Terry Gerton We have on the show talked many times about the new memo from Secretary Hegseth about his contract review of all small business sole source and set aside awards above $20 million. But I am looking forward to, with you, getting into some of the legal specifics here. And before we do that, I wanna do a couple of myth busting things. We have been using the 8(a) shorthand to talk about the target audience for this review, but that’s not really correct, is it?
Dan Ramish That’s a really important point, Terry. So this contract review is much broader than the 8(a) program, and it’s not all about DEI. This is a review of all small business set-aside contracts over $20 million across small business programs. So that’s traditional small businesses, veteran-owned and service-disabled and veteran-owned small businesses, hub-zone, woman-owned, economically disadvantaged women-owned small businesses, in addition to 8(a). So all of those programs are being reviewed as part of this Initiative and I think that those companies will have some concerns about how the Department of War is proceeding with this
Terry Gerton The other vibe you kind of get from the memo is that small business set-asides are bad, but they’re not bad. They’re part of the FAR.
Dan Ramish Terry, I think the government contract community recognizes that small businesses are a critical part of the defense industrial base. And they’re also, the rule of two makes the set aside specifically the law, right? So the rule of two, between the micro-purchase threshold and the simplified acquisition threshold, is in statute. And the FAR includes the rule of two for higher dollar contracts. So the rule of two says that an agency has to set aside a contract for small businesses if there is a reasonable expectation of obtaining offers from two or more responsible small business concerns that are competitive in terms of price, quality, and delivery. And so that’s essentially been one of the critical tools for agencies to meet their small business goals. And so for those of us that believe in the importance of small businesses as part of the defense industrial base, the set-aside program is really important in making that a reality and giving opportunities to small businesses.
Terry Gerton With that really helpful background then, help us understand exactly why DoD says it’s conducting this review.
Dan Ramish So the secretary of war cited primarily eliminating, quote, unconstitutional and non-based DEI initiatives, and then also eliminating all waste, fraud and abuse. Now, of course, waste, fraud and abuse is a concern for everyone in the government contracts community. No one is hurt more by small business fraud than small businesses themselves, because of course companies that serve as fronts for large businesses are taking business from small business companies. And so that piece of it is really all to the good and I think uncontroversial. But the scope of the review and the way that it’s framed and the timing present some concerns, even for small businesses that are doing things right, which is most small businesses, and not just the bad actors.
Terry Gerton Well, speaking of scope and timing, we understand that the awards that would be subject to review were supposed to be identified by January 31. Did they make that first deadline?
Dan Ramish Terry, I haven’t heard specific information about that. I know that this has received a lot of attention within the department and so I expect that they are progressing as planned, but I don’t have any specific insider information on that point.
Terry Gerton Well, the second timing window is pretty tight as well. The whole review is supposed to be done by the end of February, which we all know is a very short month. So let’s talk about how they’re going to conduct this review in time and hopefully in depth to meet that timeline. What are the mechanics of how this process will enroll?
Dan Ramish So this is a huge undertaking, right? Not all contracts with small businesses are set aside, of course. And of those that are set aside, not all of them are over $20 million, but when you consider all contracts that are active that are over $20 million and set aside, that’s potentially thousands of defense contracts. And the memo calls for the entire review, as you say, to be completed within about six weeks. So very little time, and the stakes are really high for small businesses because there are calls for terminating contracts or initiating enforcement actions based on the outcome of the review and of course having a contract terminated unexpectedly is a big deal for any business but it’s particularly troublesome for small businesses
Terry Gerton Well, stage one is identifying those contracts. What’s stage two?
Dan Ramish So the first part of the review is looking at whether contracts are necessary for the mission or critical to the department’s war fighting capabilities. Of course, the Department of Defense, as part of a DOGE initiative, has been looking at some of these types of issues already. And it remains to be seen how this will be interpreted and whether there’ll be significant numbers of small businesses awards that are affected by this. Hopefully there won’t be major changes in policy made in a six-week timeframe on the fly. I think the memo does reflect that contracts that only indirectly support warfighting capabilities should still be acceptable. They reference research and development, industrial based investments, and enabling products and services. The second part of the review is evaluation of compliance with the applicable limitations on subcontracting, which is a complicated rule. The starting point is the clause. So a contract clause implements the small business rule of limitations on sub-contracting. Essentially what limitations on subcontracting says is that when a small business or other socioeconomic program participant receives a set-aside contract, they’re limited in how much dollars they can pass down to subcontractors that are not also ‘similarly situated,’ is the term. So, small businesses subcontracting to large businesses, 8(a) companies that are subcontracting to non-8(a)s, and so forth. But the calculations could be pretty complicated, and it’s based on the clause, as I say. Older contracts may be subject to a different methodology. They actually changed the formula in 2021 in the FAR. And then for current contracts, there are nuances in the way that the calculations are done. So I mentioned there’s an exception for similarly situated entities. So if there are small businesses or other socioeconomic program participants that are part of the supply chain, it may not be obvious how they factor into compliance. And then there are different percentages for different types of contracts. For products and services the limit is 50%, construction contractors can be up to 85%, or for specialty trade contractors 75%. And then there are even additional special rules for mixed contracts when both supplies and services are involved and the test either for services or applies to a given contract depending on which NAICS code is assigned. So all of this is to say, this is not an analysis that is quick and straightforward and easy to conduct.
