Prime contractors vexed by reimbursement rules

How much should contractors get paid for work they farm out to subcontractors? It depends on whom you ask.

The General Services Administration, which runs a set of supply schedules that federal agencies can use to purchase products and services, has ruled that in some situations, prime contractors hired under the schedules can charge the government their own rates for work performed by subcontractors. But in other cases, GSA has said, the prime contractor can charge the government only what it is paying the subcontractor-meaning it can't keep any profits for itself.

Last year, the Defense Contract Audit Agency issued a memo saying this ambiguity was "causing uncertainty among auditors and contractors as to what rates should be used to reimburse the prime contractor for the effort of the subcontractor."

Now some contractors are saying that confusion is translating into lost profits. "I have members who have had money withheld from them that they feel they are owed," said Larry Allen, an executive vice president with the Washington-based Coalition for Government Procurement, which represents contractors. He said some Defense contracting officers interpreted the DCAA memo to mean prime contractors should be allowed to charge only what subcontractors charged them.

That means prime contractors don't get paid for their work managing the contract, Allen said. "Not everything goes well in business relationships, and as the prime, you're the one that's ultimately responsible," he said.

GSA's Web site describes two types of arrangements between contractors on its supply schedules. Each has separate rules for how much the government can be charged. Under a Contractor Team Agreement, in which multiple contractors collaborate on a project and hold joint responsibility, contractors can charge only the rate that they have negotiated with GSA.

Under a prime-subcontractor relationship, however, the prime contractor can charge its own rate for the entire project, even if the subcontractor charges a lower rate-meaning the prime contractor can keep the difference.

But the Federal Acquisition Regulation limits the amount a prime contractor can be reimbursed for subcontracting work in certain types of contracts. The regulations state: "The government will not reimburse the contractor for any costs arising from the letting, administration or supervision of performance of the subcontract, if the costs are included in the hourly rates."

According to the Defense Contract Audit Agency, the different sets of rules have caused confusion. A DCAA spokeswoman said GSA has acknowledged the problem and is working with the Pentagon to make its guidance more clear.

David Drabkin, deputy chief acquisition officer at GSA, said the appropriate reimbursement rate depends on the situation. "If the contract is a fixed-price, performance-based contract, the prime contractor, as long as it delivers the level of services contracted for, has the freedom to choose how to best achieve the agency's outcome. In other cases, it is very fact-specific and there is no general answer," he said.

Drabkin said in most cases the prime contractor should discuss the situation with the agency contracting officer in charge.

That answer isn't satisfactory to many contractors and their allies.

"It's a problem for every contractor selling services to the government," said Jonathon Aronie, a partner and expert in government contracting at the law firm Sheppard, Mullin, Richter & Hampton. "Contractors shouldn't be put in a position where the rule changes, depending on who they talk to," he said.

Aronie said prime contractors should be allowed to charge their own rate to the government and make a profit by paying the subcontractors a lower rate. "The GSA schedule is all about prenegotiated rates that are price-based, not cost-based," he said. The cost of the subcontractor to the prime contractor should be irrelevant.

Industry groups also say subcontractors, many of which are businesses, will suffer if prime contractors aren't allowed to charge a premium.

"It would be devastating for small business, because big business would not use [subcontractors]," said Bill Gormley, president of Federal Sources Inc., a McLean, Va.-based consultancy.

Patti Reardon, president of the Sterling, Va.-based firm Government Sales Consultants, said her clients have clashed with DCAA auditors over the proper rates to charge the government. "In my experience, especially dealing with a lot of smaller firms, they don't really go through these things with a fine-toothed comb… some of them aren't even aware" of the issue, she said.