by Maria L. Panichelli, Esq. and Jennifer M. Horn, Esq.

The SBA is on a roll! It seems that ringing in the new year has invigorated the agency, prompting it to finally act in response to various outstanding directives set forth in the National Defense Authorization Act for Fiscal Year 2013 (“NDAA”).

Last Thursday, the agency issued its long-awaited Proposed Rule on the Mentor-Protégé, 8(a) HUBZone and Other Programs. In addition to those proposed mentor-protégé changes, the SBA also recently rolled out a proposed rule containing major changes to the small business regulations. Some of the most important changes relate to the limitations on subcontracting set forth at 13 CFR § 125.6.

As many contractors know, the regulations set forth at 13 CFR § 125.6 establish minimum self-performance requirements for small business prime contractors performing various types of set-aside contracts. The intent of these regulations is to ensure that the financial benefits of small business set-aside contracts remain with legitimate small business contractors. The SBA does not want small business primes subcontracting the majority of their contract work to large businesses. That would deprive legitimate small businesses of contract revenue and negate the purpose of the agency’s small business programs. To avoid this problem, the SBA enacted 13 CFR § 125.6, requiring that the prime perform a certain percentage of the work itself.

The proposed revisions to § 125.6 would the change the regulation’s overall approach to this issue. The overall goal remains the same: keep small business dollars in small business pockets. However, rather than mandate the percentage of work a prime has to perform, the revised § 125.6(a) limits how much work a prime can subcontract to other contractors. Perhaps even more importantly, the proposed rule provides that subcontracts made to “similarly situated entities” are not counted towards that subcontracting limit.

For example, under the proposed rule, an 8(a) contractor performing an 8(a) set-aside general construction contract cannot subcontract more than 85% of the contract work to non 8(a) entities. Similarly, a service-disabled veteran-owned (“SDVOSB”) prime contractor cannot subcontract more than 75% of a specialty construction contract set aside for SDVOSBs to non-SDVOSB concerns. In these examples the required 15% or 25% of the work would have to be performed by the prime, or a “similarly situated entity” — i.e. a concern that is eligible for the applicable small business program through which the contract was set-aside. Strangely enough, the language of the revised regulation does not require that any of the work be self-performed by the prime itself. It will be interesting to see if that changes in any way before the final rule is issued.

To the extent the proposed revisions conflict with performance of work requirements set forth elsewhere in the SBA regulations, the proposed rule addresses that, too. The rule revises 13 CFR § 126.700 by deleting the current, unpopular requirements relating to HUBZone contractors. The proposed revised § 126.700 would require only that “[a] prime contractor receiving an award as a qualified HUBZone SBC must meet the limitations on subcontracting requirements set forth in § 125.6 of this chapter.”

Another significant change relates to the manner in which the “percentages” of subcontracted work are calculated. Under the previous rule, the work percentages were calculated using labor or manufacturing costs only (depending on the type of contract). Now, the percentage of work is to be calculated using a percentage of “the amount paid by the government to the prime” – in other words, total contract cost. As many of you know, analyzing whether or not you comply with the current regulation can be confusing, time consuming, and nerve-wracking. If enacted, the proposed revisions could greatly simplify this process, allowing contractors to breathe a lot easier. This would be a huge improvement over the current regs.

However, the proposed revisions are not without their drawbacks. As the SBA noted in the rule itself, there is a fear that the “similarly situated entity” exception could be abused. For instance, first tier “similarly-situated” subcontractors might, in turn, subcontract to second-tier large businesses, thus diverting large amounts of revenue to other-than-small businesses and circumventing the purpose of the regulation. In an attempt to avoid such abuse, the SBA added an exception to the “similarly situated entity” exception. As revised, § 125.6 provides that “[a]ny work that similarly situated entity further subcontracts to an entity that is not similarly situated will count towards the [applicable] subcontract amount that cannot be exceeded.”   A nice effort, but how practicable will it be to accurately track lower-tier subcontracting? How enforceable is this provision, really? Of course, the rule would require contractors to certify, prior to performance, that they can comply with the new subcontracting limitation requirements. However, there appears to be no mechanism in the new rule for investigation or enforcement during performance, or any sort of post-completion verification process. In effect, the proposed rule would gauge compliance with the regulation based on pre-performance conjecture, rather than actual satisfaction of the subcontracting limitation requirements throughout performance. The ABA Small Business Committee’s comments to the rule – which Maria helped to author – will likely request that the SBA consider altering the timing of the certification requirement. It will be interesting to see how these shortcomings are remedied, if at all, in the final rule.

Comments to the rule are due February 27, 2015. We will keep you posted on the status of the final rule.