Subcontract Administration - Part 3 - Monitoring Subcontracts

Continuing on in our discussion of subcontract administration, we look today at the contractor's responsibilities for administering subcontracts. The fundamental requirement is found in FAR 42.202(e)(2) as follows:

The Prime contractor is responsible for managing its subcontracts. The CAO's (contract administration official) review of subcontracts is normally limited to evaluating the prime contractor's management of the subcontracts. Therefore, supporting contract administration shall not be used for subcontracts unless

• The Government otherwise would incur undue cost,
• Successful completion of the prime contract is threatened, or
• It is authorized by some other regulation.

The term "managing subcontracts" encompasses not only what contractors might consider necessary but also activities that the Government considers necessary. For example,

1. Subcontract award
2. Technical performance
3. Financial performance
4. Monitoring (including QA and QC)
5. Payment

A contractor's internal control system over subcontracts (and intercompany orders as well) should provide for appropriate flow-down clauses into the subcontract. There are a lot of prime contract clauses that must flow-down to subcontracts. Depending upon the type of subcontract, clauses (i) giving the prime contract access to a subcontractor's books and records, (ii) limiting billings to only allowable costs, and (iii) requiring subcontractors to submit annual incurred cost proposals must be flowed down to the subcontracts.

Essentially, anything that the contracting officer does when awarding contracts (establishing requirements, selecting the contracting vehicle, selecting source, and negotiating prices), is expected of contractors when awarding subcontracts. After award, anything that DCMA (Defense Contract Management Agency) or DCAA (Defense Contract Audit Agency) does in administering and providing oversight of contracts is expected of prime contractors with respect to their subcontracts.

DCMA conducts periodic purchasing system reviews of the most significant Government contractors to ensure that their subcontracting policies, procedures, and practices are adequate for protecting the Government's interests. It is to the contractor's benefit to have their system considered adequate to avoid the need to secure the contracting officer's consent to subcontract and also to avoid billing withholds.

Subcontract Administration - Part 2 - Consent to Subcontract

The level of Government oversight on contractors' subcontracting practices is highly dependent upon the adequacy of contractors' purchasing systems. Most Government contracts include FAR Clause 52.244-2, Subcontracts. The requirements under this clause depends upon (i) whether the contractor has an approved purchasing system and (ii) the type of contract involved. An approved purchasing system is one that has been reviewed and approved in accordance with FAR Part 44 (FAR Part 44 is a subject for another day but to see what is required to have an approved purchasing system, go here). Consent to subcontract means the Contracting Officer's written consent for the Contractor to enter into a particular subcontract.

If a contractor does not have an approved purchasing system, the contractor must obtain a consent to subcontract from the contracting officer prior to awarding a subcontract under a contract that is cost-reimbursable, time-and-materials, or labor-hour. Additionally, consent to subcontract is required for fixed-price contracts that are greater than the simplified acquisition threshold (currently $150 thousand) or five percent of the estimated contract cost.

If a contractor has an approved purchasing system, the Government reserves the right to require a "consent to subcontract". These are usually and specifically spelled out in the contract, and, in our experience, a somewhat rare occurrence.

Contractors must provide a minimum level of information when applying for a consent to subcontract. Among the data required are the following:

• A description of the supplies or services to be subcontracted
• Identification of the type of subcontract to be used
• Identification of the proposed subcontractor
• The proposed subcontract price
• The subcontractor's current, complete, and accurate cost or pricing data and certificate of current cost or pricing data (when required).
• The subcontractor's Disclosure Statement or Certificate relating to Cost Accounting Standards (when required)
• A negotiation memorandum reflecting
• The principal elements of the subcontract price negotiations
• The most significant considerations controlling establishment of initial or revised prices
• The reason cost or pricing data were or were not required
• The extent, if any, to which the contractor did not rely on the subcontractor's cost or pricing data in determining the price objective and in negotiating the final price
• The extent to which it was recognized in the negotiation that the subcontractor's cost or pricing data were not accurate, complete, or current, the action taken by the contractor
• The reasons for any significant difference between the contractor's price objective and the price negotiated; and
• A complete explanation of the incentive fee or profit plan when incentives are used.

