supply performance under federal contracts. And don't be surprised if we see more action from the White House in these areas. Domestic supply production, ensuring the viability of the domestic supply chain, are high priority items. And they're going to have a critical impact, not only on availability of suppliers but also costs.
Supply chain issues are our top priority. And we would expect to see the White House agencies and auditors to continue to police these issues. So what better time than now to walk through the basics of flow-down and supply chain management through this prism. We've done a number of presentations on federal government and how the federal government is a more unique customer, differentiating federal government from commercial suppliers. And we get asked all the time, "How can you best describe the current regulatory and enforcement environment for federal contractors that want to do business with the federal government?" And all I can say in a word is, it's complicated. Anyone that's worked with government contracts knows the federal government has a sovereign as unique customer, and in ways that are very different from a commercial customer.
Many times the scope and breadth of your federal business is going to dictate your scope of obligations. For instance, if you're a fixed price commercial item subcontractor, and we'll talk a little bit more about what commercial item means in this context, the obligations you're going to undertake are much less onerous than if you were a full cost accounting standards covered contractor doing cost reimbursement work. Under that second scenario, the level of oversight of the government, the level of reporting, the audit risk, all are going to be significantly higher, primarily because of the nature of the type of contract and the obligations that that type of contract will subject you to as a company. We have seen a significant amount of efforts underway to attract more primarily commercial entities, many times with innovative solutions to work with the federal government. And in fact, I think we've seen this even more so in response to the COVID-19 pandemic.
And before I leave the pandemic, I do want to mention the fact that in this environment, the COVID-19 pandemic continues to leave its mark on federal procurement and supply chain management for federal contractors and subcontractors in a variety of ways. Remote work is still the norm in many segments, but the return to work and the requirement to return to work in some cases has also brought about additional complicated questions. Just this past month, we had a vaccination testing directive issued from the administration that applies not only to federal employees, but also to onsite federal contractors. Any non-vaccinated federal employees or onsite contractors or ones that refuse to provide their vaccination status are going to have to go through a testing regime. Paid leave requests still linger for government contractors under what we call the CARES Act, section 3610, requests for reimbursement. These issues are going to continue to be around in the near term, and we expect audits will continue in relation to these requests for reimbursement by contractors and subcontractors for impacts of the federal of the pandemic.
The other area is has led to some significant contract awards and... well, OTAs, other transaction agreement awards, which we're going to talk about later, that were issued in 2020. These are large dollar value awards primarily to pharmaceutical companies and others providing medical supplies and the like. But the issuance of these awards as OTAs rather than contract awards raises some interesting issues that we'll talk about later, particularly when it comes to flow-down of obligations.
And finally, I've already mentioned the Defense Production Act and supply chain issues, but maintaining that steady and reliable process for critical supplies is something that is in the forefront and we expect will remain there. But for commercial companies that are trying to leverage their solutions to federal customers, this can be a real challenge in terms of trying to manage, if you have a federal and commercial mixed work stream. Sometimes for these companies it's almost impossible to separate the work being done by their customers. Take an assembly line that produces a product or performs a service for all customers, regardless of whether they're commercial or federal. All customers get the benefits of the efficiency in the process. But how can a company ensure that the portion of the work that's done for the federal customer complies in all respects with applicable statutes and regulations that apply to federal work? And this doesn't just go for the prime contractor, this may be a proprietary solution that a subcontractor has.
Sometimes it's very difficult to try to divide the federal from the commercial and still maintain the efficiencies of those processes. We see these challenges pop up in all different ways, whether it's compliance with federal labor standards clauses that may require higher wages and fringe benefits, the domestic source requirements that I mentioned earlier, timekeeping, recordkeeping, intellectual property issues, profit limitations. These are just a few of the possible issues. And so, when you're dealing with these types of situations, I think it's important to understand, right upfront, whether or not this is going to be a challenge to separate the federal from the commercial piece of the work, depending on the nature of the entity that you're going to engage in federal contract performance.
But one way some companies try to enter the federal marketplace as subcontractors... Entering as a subcontractor can limit their potential exposure and regulatory burdens. In this case, as a subcontractor, there's no direct privity with the federal government and potentially more negotiation latitude with a prime contractor as compared to a federal customer. So let's talk a little bit about some of these subcontractor considerations versus higher tier contractors. Let's say you're a prime contractor and you found an opportunity you want to bid on, but you need to assemble a team of companies in order to be able to meet all the requirements. So where do you start?
