Federal Acquisition Regulation; FAR Case 2003-027, Additional Commercial Contract Types, 74667-74680 [06-9613]

Agencies

• General Services Administration
• National Aeronautics and Space Administration
• DEPARTMENT OF DEFENSE

[Federal Register Volume 71, Number 238 (Tuesday, December 12, 2006)]
[Rules and Regulations]
[Pages 74667-74680]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-9613]


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DEPARTMENT OF DEFENSE

GENERAL SERVICES ADMINISTRATION

NATIONAL AERONAUTICS AND SPACE ADMINISTRATION

48 CFR Parts 2, 10, 12, 16, and 52

[FAC 2005-15; FAR Case 2003-027; Item II; Docket 2006-0020, Sequence 
22]
RIN 9000-AK07


Federal Acquisition Regulation; FAR Case 2003-027, Additional 
Commercial Contract Types

AGENCIES: Department of Defense (DoD), General Services Administration 
(GSA), and National Aeronautics and Space Administration (NASA).

ACTION: Final rule.

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SUMMARY: The Civilian Agency Acquisition Council and the Defense 
Acquisition Regulations Council (Councils) have agreed on a final rule 
amending the Federal Acquisition Regulation (FAR) to implement section 
1432 of the National Defense Authorization Act for Fiscal Year 2004. 
Title XIV of the Act, referred to as the Services Acquisition Report 
Act of 2003 (SARA), amended section 8002(d) of the Federal Acquisition 
Streamlining Act of

[[Page 74668]]

1994 (FASA) to expressly authorize the use of time-and-materials (T&M) 
and labor-hour (LH) contracts for certain commercial services under 
specified conditions.

DATES: Effective Date: February 12, 2007.

FOR FURTHER INFORMATION CONTACT: For clarification of content, contact 
Mr. Jeremy Olson, at (202) 501-3221. Please cite FAC 2005-15, FAR case 
2003-027. For information pertaining to status or publication 
schedules, contact the FAR Secretariat at (202) 501-4755.

SUPPLEMENTARY INFORMATION:

A. Background

    This final rule amends the Federal Acquisition Regulation to 
implement section 1432 of the National Defense Authorization Act for 
Fiscal Year 2004 (Pub. L. 108-136). Title XIV of the Act, referred to 
as the Services Acquisition Reform Act of 2003 (SARA), amended section 
8002(d) of the Federal Acquisition Streamlining Act of 1994 (FASA) 
(Pub. L. 103-355, 41 U.S.C. 264) to expressly authorize the use of 
time-and-materials (T&M) and labor-hour (LH) contracts for commercial 
services under specified conditions.
    Section 8002(d)(3) of the Act limits use of T&M and LH contracts to 
the following categories of commercial services:
     Commercial services procured for support of a commercial 
item, as described in 41 U.S.C. 403(12)(E).
     Any other category of commercial services that is 
designated by the Administrator of Office of Federal Procurement Policy 
(OFPP) on the basis that--
    1. The commercial services in such category are of a type of 
commercial services that are commonly sold to the general public 
through use of T&M or LH contracts; and
    2. It would be in the best interests of the Federal Government to 
authorize use of T&M or LH contracts for purchase of the commercial 
services in such category.
    In furtherance of its statutory responsibilities, OFPP worked in 
coordination with the Councils on a series of questions for the advance 
notice of proposed rulemaking (ANPR), the proposed rule, and the 
notices of public meeting published in the Federal Register at 69 FR 
56316 on September 20, 2004 and at 70 FR 56318 on September 26, 2005, 
to obtain information describing how T&M and LH contracts are used 
commercially. In particular, the questions elicited information on the 
types of services that are commonly acquired on this basis and the 
circumstances under which these arrangements are used. Interested 
parties offered a variety of written observations in response to the 
ANPR and proposed rule. See the Federal Register at 70 FR 56320 on 
September 26, 2005. In addition, a number of interested parties 
provided oral comments during the public meetings that were held on 
October 19, 2004 and October 18, 2005, to facilitate an open dialogue 
with Government procurement policy officials.
    OFPP and several Council staff members also received a briefing 
from the Government Accountability Office (GAO) on a survey the GAO 
conducted late last year to determine how often commercial companies 
