by Brian G. Muse, Associate

Whether you agree or disagree with the policies, it is, nonetheless, a reality of federal government contracting that the federal government uses the immensity of its procurement activity to advance particular social and economic goals.  One such goal is to assure that small businesses obtain a fair share of the federal government’s procurement expenditures.  The avenue to that goal is paved with set-aside goals and set-aside contracts; that is, the setting aside of all or a percentage of a contract’s work for performance by various categories of small and/or disadvantaged businesses.

As is oftentimes another reality of federal government procurement, however, the myriad of regulations and requirements created to achieve a particular social or economic goal, in this case, set-aside compliance can create serious risks and pitfalls for even the experienced federal government contractor.  At a minimum, failure to comply with regulatory requirements for set-aside compliance can result in unnecessary paperwork and poor scores on government evaluations.  At worst, failing to comply fully with the regulatory requirements can lead to serious criminal and civil penalties, including liquidated damages.  This article examines some of the basic requirements for set-aside compliance on federal contracts.  In doing so, we want to provide contractors and subcontractors with some thoughts and ideas for managing contracts with set-aside components, and avoiding some of the serious consequences for noncompliance.

Do Set-Aside Requirements Apply To My Contract?

Contractors that enter into a contract with the federal government exceeding the simplified acquisition threshold must agree to provide small and disadvantaged businesses with “the maximum practical opportunity” to receive subcontracts on that project or procurement.  Federal Acquisition Regulation (FAR) §19.702.  Currently, that threshold is $100,000.  41 U.S.C. § 403 (11) (1987 & 2005 supp.).  In addition, for a construction contract expected to exceed $1 million, the contractor is also to submit a written “small business plan” in accordance with the requirements of the Small Business Administration and applicable Federal Acquisition Regulation.  FAR § 19.702.  The government regulations do not limit these set-aside requirements to just general contractors.  Where a subcontractor otherwise meets these regulatory requirements, that subcontractor must also comply with these set-aside goals.  Id.  The government incorporates these requirements to its contracts through its contract clause entitled “Utilization of Small Business Concerns”.  FAR § 52.219-8.

What Is A Subcontracting Plan?

As stated above, contractors with a federal construction contract exceeding $1 million ($500,000 for a non-construction contract) must submit to their contracting officer an acceptable written small business plan.  FAR § 19.702.  An acceptable small business plan sets forth a contractor’s anticipated participation goals for the following specific categories of set-aside businesses: small businesses, veteran-owned small businesses, service disabled veteran-owned small businesses, woman-owned small businesses, “HubZone” small businesses, and small disadvantaged businesses (qualifying businesses located in specific depressed areas).  Each of these categories has specific size and/or demographic criteria for eligibility.  Id.  As this article deals with requirements for set-asides in subcontracting plans (rather than eligibility to participate in Small Business Administration assistance programs), this article will not discuss these specific criteria in detail.

A subcontracting plan must contain eleven specific elements for the government to consider it “acceptable.” These requirements are set forth in FAR § 19.704 and include: (1) separate percentage goals for each category of set-aside businesses; (2) a statement of the total dollars the contractor plans on subcontracting and the total dollars it plans to subcontract to set-aside businesses; (3) a description of the supplies and services to be subcontracted; (4) a description of the method used to develop the subcontracting goals; (5) a description of the methods used to identify and solicit potential subcontractors; (6) a statement of whether the contractor included indirect costs as part of its subcontracting goals; (7) the individual employed by the contractor who will manage the contractor’s set-aside program; (8) a description of the efforts the contractor will take to ensure that set-aside businesses have an “equitable opportunity” to compete for subcontracts; (9) assurance that the contractor will include a contractual clause (FAR 52.219-8) requiring its large subcontractors to adopt subcontracting plans where appropriate; (10) assurance that the contractor will provide all periodic subcontracting reports and required surveys; and (11) a description of the types of records the contractor will maintain concerning its procedures for compliance with its set-aside requirements.  Knowing what to include in a small business plan represents only one step in compliance.  The remainder of this article examines penalties and common compliance issues of which contractors should be aware.

What Are The Penalties For Non-Compliance With Set-Aside Requirements and Subcontracting Plans?

Where a contractor fails to make a “good-faith effort” to comply with its agreed subcontracting plan, the federal government may impose a variety of penalties.  FAR § 19.701 defines a failure to make a “good-faith effort” as the “willful or intentional failure to perform in accordance with the requirements of the subcontracting plan, or willful or intentional action to frustrate the plan.” The penalties for failing to make a “good-faith effort” to comply with a subcontracting plan are substantial.  See, e.g., FAR § 52.219-16.  First, the government could hold the contractor in material breach of contract and bring an action for breach of contract.  Id.  Second, the government could assess liquidated damages against the contractor in an amount equal to the actual dollar amount by which the contractor failed to achieve its subcontracting goals.  Id.  Third, the government may exercise any other remedy available at law, including giving “Marginal” or “Unsatisfactory” scores for the contractor’s performance, which could inhibit a contractor’s ability to obtain future work.  Id.  Finally, where the government believes that a contractor actively engaged in a conspiracy to defraud the government through the performance of its subcontracting plan (such as using “sham” subcontractors), the Government may bring civil or criminal fraud and conspiracy charges against a contractor.  See, e.g., United States v. F.E. Moran, Inc., 2002 WL 2003219 (N.D. Ill.) (unpublished decision).