Well, obviously first you want to try to identify what entities exist that can meet the needs of the requirement you're trying to fill. Identification of subcontractors, the typical way to do that would be through market research. Factors to consider, performance track record, experience in this area. When we say experience in this area, I think that's twofold. One might be experienced in doing the type of work that you're looking to fulfill, but also probably experience in performing under a federal government contract. As you know, as I mentioned before, federal government contracting requires a number of different federal and regulatory requirements. Many times also requiring certain policies and procedures and other things to be in place. And if the contractor doesn't have that experience or a subcontractor doesn't have that experience, that's something you're going to want to know on the front-end. Past performance in similar projects, has it been good or bad? What's their price, their reputation in the marketplace? And are there any limitations, non-competes, or other things that may affect the ability of the subcontractor to provide that service?
The FAR 52.244-5 does have a section on competitive selection of subcontractors. And I think that's highly encouraged when there is a need and there's a number of entities that can fulfill the requirement that subcontract would be selected competitively. But once you start up a competitive selection as a prime contractor, you'd have to ensure that there are the appropriate guardrails around that selection so that it is done fair and on a level playing field. There also may be a requirement to get the government to consent to the subcontract. FAR 52.244-2 contains those requirements.
Next question is, if I've got a subcontractor in mind, how do I formalize that relationship? And the way a lot of folks do it in the federal contracting world is through a teaming agreement. And a teaming agreement will lay out the basic parameters of the relationship between the prime and the potential subcontractor. And generally has a clause that says, "If we are successful in our proposal, we will intend to award you a subcontract," and tries to lay out certain terms.
Now, in the general scheme of things, if a teaming agreement is entered into, and an award is made, and a subcontractor seeks an award, and a prime contractor and a subcontractor negotiate an award and they go forward and they do the performance, that's great. What happens though when the relationship falls apart? Let's say the contract is awarded, the prime contractor gets cold feet, decides not to award a subcontract to the subcontractor, is that teaming agreement enforceable as a contract? Well, depends. And this is really a state law issue. But I will note that there was a somewhat recent decision in Virginia, the Future Technologies, Inc. versus MicroHealth, LLC in Fairfax County Circuit Court, August 21st, 2020, that found that the teaming agreement was not enforceable. So again, this is not to say that all teaming agreements are unenforceable, but you need to carefully look at the state law and where the teaming agreement's made, and how they treat them, and the teaming agreement itself to see if it's definite enough to be enforced as a contract.
So I want to shift gears a little bit and just talk about the subcontract basics. Unfortunately, there's no uniform definition for the term subcontract in federal procurement. There are multiple sections of statutes and regulations that contain definitions of the term subcontract, FAR 19.701, FAR 44.101, 41 USC section 8701, 41 CFR section 60-1.3, is the OFCCP definition that has been interpreted rather broadly in terms of who's a subcontractor. We get this question all the time. Well, I don't know if they're really a subcontractor, they're more a vendor, or a supplier, or an independent contractor. Well, the bottom line is it doesn't really matter what you call them. If they meet the definition within, as a subcontractor, and have certain components to the relationship, they're going to be treated as one, whether you call them a vendor or supplier or sub.
Now, typically for there to be a subcontract, you need to have an arrangement, or an agreement, or contract between the parties. And the agreement must call for or require the subcontractor to furnish supplies or services that are required for, or necessary to the performance of the US government prime contract. And this is the key. I mean, make sure that it's not that they're providing just general services, meaning they're sending paper to you or providing security for your building, they're performing a service that's required for or necessary to the performance of the US government prime contract. And of course, this is a fact specific inquiry, highly dependent on the specific nature and requirements of the prime contract. So for instance, a paper supplier under a contract for consulting services probably is not going to be a subcontract, but if the contract was for the publishing of textbooks and they needed the paper to produce the textbooks, they probably would be a subcontractor. So again, it's a little tricky.
Now I will say this is the kind of thing you definitely want to figure out as quickly as possible in the procurement process, particularly given how much this inquiry is going to impact the obligations that need to be shared or flowed down to the subcontractor, what we're going to talk about next. From the subcontractor's perspective, all of these obligations, many of which create additional risk, should be factored into your proposed approach, whether it's your performance plan, or schedule, your pricing. And that's just something that's certainly not possible to do if you don't know whether you're going to be treated as a subcontractor or not. And trust me, we've had to deal with these situations, particularly on the pricing side where contractors realize after the fact that they're going to be subject to much more onerous pricing submission requirements, or audit requirements, or wages and fringe benefit requirements. And it's something they haven't factored into their pricing, and as a result, I have to absorb those costs without being reimbursed by the prime or the federal government.
So let's talk a little bit about flow-downs. Before I delve into some of the real nitty gritty of this, there's a few basic principles to keep in mind that drive the more complex process. There are certain prime contract clauses that are going to be in a federal prime contract that must be flowed down to lower tier contractors. Failure to flow down these clauses may be considered a breach of the prime contract, and put the prime contractor in jeopardy. The flow-down also may be necessary to meet certain prime contract requirements. So these are what I would call the recommended or maybe non-mandatory flow-downs. Prime contractors also may be liable for a subcontractor's failure to comply with the obligations in flow-down clauses in certain circumstances. And some of these clauses is the joint several liability for the prime is explicit.