use T&M and LH contracts in their commercial practices, either as a 
buyer or a provider. The GAO received 23 responses to its survey. Some 
of the responses came from Fortune 500 companies. Although responses 
were limited, the GAO indicated that they represented buying practices 
from a relatively wide range of industries, including airline, 
automotive and truck manufacturers, automotive and truck parts, 
business services, communications equipment, computer hardware, 
computer services, electric utilities, insurance, major drugs 
(pharmaceutical), money center bank, non-profit financial services, oil 
and gas, regional bank, retail (grocery and technology), scientific and 
technical instruments, and semiconductor.
    Finally, OFPP reviewed testimony offered to the Acquisition 
Advisory Panel established pursuant to section 1423 of SARA to evaluate 
commercial practices and other acquisition-related issues. The Panel 
specifically sought input regarding industry's use of T&M and LH 
contracts. See https://www.acquisition.gov/comp/aap/.
    OFPP made three main findings from these inputs. First, commercial 
services are commonly sold on a T&M and LH basis in the marketplace 
when requirements are not sufficiently well understood to complete a 
well-defined scope of work and when risk can be managed by maintaining 
surveillance of costs and contractor performance. Second, these same 
services are also commonly sold on a fixed-price basis. Third, a few 
types of services are sold predominantly on a T&M and LH basis--
specifically, emergency repair services. By their nature, emergency 
repair services are difficult to capture in a well-defined scope of 
work and therefore are not generally conducive to purchase on a fixed-
price basis. Industry associations, representing a wide range of 
service industries, supported these findings in their comments in 
response to the ANPR, proposed rule, public meetings, and SARA Panel 
hearings.
    OFPP advised the Councils that it is designating all categories of 
services (i.e., any service) as being available for acquisition on a 
T&M and LH basis because the findings made in conjunction with the 
rulemaking indicate that: (1) services under any general categorization 
of services, such as those examined by the GAO, are commonly sold to 
the general public on a T&M and LH basis under certain conditions; and 
(2) use of T&M and LH contracts under these conditions may be in the 
Government's best interest. However, OFPP further advised that its 
designation is limited to the same circumstances that exist when T&M 
and LH contracting is commonly used to sell services to the general 
public and where the other prerequisites set forth in section 8002(d) 
have been met. OFPP concluded, in view of the findings, that the 
identification of effective boundaries for the use of T&M and LH 
contracts is a function of the specific circumstances surrounding the 
acquisition rather than the specific type of service being sold. OFPP 
requested that the Councils reflect its designation in the final FAR 
rule.
    Specifically, OFPP requested that the rule allow an agency to 
purchase any commercial service on a T&M or LH basis if it has 
completed a determination and findings (D&F) containing sufficient 
facts and rationale to justify that a firm-fixed pricing arrangement is 
not suitable. With respect to the contents of the required D&F, OFPP 
advised the Councils that the rationale supporting use of a T&M or LH 
contract for commercial services must establish that a T&M or LH 
contract is being used under the same conditions where the private 
sector would commonly rely on these arrangements--namely, where it is 
not possible at the time of placing the contract or order to accurately 
estimate the extent or duration of the work or to anticipate costs with 
any reasonable degree of certainty. In addition, if the need is of a 
recurring nature and is being acquired through a contract extension or 
renewal, OFPP expects, consistent with FAR 7.103(r), that the D&F 
reflect why knowledge gained from the prior acquisition could not be 
used to further refine requirements and acquisition strategies in a 
manner that would enable purchase on a fixed-price basis.
    OFPP reminded the Councils that agencies will also need to comply 
with the other limitations set forth in 8002(d)--i.e., the service is 
acquired under a contract awarded using competitive procedures, the 
contract or

