The FAR Council has proposed numerous significant changes to the Federal Acquisition Regulation for payments for non-commercial time and material and labor hour (T&M/LH) contracts and when use of T&M/LH contracts are appropriate for commercial items.  Payments changes under FAR Case 2004-015 include:

Billing Subcontractor’s labor.  At the root of a proposed change to FAR 52.232-7, “Payments Under T&M and LH Contracts” is whether the government will pay for subcontractors’ efforts based upon the contract’s fixed hourly rates or on the prime contractor’s actual costs.  The new rule would require listing subcontractors, in the payments clause for the prime contractor, to be paid using contract rates for that effort.  If the subcontractor is not listed, it would be treated as an “other direct cost” (ODC) and the government would pay only the amount invoiced by the subcontractor and any relevant indirect costs but no profit.  For indefinite-delivery contracts, the contracting officer would include language in the FAR payment clause stating the subcontractors performing direct labor hours would be listed in each task order.  The change requires the prime contractor be vigilant about listing the subcontractors in the FAR payment clause and failure to do so risks the government’s refusal to pay for subcontract effort on the basis of contract rates.

The FAR payments clause provides for payment at the contract’s hourly rate for “direct labor hours performed.”  This language is commonly interpreted to encompass prime and subcontractor efforts where, for example, blended rates may be based on the assumption that both prime and subcontractors efforts will be covered by the contract labor rates.  In contrast, the clause also addresses “materials and subcontracts” and states that a prime contractor will be compensated for this effort, which is often called ODC, on a cost reimbursable basis.  The difference between these two treatments was addressed in a 2000 ASBCA decision involving Software Research Associates where the board held that subcontractors should be paid the rates in the contract if they do the work described in the contract’s labor categories and are qualified to do so while if they do not meet this test, then they are paid on a cost-reimbursable basis.

Expanding definition of “materials.”  Both FAR 16.601, Time and material contracts and the payments clause discussed above address treatment of “materials” (e.g. cost reimbursements, prohibition of profit, allowability of applicable indirect costs) but the current description does not address subcontract costs even though they are often more significant.  The proposed change would revise “materials at cost” to include “direct materials, subcontracts for supplies and services, other direct costs and applicable indirect costs.”

Contractor furnished material.  The Council has proposed amending Alternate I to FAR 52.232-7(b)(8) to state if a contractor furnishes its own materials that meet the definition of a commercial item at FAR 2.101 the price for such materials shall be the contractor’s established catalog or the market price.  The ability to charge at such prices should depend on the CO deciding whether an alternate clause should be included in the contract.  Since commercial prices presumably include an element of profit, the Council has proposed revising the FAR provision to provide for an exception of no profit or fee on these materials.

Billing subcontracts and interdivisional transfers for incidental supplies and services.  The Council is proposing to clarify that subcontracts for incidental services be reimbursed at the actual subcontract price plus allowable indirect costs while for interdivisional transfers, the proposed change would limit reimbursements to actual rates or commercial prices of the division performing the work.

Application of Prompt Payment Act.  The proposed change would add language to FAR 52.232-7(i) that would include application of the Prompt Payment Act for interim payments under T&M and LH contracts for services (Fed. Reg. 56314).

Implementing the 2004 National Defense Authorization Act, the FAR Council has proposed changes to allow for expanded use of T&M and LH contracts for commercial services under certain circumstances.   The government has studied how T&M/LH contracts are used in the commercial world and concluded they are used (1) when requirements are not sufficiently understood to complete a well-defined scope of work and risk of increased costs can be managed by surveillance of costs and performance (2) these same services are generally offered on a fixed-price basis and (3) some services - e.g. emergency repairs – are sold predominantly on a T&M and LH basis.  In light of these findings, the government has recommended the proposed rule, to make sure such contracts are used in the “best interests of the government,” allow an agency to purchase any commercial service on a T&M or LH basis if the agency has completed a determination and findings (D&F) containing sufficient facts and rationale to justify that a firm-fixed price is not suitable.  The D&F should establish it is not possible at the time of placement of the contract or order to accurately estimate the extent or duration of the work or anticipate costs with any reasonable degree of certainty (Fed. Reg. 56318).

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