Federal procurement contracts can be a lucrative line of revenue for many businesses. But deals between private entities and the government are intensely regulated and raise myriad issues not found in traditional commercial settings. Importantly, these unique challenges are not limited to prime contractors. Subcontractors, too, are bound by some of the legal and contractual obligations that govern these procurements. The result is that private parties working on government projects end up with commercial agreements that include elements of public contract law. Such a scenario creates uncommon dilemmas and potential hazards for a practitioner unfamiliar with government contracting. This article aims to help by discussing some key considerations when reviewing and negotiating a subcontract agreement on a federal project.
When an entity is awarded a government contract, certain provisions appearing in the prime contract invariably must be imposed on subcontractors. Other provisions are not required, but best practices dictate they should also be inserted as term against the sub. These are known as flow-down clauses. And, as alluded to, flow-downs can be mandatory or discretionary. How they are classified meaningfully impacts subcontract negotiations.
Flow-down clauses derive from the Federal Acquisition Regulations as well as any applicable supplemental agency-specific procurement regulations. In some instances, the regulations mandate the clause be flowed down to subcontractors. Inclusion of mandatory flow-downs in the subcontract agreement is non-negotiable. But if the regulation only requires that the substance of the clause appear in the subcontract, as opposed to the full text, then subcontractors are free to negotiate the language of the flow-down provision.
Most flow-down clauses that prime contractors attempt to include in subcontracts, however, are discretionary—the regulations are silent on their imposition. In these instances, subcontractors are neither bound to accept their inclusion nor the proposed language. And often, they should not, particularly when a prime contractor attempts to insert a slew of prime contract clauses through incorporation by reference.
Terminations for Convenience
A termination-for-convenience provision is an example of a discretionary flow-down that routinely appears in subcontract agreements. Every federal procurement contract confers a termination-for-convenience right on the government, whether the language is specifically included, incorporated by reference, or completely left out and read into the agreement by operation of law. Therefore, any prime contractor facing the possibility of a termination for convenience will want to hold a similar right against its subcontractor.
As a result, termination-for-convenience clauses in subcontracts are ubiquitous. And a subcontractor would be hard-pressed to convince a prime to strike it altogether. The better course of action is to negotiate favorable terms. For example, a subcontractor should push for a termination-for-convenience clause in the subcontract that mirrors what appears in the prime contract, as at the prime level, costs associated with the termination are usually recoverable. Additionally, subcontractors will want to negotiate a “government-only” provision such that the prime may only exercise its termination-for-convenience rights as a result of the government terminating the prime contract.
Privity and Pass-Through Claims
A fundamental tenet of public contract law is that subcontractors do not have privity of contract with the government. Thus, absent a willingness or contractual obligation for the prime to sponsor a claim by a sub against the government, known as a pass-through claim, the sub cannot seek recovery of any damages against the entity that directly caused the harm (absent a few judicially created exceptions to the privity rule). Pass-through claim provisions in subcontracts are therefore critical for subcontractors; otherwise, they are left bearing the risk of and possibly suffering from the harm caused by the government with no recourse.
The pass-through arrangement between the parties must be set up in a manner that will survive a jurisdictional attack by the government defendant, however. It is critically important that the prime remain liable to the subcontractor for the damages. Complete discharge of the prime contractor’s liability will defeat its ability to bring a claim against the government for the damages sustained by its subcontractor. A better approach is one based on contingent liability, where the sub releases the prime from liability if the prime agrees to bring the action against the government and remit any recovery to the subcontractor.
False Claims Act Liability and Indemnification
The False Claims Act (FCA), 31 U.S.C. §§ 3729–33, is a federal statute used to combat fraud against the government. It provides that any person who knowingly submits false claims to the government is subject to substantial civil penalties. Extensive and complicated jurisprudence exists over the requisite proof needed to make an FCA case. But contractors and subcontractors should well know that even an inadvertent false submission can subject them to liability.
With that said, prime contractors often include indemnification provisions specifically addressing FCA liability. But the indemnity should go both ways. Subcontractors will want to negotiate for reciprocal indemnification in the FCA context. Additionally, both parties will want to consider and outline indemnification language for losses incurred in instances that could lead to FCA liability, such as failure to comply with applicable regulatory requirements or neglecting to notice any non-compliance.
The intermingling of commercial and public contract terms in subcontract agreements requires careful review of the dispute provisions. Often, the prime contractor will flow down the disputes clause in the government contract, which, in many instances, is beneficial to the subcontractor. But often, the subcontract will also have its own dispute provision. And if the flow-down is through incorporation by reference, an inconsistency arises over which one applies. Courts differ on how to resolve this type of conflict, and their decisions usually involve how the particular jurisdiction interprets the enforceability of flow-down clauses. So it is imperative for counsel to negotiate the exclusion of the prime contract’s dispute provision and instead incorporate any elements of that clause agreed on by the parties into the text of the agreement’s dispute clause.
As adduced, one of the many distinctive aspects of procurement contracting is that the government’s reach extends beyond its contract with the awardee and into the commercial contracts between the contractor and its subcontractors. And with the prevalence of government spending and teaming, it is likely that practitioners in varying fields will have a client needing assistance with a subcontract agreement on a federal project. The considerations above will provide critical insight to counsel undertaking subcontract review and negotiation. And in turn, the client will be better positioned to make the most out of a great opportunity.