Over the past decade, Congress has focused on eliminating excessive “pass-through” charges—charges defined as overhead costs or profits passed to the Government by contractors adding negligible value over work done by lower-tier contractors.  The efforts began with the Post-Katrina Emergency Management Reform Act of 2006, which introduced limitations on tiered subcontracts after allegations that the Government grossly overpaid for goods and services provided largely by lower-tier subcontractors in the reconstruction following Hurricane Katrina.  However, until the passage of the instant rule to be implemented in FAR 15.404-1(h) effective June 8, 2015, such efforts have had little impact on agencies’ procurement processes.  This latest rule has the potential to significantly reduce the appetite for such contracts, and impact proposal and bid protest strategies.

Prior to the passage of the rule, contracting officers had little formal limitations or guidance prohibiting the acceptance of pass-through charges.  In addition to the Post-Katrina Act, the National Defense Authorization Acts (“NDAA”) of 2007 and 2009 also contained provisions regarding excessive pass-through charges, but did not fundamentally alter agencies’ procurement processes.  The Federal Acquisition Regulation (“FAR”) implemented these provisions through FAR 52.215-22—a clause requiring offerors to inform the contracting officer when they intend to subcontract greater than 70 percent of the total cost of the work, and describe the “added value” they provide in such circumstances.  Thus, in the past, so long as offerors provided necessary additional information in their proposals, contracting officers were not restricted in awarding prime contracts even when the offeror proposed subcontracting greater than 70 percent of the work.

Section 802 of the NDAA of 2013 spurred the latest change to the FAR.  The NDAA and the new rule mandate that when contracting officers are informed of a disclosure under FAR 52.215-22, they must (1) consider the availability of alternative contract vehicles and the feasibility of contracting directly with a subcontractor or subcontractors that will perform the bulk of the work; (2) make a written determination that the contracting approach is in the best interest of the Government; and (3) document the basis for this determination.  The rule does not apply to small business set asides.

Efforts may soon be underway to implement the rule.  The Government Accountability Office recently criticized the Department of Defense (“DOD”), the State Department, and USAID for failing to issue meaningful guidance to contracting officers to implement the NDAA of 2013, and in response, DOD has indicated it will issue more guidance.  In the meantime, contractors intending to propose significant subcontracting should consider the changing legal landscape in formulating bid proposal strategies.  Indeed, even if the contracting officer decides to formally justify an award to an offeror proposing to subcontract greater than 70 percent of the work, potential competitors may now seek to challenge such justifications in protests, significantly increasing risks associated with these types of offers.