New defense rules might cost contractors money

The final Defense Federal Acquisition Regulation Supplement (DFARS), released in February, is an improvement over its predecessor, but its withholding clause could cause problems and payment delays for many Defense Department contractors, experts say.

An April 25 cross-industry panel of contracting experts agreed that the new DFARS is the most comprehensive change in federal contracting in several years.

But they centered their attention on assessing the new withholding clause, which calls for withholding a percentage of the contract payment if the Defense Contracting Management Agency finds “significant deficiencies” in any of six business systems cited in the new rule.

Timothy Callahan, executive director for contracts at DCMA, said the old rule had a variety of regulations, no consistent language in determining whether a contractor’s work was adequate or inadequate, and what and how corrective actions were to be taken.

“Under the way we were operating if a contractor had a deficiency with a business system, they put forward an adequate corrective action plan; that submittal of an adequate action plan oftentimes was sufficient to change the status from a disapproved system to an approved system,” Callahan said.

“And there really wasn’t the follow-through on either the contractor’s part or our oversight to ensure that that corrective action plan was put into place,” he added.

The new DFARS business system clause normally does not apply to small businesses, competitive fixed price contracts or contracts less than $7.5 million, he said, adding that the agency will issue a withhold assessment on contracts valued at more than $50 million.

Callahan said DCMA now will use a four-phase program to determine if any of six contract business systems are judged to contain “significant deficiencies.”

“If it’s one business system, the withhold [amount] is 5 percent. If it’s two or more business systems that are being disapproved, the maximum is 10 percent,” he said.

“The withholds are against the financing arrangements of the contract,” Callahan explained, including progress payments, performance-based payments and interim cost vouchers.

The contractor then has 45 days to turn in its corrective action plan.

“If it’s an adequate corrective action plan the withhold will be reduced by 2 percent,” Callahan said. “We’re trying to minimize the hurt but still keep the pressure on to get this corrective action implemented.”

When the contractor notifies the government of the implementation, the government has 90 days to validate that corrective action has indeed occurred and that the deficiencies have been corrected.

“If we don’t get out there within 90 days, it’s another automatic reduction in the withhold [penalty] of 50 percent,” he said.

Participants at the Compusearch-sponsored panel “Contracting in a Time of Change” agreed there was a definite need for a new DFARs rule.

But Robert Burton, partner at Venable law firm and former deputy administrator in the Office of Federal Procurement Policy, called the business system clause draconian and hard to implement.

Alan Chvotkin, executive vice president and counsel at the Professional Services Council, said there is a lot of mythology surrounding the rule.

However, he praised DFARS for providing “contractor engagement and response at every opportunity. So it’s really moved to a compliance rule rather than a withholding rule.”

Chvotkin said the attributes in each of the six business systems are more clearly defined now than they were early on in the drafting process “But there’s still a lot of ambiguity and a lot of room for interpretation,” he said.

Addressing the ambiguity and need for interpretation, Chvotkin offered several steps contractors need to take even before winning a contract affected by the rule.

He said contractors should always document their own business systems, be aware proactively of the contract clauses and the risks inherent in DFARS.

Robin Schulze, director of the Government Contractor Advisory Services at accountants Baker Tilly Virchow Krause LLP, said she believed the strength of the new DFARS was its peer review requirement.

But she said, “I believe that when you get the initial determination [of a deficiency] if you were able, in your response to that, provide an action plan you could start at 2 percent [withhold] instead of the 5 percent. And the same thing should be true if you voluntarily disclose a deficiency that you’ve identified and have already started working of it.”

Defending the clause and the remediation process, Callahan suggested that if a contractor knows there is a problem and takes corrective action right away, “we can start out with a withhold of 2 percent, it doesn’t have to be 5 percent,” he added.

“We would like this to be a collaborative operation,’ Callahan said, “where we’re communicating as we go along.”