It is important to note that consent does not mean constitute a determination that subcontract costs are allowable, that all the subcontract terms and conditions are acceptable nor that the contractor is relieved from any responsibilities under the contract.

Finally, contractors should build into their processes, sufficient time for the Government to review the "consent" file. The time required by the Government varies considerably and is somewhat dependent upon the complexity and value of the subcontract. At a minimum, allow 30 days but to be safe, allow 60 days.

Subcontract Administration - Part 1

Its been a long time since we discussed a contractor's responsibility for monitoring subcontracts (see this post from 2009 which focused on surveillance responsibilities). Over the next few days, we are going to dig a little deeper into exactly what FAR requires when it comes to the prime contractor/subcontractor relationship.

To be "responsible", a contractor (or subcontractor) must have adequate financial resources to perform the contract, or the ability to obtain them, (ii) be able to comply with the required or proposed delivery or performance schedule, taking into consideration all existing commercial and governmental business commitments, (iii) have a satisfactory performance record, (iv) have a satisfactory record of integrity and business ethics, (v) have the necessary organization, experience, accounting and operational controls and technical skills (or the ability to obtain them), (vi) have the necessary production, construction, and technical equipment and facilities or the ability to obtain them, and (vii) be otherwise qualified and eligible to receive an award under applicable laws and regulations (see FAR 9.104-1).

In the case of a prime contract, the Government must determine "responsibility" before awarding a contract (see our recent seven-part series on preaward surveys). When it comes to subcontracting however, it is the prime contractors' responsibility, not the Government's, to determine subcontractor "responsibility". In essence, everything the Government does to ensure prime contractor responsibility, the prime contractor should replicate to determine subcontractor responsibility. This is a tall order but is absolutely required by FAR 9.104-4 (unless, in rare circumstances, the Government decides to take on that responsibility itself).

The approval to subcontract out part of a Government contract is not automatic. On Monday, we will look at the "Consent to Subcontract" clause.

Contract Options

Contract options allow the Government, for a specified time and at a specified price, to purchase additional supplies and services called for in a contract. Options seem like a pretty good deal - contractors increase their sales when the Government exercises options - but they are not without some risk. Sometimes its very difficult to predict prices three to five years in the future. A lot of contractors got hit hard when fuel price increased substantially in the late 90s. Its sometimes difficult to predict the availability of the type of labor needed for a particular project. If there's a local building boom going on, the wage scales and availability of construction workers is impacted. 

Generally, the contract period including all options may not exceed five years. This is not to be confused with delivery period which may exceed the five year limitation. 

Options are not automatic. The Government has a little homework to do before exercising options. The contracting officer must

• ensure that funds are available
• the requirement fills an existing need
• the exercise of the option is the most advantageous method of fulfilling the Government's need, price and other factors considered. This includes determinations that
• a new solicitation fails to produce a better price or more advantageous offer or 
• an informal analysis of the market indicates the option is more advantageous
• the time between contract award and exercise of the option is so short that the option is most advantageous

The decision to exercise options is the sole discretion of the Government. Decisions not to exercise are not typically protestable. So, contractors cannot count on the Government's exercising options to support plant expansions or long term labor contracts. There's no guarantees when it comes to options.

When proposing and negotiating option prices, contractor's need to ensure that there is sufficient provisions in the option prices to cover known and unknown market conditions. If the Government sees a bargain price, its going to take it as opposed to opening up the bidding process again. And, a bargain price for the Government is likely to hurt the contractor.

