Insight

Shaking Hands With Uncle Sam

The risks of contracting with the federal government are legion, but so are the benefits. Here are a dozen key factors for contractors of all kinds to keep in mind.

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Lori Ann Lange

January 13, 2021 08:00 AM

The Federal Government is the largest single purchaser of goods and services in the world. In fiscal year 2019, the U.S. government spent $597 billion; for fiscal year 2020, it’s estimated that expenditures will exceed $600 billion, according to Government Executive. What does all that money buy? You name it: everyday products such as office supplies and clothing but also IT services, construction, and decidedly non-everyday products like complex weapon systems.

Every year, an array of companies elects to enter the government contracts market to expand their business and take advantage of this pool of federal dollars, particularly when the private sector market is drying up. How well they do often depend on how prepared they are. Too often, companies wrongly believe that there’s no difference between doing business with a commercial customer and the government. To the contrary, federal contracts are governed by complex regulations covering bidding, performing the work, submitting and pursuing claims, and closing out the contract. There can be significant penalties for failing to comply with these regulations.

Government contracts likewise contain a large number of nonnegotiable standard clauses that dictate how the contractor must perform. If all that isn’t difficult enough, government representatives think differently than, and are motivated by factors that aren’t important to, their private-sector counterparts.

The key to success for any contractor is to educate itself about how to operate within the government system. Here are a dozen important factors and risks contractors must understand and protect against.

1. False Claims Act. The government is concerned that contractors may engage in "fraud, waste, and abuse." Many politicians, in fact, campaign on the notion that all the government needs to do to balance the budget is eliminate those three notorious malefactors. The primary tool, though not the only one, the government uses to reduce fraud is the False Claims Act. The Act prohibits, among other things, knowingly submitting a false or fraudulent claim for payment or approval, and making or using a false or fraudulent record or statement. Contractors who violate the Act may be subject to civil penalties and treble damages, as well as forfeiture of their claims, and may be prohibited from doing business with the government in the future. In more extreme situations, contractors may be held criminally liable.

The False Claims Act permits either the government or a private person (known as a qui tam plaintiff or relator, who receives a percentage of the recovery) to bring suit against the contractor. In fiscal year 2019 alone, according to the Department of Justice, more than 600 False Claims Act suits were filed, and the government obtained over $3 billion in settlements and judgments.

2. Compliance program. All government contractors are required to have a compliance program whose size depends on the size of the contractor and the amount of work it does for the government. Contractors who have a government contract in excess of $5.5 million and a performance period of 120 days or more must have a compliance program that includes:

  • a written code of business ethics and conduct;
  • monitoring and auditing to detect criminal conduct;
  • periodic evaluations of the program’s effectiveness;
  • periodic assessments of the risk of criminal conduct;
  • promotion of an organizational culture that encourages ethical conduct and a commitment to compliance with the law;
  • employee training;
  • a reporting mechanism, such as a hotline;
  • disciplinary action for improper conduct or for failing to take reasonable steps to prevent or detect improper conduct;
  • mandatory disclosure to the government of violations of the civil False Claims Act and federal criminal laws involving fraud, conflict of interest, bribery, or gratuity violations; and
  • cooperation with government audits, investigations, and corrective actions.

The adequacy and effectiveness of the contractor's compliance program are factors the Department of Justice considers when determining whether to bring charges and negotiate pleas or other agreements.

Too often, companies wrongly believe that there's no difference between doing business with a commercial customer and the government.

3. Cost or pricing data. Before the government can award or modify a contract, it must determine that the proposed price is fair and reasonable. To do so, the government can require contractors to submit cost or pricing data when submitting a noncompetitive bid or pricing a change. Generally speaking, cost or pricing are all facts in the contractor's possession that were used or could have been used to determine the proposed price, including labor and material costs, subcontractor bids, indirect costs, and make-or-buy decisions. The contractor must certify that the data it’s submitting are current, accurate, and complete. The government can audit the data and obtain a price reduction if the data is not current, accurate, and complete.

4. Cost Principles. When the contract is cost-reimbursement or there’s a cost-based change to a fixed-price contract, the amount the contractor can recover is governed by the Cost Principles, a set of accounting parameters that specify when certain costs are allowable and therefore recoverable. Among other restrictions, the Cost Principles make certain costs unallowable (e.g., public-relations and advertising costs; bad-debt collection, entertainment, fines, penalties, and mischarging costs; interest; and costs associated with lobby and political activity) and restrict the methods of allocating indirect costs.

5. Government audit rights. Depending on the type of contract, the government may have the right to audit the contractor’s books and records. It has the right to audit cost-reimbursement or incentive contracts (i.e., those in which the contractor can earn an award fee or additional profit for reduced costs or improved delivery or technical performance). It can also audit time-and-material, labor-hour, and price-redeterminable contracts (those in which the price is determined after an initial period of performance, or after completion). Generally speaking, the government does not have the right to audit fixed-price contracts if certified cost or pricing data were not required, but it can audit change orders under fixed-price contracts.

6. Cybersecurity. Contractors who receive or create certain information relating to their government contracts that is not intended for public release are subject to cybersecurity requirements, the extent of which depends on the contracting agency and the type of information.

Defense contractors who process, store, or transmit covered defense information must have a cybersecurity program in place. At a minimum, the contractor must implement the security requirements in NIST SP 800-171—the publication that contains the controls contractors have to comply with—or obtain a variance, use an external cloud-service provider that meets security requirements equivalent to those established by the government for the Federal Risk and Authorization Management Program (FedRAMP)’s “Moderate” baseline, and apply other measures necessary to provide adequate security.