These flow-down obligations too don't just end with the first tier. Many of them cascade through lower tiers of subcontracts. Some may be limited based on dollar value or type of subcontract, but you have to look and see, you can't just stop with the flow-down to the first tier. And then it's important to consider the impact of federal law, which governs many of these flow-downs because they come from the Federal Acquisition Regulation and other related statutory regulations versus state law, which state law generally governs your subcontract itself. And sometimes there can be a little bit of a conflict here in terms of the requirements and how they're treated. So it's important to make sure you articulate that in the subcontract.
Flow-down clauses which ones to include are usually determined by the nature of the prime contract and the nature of the specific closet issue. And a lot of these factors, I mentioned them earlier, but I'll go through them again because they're really important, that factors include the nature of the subcontract work, the place of performance, the prime contract and subcontract dollar value. So some of these clauses may only apply if the subcontractor is over $500,000. So I think it's important to know right on the front-end if a clause is going to be excluded just based on dollar value.
The contract type also can drive this, and that's both the prime contract type and subcontract type. Is a subcontract a fixed price, or is it a cost subcontract? Which is somewhat unusual, but certainly possible. That may drive the scope of flow-down clauses. And then also, is this a commercial item procurement and or subcontract? If the prime contract is a commercial item contract, and if so you'd see FAR part 52.212-5 as a likely clause. The scope of obligations at that federal prime contractor is going to undertake are much more narrow than a typical non-commercial item award. Likewise, if the subcontract is providing either commercial item or service, regardless of whether the prime contract is commercial item or not, if that subcontractor can demonstrate the status as a commercial item provider, FAR 52.244-6 contains a pretty limited list of the types of clauses that must be flowed down to a commercial item subcontractor. Now, keep in mind that doesn't mean other clauses can't be flowed down, it's just the list of mandatory clauses is much more narrow when you have a commercial item subcontract.
So let me shift gears a little bit and talk about the sources of the flow-down clauses. As you might expect, given the breadth of the products and services, the federal government procures as well as the diverse nature of federal agencies and their missions, the sources of flow-down clauses and related obligations are varied. And there are other factors. Think about classified procurements, for example, that can add a whole nother layer of complexity onto this process. But while the lack of a unified flow-down clause source does make this entire process a little bit cumbersome and labor-intensive, let's talk about some of the common sources of flow-down obligations.
Federal Acquisition Regulation, FAR, and FAR clauses that are contained in there in FAR subpart 52.2 are the primary sources of your flow-down clauses and obligations. To ascertain the clauses that the prime contractor is subject to, the best place to look is section I of the award of contract and or the solicitation will contain the primary list of flow-down clauses. But I will say, section I is not the exclusive part of a contract where you might find FAR clauses. You could find them in other sections, the stop-work clause, for instance, typically is not in section I and other places. But it's a good place to start in terms of looking at and understanding, okay, if you're the prime, "What is it I need to flow down out of here?" And if you're the sub, "Okay, here's the subset of clauses, which ones of these apply to me or which ones don't?"
And I'll say, if you are representing a subcontractor, if it's possible, get a copy of the prime contract, or at least the section I clauses. Although the reality is a prime contractor may not be willing to provide the document, so it's going to depend, but if you can't get a copy of the contract, at least look at the RFP to get a better roadmap to identify what the key prime contract clauses are that you should expect to be flowed down to you. But bottom line was there's no substitute for a careful review of all the flow-down tests in the different clauses themselves and the relevant FAR provisions that those FAR subpart clauses reference. As we'll talk about in a minute, the devil is in the details and a lot of these reviews to determine whether or not flow-down is required.
Another source are federal agency supplements, and depending on the particular agency you're dealing with, these supplements mirror the FAR in terms of structure, but they impose an agency specific unique requirements. And each agency is going to have their own specific additional flow-down obligations. And these supplement will potentially alter some of the FAR flow-down obligations. The most well-known supplement would be the DFARS, the DoD FAR supplement, but virtually all agencies have some supplement that is going to potentially impact your flow-down obligations. For instance, the Veterans Affairs has a particular clause in their personal identity verification of contractor personnel. And this is a VAAR 852.204-70B. And when you take a look at that clause, the flow-down obligation in there is pretty clear. It says, "The contractor shall insert this clause and all subcontracts, where the subcontractor's employees will require frequent and continuing access to VA facilities or information systems."
