Subcontract Flowdowns: The practical challenge with selecting the version of a regulatory clause to incorporate into subcontracts

By Garth Dimock

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Contractors are contractually obligated to incorporate designated prime contract clauses into subcontracts issued under U.S. government contracts. These “mandatory” clauses characteristically include language in the clause that sets out this requirement, such as “include this clause” or “include the substance of this clause” in subcontracts issued in the performance of the prime contract. A quick review of the Federal Acquisition Regulation (FAR) and Defense Federal Acquisition Regulation Supplement (DFARS) shows around 150 mandatory clauses, with slightly more having the requirement to “include this clause” than having the requirement to “include the substance of this clause.” 

Contractors creating terms and conditions documents used to incorporate regulatory clauses into subcontracts are faced with two complicating factors. First, the clauses are frequently revised, and second, contractors often provide the same supplies or services under multiple concurrent prime contracts issued at different points in time.

The combination of these two factors creates situations where contractors can be subject to disparate regulatory requirements while performing the same task under contemporaneous contracts. And as contractors generally combine requirements, this aggregation introduces the additional challenge of determining which version of a regulatory clause to flow down to subcontractors.

This article will address the question of whether contractors – prime and higher tier subcontractors – should incorporate the version of a clause set forth in the prime contract or the version of a clause in effect at the time a subcontract is placed. It will describe the challenge, review industry approaches, offer a suggested approach and recommend regulatory changes.

The Challenge

As observed, regulatory clauses are frequently revised. Each version is designated by a date included at the end of the title of the clause, for example, DFARS 252.225-7009 Restriction on Acquisition of Certain Articles Containing Specialty Metals (Dec 2019).

The American Bar Association Section of Public Contract Law’s Guide to Fixed-Price Supply Subcontract Terms and Conditions, Fifth Edition (the ABA Guide) sets forth a list of recommended FAR and DFARS clauses to include in contractors’ subcontract agreements. The ABA Guide states the clauses that should be flowed down to a subcontractor are the clauses included in the prime contract, even if the current regulatory clause differs due to a subsequent revision.¹

 For mandatory clauses that expressly state “include this clause” it is hard to argue the recommendation is not technically correct; however, it creates operational challenges for contractors.

 It is not uncommon for a contractor to concurrently provide the same or similar supplies or services to the U.S. Government under separate prime contracts that were issued at different points in time; and for the different prime contracts to include different versions of a given clause. Contractors performing the same or similar task under multiple prime contracts regularly combine such requirements into a single subcontract.

This aggregation of requirements has the benefits of:

(i)   Reducing the number of subcontracts required, which has a positive impact on the acquisition schedule and contractors’ administrative cost.

(ii)  Creating larger order quantities that reduce the cost of the supplies or services acquired. While aggregating requirements provides significant benefits to the U.S. government, it introduces challenges in creating efficient compliant approaches to flowing down mandatory prime contract clauses.

With the possibility of a single subcontract for the same items including conflicting and outdated regulatory requirements, contractors are faced with the question of whether the subcontracts should include the multiple versions of the clauses set forth in the prime contract or the single version of the clause in effect at the time the subcontract is placed.

In such situations, implementing the guidance set forth in the ABA Guide of including the versions of the clauses in the prime contract notwithstanding subsequent revisions is problematic.

In broad terms, mandatory flow-down clauses can be viewed as falling into two categories:

(i)   Clauses that place requirements on the sourcing or content of the supplies or services provided (Sourcing Clauses).

(ii)  Clauses that place requirements on contractors’ policies or procedures not directly related to a deliverable (“Process Clauses”). Sourcing Clauses affect the sourcing and manufacturing of items provided, such as: (i) FAR 52.204-25 Prohibition on Contracting for Certain Telecommunications and Video Surveillance Services or Equipment, (ii) DFARS 252.225-7007 Prohibition on Acquisition of Certain Items from Communist Chinese Military Companies, (iii) DFARS 252.225-7009 Restriction on Acquisition of Certain Articles Containing Specialty Metals, and (iv) DFARS 252.246-7008 Sources of Electronic Parts. Process Clauses affect policies or procedures but do not directly impact the deliverable, such as: (i) FAR 52.203-12 Limitation on Payments to Influence Certain Federal Transactions, (ii) DFARS 252.203-7004 Display of Hotline Posters, (iii) FAR 52.230-2 Cost Accounting Standards, and (iv) DFARS 252.204-7012 Safeguarding Covered Defense Information and Cyber Incident Reporting.

