Following up on our post earlier this week giving a general overview of the Defense Production Act of 1950 (“DPA”), 50 U.S.C. §§4501 et seq., this post comments on President Trump’s March 18, 2020 Executive Order on Prioritizing and Allocating Health and Medical Resources to Respond to the Spread of COVID-19 (the “COVID-19 E.O.”) and provides some key considerations that companies should keep in mind if they are concerned about receiving prioritized or rated contracts or allocation orders or directives under the DPA.

The COVID-19 Executive Order

The COVID-19 E.O. is a follow-on to President Obama’s Executive Order 13603 (the “2012 E.O.”), which itself was patterned after earlier executive orders delegating DPA authority to the heads of various agencies.  The 2012 E.O. delegated authority with respect to “health resources” to the Secretary of Health and Human Services (the “Secretary”), with “health resources” defined broadly to include “drugs, biological products, medical devices, materials, facilities, health supplies, services and equipment required to diagnose, mitigate or prevent the impairment of, improve, treat, cure, or restore the physical or mental health conditions of the population.”

The DPA requires that to use prioritization or allocations authority in the civilian marketplace, the President must make certain findings as to the scarcity of material and the need to invoke the prioritization or allocations authority.  The DPA suggests that such findings will be made on an item-by-item basis.  The 2012 E.O. and existing regulations implement this process by requiring the head of the department invoking DPA authority to make the required findings as to scarcity and need and submit them to the President for approval before exercising DPA authority.

The COVID-19 E.O. appears to deviate from this approach in its delegation of DPA authority to the Secretary with respect to “all health and medical resources needed to respond to the spread of COVID-19 within the United States.”  In particular, the COVID-19 E.O. appears to be intended to avoid the pre-approval requirements established under the DPA and existing regulations by making a finding that the pre-approval requirements have already been met with respect to health and medical resources needed to respond to the spread of COVID-19.  The COVID-19 E.O. also appears to allow the Secretary to make this finding with respect to “additional specific health and medical resources,” which presumably are not required to be directly necessary in responding to this spread.

Although others view the COVID-19 E.O. as establishing a completely new delegation of authority independent of existing regulations, the language of the order does not appear to otherwise change existing frameworks under the DPA, except potentially by expanding the Secretary’s authority to “medical resources,” which are not defined in existing regulations.

It remains to be seen whether the apparent intent to avoid pre-approval requirements for all health and medical resources needed to respond to the spread of COVID-19 would be valid for any attempt to control the general distribution of material in the civilian market.  Broadly avoiding the pre-approval requirements could be viewed as inconsistent with the text of the DPA, especially when the COVID-19 E.O. does not indicate that particular items are scarce as appears to be contemplated by the statute.

Key Considerations for Contractors

Although the President has independent DPA authority, the U.S. Department of Health and Human Services can probably be expected to exercise its DPA authority through existing regulations in the form of the Health Resources Priorities and Allocations System (“HPAS”).  The HPAS functions similarly to the priorities and allocations systems in other contexts, including the Defense Priorities and Allocations System (“DPAS”), the Agriculture Priorities and Allocations System, the Energy Priorities and Allocations System, and the Transportation Priorities and Allocation System, which are respectively managed by the U.S. Departments of Commerce, Agriculture, Energy, and Transportation.

This section details a few key considerations companies should keep in mind if they have received or are concerned about receiving a rated contract.  As discussed in more detail in our earlier post on the DPA, performance of rated contracts must be prioritized above competing commercial or non-rated governmental obligations—even if doing so could result in a breach of other obligations.

  • Identifying a Rated Contract.  Rated contracts generally must include at least four elements:  (1) a priority rating (e.g., DO-HR or DX-HR); (2) a specific required delivery date or dates; (3) a signature certifying that the rated order is authorized and regulatory requirements are being followed; and (4) a statement that the rated order is certified for national defense use or is placed in support of emergency preparedness requirements.  Rated contracts can come directly from the government or from prime contractors or higher tier subcontractors who hold rated contracts or subcontracts.  Subcontractors must comply with rated orders, but when receiving a rated subcontract, subcontractors can and should ask the prime contractor to verify that the prime contract is indeed rated and that the subcontract is necessary to fulfill the prime contract’s requirements.  The subcontract should include at least the elements described above.
  • Identifying the DPA Authority.  It may also be helpful to identify the DPA authority being exercised, i.e., which priorities and allocations system is triggered and which agency has issued the prime contract.  While DPA authority has been delegated and in some instances sub-delegated—for example, the DPAS is used by the Departments of Commerce, Defense, Energy, and Homeland Security, as well as the General Services Administration—not every agency directly holds DPA authority.
  • Acceptance or Rejection of a Rated Order.  A company that is subject to a priorities system generally must reject a rated contract if they are unable to satisfy the contract by the date specified (scheduling conflicts do not constitute an inability to fill the order, unless with another, higher- or identically rated contract).  In such cases, the company must offer to fill an order on the earliest acceptable date.  A company generally may reject a rated contract on various other specified grounds, including if (1) the prime contractor or higher level subcontractor placing the order is unwilling or unable to meet regularly established terms of sale or payment; (2) the contract is for an item the receiving company does not supply or a service the receiving company is unable to perform, with some exceptions for recent provisions of supplies or services; or (3) the prime contractor or higher level subcontractor placing the rated order (as opposed to the Government) makes the item or performs the service being ordered.
  • Sourcing Materials for a Rated Contract.  Companies may (and, under HPAS, are required to) generally flow down the rating on their contract to any suppliers in order to obtain items or services needed to fulfill the rated contract—at whatever level throughout the procurement chain.
  • Negotiation of Terms for a Rated Contract.  Rated contracts must generally follow the terms of the usual dealings among companies.  A company receiving a rated contract is prohibited from discriminating against it in any way, for example by charging higher prices or by imposing different terms and conditions than for comparable unrated orders.  However, as mentioned above, the entity placing a rated order must be willing and able to meet regularly established terms of sale or payment.
  • Potential Breach of Non-Rated Contracts.  As mentioned above, rated contracts must be prioritized against non-rated contracts—even if this may cause the contractor to breach the non-rated contract.  However, the DPA and the relevant priorities and allocations systems provide that a company cannot be held liable for damages or penalties for any act or failure to act resulting directly or indirectly from compliance with a rated contract.  That said, courts have found in the past that the federal government does not have an obligation to reimburse a company for potential lost profits attributable to nonperformance of unrated contracts.

In addition to the prioritization authority under which rated contracts are issued, the COVID-19 E.O. also invokes DPA allocations authority.  As discussed in more detail on our earlier post, the allocations authority is quite broad and permits the President to allocate or control materials, services, and facilities in any manner deemed necessary or appropriate to promote the national defense.  Although less likely to be encountered, companies should also track allocation orders and directives as they could have a significant impact on individual companies or even entire sectors of the economy.