This post was written by Stephanie E. Giese.

Contractors for the U.S. Department of Defense, as well as the civilian agencies should expect to start seeing the Defense Contract Audit Agency (“DCAA”) recommend disallowance of certain contract costs on grounds that a contractor or subcontractor fails to “add value” when it subcontracts out more than 70% of its work under a federal government contract. As a result of new DCAA guidance, now such contractors and subcontractors may be required to provide evidence of “adding value” to DCAA during forward pricing rate proposal audits, incurred cost audits, and audits of final vouchers.

In February 2011, DCAA published guidance regarding auditing compliance with FAR 52.215-23, Limitations on Pass-Through Charges. FAR 52.215-23 is a clause that applies to prime contractors and subcontractors at all tiers with cost reimbursement contracts that exceed the simplified acquisition threshold. For DoD contractors and subcontractors FAR 52.215-23 applies not only to cost reimbursement contracts, but also fixed-price contracts, except those for commercial items or those awarded with adequate price competition. For example, DCAA may disallow a contractor’s indirect costs and fee on work performed by a subcontractor if the subcontractor is performing 70% of the total cost of the work under the contractor’s prime contract. In this case, DCAA may disallow the prime contractor’s indirect costs and fee related to the subcontract if the prime contractor is not successful in proving its subcontract management functions “add value” to the performance of its government contract. The same rule applies to a subcontractor who subcontracts 70% of the work under its subcontracts to lower-tier subcontractors. In other words, the federal government does not want to pay a government contractor for indirect costs and fee associated with managing a subcontractor (in addition to the subcontractor’s indirect costs and fee) if the subcontractor is actually doing most (more than 70%) of the work, unless such a contractor can show it “adds value”.

Determining whether a contractor complies with the FAR 52.215-23 clause is going to be very subjective based on the definition of “added value” in the clause. “Added value” means “that the Contractor performs subcontract management functions that the Contracting Officer determines are a benefit to the Government (e.g., processing orders of parts or services, maintaining inventory, reducing delivery lead times, managing multiple sources for contract requirements, coordinating deliveries, performing quality assurance functions).”

Contractors and subcontractors should look for this FAR 52.215-23 clause in their solicitations and contracts with the government and be prepared to comply with it. Compliance includes, but is not limited to preparing evidence for DCAA to show that its subcontract management function “adds value”, as well as flowing the same requirements down to suppliers.