Infotech and the Law: Paying subcontractors under T&M contracts gets complex

John Jensen

The contracting community should prepare itself for new rules that could significantly affect payment for work done by subcontractors under time-and-materials or labor-hour contracts. The rules would change the central payment clause, Federal Acquisition Regulation 52.232-7, "Payments under Time-and-Materials and Labor-Hour Contracts."

At the root of the proposed change is whether the government will pay for the subcontractor's efforts based on the contract's fixed hourly rates or on the prime contractor's actual costs.

The FAR payments clause provides for payment at the contract's hourly rates for "direct labor hours performed." This language is commonly interpreted to encompass prime and subcontractor efforts. Use of blended rates, for example, is based on the assumption that both prime and subcontractor efforts are covered by the contract labor rates.

The clause also addresses "materials and subcontracts" and states that a prime contractor will be compensated for this effort, often called "other direct costs" on a cost-reimbursable basis.

The difference between the two categories of subcontract effort was addressed in February 2000 in an Armed Services Board of Contract Appeal's decision involving Software Research Associates. The board held that subcontractors should be paid the rates stated in the contract if they do work described in the contract's labor categories and are qualified to do so. If the subcontractors do not meet this test, then they are paid on a cost-reimbursable basis.

Enter the proposed rule change. The new rule would require listing subcontractors, in the FAR payments clause for the prime contractor, to be paid using the contract rates for that effort. If the subcontractor is not listed, it would be treated as an "other direct cost," and the government would pay no profit on the subcontract effort. Thus, prime contractors must be sure that the FAR payments clause, as set forth in the prime contract, lists subcontractors.

The rules for indefinite-delivery contracts would be different. The contracting officer could include language in the FAR payment clause stating that the subcontractors performing direct labor hours would be listed in each task order. If the contracting officer chose this approach, the contractor must be sure that the orders name the subcontractors.

This change would the prime contractor to be vigilant about listing the subcontractors in the FAR payment clause. Failure to do so would risk the government's refusal to pay for subcontract effort on a basis of the contract rates, and in some cases it would change dramatically the financial aspect of the contract for the prime contractor.

There are other important proposed changes to "Payments under Time-and-Materials and Labor-Hour Contracts." For one, a contractor would have no right to payment for subcontract efforts expended before the government formally consents to use that subcontractor. Payment would be at government's discretion. Also, prime contractors would have to substantiate the direct labor-hour effort expended by subcontractors with the same level of detail it gives for prime contractor employees' efforts. It also would require both prime and subcontractor employees meet the qualifications of the labor categories.

The proposed rule can be found at 70 Fed. Reg. 56314. Comments are due by Nov. 25.

John Jensen co-chairs the government contracts practice at Pillsbury Winthrop Shaw Pittman LLP, McLean, Va. He can be reached at john.jensen@pillsburylaw.com.

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