One of the most common questions I get from clients and potential clients is how their small business should comply with the subcontracting restriction.
In this post I unpack the limitation a bit.
What is the Subcontracting Restriction?
Subcontracting limitation is, as the name suggests, a limitation on the amount of work that a prime contractor can subcontract to an entity not in a similar position.
A similarly situated unit is a company that (1) shares the socio-economic label of the main contract and (2) is a small company according to the NAICS code assigned by the main contractor to its subcontractor. (True – a prime contractor should assign a NAICS code to their subcontractors.)
In essence, the purpose of restricting subcontracting is to prevent small company contractors from acting as a passage for companies not in a similar situation. Thus, the restriction on subcontracting imposes an own performance obligation on the main contractors of small companies.
When does the subcontracting restriction apply?
The restriction applies to only over any small business price set aside. In particular, this applies to all closure contracts for small companies whose value is above the simplified acquisition threshold and to any socio-economic set-aside contract (regardless of value).
How much work can you subcontract?
The actual limit on subcontracting depends on the type of work requested.
- In the case of general service contracts, the main contractor may not pay more than 50% of the amount paid to him by the government to companies in another location. In other words, the general contractor (along with all similarly situated companies) must carry out at least 50% of the work, as measured by the amount paid by the government to the general contractor. Certain direct costs (such as air travel or cloud computing costs) may be excluded from the calculation.
- For general works contracts, the main contractor may pay no more than 85% of the amount paid to him by the government to companies not in a similar position. In the case of specialist building projects, the limit is reduced to 75%. Material costs are excluded from both calculations.
- In the case of supply contracts, the prime contractor may pay no more than 50% of the amount paid to him by the government to companies not in a similar situation. Keep in mind that supply and manufacturing contracts can also include SBAs Non-Manufacturer Rule– quite a complicated topic that we will address in future posts.
However, what happens when your contract includes a bit of services and a bit of delivery? In this case, the contracting authority must assign the NAICS code that most closely matches the main purpose of the project that governs the applicable subcontracting limitation. Importantly, the restriction only applies to the relevant part of the work – meaning that the service restriction applies when services predominate and only to the service part of the work. Only one restriction can apply per contract.
What about joint ventures?
I am often asked if Joint ventures for small businesses must comply with the subcontracting restriction. Yes! As a prime contractor, the joint venture company is subject to the same restrictions as any other small business.
A second consideration also applies to joint ventures: the delivery of the work. This requires that the managing partner of the joint venture (ie the entity on which the eligibility of the joint venture is based) performs at least 40% of the work that the joint venture undertakes.
In joint ventures, it can be difficult to comply with both subcontracting restrictions and work performance requirements. First, the JV should comply with the subcontracting constraint as this will determine how much work it will undertake. Based on that amount, the managing partner should then aim for a benefit at least 40%.
Take, for example, a joint venture that performs a general service contract. The joint venture (as prime contractor) may subcontract 50% of the work to companies not in a similar position subject to the applicable subcontracting restriction. Assuming the joint venture performs the remaining 50% itself (i.e. it does not subcontract work to similarly situated companies), the managing partner must perform at least 40% of the 50% of the work performed by the joint venture (or 20% of the contract amount ).
A few words of caution. First, a non-executive partner company cannot escape its performance cap by subcontracting work to itself (or its affiliates). That is, SBA regulations state that when determining compliance with work performance requirements, they consider all work performed by the non-executive partner company (and its affiliates) at all contract levels. Second, SBA has made it clear that the managing partner can not Rely on subcontractors to meet the 40% performance minimum.
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There you have it: a brief introduction to one of the more confusing concepts in small business contracting. As confusing as it is, it’s important that small businesses understand the limitations of subcontracting and ensure a plan for compliance before You are bidding on opportunities. Violating the restriction carries severe penalties, so it’s best to avoid problems.
Keep in mind that limiting subcontracting and meeting job requirements have nuances that have not been discussed in this post.