Government contractors, including defense contractors, who do not process, store, or transmit covered defense information must still implement security controls when federal contract information resides in, or transits through, their information systems. There are 15 security controls encompassing such things as limiting access to information systems, identification and authentication of system users, sanitizing or destroying media containing federal contract information, use of virus-protection software, and limiting physical access to information systems. Specific contracting agencies may impose additional requirements.

Further, when the Cybersecurity Maturity Model Certification (CMMC) program is fully implemented, defense contractors (except those who sell commercially available off-the-shelf products) will need to have a third party certify the contractor's ability to protect controlled unclassified and federal contract information. Contractors will be certified to one of five maturity levels ranging from basic cyber hygiene to advanced depending upon their cybersecurity processes and practices. The contractor must be certified to at least the level specified in the government's solicitation to be eligible to win the contract.

7. Prevailing wages and paid sick leave. Government contractors who perform service and construction contracts are required to pay their workers the applicable prevailing wage rate and fringe benefits set forth in the contract's wage determination(s). They must also pay their workers overtime for any hours worked in excess of 40 hours per week. Prime contractors are financially liable for subcontractor violations—if a subcontractor at any tier fails to pay required wages or fringe benefits and the Department of Labor is unable to recover the underpayment from the subcontractor, the prime contractor is liable.

In addition to prevailing wages, government contractors who perform service and construction contracts are subject to federal minimum wage requirements. The 2020 federal minimum wage for government contractors is $10.80 per hour and will rise to $10.95 on Jan. 1, 2021. It applies not just to employees directly performing work on the contract but also those working “in connection” with the contract if the employee spends 20 percent or more of his or her hours performing work connected to the contract. An employee is considered to be performing in connection with a government contract if her or she performs duties necessary to the performance of the contract but is not doing the specific contract work. Employees such as receptionists, secretaries, administrative assistants, and document clerks can therefore fall within the purview of the requirement.

Finally, contractors must give paid sick leave, up to 56 hours annually, to their employees who are working on or in connection with a federal contract. Covered employees accrue no fewer than one hour of paid sick leave for every 30 hours worked, and this leave is in addition to any fringe benefits required to be paid under applicable prevailing wage laws.

8. Buy American Act. Contractors who supply goods or construction materials to the government must comply with the Buy American Act—which mandates that only domestic items be supplied—unless granted a waiver. In general, an item is considered domestic if it is manufactured in the United States and, depending on the type of product, meets domestic content requirements.

9. Covered Chinese telecommunications and video surveillance equipment and services. Contractors are prohibited from supplying to the government and, more importantly, using in their internal operations, certain Chinese telecommunications and video surveillance equipment and services. Among the banned products are telecom equipment from Huawei Technologies and ZTE and their subsidiaries or affiliates, as well as video surveillance and telecom equipment produced by Hytera Communications, Hangzhou Hikvision, Digital Technology, or Dahua Technology, and their subsidiaries or affiliates.

10. Counterfeit parts. Certain government contractors must have a program in place to detect counterfeit electronic parts, and an avoidance system to ensure that counterfeit or suspected counterfeit electronic parts are not used in performing government contracts. They also must comply with the government's order of preference for obtaining parts, which prioritizes purchasing from the original manufacturer, authorized suppliers, or suppliers that obtain parts from the manufacturer and authorized distributors.

11. Equal employment and affirmative action. The government has three key equal employment opportunity programs that require contractors not to discriminate and to take affirmative action in hiring and employment decisions. Executive Order 11246 prohibits discrimination on the basis of race, color, religion, national origin, sex, sexual orientation, and gender identity. The Vietnam Era Veterans’ Readjustment Assistance Act (VEVRAA) prohibits discrimination against veterans, while Section 503 of the Rehabilitation Act of 1973 prohibits discrimination against individuals with disabilities.

In addition, depending on the type and size of the contract, contractors must develop and implement written affirmative action plans and must submit an annual Employer Information Report (EEO-1) and a Federal Contractor Veterans' Employment Report (VETS-4212). The Office of Federal Contract Compliance Programs (OFCCP) may audit the contractor for compliance and require the contractor to implement remedial measures.

12. Small-business subcontracting. Government policy is intended to ensure that a fair share of its contracting dollars go to small businesses. When the government awards a contract to a large business subcontractor, it usually requires the contractor to award a specified percentage of the work—which can vary from contact to contract—to small business subcontractors. Contractors must submit small business subcontracting plans and reports on their progress toward meeting the small business goals. Contractors who fail to make good faith efforts may be subject to liquidated damages.

Overall, contractors who fail to comply with their obligations under their government contracts may be subject to a variety of penalties including withholding of payment, liquidated damages, forfeiture of claims, termination of the contract for default, and suspension and debarment from doing further business with the government.

Considering all the risks associated with working with the government, contractors might ask themselves why they’d want to do so in the first place. Well, there are a number of benefits. First, the government is reliable customer; it will not go bankrupt or be unable to pay its bills. Second, unless there’s a dispute, the government pays its contractors promptly, usually in 30 days or fewer. Third, the government has programs under which contracts may be awarded solely to small businesses on a set-aside (that is, only small businesses can compete for the work) or sole source basis. Fourth, if the contractor follows the rules, the government generally is fair and does not attempt to reduce the contract amount due for business reasons, as often happens in the private sector. Finally, some government contracts are prestigious; enabling the contractor to build its résumé.

Government contracts can be valuable, profitable opportunities, especially during difficult economic times when the commercial market is shrinking. To be successful, though, contractors must understand how to do business with the government, and the unique risks associated with contracting with the federal government.

Lori Ann Lange is a partner and co-chair of Peckar & Abramson's Government Contracting & Infrastructure practice, leading the firm's federal government contracting efforts. She specializes in counseling government contractors in all aspects of contracting with the federal government, including solicitation and contract reviews, bid protests, small business issues, claims and disputes, and corporate compliance counseling.

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