For Process Clauses, incorporating the versions of the prime contract clauses into the subcontract agreements revisions requires contractors to have policies and procedures in place for each version of a clause included in active prime contracts. This includes the outdated clauses that the U.S. Government has determined are no longer sound policy.

Contractor’s employees are required to understand the varying requirements of the prime contract on which they are working and modify their work accordingly. For employees who charge tasks directly to a contract, this is not economically feasible, and for employees who charge tasks indirectly, it is for all practical intent impossible.

An example of this challenge is DFARS 252.204-7012 Safeguarding Covered Defense Information and Cyber Incident Reporting. This clause was originally promulgated in November 2013 and revised in August 2015, September 2015, December 2015 and October 2016. Contractors who received multiple contracts during that period would be required to perform under and flow down four sets of requirements.

For Sourcing Clauses, incorporating the versions of the prime contract clauses into the subcontract agreements requires contractors to serially track each part through the sourcing, manufacturing, inventory and installation process.

An example of this challenge is DFARS 252.225-7009 Restriction on Acquisition of Certain Articles Containing Specialty Metals. This clause was originally promulgated in July 2009 and revised in January 2011, June 2012, March 2013, June 2013 and October 2014. Contractors delivering parts concurrently subject to this clause under multiple prime contracts would be required to source, manufacture, inventory and install items that comply with each version of the clause.

Contractors usually manufacture parts on the same production line with no identification as to the prime contract under which the part was produced. If contractors did invest the time and resources to serialize and track all parts to a specific prime contract during production, any such traceability would be lost in inventory. Outside limited circumstances, contractors do not maintain systems that track parts through the inventory process that would honor any such identification.

Further, even if contractors made the investment to maintain such inventories, as most contractors utilize Enterprise Resource Planning (ERP)
or Manufacture Resource Planning (MRP) systems that transfer assets across multiple prime contracts, any such integrity would be lost for
install parts.

Therefore, it is not practical to trace assets from source to the end item deliverable by prime contract. In addition, the expectation that contractors comply with multiple versions of the same clause is unrealistic.

Industry Approaches

As addressed, the ABA Guide sets forth recommended FAR and DFARS clauses to include in subcontract agreements. It also states the U.S. government may impose additional prime contract unique flow-down clauses not set forth in the recommended list. Therefore it is important that these additional clauses be identified and included in subcontracts where applicable.

As such, if a contractor utilizes the list of clauses in the ABA Guide, or a similar in-house generated generic list of regulatory clauses, these generic lists need to be amended or supplemented with any additional prime contract specific clauses not included in the generic list.

A survey of major Department of Defense (DoD) contractors’ publicly available supplier terms and conditions shows three general approaches to the structure of subcontract terms and conditions flow-down documents:

(i)   A standard standalone generic terms and conditions flow-down document used on all subcontracts independent of the prime contract.²

(ii)  A standard generic terms and conditions subcontract flow-down document along with a supplemental terms and conditions subcontract flow-down document for each prime contract that sets out prime contract unique clauses.³

(iii) A single all-inclusive terms and conditions subcontract flow-down document specific to each prime contract.⁴

The survey also shows contractors employ two general approaches to addressing the versions of clauses incorporated into subcontract agreements:

(i)   Citing the specific version of the clause in the subcontract flow-down document.⁵

(ii)  Not citing the specific version of each clause in the subcontract flow-down document but including language elsewhere in the document that sets out which version of the clause controls, such as the effective version of the U.S. Government clauses, shall be the version in effect as of the date this order is placed.

