Subcontracting Government Contracts: Best Practices

During the 2020 fiscal year, the United States government shelled out upwards of $665 billion on contracts, an uptick of more than $70 billion from the previous year. To claim as big of a slice of that pie as possible, prime contractors routinely enlist the services of subcontractors so they can take on more work.

Under these arrangements, primes and subs often find themselves in otherwise-avoidable predicaments because they don’t do their due diligence when it comes to creating and agreeing to subcontracts.

Keep reading to learn more about what government subcontracting is and the best practices to follow when subcontracting government contracts for both primes and subs.

Government Subcontracting: The Basics

If you’re wondering how to subcontract with the government, here’s a brief primer.

When primes win business from the federal government, they often look to hire subs to be responsible for certain clauses in the contract. By doing so, they’re able to take on more projects without having to hire more workers themselves. At the same time, subcontracting also enables small businesses to get work from the government they wouldn’t be able to land themselves, albeit indirectly.

With the proper contractual arrangements in place, subcontracting is a win-win-win scenario for all three parties: the government, the prime and the sub.

Unfortunately, not every subcontracting contract leads to smooth outcomes for all parties. For example, it’s not uncommon for subs and primes to get into disputes when subcontracts aren’t written as thoroughly as they should be.

The good news is that by doing your due diligence and understanding the best practices of subcontract management, it’s easier to avoid such disputes, leading to better outcomes for both sides of the equation.

How to Manage Government Subcontracting

When it boils down to it, subcontracting is like any interpersonal relationship. If you want things to go well, you need to treat the other side with respect. Since two parties are going to be working together, both sides want to make sure the other is accountable and is pulling their own weight. After all, everyone can remember what it was like to work on a group project in high school when somebody slacked off. There’s tension, distrust, and the work doesn’t go as smoothly as it otherwise should.

Ensuring successful engagements between primes and subs starts with taking the right approach. To do this, both sides need to:

• Operate with integrity and work together in a cooperative spirit. Whenever you’re contracting with the federal government, the work is typically governed by laws and regulations. As such, primes don’t have a lot of wiggle room. Since an issue will almost certainly come up during the course of the contract, it’s important for both primes and subs to know who they’re getting into business with and make sure that the party intends to operate with integrity and be as cooperative as possible.
• Communicate effectively, honestly, and with transparency. For the best results, both parties need to be honest and transparent, communicating any issues as they arise. That way, they stay on the same page. Understanding that subs might not have as much experience working with the government, it’s imperative that primes tell their subcontractors to report any issues that come up immediately since a failure to do so could result in a contractor incurring a loss of certain claims.
• Be empathetic and understanding of the other side’s concerns. While some folks might think empathy is a bit too mushy to bring into a business relationship, the fact of the matter is that the kinder you are to your business partners, the better things turn out. By understanding where the other side is coming from, you get a better understanding of your negotiating power. For example, when a sub understands why a prime is thinking of things in a certain way, they’ll know where pushing back is a non-starter. At the same time, they’ll also know where primes can modify provisions in a way that’s acceptable to them.

Now that you have a better idea of the right approach to take to subcontract management in government contracting, let’s drill down a bit further to explore additional best practices for managing flow-down clauses, pass-through claims, and claims between primes and subs.

Best Practices for Flow-Down Clauses

In government contracting, a flow-down clause is a Federal Acquisition Regulation (FAR) that essentially stipulates that the subcontractor will be bound to the contractor in the same manner that the contractor is bound to the government. In some cases, flow-down clauses refer to other risk-shifting provisions that protect prime contractors in the event their subs mess up.

The federal government contracting world is unique in the sense that primes are forced into strict positions and often lack the flexibility to negotiate. In most cases, what’s in the contract is regulatory mandated, and the prime is more or less bound by what the government says. Similarly, in the event a dispute arises, primes need to follow a distinct set of resolution procedures, which includes going to specific courts and following complex administrative processes.

A lot of the time, subs — who are used to working on commercial contracts or with smaller, local governments — aren’t aware of all these provisions. Since the resolution process is different, more complicated, and can take longer, it’s important that everyone stays on the same page and knows what to expect. Due to these nuances in the federal government space, flow-down clauses are often a bit different, and likely more important, than they are in other lines of work.