Okay. So it's, shall flow-down, shall insert this clause. Pretty straight forward, but the more you read... This is where I said the devil's in the details. Obviously, this clause only was going to apply to subcontractors where they require frequent and continuing access to VA facilities or information systems. So that's, again, a determination that needs to be made, and like-minds may differ what is frequent and continuing access when it comes to flow-down of this clause.
The other area to look at very carefully are the prime contract section H clauses and other what we call quasi standard clauses. Section H of the contract typically will have contract clauses that impose obligations on the prime contractor, and it could be a wide range of contract specific obligations. Sometimes these are FAR based or based on agency supplements, but other times they're just based on federal statutes or agency guidance, or other contract specific needs of the agency. Some of these types of clauses are performance location, site access restrictions, you'll sometimes see security or privacy clauses embedded in section H, also this is where you'll probably see sections on key personnel and employee issues, standards on background checks. Other things like that that may need to be certainly met, not just by prime contractor employees, but subcontractor employees that they're going to fill those roles.
And finally, the last place to look is really in the statement of work itself within the contract. You may find performance standards or things like labor category information for labor standards clauses that may apply, the Service Contract Act or Davis–Bacon Act. You may find these other obligations embedded in the statement of work. And you got to be careful because it's very easy sometimes to miss these, I call contract specific obligations. And same goes for attachments to the RFP or the contract. This is where you might find things like labor standard wage determinations, record keeping obligations, other things like that. I recently saw a contract that had, as a contract attachment, a supply chain resiliency plan, something that again is not necessarily the root of a FAR clause, but for a variety of reasons not uncommon to see these days.
So, how does this higher tier contractor determine what must or should be flowed down? And I think the key here is you need to have a negotiating team that's familiar with the FAR and the relevant agency guidance and supplements. That's number one. You need to look to as to what needs to be flowed down. Is it the exact clause or is it the substance of a clause? And you'll see clauses will differ in terms of what needs to be flowed down, like that VA clause I mentioned earlier. And who it needs to be flowed down to. It may be a subset of your subcontractors, not all of them. But bottom line is there's no substitute for reading the fine print of all these clauses and making sure that no matter what side of the table you are on for the negotiation, that you understand whether or not this is a required flow-down, and if it's not required, then identifying what are the reasonable or the reasons that the prime contractor would want to flow this down.
So mandatory flow-downs, I'm not going to spend a lot of time on these. I think most of these are pretty self-explanatory. Mandatory flow-downs are the prime contract clauses that specifically require inclusion of substantially all of their texts in the subcontracts entered into to support the prime contract. Usually the determination is pretty easy to make. For instance, FAR 52.22-26, the equal opportunity clause is pretty explicit. The contractor shall include the terms and conditions of this clause, and every subcontractor purchase order that is not exempted so that these terms and conditions will be binding upon each subcontractor or vendor. So again, pretty clear, of course it does call into question. There's an out there if you're exempted, but by and large, pretty clear, this needs to be flowed down. And certainly, if a subcontractor believes it doesn't apply, the burden should really be on them to prove that no, it doesn't apply, we're exempted, and here's why.
I mentioned it earlier, the July, 2021 proposed rule to raise the federal minimum wage to $15 an hour, I think I mentioned that in my intro, but that came out. And there's, again, a push to move the wage, starting in early 2022, up to $15 an hour. And I wanted to take a real world example, at least a recent example, on flow-down language. And so, I pulled that clause and the flow-down requirement on that. Again, it's pretty clear the contractor and any subcontractor shall include in any covered subcontracts, the executive order, minimum wage contract clause, and shall require as a condition of payment the subcontractor include the minimum wage clause in any lower tier subcontracts. So here, this one flows all the way down the chain. It's not just the first tier subcontract, it has to go down the lower tiers. Goes on to state, the prime contractor or any upper tier contractor shall be responsible for the compliance by any subcontractor or lower tier subcontractor with the executive order, minimum wage requirements, whether or not the contract clause was included in the subcontract.
So here, as I mentioned earlier, this is the... What happens if I don't flow it down? Well, the clause is pretty explicit that the prime contractor or any upper tier contractor is still going to be responsible for the compliance. If your lower tier subcontractor doesn't pay $15 an hour after the requirements in containing the contract, you're going to be responsible for paying that. But then again, there also is this language in there that... In the beginning, I said the contractor and subcontractor shall include in any covered subcontract, the executive order, minimum wage. Well, so there's a little bit of a caveat, right? What's a covered subcontract? Well, that's when you have to go back to the actual regulation itself to figure out what contracts and subcontracts is this particular clause apply to. And just as an aside, it's really service contract Davis-Bacon Act contract.