[[Page 74669]]

order includes a ceiling price that the contractor exceeds at its own 
risk, and any subsequent change in the ceiling price is authorized only 
upon a determination, documented in the contract file, that it is in 
the best interest of the procuring agency to change the ceiling price. 
Finally, OFPP requested that the rule include appropriate additional 
mechanisms that help agencies manage risk by maintaining surveillance 
of costs and contractor performance, since effective surveillance is 
emphasized in commercial use of T&M and LH contracts.
    The Councils concur with OFPP's findings and conclusions and have 
shaped the rule accordingly.
    DoD, GSA, and NASA published an advance notice of public rulemaking 
(ANPR) in the Federal Register at 69 FR 56316 on September 20, 2004 and 
a proposed rule at 70 FR 56318 on September 26, 2005. Comments were 
received from 13 respondents in response to the proposed rule. The 
Councils considered all of the comments and recommendations in 
developing the final rule. The Councils made the following changes to 
the rule as a result of the public comments and deliberations:
    (1) 16.601(d)--Added a requirement for the head of contracting 
activity to approve any D&Fs that would extend the period of 
performance beyond five years for both commercial and non-commercial 
T&M contracts to help ensure T&M contracts are only used when no other 
type of contract is suitable, to maximize the use of fixed price 
commercial contracts consistent with the statute, and to avoid 
protracted use of non-commercial time-and-materials contracts after 
experience provides a basis for firmer pricing.
    (2) Clause 52.212-4 Alternate I--
    (a) Paragraph (i)(1)(ii)(B)--Eliminate the provisions that only 
permitted reimbursement of subcontract costs at the hourly rates in the 
contract schedule when the subcontractors are listed in contract 
because the provisions were problematic and contrary to standard 
commercial practice (see Comment 4.b.(6)(a)). Instead added provisions 
that require the subcontract to be reimbursed at the hourly rates 
prescribed in the contract except when the employees performing the 
work do not meet the qualifications specified in the contract.
    (b) Paragraph (i)(1)(ii)(C)(2)--Eliminated the provisions that 
required commercial contractors to give the Government credit for 
rebates, refunds, or discounts that ``accrued to'' the contractor 
because the provision could have imposed unique Government accounting 
requirements on commercial T&M contracts (see Comment 4.b.(7)(b)).
    (c) Paragraph (i)(1)(ii)(C)--Excluded indirect costs as a type of 
cost that could be reimbursed at actual costs since the indirect costs 
will be reimbursed at the fixed amount in the schedule(see Comment 
4.b.(8)(a)).
    (d) Paragraph (i)(1)(ii)(D)(1)--Revised the rule to allow 
contracting officers to establish the types of other direct costs (ODC) 
that will be reimbursed at actual costs and the fixed amounts for 
indirect costs at the order level on indefinite delivery indefinite 
quantity (IDIQ) contracts. The type of ODC that will be needed to 
perform an order and any fixed amount for indirect costs may need to be 
established on an order-by-order basis (see Comment 4.b.(8)(a)).
    (e) Paragraph (i)(4)(ii)(A)--Revised the rule to recognize that 
companies use both paper-based and electronic timecards (see Comment 
4.b.(9)(b)).
    (f) Paragraph (u)--Eliminated the subcontract consent provisions 
because the provisions were unduly restrictive, inappropriate, and the 
provisions could have permitted the Government to inappropriately 
impact a company's commercial reputation (see Comment 4.b.(6)(a)).
Public Comment
    The public comments are discussed below:
    Comment: Commercial Item Definition. Agree with deleting the 
exclusion of ``services that are sold based on hourly rates without an 
established catalog or market price for a specific service performed or 
a specific outcome to be achieved'' from the definition of a commercial 
item to be consistent with SARA.
    Comment: Market Research. Agree with adding ``type of contract'' to 
the examples provided for determining practices of firms engaged in 
producing, distributing, and supporting commercial items because it 
assists with the implementation of SARA.
Appropriate Use
    Comment: Support OFPP's decision to restrict commercial T&M/LH 
contracts to circumstances where no other contract type is suitable 
instead of developing a list of commercial services commonly sold on a 
T&M/LH basis. The conditions for using commercial T&M/LH contracts 
(i.e., the contracting officer executes a determination and finding 
that no other contract type is suitable, the contract includes a 
ceiling price that the contractor exceeds at its own risk, and 
subsequent changes in the ceiling price only authorized upon a 
determination that it is in the best interest of the Government) 
implement the statute in a clear and concise manner.
    Comment: Support OFPP's conclusion that the use of T&M/LH contracts 
should not be limited to a list of specific categories of services. 
Many types of commercial services are sold and purchased on both T&M/LH 
and firm fixed-price (FFP) basis depending on the circumstances of the 
particular project. There are no general rules or practices that 
restrict use of T&M/LH to any specific service categories. Regardless 
of the service type, there are often times when work cannot be 
sufficiently defined at contract award to provide for meaningful firm-
fixed prices.
    Comment: Limit as much as possible the types of services eligible 
to be procured on a commercial T&M/LH basis. A list of the types of 
services commonly sold using commercial T&M vehicles would help 
contracting officers chose the appropriate contract type and draft the 
required D&F.
    Response: As discussed above, OFPP's decision is based on its 
findings that-- (a) commercial services are commonly sold on a T&M and 
LH basis in the marketplace when requirements are not sufficiently well 
understood to complete a well-defined scope of work and when risk can 
be managed by maintaining surveillance of costs and contractor 
performance; (b) these same services are also generally offered on a 
fixed-price basis; and (c) a few types of services are sold 
predominantly on a T&M and LH basis--specifically, emergency repair 
services. Based on these findings, OFPP recommended to the Councils 
that the rule allow an agency to purchase any commercial service on a 
T&M or LH basis if it has completed a determination and findings (D&F) 
containing sufficient facts and rationale to justify that a firm-fixed 
pricing arrangement is not suitable. OFPP stated that this conclusion 
is consistent with the statutory requirement in section 8002(d) that 
contracting officers must execute a D&F that establishes that no 
contract type is suitable before pursuing one of these arrangements. 
The Councils agree with OFPP's finding and shaped the rule accordingly. 
The Councils do not believe it is practical or feasible to develop and 
maintain a comprehensive list of services sold on a T&M/LH basis 
because many services may be sold on both a T&M/LH and fixed price 
basis depending on the circumstances of the acquisition. The rule 
clearly provides that commercial T&M/LH contracts can only be used when 
the other commercial services' contract types are not suitable.