Contractors that do not cite the specific version of the clause state that either the version of the clause as of the date of the issuance of the prime contract controls⁶ or that the version of the clause as of the date of the issuance of the subcontract controls.⁷

Some contractors add qualifying language that if the version cited, or if the version at the time of the placement of the subcontract, differs from the version in the prime contract, the version in the prime contract governs.⁸

This is a questionable approach as it requires subcontractors to obtain and review the prime contract – which is not readily available to subcontractors. It also requires a subcontractor to be aware of any relevant modifications to the prime contract and implement such without an equitable price adjustment.

While from a legalistic perspective it might be argued that this added language ensures adherence to the approach recommended by the ABA Guide, practically it is not workable and does little to advance actual compliance with the regulatory requirements.

Suggested Approach

Incorporating the version of a clause in effect at the time of placement of a subcontract is the best practical solution to the challenges addressed herein. This approach allows contractors to implement efficient contracting processes. It also provides for a contract with which subcontractors operating under multiple contracts can realistically comply.

Early versions of the American Bar Association Section of Public Contract Law’s Model Fixed-Price Supply Subcontract Terms and Conditions recommended this approach. It stated it was preferable not to include the date of the clause and instead include language that the clauses incorporated are those in effect as of the date of the order.⁹

It is noteworthy that the Report on Contractual Flow-Down Provisions in the Federal Acquisition Regulation (FAR) and Defense Federal Acquisition Regulation Supplement (DFARS) by the Institute for Defense Analyses, which looked into the misapplication of flow-down clauses by contractors, did not address the versions of clauses incorporated into subcontract agreements, suggesting a limited concern in this area from the U.S. government.¹⁰

Counterarguments to this approach are: (i) it is a technical breach of the prime contract, and (ii) that it could place a contractor at a disadvantage or unable to fulfill its prime contract obligations. These arguments can be viewed in terms of those argued to have a negative effect on the U.S. government and those argued to have a negative effect on contractors.

Regarding the impact to the U.S. government, while flowing down a different version of a mandatory clause could be argued is a technical breach of a contractor’s obligations, it is difficult to see the harm to the U.S. government in incorporating the version of a clause that is in effect at the time of the subcontract award, as this approach implements current U.S. government policy. No instances have been found in which the U.S. Government has challenged the incorporation of a version of a clause that is more current than the version of the clause set out in the prime contract.

Another argument advanced against incorporating the version of a clause in effect at the time of the subcontract award is that in situations where the revised clause lessens the requirements on a contractor, the U.S. government is entitled to consideration.

While again in theory this argument is sound, in practice contractors’ accounting, estimating and pricing procedures do not typically have the fidelity to quantify impacts associated with revisions to a clause with the precision necessary to support pricing a contract action. The administrative costs to the U.S. government and contractors for quantifying such a price adjustment and processing a contract modification likely outweigh any benefit to the U.S. government. 

From the contractor’s perspective, the counterarguments generally center around Process Clauses that set out thresholds impacting accounting and pricing practices, such as FAR 52.230-1 Cost Accounting Standards Notices and Certifications and FAR 52.215-12 Subcontractor Cost or Pricing Data.

The argument is that if a dollar threshold of a clause is increased and a contractor flows down the revised clause with a higher threshold than is in the prime contract, the contractor is exposed for subcontracts placed with a value between the two thresholds. With the U.S. government moving away from incorporating absolute dollar values in clauses and instead referencing the thresholds set out in the regulations the risk in this area is minimal.

Additionally, the risk of a U.S. government challenge associated with implementing current U.S. government regulations and policies seems low. Other writings seem to support this conclusion, with one stating that using the subcontract date will usually not create problems for the U.S. government or the contractor.¹¹

In a seamless contracting environment with unlimited resources, the U.S. government would update all active prime contracts with each clause revision. And in this seamless environment, contractors would follow with updating all subcontracts down the supply chain.

The approach of using the clause current at the time of placing a subcontract efficiently implements this objective. It also addresses the challenge of contractors performing under multiple contracts with different versions of a clause.

Recommended Regulatory Changes

The iterations in regulatory clauses coupled with the acquisition strategies of the U.S. government and contractors often require contractors to comply with multiple versions of a given clause under concurrent contracts. To the extent contractors comply with the conflicting clauses, this compliance adds cost and impacts procurement schedules for the sole purpose of respecting outdated regulations.