It's pretty broad, but nevertheless, still important to look at it. How do you determine? Are they covered or not? And what's the test for that? Well, that's something I think you've got to look at very closely. And all of this should just serve as a warning to be wary of what appears to be a simple clause. Sometimes these are simple, but like this one, the use of covered subcontract does make it a little bit more complicated in terms of trying to figure out do we fall within the scope of this July, 2021 proposed rule. So other mandatory flow-downs may require some judgment on the part of the prime contractor. For instance, FAR 52.203-16, preventing personal conflicts of interest, looking at it, you have to look at that clause carefully and see, is this something that's going to be applied to my particular subcontractors based on the nature of the work, based on the nature of what the subcontractor is going to do? It depends.
Other factors such as dollar values, nature of the subcontract work, type of subcontract, all are going to impact this inquiry. For instance, FAR 52.204-2, security requirements, the flow-down says that language in that clause has flowed down terms that "conform substantially to the language of this clause." So it doesn't have to be exact, but substantially conform to all subcontracts that require access to classified information. Okay, well it's all subcontracts, but again, caveat it because it's only those that have required access to classified information.
In addition, another clause I think that's important to look at is FAR 52.215-2, audit and records negotiation. This is the standard FAR audit clause that gives access either to the government or to a prime contractor theoretically to audit rights for a particular contract. And in this case, now, the flow-down language says, it goes, "As we flow-down to all subcontracts that exceed the simplified acquisition threshold, which is a very low dollar figure, that's in effect as of the date of the subcontract award, and that our cost reimbursement incentive, time and materials, labor hour, or price re-determinable, or any combination of these, and for which certified costs or pricing data are required, or that require the subcontractor to furnish reports as discussed in paragraph E of this clause..." I should say actually it's or for which certified costs or pricing data are required.
The reality is, when you look back at this clause, even though it is a broad clause, what it doesn't say in that list of types of contracts, it doesn't say anything about a fixed price contract, a subcontract. So if you have a fixed price subcontract, arguably this clause doesn't need to be flowed down. But if you have time and materials, or labor hours, or cost reimbursement subcontract, yes, then flow-down is required. I only mentioned this clause because I've seen this clause in a number of fixed price subcontracts. And I think, again, it's a function of maybe not reading the clause carefully enough or objecting in a way that you could to the flow-down of the clause by the prime contractor.
Now, I mentioned earlier some commercial item flow-downs, and I do want to talk for a second about them. This is a short FAR way to limit the flow-downs from a prime contract to a subcontract as long as the subcontractor can demonstrate that it meets the definition found in FAR 2.101 of a commercial item subcontract. At a high level, to be a commercial subcontractor, the product or service being provided must be sold or offered for sale in a commercial marketplace and be similar, meaning no more than minor remodify to what's being provided under the federal contract.
And you'll see in FAR 2.101, there's a pretty detailed definition of the types of products and services that can be qualified as commercial items. And importantly for services, it's services, what they call services of a type, offered competitively in substantial quantities in the commercial marketplace based on established catalog or market prices. So again, this is a definition that does have some flexibility in terms of the type of service. If it doesn't mirror up exactly with what you sell in the commercial marketplace, that's not determinative, and the same goes for if the product isn't necessarily exactly the same. And why am I focusing on this? Well, because if you can meet these definitions, this is something as a subcontractor you definitely want to take advantage of. I mean, the FAR makes it clear, there's a limited number of required flow-downs for commercial items subcontracts.
And even better, there is something called COTS, commercial off the shelf contracting. And if you're a COTS contractor, that's essentially you're providing basically the exact same thing that you are providing in the federal marketplace in the same form that you would be selling in the commercial marketplace. And if you can qualify as COTS, there's even a smaller subset of clauses that will apply to you. There are particular clauses that have exceptions that say, "This doesn't apply to a COTS subcontractor." So again, it's something you want to carefully look at and make sure you understand whether or not this is something I can take advantage of.
Let me shift gears a little bit to non-mandatory flow-downs. And non-mandatory flow-downs are prime contract clauses that should be flowed down in a subcontract to ensure that the subcontractor will provide adequate assistance or cooperation to enable the prime contractor to meet its contractual requirements with the government. Now, look, that's probably a statement that would have been wholly adopted by prime contractors and objected too by subcontractors in many cases. But the types of clauses that we're talking about here are ones that prime contractors will want to flow down to give themselves flexibility. For instance, the FAR disputes clause, the FAR changes clause, 52.243-1, the termination for convenience clause, 52.249-1.
So for instance, for the termination for convenience clause, if the government terminates the contract with the prime for convenience, the prime is going to want to have the ability to terminate its subcontracts for convenience. And so, well, again, not a required flow-down, it does make logical sense to include these at least as part of the negotiation. Another one that comes to mind, I mentioned it earlier, the domestic source restrictions. This is the Buy America Act and related clauses, FAR subpart 52.225. I want to talk about a real world case that reveals what can happen when a prime doesn't flow down the Buy America Act clause to one of its subcontractors. And remember, it's not a required flow-down. This falls into this category of what I would call recommended non-mandatory flow-downs. In the case Energy Labs Inc versus Edward Engineering Inc, Northern District, Illinois, June 2nd, 2015, the prime contractor failed to flow down the Buy America clause. And the government determined thereafter that the prime was not in compliance with the act. And this subjected the prime contractor to various consequences.
