Avoiding FCA Violations from Limitations in Subcontracting and Performance of Work Requirements

By Camilla J. Hundley, associate, PilieroMazza PLLC

      Members of the government contracting community are familiar with the contracting opportunities offered specifically to small and disadvantaged businesses. The availability of small business contracts and set-aside contracting opportunities through the Small Business Administration’s 8(a), mentor-protégé, and various set-aside programs (such as those for service-disabled veterans and for women), offer important opportunities for small businesses to grow without competing against mega companies with endless resources. However, certain requirements for performance under these programs can cause confusion and even liability under the False Claims Act (FCA) for contractors who don’t watch their steps throughout contract performance.

Background

      The Small Business Act (the Act) codifies federal policy to promote the growth of small businesses through preferential award of procurement contracts. It also authorizes the SBA’s 8(a) Business Development Program, intended to help “eligible small disadvantaged business concerns compete in the American economy through business development.”

      In order to accomplish the goal of promoting small business growth, the limitations on subcontracting provisions of the Act generally require that the prime contractor under a set-aside contract perform a percentage of the work with its own personnel. Specifically, the SBA regulations require that the cost of labor on any contract awarded under a small business set-aside—including contracts awarded to joint ventures (JV) or mentor-protégé joint ventures—must be performed:

• 50% by the prime contractor for small business set-asides;
• 50% by the prime contractor for 8(a) contracts; and
• 40% by the prime contractor for mentor-protégé joint ventures.

      If the contract is for a construction project, the prime contractor in any instance is required to perform 15% of the project.

      Notably, subcontracts issued to “similarly situated entities”—for example, entities with the same socioeconomic classification as the prime contractor, in addition to being small under the NAICS code assigned to the prime contractor’s procurement—may be counted towards the prime contractor’s performance calculation. Adding to the confusion, the FAR includes its own limitations on subcontracting; if the FAR rules are incorporated into a contract, then they become a contractual obligation.[1]

      Limitations on subcontracting get even more complicated when an 8(a) small business and non-small business enter a joint venture eligible for the award of 8(a) contracts, including:

• The parties must abide by the internal performance of work requirements, which require that the 8(a) firm must perform at least 40% of the work performed by the joint venture; and
• Because the JV is considered an 8(a) entity, the JV is also subject to the limitations on subcontracting applicable to 8(a) firms in general.

      Thus, under the limitations on subcontracting rules, the JV itself can only subcontract out a certain percentage, depending on the nature of the work, of the cost of labor for the contract; additionally, under the internal performance of work requirements, the 8(a) member must perform at least 40% of the work, calculated by the cost of labor, that the JV did not subcontract out.

      If the joint venture is between a mentor and protégé, the protégé must perform at least 40% of the work, again calculated by the cost of labor, performed by the joint venture and cannot include work subcontracted to a similarly situated entity in that calculation.

      These requirements can be confusing, but they are critical to understand. The Court of Federal Claims holds that the limitations on subcontracting clause is a material portion of a contract. The Act imposes hefty penalties for violations, and the SBA considers violation of the subcontracting limitations to be potential grounds for debarment. The Justice Dept. not only has pursued contractors under the FCA for violating this clause, but also has expressly stated its intent to continue to bring charges for such violations.

Notable FCA Cases

      Earlier this year, DOJ announced a settlement to resolve allegations that a non-small business “violated the FCA by fraudulently obtaining construction contracts reserved for disadvantaged small businesses.” DOJ alleged that a non-small business and an 8(a) firm entered a JV agreement. The JV successfully secured an 8(a) set-aside award on a Multiple Award construction contract for the Air Force. Notwithstanding internal performance of work requirements, the non-small business managed the JV and used its own employees to complete nearly all the work the JV performed. Although the non-small business did not admit liability in the settlement, it did pay $400,000.00 to resolve the allegations. The Special Agent in charge of the Air Force Office of Special Investigations cautioned: “The Dept. of the Air Force takes the protection of federal SBA set-aside funds seriously, especially when abuses impact the military’s warfighting capability...OSI along with our joint partners are dedicated to protecting the integrity of government procurement practices from fraud, waste and abuse while ensuring those who violate the law are held accountable.”

      This settlement follows an earlier case in which an 8(a) program mentor agreed to pay an FCA settlement of $928,000.00. There, again, a large construction company mentor and 8(a) small business entered an SBA-approved JV to bid on set-aside contracts. In addition to allegations that the businesses did not form a qualifying JV and thus were ineligible to jointly bid on 8(a) contracts, the DOJ alleged that the large business’s relationship with the 8(a) business violated the terms of a set-aside contract awarded to the small business, which required the 8(a) small business to perform at least 15% of the cost of labor on the contract. There, the SBA General Counsel warned: “SBA has no tolerance for waste, fraud or abuse in any government contracting program and is committed to working with our federal partners to ensure the benefits of these programs flow to the intended recipients.”

Conclusion

      Plainly, DOJ, SBA, and federal investigative agencies remain committed to ensuring that those who participate in 8(a) contracts do so honestly and fairly. Although the FCA imposes a “knowing” or “reckless” standard for violations, the inherent complications of calculating and maintaining the limitations on subcontracting and internal performance of work requirements can easily form a trap for the unwary. It is essential that contractors on small business set-aside contracts keep these requirements in mind and monitor their performance of work throughout their contracts.

FOOTNOTE: [1] After years of confusion regarding the discrepancies between the SBA limitations on subcontracting requirements and the related FAR clauses, on Aug. 11 the FAR Council published two final rules that largely mirror the SBA’s rules. PilieroMazza’s comments on the highly anticipated FAR changes were published at https://bit.ly/3AoAJpk.

Camilla Hundley is an associate with PilieroMazza PLLC. If you have questions about your firm’s compliance with the limitations on subcontracting requirements, please contact Camilla or a member of PilieroMazza’s False Claims Act or Government Contracts practice groups. This column was reprinted with permission from PilieroMazza PLLC.

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