Avoiding Common Pitfalls For Small Business Set-Aside Compliance

1.    Know Your Subcontractors — Make sure you take the necessary steps to verify subcontractor status.

Each of the six set-aside categories previously noted has specific criteria a business must meet to participate in Small Business Administration programs, such as eligibility for set-aside contracts.  Although it is not necessary for large contractors to know the specific elements of these requirements, a contractor must know what the Small Business Administration and relevant regulatory provisions require a contractor to do prior to listing a subcontractor on its subcontracting plan.  The answer, not surprisingly, depends on the specific setaside category.  For small business, veteran-owned small business, service-disabled veteran-owned small business, and women-owned small business concerns, a contractor may rely on the written representation of a subcontractor that it meets these criteria.  A contractor, therefore, need not conduct an investigation, so long as it has a written representation of the subcontractor’s status and a good-faith belief in the veracity of the subcontractor’s written representations.

For “HubZone” small businesses and small disadvantaged businesses, however, a contractor must take certain affirmative steps to verify that a subcontractor is registered with the Small Business Administration.  To check on small disadvantaged business status subcontractors, a contractor can confirm their status by accessing the Small Business Administration’s online “Pro-Net” database at www.sba.gov, or by contacting the Small Business Administration’s Office of Small Disadvantaged Business Certification and Eligibility.  For HubZone businesses, a contractor must verify a subcontractor’s status by contacting the Small Business Administration by electronic mail at hubzone@ sba.com, or on the Small Business Administration’s website at http://dsbs.sba.gov/dsbs.dsp_search hubzone.cfm.

2.    No Funny Business — Make sure your small or disadvantaged subcontractors aren’t mere “storefronts.”

Often, contractors find it difficult to meet all of the set-aside goals listed in their subcontracting plans.  Contractors must, however, resist the temptation to use purported small or disadvantaged subcontractors who are “storefront” or “sham” contractors to satisfy set-aside goals.  Federal court decisions advise that “storefront” arrangements, whereby small or disadvantaged subcontractors “only passed paper in order to meet the [set-aside] goals established for [a] project,” can result in civil or criminal penalties for conspiracy to defraud.  United States v. F.E. Moran, Inc., 2002 WL 2003219 (N.D. Ill.); see also United States v. Barker Steel Co., 985 F.2d 1123 (1st Cir. 1993).  Hence, contractors must ensure that the subcontractors used to meet set-aside goals actually perform the work stated in the contractor’s subcontracting plan — not just pass work through to other larger contractors who actually perform the stated work.

3.    It is the Effort That Matters – Document your "good faith effort" to satisfy your subcontracting plan.

As indicated above, applicable regulations require a contractor to provide assurances in its subcontracting plan that it will file necessary reports and maintain documentation and paperwork concerning set-aside compliance.  Most notably, this includes completing two reporting forms.  The first is Standard Form (SF) 294, which a contractor must submit to its Contracting Officer for a given project on a semiannual basis.  The second is Standard Form (SF) 295, which a contractor must submit annually to federal government agencies with which it has contracts.  Both forms provide a breakdown of a contractor’s setaside performance under its subcontracting plans.

Importantly, contractors must ensure that they maintain documents and data supporting these forms to demonstrate their “good faith efforts” to satisfy setaside goals.  Where a contractor fails to meet its goals, a Contracting Officer will review the contractor’s records to determine the steps the contractor took to satisfy this requirement.  Specifically, a contractor should possess documentation to demonstrate: (i) potential set-aside subcontractors contacted by the contractor; (ii) the reasons why any potential setaside subcontractors were not contacted or not offered contracts; and (iii) the efforts the contractor employed to monitor its set-aside programs and provide internal guidance on proper compliance.  Remember, Contracting Officers and the Small Business Administration may conduct audits of a contractor’s set-aside compliance.  Where a contractor proves unable to offer evidence of a “good faith effort” to meet its set-aside goals, the government may find the contractor in breach of contract, impose liquidated damages, and give “Marginal” or “Unacceptable” subcontracting scores.
 
4.    After Reading this Article, Review Your Procedures to Ensure that You are Meeting Your Set-Aside Requirements.

The above information and recommendations are intended to apprise contractors of certain key issues related to small and disadvantaged business set-aside compliance.  We cannot cover in this article every specific problem or issue a contractor may face in meeting its set-aside obligations.  The best suggestion is to make sure you know all the requirements and then review your procedures to confirm you are, indeed, meeting those requirements.

Conclusion

Large construction contractors (including large subcontractors) that work with the federal government must be aware of the federal government’s small business programs and goals that such contractors “set aside” percentages of subcontracts on certain projects for performance by small and disadvantaged businesses.  This involves compliance with a number of regulatory requirements that can create pitfalls for even careful contractors.  These pitfalls may lead to steep monetary penalties and legal entanglements.  Contractors should, therefore, inform themselves of these requirements, and confirm through internal review that they are meeting any applicable requirements.


The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.

Watt, Tieder, Hoffar & Fitzgerald is one of the largest construction law firms in the world, with a practice that encompasses all aspects of construction contracting, claims and disputes resolution, and transactional legal services. WTHF principally represents large general contractors, design firms, and sureties throughout the country and internationally.