In the lawsuit, the prime contractor tried to argue that even though it didn't flow down the clause, the requirements should have still applied to the subcontractor based on something called the Christian doctrine, we'll talk about in a minute, and that the Buy America Act still applied, even though they failed to flow it down. Well, the district court rejected this argument and their prime contractors attempt to shift the responsibility for failure to flow down to the subcontractor. And instead it was the prime contractor that was left holding the bag and dealing with these consequences of noncompliance with the Buy America Act.
Now, if you recall earlier, I mentioned the fact that flow-down can come from a variety of sources. Some of these are readily apparent in the FAR, but others are not so much. And so, I want to go back to the Defense Production Act and something called the Defense Priorities and Allocations System program, DPAS, and the CFR sections addressing the DPAS section. Under DPAS, the government can issue what are called rated orders. And as I mentioned earlier, rated order can require a prime contractor and subcontractors, if it's flowed down, to prioritize production and support of a critical government mission. These rated orders are identifiable on their face by the inclusion of the letters DX and DO. And there's a whole set of regulations called the DPAS regulations found at 15 CFR 700. Okay. You're probably now asking, "Why is he spending time on this?" Well, let me tell you why.
So when you look at the FAR clause for DPAS, is FAR 52.211-15, it says nothing about flow-down of these obligations. And why does it? I'm not quite sure. But if you think about it, if you have enhanced production schedule that you need to meet as a prime, you probably need to impose that obligation on your subcontractor. So maybe not a mandatory flow-down, probably a recommended one. But wait, it's even more complicated. Look at the DPAS regulations, 15 CFR 700.15A, and that regulation states that, "A person must use rated orders with suppliers to obtain items needed to fill a rated order." So not your typical flow-down, but pretty clear that the intent behind this is that a prime contractor must use rated orders with their suppliers. And so, I think it's a good example of sometimes you have to look beyond the FAR clause and into the more detailed regulations, particularly for something like DPAS to make sure that even if the regulation is silent, at least the FAR regulation, there may be other guidance that will require flow-down.
Okay. The other thing that we've seen happen is, and this is all part of negotiation, of course, you can see tailoring of clauses. And I talked a little bit about clauses that require flow-down and substantially the form, and maybe not exactly the form. So tailoring things like, let's say, the termination of convenience clause, so that it only permits convenience termination if the prime contractor is terminated, that's one typical tailoring that we see. But there's also just a whole large number of what we call judgment call or non-mandatory flow-downs. And there's no way we can go through all these, but the key is, again, making sure you understand what is it. As the prime contractor, you need to flow down to your subs so that you can ensure that your performance to the federal government isn't jeopardized. And of course, negotiating leverage is going to factor into all of these things, in terms of how you can get the clause in or keep it out, depending on your position.
But let me shift gears to flow-down negotiation before I close out with some of the more common supply chain issues we're seeing. When it comes to flow-down negotiations, there's a very fine line between painful and painless. Trust me, I've been on both ends of that spectrum, but no two of these negotiations are alike. And I guess as a result, I've been able to compile a list, based on my experience, of flow-down negotiation, issue strategies, and tactics. And I will say, whenever given the chance to have another season government contract lawyer negotiating other side table, I'll take that a hundred out of a hundred times when it comes to flow-down negotiation, as opposed to someone unfamiliar with the FAR and government contract law.
But with that, let me talk... This is a little list of the pros and cons of flow-down strategies and tactics, as well as the ones that I find the most challenging to deal with. First one is copy and paste from the prime contract. This is a lazy man approach, where a prime contractor just copies and pastes all the prime contract clauses and slaps them into a subcontract. As I mentioned earlier, there's a variety of reasons why certain clauses may not apply. And this usually results in a long drawn out negotiation, particularly if the subcontractor is concerned with some of the clauses that the prime is trying to impose on them. It's a similar argument that I've seen used a lot is it's a standard clause. Prime contractor tells the subcontractor rep, "Well, this is a standard clause. It's in all our contracts." And my response is always, "That's fine." It doesn't mean it's a standard clause that I have to accept. It's not a clause I... Just because three other parties accepted, it doesn't mean I necessarily will.