While the approach is a practical solution to the current challenges, it is recommended regulatory changes be implemented to set out clear guidance and ensure all parties are operating to a consistent standard.

It is also recommended the U.S. government create a new clause that would allow contractors the option of following the requirements set forth in the version of the clause included in the prime contract or the latest published version of the clause in the FAR or its supplements. Such a clause could be structured along the lines of the following draft FAR clause.

52.XXX-XX Compliance with Contract Clauses

(1) The contractor is under no obligation and is not contractually required to comply with requirements set forth in any version of a contract clause other than those incorporated herein. However, notwithstanding the version of a clause set forth in this contract, the contractor’s compliance with the current version published in the Federal Acquisition Regulations shall be considered compliance with this contract, and such compliance shall not constitute a breach of this contract.

(2) The contractor shall incorporate the substance of this clause, including this paragraph in all subcontracts issued under this contract.

Summary

The revisions to the regulatory clauses coupled with contractors performing concurrently under multiple prime contracts issued at different points in time creates a challenge for contractors in selecting the appropriate version of a clause to flow down to subcontractors.

The ABA Guide’s recommendation of incorporating the version of the clause in the prime contract is not a practical solution. To the extent followed, it requires contractors to implement costly procedures requiring compliance with conflicting and outdated regulations.

It is recommended the U.S. government create a new contract clause that gives contractors the option of complying with the version of the clause incorporated in the prime contract or the latest published version.

Prior to the U.S. government implementing the recommended regulatory change, it is suggested that a reasonable approach is to follow the guidance provided in the earlier version of the ABA’s Model Fixed-Price Supply Subcontract Terms and Conditions. This guidance did not include the date of the clause and instead included language that the clauses incorporated are those in effect as of the date the subcontract is placed. CM

 

Garth Dimock

Thirty-five years of private industry experiences with large DOD contractors negotiating terms and price with the government and subcontractors.

Guide to Fixed-Price Supply Subcontract Terms and Conditions, Fifth Edition, p. 2. Published by: The American Bar Association Section of Public Contract Law.

Raytheon Technologies – Purchase Terms and Conditions Website, https://www.rtx.com/en/suppliers/purchase-terms-and-conditions; BAE Systems – U.S. Terms and Conditions Website, https://www.baesystems.com/en/what-we-do/suppliers/united-states/u-s-terms---conditions; General Dynamics Mission System – Supplier Terms and Conditions Website, https://gdmissionsystems.com/about-us/suppliers/terms-and-conditions; L3harris Technologies, Inc. General Terms and Conditions Website, https://www.l3harris.com/suppliers.

Lockheed Martin Aeronautics Supply Chain Management Terms & Conditions Website, https://www.lockheedmartin.com/en-us/suppliers/business-area-procurement/aeronautics/terms-and-conditions.html; Northrop Grumman – Contracting Data Terms And Conditions Website, https://www2.northropgrumman.com/suppliers/Pages/TermsAndConditions.aspx; General Electric Aviation – Doing Business with Aviation Website, https://www.geaviation.com/company/doing-business-aviation.

The Boeing Company – Terms and Conditions Website, http://www.boeingsuppliers.com/terms.html.

Lockheed Martin Aeronautics, BAE System, Boeing, and General Electric Aviation.

Raytheon Technologies and General Dynamics Mission Systems.

Northrup Grumman and L3Harris.

Lockheed Martin Aeronautics, L3Harris, BAE System, and General Electric.

Robert G. Bugge, A User’s Guide to the ABA’s Model Fixed-Price Supply Subcontract, Public Contract Law Journal, Vol. 15, No. 2 (1984), pp. 502-527 (26 pages), Published by: American Bar Association.

Mark F. Kaye, et al. Report on Contractual Flow-Down Provisions in the Federal Acquisition Regulation (FAR) and Defense Federal Acquisition Regulation Supplement (DFARS). Institute for Defense Analyses, 2017.

E. Sanderson Hoe, Richard B. Oliver & Thomas M. Abbott, FlowDown Clauses in Subcontracts, Briefing Papers No. 85-5 (May 1985).