[[Page 74670]]

    Comment: Clarify whether competitive procedures means ``full and 
open competition'' or ``limited competition'' when the competition is 
conducted with as many sources as practicable under one of the 
authorities listed in FAR 6.302.
    Response: Sole source commercial T&M/LH contracts are not 
authorized. Commercial T&M/LH contracts may be awarded under the 
statutory authorities that permit contracting without providing for 
full and open competition. When these authorities are used, contracting 
officers are required to solicit offers from as many potential sources 
as is practicable under the circumstances. Nothing in this rule 
requires ``full and open'' competition.
    Comment: Restrict the use of T&M contracts to when it is not 
``practicable'' instead of not ``possible'' at the time of placing the 
contract or order to accurately estimate the extent or duration of the 
work or to anticipate costs with any reasonable degree of certainty. It 
may be ``possible'' to estimate the duration and cost of work but 
impracticable given the time and effort that would be required, the 
urgency of the work, and the agencies competing priorities.
    Response: T&M contracts comprise the highest contract type risk to 
the Government. As such, they should only be used when it is not 
possible at the time of award to estimate accurately the extent or 
duration of the work or to anticipate costs with any reasonable degree 
of confidence. Also, restricting the use of T&M contracts to when it is 
not ``possible'' is consistent with the requirements for non-commercial 
T&M contracts.

Determination and Finding (D&F)

    Comment: Delete the minimum D&F requirements for justifying no 
other contract type is suitable because specifying the minimum 
requirements imposes a potentially greater burden on contracting 
officers than the corresponding provisions for non-commercial T&M/LH 
contracts. Delete the requirement to execute a D&F for each order when 
the indefinite-delivery contract is priced on a T&M/LH or FFP basis 
because it is inconsistent with FAR 1.602-2 which stipulates 
``contracting officers should be allowed wide latitude to exercise 
business judgment.'' SARA requires a D&F to justify the contract type, 
not the use of the contract once justified.
    Comment: Eliminate the requirement for approval one level above the 
contracting officer for a commercial T&M/LH IDIQ contract that only 
allows for issuance of orders on a T&M/LH basis to be consistent with 
non-commercial T&M/LH contracts. Commercial T&M/LH contracts pose no 
greater risk to the Government than non-commercial T&M/LH contracts.
    Comment: The rule contradicts and goes beyond the intent of SARA by 
potentially creating, in practice and effect, a prohibition on the use 
of T&M contracts. Specifically, the rule adds administrative burden and 
procedural complication to the use of T&M contracts which would inhibit 
the use of these contracts as a practical contracting tool, e.g., 
requiring a D&F for each T&M task order is beyond the intent of Section 
1432 and appears to show little confidence in the business judgment of 
contracting officers.
    Comment: Develop an approval level for D&Fs commensurate with the 
risk to the Government.
    Response: The Councils acknowledge that the rule contains 
additional requirements for commercial T&M/LH IDIQ D&Fs than those 
required for noncommercial T&M/LH IDIQ D&Fs. While the Councils 
recognize these additional requirements may be more burdensome, the 
Councils believe the additional requirements are needed to encourage 
the preference for the use of fixed price contracts for commercial 
items. In addition, the Councils believe additional controls are needed 
to ensure both commercial and non-commercial T&M contracts are only 
used when no other type of contract is suitable. The Councils revised 
the rule to require head of contracting activity approval for any D&Fs 
that extend the performance period beyond five years for both 
commercial and non-commercial T&M contracts.
    Comment: Establish a $100,000 threshold for D&F to recognize a 
reasonable level at which tangible deliverable would be expected.
    Comment: Exempt small purchases at or below the five million dollar 
commercial item threshold at FAR 12.203 from the D&F requirements. This 
threshold allows agencies to use simplified acquisition procedures up 
to five million dollars for commercial item acquisitions. The Councils 
have discretion to implement the statutory provisions addressing D&Fs. 
See Chevron, U.S.A. v. Natural Resources Defense Council, Inc., 467 
U.S. 837, 844 (1984).
    Response: When a statute is silent or ambiguous with respect to a 
certain issue, agencies have discretion to interpret the statute in a 
reasonable manner, consistent with its legislative history. However, 
the statute is not ambiguous and the legislative history contains 
nothing which would support an interpretation that the D&F condition 
can be limited to a dollar threshold. The statute requires a D&F for 
T&M/LH contracts regardless of the dollar amount.
Nonconforming
    Comment: Paying for reperformance, excluding profit, is a 
significant improvement over the ANPR and properly reflects commercial 
practices. The parties will be permitted to tailor the provision 
pursuant to FAR 12.302 when customary commercial practices provide 
different warranty terms.
    Comment: Except for the default 10 percent profit rate, the 
proposed provisions are the same as those used for non-commercial T&M 
contracts. These provisions contain significant departures from terms 
typically found in the commercial marketplace. The proposed 10 percent 
default profit rate is irrelevant if the contracting officer knows the 
contractor's profit rate. Contracting officers could terminate the 
contract or retain another contractor to complete the work as provided 
in FAR 52.246-6(f) and (g) if a contractor is expending best efforts 
and still not performing properly. Require contracting officers to 
better focus on the requirements of FAR 7.105, Contents of Written 
Acquisition Plans, rather than adopting the proposed inspection and 
acceptance clause.
    Comment: Contractors are under less budgetary pressure to perform 
under a T&M contract than a FFP contract and should be held to as 
stringent quality standards as FFP contracts. Paying for rework will 
not discourage ``shoddy work'' since the contractor will be reimbursed, 
without profit, for its costs. Develop an appropriate profit percentage 
based on historical data or some other measure to avoid a potential 
unintended consequence of establishing a 10 percent profit standard for 
T&M contracts. A 10 percent profit may be excessive for low risk T&M 
contracts.
    Response: The comments reflect a varying set of commercial 
practices for nonconforming supplies and services. The ANPR required 
contractors to repair or replace rejected supplies or reperform 
rejected services at no cost to the Government. Public commenters on 
the ANPR said requiring contractors to repair or replace rejected 
supplies or reperform rejected services at no cost to the Government 
imposed more contract risk on the contractor than the non-commercial 
clause. The Government is essentially imposing a fixed-price level of 
risk. Combining a ceiling price that contractors exceed at their own 
risk and a requirement that the contractor use ``best efforts'' to 
perform within the