And so, again, whenever I hear that, I cringe a little bit knowing it's going to be a long day of negotiating. The other thing that I've seen is this whole idea of, "We'll just substitute..." wherever it says contracting officer in the particular clause, we'll do a blanket substitution and substitute the word prime contractor for contracting officer. And all I'll say to that is, sometimes that can work, sometimes it may make sense, and sometimes it just doesn't make sense, because remember the contracting officer works for federal government, who's a sovereign, and just substituting the prime contractor for the contracting officer in certain types of clauses, this rates the meeting of the clause. And so I'd be careful of that.
The other is incorporation by reference versus full text and tailoring. I have seen situations where incorporation is just done through go to this website, or go to this other location where all the clauses are. And you got to be careful there because it's very easy to miss some of these small print references, the terms and conditions that are on separate websites or other purchase order documents. I just had a case where the prime tried to use this kind of message to flow down hundreds of clauses, even though the subcontractor was a commercial item subcontractor. And most of those clauses didn't apply. But I think the hope was they just didn't click on the link, if you will, that showed the incorporated clauses.
The other thing that you need to look at is possible conflict between some standard subcontract terms and conditions and flow-down clauses. I've had a number of situations where there's a standard master subcontract agreement, and some of the clauses in that agreement may conflict with the flow-down clauses. So I think you've got to look at those two documents carefully, and if a flow-down clause conflicts, I may require a tailoring of that or vice versa, or tailoring of the actual subcontract terms and conditions of it. For instance, on a warranty provision or some other clause that might just have a different timeline or different date or dollar value.
The other issue that you got to look at, this is this tricky one, is the FAR clause version date issue. And the FAR updates clauses periodically. And I've seen situations where there's an attempt to flow down an old version of the FAR clause. So a version from 1988, even though it was updated in 2015. And it gets really tricky because then you have to think, "Well, which one of these applies? The current version that we all understand and deal with, or the old version that somehow made its way into this contract?" So I think, carefully, if you see that issue, make sure you flag it.
A couple more, the self deletion strategy. This is my biggest pet peeve, where a private contractor will go to a sub and just say, "Well, look, if it doesn't apply, it doesn't apply, it just self deletes. Don't worry about it." Well, my response to that is, "If it self deletes then it shouldn't be in there." And I've had situations come up where contractors have agreed to this self deletion, and then later on because of some particular change in performance or expansion in scope, a clause that didn't apply all of a sudden applies, and they haven't placed it into their proposal and placed it into their solution. So the bottom line is this is all about clarity, completeness, and compromise, and making sure you go through and look at this very carefully to see what needs to be included and then what should be included.
But what happens if somebody rejects all your clauses? What do you do if you're the prime contractor and your subcontractor won't accept the clauses you propose? What do you do now? Well, I think first you need to ask yourself how many of these are mandatory clauses. And if they're rejecting mandatory clauses, what's the basis? Who's advising them? Are these risks I want to accept as a higher tier contractor? I mean, what's the federal agency going to say if they find out my subcontractor won't accept certain clauses? And yeah, at the end of the day, is this an entity I really want to do business with? One of the things, and I mentioned this earlier, I'm just going to touch on this very quickly, is there is this doctrine called the Christian doctrine that does... And we can do a whole course on that.
But basically what it says is that there are certain FAR clauses that express a significant or deeply ingrained strand of public procurement policies, such as the termination for convenience clause. Those can be read into prime contracts if admitted by the contracting officer, generally to protect the government. The good news I think on subcontract flow-down negotiation is that generally it's unlikely that a board or court would apply Christian to a subcontract. Well, it is something you have to deal with as a prime contractor negotiator the government not likely to apply in the context of a subcontract.
But nevertheless, I mean, if you do have a situation where a subcontractor refuses to accept flow-down clauses, you have to look at different options. Do you need to put in an identification provision and some kind of financial hold back or escrow to account for the risk? Do you need to renegotiate pricing if they're refusing to accept it? And in more rare cases, do you need to disclose this to the federal customer or potentially re-compete their requirement because you simply can't get the subcontractor to comply? I think this is all going to depend on your particular circumstance.
Okay. We're beginning to come to the close of our 60 minutes together, but I'd like to take some time to just highlight a few, what I like to call the hot areas of a flow-down supply chain management. We've talked a lot about flow-downs and hope that was helpful to you. But these are more substantive areas that each one of them have evolved over the last few years and moved, I would say, into the forefront of supply chain discussions. And I expect a lot of these are going to continue to be front and center on the radar screen to come. But instead of a top 10, I've got really a top six list here of flow-down issues that I just want to cover. One is a CPSRs. The second is counterfeit electronic parts. Third, labor standards EEO. Fourth, cybersecurity. The fifth is the 2019 NDAA section 889, ban on certain Chinese companies. And OTA, or other transaction issues.