Terry Gerton So thousands of contracts with complicated provisions in six weeks might lend one to raise an eyebrow at how thorough that analysis could be.
Dan Ramish Absolutely. And the other detail is, in some cases, of course, you’re dealing with IDIQ contracts, and then so there may be compliance across, you have to consider compliance across multiple orders, and compliance is measured at the end of the base term of a contract by default, and then the end at each option period. And so it’s possible for a contractor to be out of compliance in a given moment, but they’ll be in compliance by the end of the period. And so there are a lot of reasons why it might not be obvious whether a contractor complies and agencies are not likely to have the information they need make a full determination.
Terry Gerton There’s a third element here about whether contracts are being performed at or below market rates. What’s your assessment of that provision?
Dan Ramish So that could potentially be problematic. Set-aside contracts are competitions between small businesses or socioeconomic program participants. And when a set-aside contract is awarded, it may be that there were one or more large businesses that could have performed the job for less. And so part of the notion of these set-aside contracts is that, of course, you’re procuring products or services at a fair and reasonable price, but you’re limiting competition to small businesses or participants in a particular program. And so hopefully, the government’s analysis will take into account this set-aside context. Otherwise, terminating small business set-aside contracts because a lower price could be available from a large business would be contrary to the whole set-aside framework.
Terry Gerton Dan, you’ve just described a very, very complicated set of math problems and analysis. Any time there’s complexity like that, it’s got to open up some legal questions or uncertainties. As you think about how this will play out, what comes to the top of your mind?
Dan Ramish Well, so the federal government has very broad rights to terminate government contracts for convenience when doing so isn’t determined to be in the government’s best interest. But those rights aren’t unlimited. And termination for convenience is a discretionary act by the contracting officer. Because of the breadth of the discretion, challenges to convenience terminations are uncommon. But the types of circumstances we have here, where there’s a very quick review, where it’s being directed at a high level up the chain, present risks that there could be legal challenges to the terminations. One of the potential questions will be the extent of involvement of the contracting officer. In most cases, the contracting officers are required to be the one to make the termination decision and put their own mind to the problem and consider the merits of the case. And there’s a question of whether this expedited review can really involve individual consideration by the contracting officer of each contract. And there’s also some case law indicating that termination, simply to acquire a better bargain from another source, can amount to bad faith. And of course, we have the specific criterion in the memo looking at termination of contracts that are not at market rates, consistent with market rates. So that would potentially create some legal risk for the department if they move forward with that kind of termination.
Terry Gerton What about the Alaskan Native and Native American firms who seem to be a likely target of this? Is this an attack on their statutory preference position?
Dan Ramish I think it’s possible, you know, of course we’ve seen a lot of attacks on 8(a) and sole source 8(a) awards. As mentioned, this particular initiative is broader than that and so doesn’t seem to obviously be targeted at ANCs or other particular 8(a)s. The other thing is, of course, the executive branch doesn’t have the ability to change the law. If their real view is that the statutory programs need to change and need to be reformed, then ultimately, that’s a matter that has to be taken up with Congress, and of course Congress will work with the Department of War and consider their views, but ultimately that’s not something that the department can act on their own.
Terry Gerton So if you’re a business that falls into this window, $20 million contract with the Defense Department covered under the 8(a) or other sort of set-aside programs, what should you be doing now to prepare as this process rolls out through the rest of the month?
Dan Ramish Well, Terry, as I said, I think it’s predictable that the Department of Defense may reach out asking about compliance information relating to limitations on subcontracting. It’s a complicated analysis, and they couldn’t conclusively determine that a contractor is non-compliant based on information the government already has, typically. And so a small business should be prepared to demonstrate how they comply with the limitations on subcontracting or their covered contracts that are above that $20 million threshold and are set aside. And if they aren’t currently in compliance, they need to be able to explain how they will be at the end of the operative period, which of course also meets the test. And they need be able provide supporting documentation. But I think more broadly, it’s possible that small businesses will get other questions as part of this review. And I think we’ve seen that it’s important for small businesses to respond promptly and not to ignore those requests and so there may be questions about the scope or pricing under the contract and small businesses would be well served, you know, being prepared to make the case that their contract serves the department’s mission and the war fighter and delivers good value for the price.
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