[[Page 74671]]

ceiling price means contractors are required accomplish a certain 
result (i.e., performance of the work specified in the Schedule) within 
a specified dollar amount (i.e., the ceiling price). The Councils 
agreed that contractors are generally only required to use ``best 
efforts'' to accomplish the desired results within the established 
ceiling price on both commercial and non-commercial T&M contracts as 
opposed to FFP contracts which requires contractors to accomplish 
stated results within the fixed price. Therefore, the Councils revised 
the proposed rule to be consistent with the non-commercial T&M 
requirements. The 10 percent default profit rate will only be used when 
the contracting officer does not know the contractor's actual profit 
rate, which may be commonplace in competitive awards. Contractors are 
under less budgetary pressure to perform under a T&M than a FFP 
contract. However, it is not appropriate to hold contractors to the 
same standards used on FFP contracts. The risk of ``shoddy work'' is 
inherent to all ``best efforts'' type contracts. Accordingly, T&M/LH 
contracts are only authorized when no other contract type is suitable. 
The 10 percent default profit rate is arbitrary, not necessarily 
representative of the actual profit rates. However, the rate is 
intended to protect the Government by helping to ensure profit is not 
paid for replacement or reperformance.
    Comment: The proposed rule does not address reimbursement of costs 
for providing accommodations to the Government for testing and 
inspections at contractor and subcontractors' facility. Fairness 
dictates that the Government reimburse contractors and subcontractors 
for reasonable costs incurred for the required accommodations.
    Response: The costs for providing accommodations to the Government 
for testing and inspecting at contractor and subcontractors' facilities 
are generally included in the fully burdened labor rate.
Subcontracts and Interdivisional Labor
    Comment: Reimburse subcontract labor at the schedule labor rates 
without listing the subcontractors in the contract for standard 
commercial services, e.g., ``on-call'' IT installation and repair 
services in support of commercial IT products. Reimburse subcontract 
labor at the schedule labor rates without listing the subcontractors in 
the contract when the contractor's proposal indicates that some of the 
work may be performed by subcontractors that meet the contract's 
qualification requirements and that the price for that ``type of work'' 
will be the prime contract's labor rate which may be blended or other 
rate. Reimburse subcontract labor at the schedule labor rates without 
subcontract consent when the subcontractor personnel satisfy the 
qualification and other requirements for the labor categories for which 
the contractor is seeking compensation. T&M/LH contracts specify the 
required labor qualifications. Whether the person filling the position 
is an employee of the prime or a subcontractor, the qualifications must 
be met. The Government has already determined the price for the ``type 
of work'' to be fair and reasonable by competition. Include 
interdivisional transfers and subcontracted labor costs as elements of 
``time'' instead of ``materials'' to allow prime contractors to recover 
adequate compensation for the time and resources it expends on 
administering subcontracts and for the financial exposure is assumes 
for its subcontractor's performance.
    Comment: Appreciate the Councils efforts to clarify the treatment 
for subcontracts and interdivisional transfers but recommends 
reimbursing all subcontract labor at the schedule labor rates to avoid 
confusion over whether the costs are reimbursable as ``material'' or 
``labor.'' Separately address the proper treatment for subcontracts and 
interdivisional labor to avoid inevitable disputes over whether the 
costs should be treated as ``labor'' or ``material.'' Contractors 
frequently require use of subcontractors for any number of reasons 
included to:
    (a) Secure specific skill sets;
    (b) Augment an existing workforce;
    (c) Use small and/or small, disadvantaged businesses to meet 
socioeconomic goals;
    (d) Incorporate small business innovative solutions; and
    (e) Replace subcontractors during contract performance for failure 
to achieve the prime contractor's performance standards.
    Prime contractors may not know which subcontractors will be used to 
perform the work since T&M contracts are used when it is not possible 
to estimate accurately the extent or duration of work at the time of 
award. Contractors will not know at the time of award which 
subcontractors may be used to fulfill ``on call'' or ``on demand'' 
services. It is unfair to require contractors to perform services 
without knowing in advance whether the necessary subcontractors can be 
brought to task and how the contractor will be reimbursed. Expand the 
definition of ``subcontract'' to clarify that subcontracts on 
commercial contracts includes ``transfers of commercial items between 
divisions, subsidiaries, or affiliates of a contractor or 
subcontractor'' to be consistent with FASA which specified 
interdivisional transfers for commercial items are to be treated as 
subcontracts (see FAR 12.001). Clarify the provisions that allow 
contractors to be reimbursed for its own material at the contractor's 
established catalog or the market price includes services that meet the 
definition of a commercial item at FAR 2.101. Do not object to 
appropriate subcontractor disclosure requirements when the contractor 
does not have an approved purchasing system and the subcontract will be 
cost-reimbursement, time-and-materials, labor-hour, or letter contract 
(see FAR 44.201(b)(1)) but the Government should not interject its 
authority over the prime contractor's determination of how to 
accomplish the work being bid and awarded. Recommend the Councils 
instead consider a notification requirement without the need for formal 
contract amendment. In the commercial world, sellers are generally free 
to delegate their duties to subcontractors as they see fit. In the 
Government world, agencies make these determinations in the evaluation 
of a contractor's proposal and through oversight of awarded work. The 
Government could be exposed to claims for delay or disruption when the 
contractor is attempting to substitute one qualified subcontractor for 
another and approvals are improperly denied or unreasonable delayed. 
The Councils concerns that the basis for ``best value'' determination 
used to award the contract may be altered by contractors adding or 
substituting subcontractors after award do not justify the provisions 
that limit reimbursement of subcontract costs to those listed in the 
contract or those subsequently approved by the contracting officer. The 
question is not one of reimbursement but of Government payment for 
services rendered. The attendant administrative procedures in the 
proposed rule might impede the contractor's ability to deliver services 
in accordance with the terms of the contract. The ``consent to 
subcontract'' provisions and payment limitations significantly increase 
the risk to contractors for meeting contract deliverables. The 
administrative and financial burden of establishing and maintaining a 
list of subcontractors that can be reimbursed at the hourly schedule 
rates increases contract execution risk.