There's no time like the present when it comes to staying abreast of these developments. And it's truly not an overstatement to say there's an indispensable need to carefully monitor all these developments and how they affect your supply chain. I mean, over the past few years, we've just seen these efforts to reign in the supply chain through executive orders, regulations, and the like. And I think this can best be seen in those areas of counterfeit electronic parts, cybersecurity, and the bands I'm going to talk about in a second. But you couple that with a renewed focus on protecting US companies from unfair foreign competition through strengthening the Buy America Act and spurring future enforcement efforts. And this creates this perfect storm of compliance challenges for the unwary.
Let me talk first about CPSRs, contract purchasing system reviews. CPSR is one of the business system rules, DFARS clause 252.244-7001. And that section contains 24 listed criteria in the clause. And what this really means is that, an administrative contracting officer will consider a CPSR, a purchasing system review, when a prime contractor has 25 million in sales over the next 12 months, excluding certain contracts. And these CPSRs are really just a government assessment of your system as a higher tiered contractor to bring in subcontractors. And they also will consider systems that you need to detect and avoid counterfeit parts that we'll talk about in a minute.
But the bottom line is that DCMA, Defense Contract Management Agency, does these audits, and they will find systems either approved or disapproved. And if they disapprove the system, they will typically make some kind of finding and identify significant deficiencies that need to be identified. Consequences for disapproved systems could be really severe, including withholdings and all kinds of other very ugly consequences. Now I mentioned counterfeit electronic parts, and I'll just briefly mention DFAR 252.246-7007. There's a pretty complex set of regulations here. But the bottom line is that the federal government is looking very carefully and very closely at whether or not, within the supply chain, counterfeit electronic parts are being used such that they might jeopardize the ultimate product that's being provided to the government. Within these regulations, there's 12 specific areas that need to be addressed and penalties for non-compliance.
Labor standards clauses, EEO, Affirmative Action, here... Again, this is a very broad topic, but there are a number of clauses that the Service Contract Act, EEO, Affirmative Action, they all require flow-down to subcontractors. And the only thing I'll mention here is that the federal authorities that implement these clauses, and administer them, and enforce them, take very broad view on what a subcontractor is. So if you have a situation where you're trying to determine whether flow-down is required or not, I'd say look very carefully when it comes to these labor standards clauses and EEO clauses.
Now, cybersecurity, this is an ever evolving area. There's been a significant amount of DOD guidance issued. And the point here is that when we talk about cybersecurity compliance, it's not just the prime contractors compliance, but most of these clauses require a flow-down of the requirements in all subcontracts and other contractual instruments, as long as too narrow exceptions don't apply, which is under the micro-purchase threshold or a COTS item. So, this is one you need to stay on top of, because the DOD guidance in September, 2020, they just issued a framework for verifying contractor compliance with the requirements. It just adds a whole nother layer of analysis that you need to take into account when looking at different subcontractors and whether they can comply.
I mentioned the 2019 NDAA section 889, and I'm only going to touch on this because what it basically did was it was a section of the National Defense Authorization Act that banned contractors from using Huawei and ZTE services under federal contracts. There have been a previous ban of a company called Kaspersky, a Russian company. And this DOD rule was interim rule, was issued in July, 2020. And there are FAR clauses now, and a DFARS clause, FAR 52.204-25, and a companion DFARS clause. But the bottom line here is, the government's taking a very active stance and preventing higher tier contractors from using these lower tier contractors, and the flow-down requirement is pretty clear, and includes acquisition of commercial items. So you just got to be aware of that.
And finally, just when we thought it was going to handle all this flow-downs... I want to talk a little bit about OTAs and other transaction authority. We've seen a huge jump in the use of other transaction authorities and set of federal contracts. OTAs are legally binding instruments that may be used for a bunch of research and prototyping activities. The bottom line is they're not standard contracts. So they're not generally subject to the federal laws and regulations that apply to government procurement contracts. And flow-down obligations are going to vary. So there are a lot less well-defined. Again, I think it just requires an extra level of nuance to ensure you're in compliance.
So with that, I'm going to wrap up here. I hope this has been helpful over the last 60 minutes or so. There is a lot to cover here in the world of supply chain. And if I can just leave you with a few thoughts, which is, look, review your supply chain for areas of high risk. We've talked about a lot of the areas where it can pop up. You need to do that kind of review. Review your agreements and contracts and subcontracts carefully. What's your scope of flow-down obligations? What's your scope of compliance? Review your supplier screening process. How do you select folks? Is it competitive? What are you looking for?
And the bottom line is, you have to just make sure that you sharpen your pencils whenever you come down to subcontractor selection and flow-down negotiation. As I said, the devil's in the details. Read every clause and provision that's proposed for flow-down, and only flow-down, or accept the appropriate laws. And bottom line, stay on top of the current developments when it comes to supply chain management, because failure to do so, it can be a real big headache. Hope you found this helpful. Thank you very much. And until we meet again. Thank you.