The Truman Committee

Back in 1940, a relatively unknown Harry S. Truman was elected Senator from the State of Missouri. While campaigning in Missouri, Truman heard about wasteful spending and profiteering in the construction of Ft. Leonard Wood. After being elected and determined to see for himself whether the stories were true, he jumped into his Plymouth (some accounts say it was a Dodge) and drove not only to Ft. Leonard Wood but to many other military installations across the mid-west and down to Florida. In fact, he traveled more than 10,000 miles on these visits. Everywhere he traveled, he witnessed poverty among the workers and contractors reaping excess profits off of their cost reimbursable contracts. He found no accountability for poor quality and he also found that most of the contracts were held by a small number of contractors based on the East Coast rather than spread out among companies in the various states.

He returned to DC and reported his findings. A year later, in 1941, the Senate formed the "Senate Special Committee to Investigate Contracts Under the National Defense Program" (later known as the Truman Committee) and appointed Truman to head it up. From 1941 until he stepped down to concentrate on running for Vice President, the Truman Committee held 432 public hearings, listened to 1,798 witnesses and published 2,000 pages of reports. It is said that his efforts saved billions of dollars in wasteful military spending and saved countless lives. The bi-partisan Truman Committee had a reputation for honesty and courage, was viewed as successful and the headlines it generated became popular among the American people. Truman's dogged pursuit of unscrupulous contractors propelled him into the Vice Presidency.

Some historians believe that Truman was the precursor to the contract management we have today; the Defense Contract Management Agency, the Defense Contract Audit Agency, the various Inspector General organizations, the Office of Federal Procurement Policy, the Government Accountability Office and many others. Certainly, none of these Agencies existed before the Truman Committee nor was there any other form of organized contract oversight. In fact, the Committee was extremely critical over the lack of Government oversight of Government contracts and many of its recommendations centered upon the need for increased contract oversight.

The next time someone shows up to conduct a review of one of your business systems, a proposal you've submitted, a payment request you've turned in, or to see whether you've engaged in any defective pricing, you can thank the man where the "buck stopped".

From all of us at Pacific Northwest Consultants, have a Merry Christmas. We'll be back on Thursday.

What are "Letter Contracts"?

A "Letter Contract" (also known as an Undefinitized Contract Action or UCA) is a type of contract. Its a temporary contract that allows contractors to get started on a project before a "real" contract can be negotiated. Letter contracts are used rarely and only when the Government's interests require that work start immediately because there is insufficient time to negotiate a definitive contract. We see these used in contingency operations (e.g. Iraq & Afghanistan) or in natural disasters (Katrina) to get supplies or relief rolling. Letter Contracts are also used to allow contractors to procure "long lead" items that need to be ordered immediately in order to complete production by a specified due date.

The use of a letter contract must be approved, in writing, by the head of the contracting activity (HCA). This approval must include a finding that no other contract is suitable (see FAR 16.603-3). The letter contract must also include a NTE (not-to-exceed) price. Herein lies the risk for both the Government and contractor. If the Government does not have time to negotiate a contract, the contractor probably doesn't have sufficient time to prepare an adequate estimate of costs. Significant oversights could lead to unanticipated financial burden. On the other hand, since the contractor does not have sufficient time to prepare an adequate estimate, the tendency is to throw everything including the kitchen sink into the NTE price (defective pricing does not apply at this point in the contracting process). If any of those costs have been incurred at the time of contract definitization, the Government is hard -pressed to question them.

The Government and the contractor are required to definitize  a letter contract (agree upon contractual terms, specifications, and price) by the earlier of

• 180 day period after the date of the letter contract, or 
• The date on which the amount of funds obligated under the contract action is equal to more than 50 percent of the negotiated overall ceiling price for the contractual action.

Letter contracts do not obligate the Government to pay up to the amount of the NTE price. The maximum liability of the Government is the estimated amount necessary to cover the contractor's requirements for funds before definitization, but shall not exceed 50 percent of the estimated cost of the definitive contract unless approved in advance by the official who authorized the letter contract.

There are a few restrictions on the use of letter contracts. They cannot be used to

• Commit the Government to a definitive contract in excess of funds available at the time of contract.
• Be entered into without competition when required.
• Be amended to satisfy a new requirement unless that requirement is inseparable3 from the existing letter contract.