On November 17, 2023, the Department of Defense (“DOD”) published a Final Rule – over five years in the making – addressing DOD policies regarding the applicability of laws to commercial products, commercial services, and commercially available off-the-shelf (“COTS”) products (DFARS Case 2017-D010). Partially implementing Section 874 of the Fiscal Year 2017 National Defense Authorization Act, DOD has imposed new regulations that expressly prohibit Contracting Officers (“CO”) and prime contractors alike from incorporating regulatory requirements of the Federal Acquisition Regulation (“FAR”) and the Defense Federal Acquisition Regulation Supplement (“DFARS”) in prime contracts and subcontracts unless mandated by regulatory text.
Implementation
For prime contractors, DOD is implementing this prohibition by amending DFARS 252.244-7000 to state that the “Contractor shall not flow down the terms of any [FAR] or [DFARS] clause in subcontracts for commercial items at any tier” unless expressly stated and required by (1) the particular DFARS clause, (2) FAR 12.301(d), (3) FAR 52.212-5(e)(1), or (4) FAR 52.244-6(b)(1). Notably, there is no allowance for prime contractors to include other terms that may be deemed consistent with customary practice (though that discretion is afforded to Contracting Officers, discussed below). Previous iterations of the DFARS (particularly DFARS 252.244-7000), seemingly left prime contractors with great discretion in flowing down additional terms to commercial subcontractors where necessary to facilitate compliance with their own contractual obligations – but the Final Rule makes clear such additional flow downs are prohibited from now on.
Similarly, DFARS 212.301(f) is being amended to state “The Contracting Officer shall not use other FAR or DFARS provisions and clauses unless required by the FAR or DFARS or consistent with customary commercial practices.” Previously, DFARS 212.301 provided a list of DFARS clauses that applied to commercial contractors, but did not expressly prohibit COs from incorporating additional, non-mandatory terms deemed “necessary” to meet the agency’s needs. The revision to DFARS 212.301(f) severely limits the CO’s discretion by expressly prohibiting incorporation of additional FAR/DFARS clauses – though still leaves room for COs to argue that additional clauses are “consistent with customary commercial practices.”
Impact on Prime Contracts with the Federal Government
The Final Rule became effective November 17, 2023, and is applicable to all new contracts and solicitations after that date. However, the Final Rule also gives COs discretion to apply these requirements to existing prime contracts. Unless a CO issues a modification to the existing prime contract to remove non-mandatory FAR/DFARS clauses, all existing contract terms remain in effect.
The Final Rule only impacts DOD contracts – this only is a regulatory change to the text of the DFARS, meaning contractors may still be subject to a plethora of additional, non-mandatory terms when negotiating with civilian agencies. Without a subsequent change to the FAR, contractors may be forced to simultaneously manage two separate company processes for negotiating and flowing down contract terms – though we note the FAR Council currently has an open FAR Case purporting to address the same concerns.
As noted above, COs still are afforded some discretion to include non-mandatory FAR/DFARS clauses “consistent with customary commercial practice.” Prime contractors should be prepared to negotiate over whether additional “non-mandatory” FAR/DFARS clauses should be incorporated into their contracts as being “consistent with customary commercial practice.” However, amendments to the DFARS certainly provide prime contractors additional negotiation leverage in demanding non-mandatory provisions be excluded from their contracts.
Impact on Prime Contractors Flowing Down FAR/DFARS Clauses to Subcontractors
Historically, many DOD prime contractors simply would flow down the “kitchen sink” to every commercial products/services subcontractor, vendor, and supplier (i.e., every potentially applicable FAR/DFARS clause). Certain DOD prime contractors would include a prefatory paragraph noting that certain FAR/DFARS clauses, if inapplicable, were self-deleting. The revisions to DFARS 252.244-7000 seems at least to call into question this practice, and at most to outright prohibit these overinclusive FAR/DFARS lists in DOD subcontracts. In either event, DOD prime contractors should thoroughly analyze the requirements of their prime contract and ensure non-mandatory terms are not erroneously flowed down to commercial product/service subcontractors (whether by limiting the referenced clauses or by continuing to utilize the “self-deleting” prefatory text).
Prime contractors should pay particular attention if they have agreements with both DOD and civilian agencies, and should make a determination whether to bifurcate their flow-downs based on the prime contracting agency. Prime contractors arguably can continue flowing down any non-mandatory terms to commercial subcontractors. We note, though, that the FAR Council also has several open cases addressing commercial contracting. We will be keeping a particular eye on FAR Case 2018-006, which purports to implement a new definition for “subcontract” as well as a “new approach to the prescription and flow-down of provisions and clauses applicable to acquisitions of commercial items…” and was expressly called out in the Final Rule. (For more on the revised definition of “subcontract,” see our discussion here).
The DFARS revisions should be viewed as a big win for commercial product/service subcontractors. For years, subcontractors have pushed back on prime contractors flowing down a host of inapplicable clauses. The DFARS revisions give subcontractors additional leverage in these negotiations. Given the revisions, it likely makes sense for subcontractors to review the DFARS and stated FAR clauses to get a better understanding of the clauses they are required to accept in contract negotiations to best prepare for pushing back on non-mandatory provisions.
Take for example the Buy American Act (“BAA”) requirements in FAR 52.225-3. According to FAR 52.212-5(a), this is a mandatory clause for commercial prime contractors. However, FAR 52.225-3 is not listed either in FAR 52.212-5(e) or FAR 52.244-6(c)(1) as a mandatory flow down for commercial subcontractors. Per the Final Rule, prime contractors subject to the BAA regulations under DOD contracts will be prohibited from flowing down the regulatory requirements of FAR 52.225-3, regardless of whether a subcontractor is providing products subject to the statutory preference. In other words, subcontractors now have all the negotiating power to refuse compliance with the FAR 52.225-3 regulatory requirements – prime contractors cannot force these requirements into their contracts. This will require more creative thinking moving forward to ensure prime contractors are able to comply with their own contractual and regulatory obligations (perhaps, for example, by requiring a separate country of origin certification from subcontractors).
Consequences for Prime Contractors Improperly Flowing Down Non-Mandatory Terms
Historically, prime contractors who failed to flow down mandatory contract provisions have been subject to a host of potential noncompliance concerns, including breach of contract. The proper flow down of required FAR/DFARS clauses even has been the subject of several False Claims Act cases where a subcontractor failed to perform consistent with the requirements of the prime contract. In short, there were many reasons for prime contractors to flow down the kitchen sink in an effort to limit their potential liability for subcontractor noncompliance.
The DFARS revisions seemingly flip the script and suggest the practice of flowing down too many clauses may create risk for the prime contractor. According to the Final Rule, the “ramifications of improperly flowing down” FAR/DFARS clauses “would be determined in accordance with the terms of the contract.” Therefore, in theory, DOD prime contractors improperly flowing down non-mandatory FAR/DFARS clauses to commercial products/services subcontractors may result in DOD taking the position that the prime contractor breached its contract. We’ll believe it when we see it, but it’s at least theoretically possible based on the text of the Final Rule.