[[Page 74672]]

    Comment: Consent to subcontract is inconsistent with the underlying 
intent of commercial acquisitions.
    Coalition and Comment: Reimburse interdivisional transfers at the 
schedule hourly rates like subcontract labor. The proposed rule 
restricts reimbursement for interdivisional transfers (e.g., transfers 
from divisions, subsidiaries, and affiliates under the common control 
of the commercial contractor) to cost, without profit or fee, unless 
the interdivisional transfer meets the definition of a commercial item 
at FAR 2.101. Commercial contractors will be required to identify the 
actual costs, potentially subjecting their allowability to a 
determination under the cost principles. Commercial contractors should 
have the ability to use any of their resources without penalty of 
profit erosion. These contracts have commercial market reference points 
and disallowing profit discourages vendors from using their best 
employees to meet the Government's needs.
    Comment: Revise the instructions for reimbursing subcontracts at 
the schedule rate to clearly permit the listing of actual or 
``potential'' subcontractor name(s) since the subcontractors listed for 
reimbursement at the schedule hourly rates may reflect a pool of 
``potential'' subcontractors that may or may not actually work on the 
contract.
    Comment: Reimburse all subcontract costs at the schedule hourly 
rates without requiring contracting officer consent to be consistent 
with commercial practices.
    Comment: Reimburse subcontract efforts requiring consent only if 
proper advance consent is obtained. Do not allow contracting officers 
to retroactively grant consent for subcontracts.
    Comment: Restrict reimbursement of subcontract costs to actual 
costs because the prime contractor could subsequently negotiate lower 
rates with subcontractors that were authorized to be paid at the 
schedule rates and the Government would pay excessive prices for 
subcontracted effort that may be of a level less than that envisioned 
by the Government. Reimbursement at the schedule rates encourages 
contractors to maximize profit by subcontracting out more of the effort 
at lower subcontract rates. Government will expend additional resources 
to monitor the quality and efficiency of subcontract labor since the 
subcontract effort will not be readily apparent when billed at the 
schedule rates.
    Comment: Restrict reimbursement of subcontract costs to actual 
costs as long as those costs do not exceed the prime's rates. 
Subcontractors have reported primes charging prime contractor labor 
rates for the subcontractor's labor while paying the subcontractors 
significantly lower rates. Vendors should make a reasonable profit on 
services provided to the Government but there is no justification for 
unduly enriching contractors by allowing them to charge their own 
higher rates for subcontract effort. Permitting contractors to bill 
their established rates for work they subcontract out will likely have 
the unintended consequence of creating new vendor organizations 
developed solely to extract higher profits from Government projects. 
Contractors that believe the Government is best served by permitting 
the wide use of subcontracts are free to do so in FFP agreements. 
Revise or restate in a clearer fashion the provisions regarding 
reimbursement for subcontract efforts at proposed FAR 52.212-
4(i)(1)(ii)(B) because the provisions are difficult to follow.
    Response: The methodology in the proposed rule was problematic and 
contrary to standard commercial practice.
    First, the rule permitted reimbursement of commercial materials, 
including subcontracts and interdivisional transfers, at the 
contractor's established catalog or market price. At the same time, the 
rule limited reimbursement of qualifying commercial subcontracts to 
actual costs unless the subcontracts were listed in the contract for 
reimbursement at the hourly schedule rates. For some commercial 
companies, the established catalog or market price for its commercial 
material (including subcontracts and interdivisional transfers) is the 
prime contractor's established catalog or market price for labor. 
Reimbursing commercial materials at actual cost is inconsistent with 
commercial practices and contrary to the statutory preference for 
acquisitions of commercial items and the intent of FASA, i.e., 
established acquisition policies more closely resembling those of the 
commercial marketplace. In addition, subcontracts under FAR Part 12 
include transfers of commercial items between divisions, subsidiaries, 
or affiliates of a contractor or subcontractor. While the actual costs 
for subcontracts other than interdivisional transfers can be easily 
determined from an independent third party invoice, actual costs for 
interdivisional transfers can only be determined using the procedures 
of FAR Part 31. Imposing FAR Part 31 requirements on commercial 
interdivisional transfers is contrary to commercial practices and the 
intent of FASA. Further, the proposed rule failed to fully consider the 
implications of subsequently altering the elements included in the 
catalog or market prices. The catalog or market prices will be 
determined fair and reasonable based on competition. Subsequent 
modifications to the elements of those prices could impact the overall 
pricing integrity and the fair and reasonable determination. Finally, 
limiting reimbursement to actual costs discourages subcontracting and 
would have a negative impact on small businesses. Small businesses 
traditionally receive approximately 35 percent of subcontracts on 
Government prime contracts and only 24 percent of prime Government 
contracts. Reimbursing subcontracts at actual costs is not consistent 
with the treatment on all other flexibly priced Government contracts 
where prime contractors are paid profit on subcontract costs. 
Restricting reimbursement of subcontract costs to actual costs ``as 
long as those costs do not exceed the prime's rates'' is not equitable 
or fair. Upon further consideration, the Councils believe it is 
appropriate to reimburse commercial subcontracts at the schedule labor 
rates without listing the subcontracts when the contractor's 
established catalog or market price includes the price of its 
subcontracts for the reasons discussed above. The Councils revised the 
rule accordingly. In addition, the Councils believe imposing 
subcontract consent requirements on these commercial subcontracts is 
unduly restrictive and inappropriate and revised the rule accordingly. 
If a contracting officer failed to provide a timely consent or 
disagreed with the subcontract award, the Government could wrongly 
affect contract performance and potentially impact a company's 
commercial reputation. The Councils also revised the rule to recognize 
that subcontracts under FAR Part 12 include transfers of commercial 
items between divisions, subsidiaries, and affiliates of a contractor 
or subcontractor to be consistent with FAR 12.001. Finally, the 
Councils did not believe it was necessary to clarify that qualifying 
services are commercial items since the definition of commercial items 
at FAR 2.101 clearly identifies the services that meet the definition 
of commercial services.
    Comment: Agree subcontract consent applies only to costs that are 
directly charged to the contract and not overhead expenses and G&A but 
recommend explicitly stating so in the final rule to avoid future 
questions about the application of this provision.

[[Page 74673]]

    Response: As noted above, the final rule does not require 
subcontract consents.
Material Costs
    Comment: Agree there should be no ``most favored customer'' pricing 
requirement because it is a barrier for market entry and inconsistent 
with the Government pricing policies at FAR Subpart 15.4.
    Comment: Refunds. Reimbursement of material at actual costs less 
any rebates, refunds, or discounts received by or accrued to the 
contractor is contrary to commercial practice which does not rely on 
cost accounting information. If an accrual entry is made at all, the 
accrual is typically identified to more global considerations (e.g., 
total volume of purchases), not individual contract actions. The 
reference to accruals and other cost accounting data is not 
appropriate.
    Comment: Delete the requirement for commercial companies to give 
the Government credit for rebates from interdivisional labor since the 
divisions will likely have little visibility into the other business 
units.
    Comment: Delete the requirement to provide the Government credit 
for rebates on commercial T&M contracts. Vendors typically provide some 
services (e.g., maintenance on standard equipment) through the 
organizational resources of their commercial business. Federal entities 
have little visibility into those business units, creating a dilemma as 
to how to account for a rebate.
    Response: The Councils do not believe it is appropriate to require 
unique Government accounting requirements for materials on commercial 
T&M/LH contracts. The Councils revised the rule to only require 
contractors to reduce the costs of material for any rebates, refunds, 
or discounts that are identifiable to the contract.
    Comment: Revise the proposed provisions to say modification to 
items that meet the definition of commercial items at FAR 2.101 are 
reimbursed at ``price'' instead of ``actual costs'' for to be 
consistent with FAR Subpart 15.4.
    Response: Depending on the circumstance of a particular 
acquisition, it may be appropriate to pay ``price'' instead of 
``costs'' for modifications to commercial items. To provide maximum 
flexibility to the contracting officer, the Councils revised the rule 
to permit reimbursement at either price or cost.
Indirect Costs and Other Direct Costs
    Comment: Exclude indirect costs from the definition of material 
costs to eliminate the two contradictory methods for reimbursing 
indirect costs. The proposed rule permits reimbursement at a fixed 
amount but also defines indirect costs as an element of material costs 
that can only be reimbursed at actual costs unless the material meets 
the definition of commercial item.
    Response: The Councils revised the rule to eliminate the 
contradictory methods. Instead of excluding indirect costs from the 
definition of materials, the Councils revised the provisions in the 
alternate clause at FAR 52.212-4, Alternate I (i)(1)(ii)(D)(2) to 
exclude indirect costs from being reimbursed at actual cost.
    Comment: Agree with the provisions that permit reimbursement of 
indirect costs at a fixed price on a pro-rata basis over the period of 
contract performance but recommend clarifying that the fixed price 
could be adjusted as new work is added and also allowing contractors to 
be reimbursed at the Government approved percentage mark-up for non-
commercial contracts. Cost Accounting Standards (CAS) covered 
contractors are required to allocate material handling in accordance 
with their approved accounting practices. Material handling rates are 
well-recognized in Federal and commercial markets. The Councils are 
proposing to reimburse indirect costs at a fixed price because of 
concerns over violating the cost-plus-a-percentage-of-cost prohibition. 
Material handling rates do not add fee or any other price component to 
cost and therefore could not be considered a cost-plus-a-percentage-of-
cost violation. Recommend revising the coverage to permit contractors 
to recover material handling provided it is excluded from the hourly 
rates.
    Response: If new work is added, a fixed amount may be added for 
indirect expenses if appropriate. Nothing in the rule prevents contract 
changes. The approved percentage mark-up for non-commercial contracts 
is subject to the allowability provisions of FAR Part 31. The Councils 
believe it is more appropriate to reimburse indirect costs without 
imposing the requirements of FAR Part 31 to be consistent with 
commercial practices. While the commenter disagrees, the Councils 
believe use of a fixed rate violates the cost plus percentage of cost 
contract prohibition. CAS covered contractors already allocate material 
handling and other indirect costs to commercial and non-commercial FFP 
contracts in accordance with their disclosed accounting practices. 
While the costs are allocated to those FFP contracts, the allocation 
may be different from the amounts recovered under the contracts for 
those elements of cost.
    Comment: Clarify which contracting officer (the contracting officer 
who awards the contract or the one that awards the task order) has the 
authority and ability to make determination on the method for 
reimbursing subcontract efforts and the allowability of ODC and 
indirect costs for IDIQ or Multiple Award Schedule (MAS) contracts.
    Response: As stated in the alternate clause at (i)(1)(ii)(D)(1) and 
(2) of 52.212-4, Alternate I, the contracting officer awarding the 
indefinite delivery contract can authorize other contracting officers 
to determine how ODC and indirect costs will be reimbursed.
    Comment: Revise the rule to clarify ODC and indirect costs will 
only be recovered as stand alone elements of costs if the amounts are 
not also included in the loaded labor rates.
    Response: ODC and indirect costs should only be recovered as 
separate elements of costs if they are excluded from the schedule labor 
rates. However, contracting officers will not always know the elements 
of costs included in the schedule labor rates since commercial T&M/LH 
contracts can only be awarded using competitive procedures. Generally, 
contracting officers are precluded from obtaining detailed cost 
information on these types of acquisitions. However, contracting 
officers will know the proposed amount for indirect expenses and the 
types of ODC proposed to be reimbursed at actual costs for each 
competing contractor during the proposal evaluation phase.
Government Oversight
    Comment: The right to interview contractor employees is 
unreasonable intrusive and contrary to customary commercial practice. 
Notwithstanding a statement by the Councils to the contrary, no similar 
right exists in the FAR for any contract type. The audit clause at FAR 
52.215-2 gives the contracting officer the right to examine ``records 
and other evidence'' to verify claimed costs. Records are not defined 
to include interviews and it is hard to believe ``other evidence'' 
includes employee interviews. This new right lacks precedent in the 
FAR. Not even the Offices of Inspector General under the Inspectors 
General Act has this authority. The Government does not need this newly 
created contractual right because the Government already has this right 
in cases of alleged fraud or wrongdoing pursuant to its subpoena powers 
under applicable statutes. The Government should rely on the invoices 
which are required, under penalty of

[[Page 74674]]

law, to be accurate. The right to interview employees is not required 
by SARA or any other law. This authority also conflicts with FASA which 
requires commercial item contracts contain only those terms and 
conditions that are required by law or customary in the commercial 
marketplace. There is no provision in SARA for this approach, a fact 
recognized by Defense Contract Audit Agency (DCAA) in its April 9, 2004 
``GSA Schedule'' memorandum.
    Comment: Commercial T&M/LH contracts are subject to a strict 
oversight process performed by company project managers that are 
accountable for the successful completion of the work.
    Comment: Oppose the rule because commercial contracts will not be 
subject to full oversight and audit provisions. To protect taxpayer 
interests, commercial T&M/LH contracts should be subject to full 
oversight, audits, and CAS. