Subcontracts

Q. What requirements govern use of subcontractors in procurement?

A. There are no requirements regarding subcontracting in the Best Practices Procurement Manual (BPPM) except those in Appendix A dealing with contract clauses and flowdown requirements to subcontractors, and the guidance in Chapter 7 which deals with Disadvantaged Business Enterprise. The management of subcontracts by grantees is largely a matter of good business practices, and the extent of your involvement would depend on the circumstances of each case. For example, in a firm fixed price contract for commercial items awarded as a result of adequate price competition, you would not normally be concerned about how the prime chose its subcontractors because the price being offered is presumably competitive and reasonable, and the prime contractor is assuming 100% of the risk for its subcontractors’ performance. Where, however, you are awarding a prime contract that involves the assumption of risk by the grantee for the prime contractor’s performance as well as its subcontractors, you will want to take a more active role in negotiating with the prime contractor concerning the subcontractor than you would where the prime contractor is assuming 100% of the risk of performance. The former case would include cost reimbursement, time and materials, and labor hour contracts. In these cases you are assuming the risk of cost overruns and the risk of otherwise poor performance, and you will want to ensure that the prime contractor has selected competent subcontractors and that it has adequately determined and documented the reasonableness of the subcontract prices through cost or price analysis. The subcontractors should be selected through competition to ensure that the best team has been assembled at the best combination of price and performance, or the prime contractor should adequately explain why competition is infeasible. If the subcontractor in these cases has not been determined at the time of the prime contract award, you may want to include a provision in the prime contract requiring the prime contractor to submit the proposed subcontract for your consent prior to its award by the prime contractor. You may want to examine the Federal policies in FAR Part 44 – "Subcontracting Policies and Procedures," and the contract clause at FAR 52.244-2, "Subcontracts." You are not required to follow the FAR but the guidance here may be useful. (Reviewed: October, 2010)



Q. Can subcontractor overhead (monitoring subcontractor work by prime contractor) be negotiated on a case by case basis for a task order contract, and can that negotiated value be expressed as a percentage of the contractor's cost for the task order.
We are negotiating an Agreement for On-Call Emergency Railroad Right of Way Repair services. The contract would be used in the event of an emergency that the District's Operating contractor would not be able to respond to adequately. In the event of an emergency, the Contractor would be issued a Not To Exceed order on a time and material basis. Prevailing wage rates would be used for labor. A known industry standard (the "blue book") would be used for equipment rental rates, and actual cost would be used for material. We anticipated negotiating the prime contractor's subcontractor oversight (subcontract overhead) on a case by case basis based on the amount of subcontract participation and risk to the prime contractor, and expressing that negotiated value as a percentage of the Contractor's cost. The Contractor has expressed a reluctance to use this method to determine a fair and reasonable cost, citing adverse determination from a prior audit (FAR based).

A. Our recommendations for negotiating the prime contractor's charges to you for subcontract management effort would begin with understanding how this contractor normally accumulates these costs in its accounting system and charges them to other customers. From this information we would suggest a cost-benefit analysis to determine if using the normal accounting and charging methodology would in fact produce an equitable result for your contract; i.e., would the estimated charges to you represent a fair and reasonable outcome given (1) the estimated amount of subcontract management effort expected by the prime contractor, (2) the dollar value of the subcontracts, and (3) the proposed overhead charge of the prime contractor against the expected dollar value of the subcontracts. If you can determine that the result of using the prime contractor's normal accounting treatment would produce a fair and reasonable cost outcome, you could enter into an advance agreement with the prime contractor to use this costing methodology, and you should stipulate in the contract that the overhead pool will be audited and the final billings adjusted to reflect the audited overhead rate. Do not use a predetermined, fixed rate that is not subject to later audit because predetermined (fixed) overhead rates are not allowable for contracts with commercial concerns. Such fixed overhead rates applied to actual costs incurred have also been held to be a violation of the prohibition against cost-plus-percent-of-cost contracts. You may also wish to consider a pricing approach that allows the prime contractor to bill you directly for its labor effort in managing the subcontractor; i.e., treating this effort as any other direct labor effort under the contract. This would allow you to negotiate the level of effort and the cost in a way that produces a fair outcome for both parties. If you follow this approach, however, you must be sure to eliminate any similar management costs from overhead pools that are being charged to you so that there is not a duplication of direct and indirect costs. Once again we would suggest an advance agreement in the contract stating the cost methods being used and any agreed-upon adjustments to the overhead pool to eliminate duplication of costs, if necessary.
Still another approach might be a fixed dollar amount of fee or profit negotiated on a case by case basis to compensate the prime contractor for its management efforts and risks in the subcontract effort called for in the Task Order. Once again, if you use this approach you will want to be certain that any similar subcontract management costs have been removed from overhead pools being charged to you so that there is not a double recovery - one through overhead charges and one through additional profit. Whatever method you believe best for your situation, we would advise discussing the methods being considered with the cognizant government auditors who have knowledge of this contractor's accounting system and billing practices, and get their opinion on the method you are thinking about negotiating. Many times they will have additional insights that will prove beneficial and avoid problems later at the time of final contract audit. (Revised: October, 2010)