Before the contract is signed, what text are you required to add? Some items are good ideas, even if they aren’t required.
When dealing with federal government contracts, one commonly held belief is that there are standard terms and conditions that contractors must include in all subcontracts—and that subcontractors are obligated to accept those terms and conditions. This is largely untrue. In fact, very few clauses must be included in a subcontract and most of those deal with clean water, non-discrimination and other socio-economic issues. Those clauses impose obligations that are required by federal law in any event, so it does not matter whether the clause is included or not.
Additional Resources in this Section:
A different approach is needed, one that focuses on clauses the prime wants or the sub doesn’t want – a classic negotiation situation. We urge you to think about those issues in the context of your own prime subcontract negotiations.
A number of texts are available that include suggested terms and conditions. The ABA Public Contract Section publishes such a text. It would be wise to have a collection of these materials in every subcontracts department so you have examples of clauses. But that doesn’t mean you should use these clauses or that they are required, or that you cannot draft something better for your particular situation, whether you are a prime or a sub. This is an area where robotic approaches are inappropriate.
A different approach is needed, one that focuses on clauses the prime wants or the sub doesn’t want – a classic negotiation situation. The purpose of this resource is to cause you to think about those issues in the context of your own prime subcontract negotiations.
A number of texts are available that include suggested terms and conditions. The ABA Public Contract Section publishes such a text. It would be wise to have a collection of these materials in every subcontracts department so you have examples of clauses. But that doesn’t mean you should use these clauses or that they are required, or that you cannot draft something better for your particular situation, whether you are a prime or a sub. This is an area where robotic approaches are inappropriate.
What Clauses Should Be Included in a Federal Government Subcontract?
“In the final analysis, it is the economic and political relationship between the prime and the sub that is of utmost importance. The legal part of the transaction is much less important.”
Contrary to what many people think, there are very few clauses that absolutely have to be flowed down from (1) the federal government to (2) the prime contractor, and then (3) to the various tiers of subcontractors.
But there are basic clauses that are probably most important to a prime in a subcontract. They are: (1) changes; (2) inspection; (3) terminations; and (4) warranties.
All of these clauses are not mandatory flowdowns. While it may be very wise to flow these clauses down to protect the prime or the subcontractor, they are not clauses that must be flowed down. Therefore, they are not non-negotiable items. Although the prime may think differently, these clauses are fully negotiable by the subcontractor if it has sufficient bargaining power.
Items That Must Be Considered During Subcontract Negotiations
The federal government recommends that certain clauses be flowed down.
For example, the FAR suggests that the Termination for Convenience clause (or the same) language be included in subcontract terms. Further, if it is not included, the government may not pay for recoveries in excess of what would have come out of the standard, federally oriented termination for convenience.
Obviously, this is a clause that needs to be flowed down for protection purposes even though it is not mandatory.
Are There “Standard” Terms and Conditions in a Federal Subcontract?
There are, in effect, no standard prime contract or subcontract terms and conditions. While the prime or the subcontractor may insist on having their terms or their “boilerplates” included, all they are doing is stating their preference that you use their terms and conditions. There is no reason not to take logical and polite exception to the terms, and negotiate for terms you want.
Taking Exceptions to Terms and Conditions
Politeness, truthfulness and openness are always best if you cannot accept a term for one reason or another. The other side may have had other contractors complain about similar terms, and they may decide to say, “All right, we will take it out if we can agree on other things.” If necessary, give them the basis for your objection. However, if you do not have to give a basis for an objection, do not do so. The other side may come up with a different basis from yours on its own, and pull the clause.
Another technique that many people use is to try to give up from, or agree to no more in the subcontract, than the federal government would require of its prime contractor. An example is the inclusion of an onerous Notice of Changes clause, which a subcontractor would have difficulty complying with. In this situation, the subcontractor could simply state, “we will accept the Federal Clause as a provision — after all that is what the government is requiring of you, and it would be unnecessary or unfair to require more of us.”
If you know the federal clauses, it would be a good opportunity to fall back on them as a baseline that you do not want to go beyond. This is true for all important terms and conditions. American Pipe and Steel Corp. v. Firestone, 292 F.2d 640 (9th Cir. 1961) (meaning of term “equitable” adjustment in a subcontract—federal concept applied).
Particular Terms and Conditions
As indicated above, there are particular terms that need additional focus in every subcontract negotiation:
1. Changes Clause
The Changes Clause is one of the most important clauses. It is one of, if not the only way, that contract prices and schedules can be changed. A subcontract cannot be accepted if it contains a Changes Clause that the subcontractor does not understand the operation of. As stated, while the federal clause is not perfect, at least people understand it, and there are numerous board and court decisions interpreting it. Go with predictability. Remember, in a commercial subcontract, the Changes Clause should be bilateral, not unilateral. Can this be negotiated in other subcontracts?