Despite this, primes are often reluctant to negotiate with subs in the first place, for a variety of reasons. For starters, the last thing a prime wants is to hire a sub that ends up damaging their relationship with the government, leading to a loss of work. Even if a sub messes up, the prime is still on the hook because the government is contracted with them. What’s more, in the event an issue arises in the subcontract, the prime doesn’t want to be stuck in the middle, forced to fight both sides. Additionally, primes may worry about the potential consequences they’ll face if their sub lies or commits fraud.

But it’s not all smooth sailing for subs either, particularly those who are relatively new to the federal contracting space and aren’t used to its complexities. Oftentimes, subs are worried about what might happen if something were to go wrong while work is being completed. The sub won’t be able to go to the government directly, and they likely won’t want to endure the long process required to potentially get remedies.

First and foremost, mandatory flow downs are a no brainer. Any FAR provisions that outline where you need flow downs need to be adhered to. Keep in mind that mandatory flow downs aren’t automatic; you still need to include specific language in your subcontract.

Beyond these requirements, primes need to be vigilant when it comes to making sure a sub is performing correctly. To this end, primes need to think about what protections they need to build in — including notice failures and clauses about disputes — to protect themselves.

For example, imagine the government terminates a prime for convenience. In such a scenario, nobody is at fault, but the government no longer needs the contract to be fulfilled. If the subcontract doesn’t have language that reflects the subcontractor can be terminated for convenience, the prime may be on the hook for the remainder of that contract. Luckily, this scenario can easily be avoided by flowing down a convenience clause to the subcontract.

Ultimately, primes need to think through every possible contingency and scenario that might come up during the course of work. If any of these possibilities implicates the sub, it should be flowed down to the subcontract.

On the flip side, a sub might want to push back against a terminated for convenience clause being flowed down directly, which would mean that the prime could terminate their agreement for convenience. Instead, they can suggest language that indicates the sub can be terminated for convenience only in the event that the prime is terminated for convenience first.

The biggest mistake subs make is agreeing to nonspecific vague flow down clauses. When a stipulation is unclear — think: “All relevant and applicable provisions of the prime contract are incorporated by reference except that the owner should be changed to contractor and contractor shall be changed to subcontractor” — subs are essentially agreeing to something they don’t have any idea about. If a sub has never seen the prime contract, there’s no way to tell what they’re getting into.

For the best outcomes, subs need to understand their exact obligations and responsibilities and only accept flow-down clauses that fit under that umbrella. Whenever possible, subs should never agree to catch-all flow-down clauses.

Tip: As you can see, there’s a lot to consider here. In most cases, contractors and subcontractors would be wise to enlist legal counsel who can help them navigate these complex issues.

Best Practices for Pass-Through Claims

Unlike primes, subs don’t have a direct path to submitting claims against the federal government. That’s because the government has sovereign immunity, and only parties that are contractually bound to the government can enter into litigation with it.

In the event the government suspends a project in a way that causes the sub to incur damages or delays that they weren’t anticipating, they need to put together a claim and ask the prime to sponsor it, thereby passing it through to the federal government.

This is a long and arduous legal process that can become a huge source of conflict in sub-prime relationships. On one hand, the prime is worried about being stuck in the middle of an argument between the government and their sub — and that they might be responsible in the event the sub is acting in a fraudulent manner. On the other hand, the sub is worried about not having a direct remedy for a claim and not being able to endure a lengthy process even if they do.

Subcontracts need to be drafted in a way that addresses these concerns, including: outlining which issues the prime will sponsor, how subs will help in the preparation and litigation of a sponsored claim, and what will happen in the event a sub commits fraud during this process, among other relevant issues. Further, subs should also include arbitration clauses, dispute clauses, and liquidating agreements to cover every possible scenario.

Best Practices for Claims Between Primes and Subs

What happens when a prime refuses to honor a subcontract by refusing to pass through a claim that is supposed to be passed through? What happens when a subcontractor doesn’t communicate transparently, which causes issues with a project?

Any issues that might arise between primes and subs need to be addressed in the subcontract. This should include topics like mandatory mediation, arbitrability, where disputes will be settled, and who’s responsible for covering legal fees.

As you can see, managing government subcontracts is no easy feat. But with the right approach, both parties can protect themselves and build more resiliency into their businesses because of it.

For more information on the best way to manage government subcontracts, watch this webinar.

This content was adapted from a webinar presented by Maria Panichelli, partner and chair of the government contracting practice group at McCarter & English, LLP.