2. Inspection Clause
The standard federal inspection clause is also hardly perfect, but it also has definite rights and obligations that people tend to understand. It is much better to use this clause than to do nothing, or do something incomplete because under UCC 2-513 the prime contractor can often then inspect in “any reasonable manner.” That is certainly unacceptable.
Inspections should be closely defined in terms of the parties’ rights and obligations, and most importantly as far as standards for inspection and rejection. Next to the Changes Clause, the Inspection Clause, and any clause dealing with terms of acceptability criteria are highly important. They state the final close out standards by which performance is completed and items must be accepted and paid for. Pay particular attention to negotiation of this clause and its details. Remember, also, that such requirements tend to be scattered through more than one provision neatly labeled, “Inspection.”
Should There Be a Warranty Provision in Federal Subcontracts?
“A different approach is needed, one that focuses on clauses the prime wants or the sub doesn’t want – a classic negotiation situation.....think about those issues in the context of your own prime subcontract negotiations.”
The Federal Government often does not use warranty provisions. Once an item is accepted, the federal government’s only protection and remedy is for latent defects. At the subcontract level, commercial parties generally have some kind of warranty provision.
Most companies attempt to do two things with the warranty provision:
1.Replace or Repair
Companies often only want to be obligated to “replace or repair” items instead of beingsubject to broad payment obligations for “damages.” Repair and replace obligations are predictable. If you are running production lines, you know how many items roughly are being returned. You can use that in your future pricing. You know the cost to repair and replace, and whether doing so is inexpensive, or if it is expensive, at least such costs are predictable.
2. Capping Out Warranty Obligations
Secondly, many companies will try to cap out warranty obligations, and so state in a Warranty Clause, which holds that in any event, the company will not pay more out than a set amount, or the total subcontract price, to respond to claims of the prime contractor. Why would you want to sell an item—for example, a radio for $10,000.00— and then be open to claims of $100,000.00? Selling a radio, and knowing you will only have to pay the profit on the sales price back, i.e. $1,000.00, sets at least a predictable limit on damage claims coming back against a company.
Are Assignment Issues a Concern in Federal Subcontracts?
The prime’s boilerplate for subcontracts will often state that items of work cannot be subcontracted or assigned to certain other parties without the prime’s permission.
This may not be enforceable in court. This provision can, and often does, provoke disputes. Have a clear idea of what to do about further subcontracts, say so politely, and offer to keep the prime informed. The prime will often consent to such a provision. However, do not give the prime contractor the right to approve any subcontracts as that can provoke disputes and work stoppages. If no provision is in the subcontract, the U.C.C. permits further subcontracting. U.C.C. 2-210.
How Do I Ensure There Are No Disputes About Ownership of Data in a Federal Subcontract?
There is an excellent separate course on data rights. Subcontractors have peculiar rights they need to be attentive to. If they have specific things that are being utilized that have technical data rights (proprietary/trade secrets), and items are being sent to the federal government, subcontractors need to make sure there is no dispute later about ownership of the data.You may need to get a predetermination of those rights from the prime or the contracting officer to be sure there is no misunderstanding about who owns the underlying technical data. This is especially true when items are being substantially modified, and then sent up the chain to the government. The government could argue that at least the modifications are theirs with unlimited rights given the inclusion of standard data rights clauses. If this is not the case, it needs to be clearly spelled out.
Moreover, subcontractors with highly proprietary projects need to look carefully at technical data clauses or other limitations thereon, and probably fight to get them all out of the subcontract. If the item is commercial, of course, no such clauses should be included.
How Do I Structure my Subcontracts to Avoid Additional Work for My General Counsel?
As can be seen from all of the foregoing materials, there are numerous decisions that need to be made during the subcontracting process when subcontractors are in their formation stage.
Having individual subcontract administrators on either the prime’s or subcontractor’s side constantly running to their superiors to get clearances to modify a clause or delete a clause is obviously an inefficient way to proceed.
Some large companies have developed a policy or operations manual that gives guidance to individual subcontract administrators on both sides so that they may determine on their own the levels of flexibility that they have in subcontract negotiations.
For example, a company may decide that it will not allow any modification in its cost or pricing data requirements or its warranty clauses without the corporate general counsel’s approval. That may well be a wise course, in light of the fact that essential legal issues are involved.
However, having the general counsel’s office review all subcontract terms and conditions has not worked for a number of companies. Particularly, if there is a high volume, it is not possible to have each subcontract have a thoughtful review by the legal department.
What is the Best Way for a Large Company to Proceed?
A “management by exception” policy is probably the best course. A detailed policy manual that allows individual subcontract administrators on each side to know what they can and cannot agree to, and where they must go for an approval to deviate, seems like the most logical course. It is what many large companies use that have significant volumes of subcontract activity.
Once a system is agreed to in a company, the issue then becomes how does one decide what the company’s policies are in subcontract terms and conditions. Does the company, if it is a prime, want to have very strong terms and conditions, middle-of-the-road terms and conditions, or easy terms and conditions?
The Consequences
Relatively easy terms and conditions minimize negotiation time and objections, and lead to speedier contract placements. However, that particular prime contractor may be leaving something on the table in terms of additional useful requirements that it could get.
Many prime contractors and large subcontractors, particularly in the aerospace industry, have onerous terms and conditions. They are much more difficult to comply with than what the federal government requires of them. This often leads to extended negotiations and impasses with both sides finally going back to agreement on some middle-of-the-road approach after the expenditure of significant effort.
Would it not have been easier to start with a middle-of-the-road approach to begin with? Are onerous provisions going to be enforced? We suggest some may not under the unconscionable terms provision of U.C.C. 2-302.
A historical approach in deciding how to deal with each individual clause is often best. More senior people, who deal with subcontracts on a daily basis over a period of time in the particular business or industry, know what terms and conditions are generally acceptable, what are not, and where compromises may be made. They also know the company’s business, and what terms and conditions it must have.
A Complete Review and Decisions
The authors have been involved in counseling situations in which companies set aside four consecutive Saturday mornings, and have these experienced people meet to go through the specific company’s terms and conditions discussing the pros and cons of what to include and what not to include. On some occasions, teams were assigned (consisting of two or three people) to deal with specific clauses that were identified as problems from the company’s perspective. Some companies are particularly concerned about warranties, indemnities, or termination clauses. The individual small team can then present their recommendations and findings back to the entire group to make a final decision.
At some point, the entire approach and recommendations need to be discussed with and approved by counsel. They should also be circulated to other interested parts of the company to see if they agree with the approach.
Once this has been done, all of the company’s relevant experience in terms of historical perspective and technical expertise can then be blended into the final product. The final product will not be perfect; there will be errors and mistakes, and the other side in negotiations will no doubt object to various terms and conditions. However, the company’s approach will have been a systematic one, and will represent the company’s best efforts to get a manageable set of terms and conditions in addition to providing guidance to individuals about how to proceed.
How Do I Improve My Prime/Subcontractor Relationships?
The rise in outsourcing, teaming, partnering, and other types of arrangements have caused prime federal contractors to shift increasing initial work responsibility to other companies: subcontractors. This places increased importance on the need to understand the complex issues involved in the prime/subcontractor relationship.
The Basis of the Relationship.
This relationship is political, economic, as well as legal/contractual. Far too much attention tends to be placed in the United States on the legal and contractual aspects of it. International companies tend to place far more emphasis on the economic and political portion of this relationship. Indeed, many of these companies deal with their subcontractors solely on an economic and political basis: Is the subcontractor producing high quality products at a reasonable price? Is it delivering on time? Can it be relied upon? Often the vendor is not the lowest cost vendor and there may not be signed written contractual documents in effect once the business relationship has been established.
What can we learn in the United States from the experience of prime/subcontract relationships in foreign countries? We can probably learn to be more focused on the business aspect of the relationship and how the subcontractor really supports the prime contractor’s efforts with its federal customer. Contract clauses, provisions, and requirements are basically irrelevant if the subcontractor is not providing high quality work on time and at a reasonable price in a non-adversarial way that supports the prime contractor’s efforts with its customer.
The Paradox in the Federal Government’s Interest and Role in Subcontract Relationships with Primes.
It is often said that the federal government has no relationship whatsoever with subcontractors—It contracted with the prime contractor and paid fees to the prime contractor to manage all of the work, including whatever work the prime has subcontracted. Therefore, the federal government has no relationship and no interest in dealing with various subcontract issues.
“There are, in effect, no standard prime contract or subcontract terms and conditions.”
Like many general statements, this statement can be true at various times. It is certainly not correct when there are problems in the relationship between the prime and the subcontractor. At that point, the government, notwithstanding lack of privity, is very interested in issues of the relationship between the prime and the sub. In addition, the government may at times become intrusive in this relationship when it perceives it to be in its economic or social interest to do so. We set out below areas in which problems arise between primes and subs and the prime’s federal customer.
Approval Process: Desire for Oversight Without Responsibility.
Unlike commercial contracts, the federal government often does not retain the right to approve a prime’s selection of its subcontractors. In commercial contracts, it is not unusual to see a provision prohibiting all subcontracting unless there is specific approval by the customer. And the buyer often asserts it has complete discretion whether to give that approval or not. This may not be true under state law.
At the federal level, while the government may not choose to retain the right in its contractual document to approve subcontractors, it has some scrutiny and control over subcontract selection during the proposal process. The government is within its right in a negotiated procurement to question the prime contractor about its subcontractor selections (and their proposals) because this goes to the basis of the business bargain.
If the prime contractor responds to various questions and answers by enumerating various subcontractors it will use, and specifying functions and approaches that they will use to do the work, the contractor will have difficulty after award in shifting away from that subcontractor. See TRW, Inc. (GEODSS), ASBCA No. 27,299, 27,602, 87-3 BCA ¶ 19,964. (When the contractor wants to switch approaches to save money after award.)
In addition, there are standards for Approval of Subcontractor clauses set forth in the (FAR Subpart 44.2.). Approval requirements for subcontractors and use of the clause are largely discretionary. The clause is seen most often in cost-type and incentive contracts, as well as in larger construction contracts that may be fixed price. These clauses provide for the government to approve subcontractors after contract award. They provoke problems and disputes and have resulted in a significant amount of litigation.
Litigation generally takes the form of disputes over what the government’s actual approval rights for vendors are. Can the government simply refuse to approve vendors that it doesn’t like or thinks are risky? he answer to that is probably: No.The Government has to exercise its approval authority in a reasonable fashion over vendors. See cases collected at 3 CCH Government Contract Reports ¶ 21,540.75 et. seq.
At the same time the government can certainly raise reasonable questions and ask for data before it approves the vendor. A contractor should be prepared to respond promptly to reasonable requests for such information.
But, if the government simply chooses not to approve because it thinks the vendor proposed may fail, that is not a satisfactory reason.
Example: The contractor has received a prime contract from the Department of Transportation to install a train washing system at a government depot. It recognizes that there are only several suppliers of the actual washing mechanisms. In the past, the government has used a European concern whose price for the subcontracted items is $1.7 million.
The contractor finds a large American company that has recently purchased a small business that provides similar types of equipment and quotes $700,000 to do the work. The government disapproves the vendor because it does not have sufficient experience in the government’s view.
Is this permissible? Probably not. The government may end up paying the $1 million vendor price difference via a constructive change order.
Applying the Government Approach to Vendor Selection; Contractor Procurement System Reviews (CPSR’s)
The government has a formal procedure for larger contractors in which it reviews their entire procurement system periodically. If it approves the system, then it does not approve most individual subcontract actions. There is an extensive listing of the things that a contractor will be inspected for in terms of its procurement system when these reviews take place every several years. (FAR 44.303)
Contractors who have gone through such procurement system reviews invariably say that the primary focus of the government is on reviewing vendor procurements to see what level of competition has been obtained. Contractors should learn from this experience. The government wants to see the rationale and level of competition among vendors or a written explanation as to why such competition was not possible.
This is an area in which reasonable paperwork makes sense—not for paperwork’s sake, but because it can reflect several years after the fact when one of these inspections is taking place that a contractor has a system in place, in which he routinely obtains competition to the maximum extent possible from all vendors.
Contractor should be sure such a system is in place on a day-to-day basis. In preparation for a CPSR type inspection, a contractor should do his own random sample to be sure competition is being obtained and it is documented in the files for inspection. If it is not, the contractor had best put in place some serious upgrades immediately and explain that to the inspection team in the introductory briefing when they arrive. It is not unusual to have fifty government employees on a CPSR team in the contractor’s plant for a week or two doing such a review.
Federal Government Direction to Prime Contractors To Use Specific Subcontractors: Again, Oversight without Responsibility.
In numerous ways the government on occasions directs, encourages or suggests that prime contractors use specific vendors.
What Should the Prime/Subcontractor Relationship Look Like?
We hope the foregoing materials have shown you that there are no standard terms and conditions, few mandatory flowdown clauses, and really not much federal intrusion into what the prime and subcontractor do.
The subcontract between the prime and the subs is essentially a commercial undertaking. The prime and the sub can do what they want and what they are able to negotiate between themselves.
In the final analysis, it is the economic and political relationship between the prime and the sub that is of utmost importance. The legal part of the transaction is much less important.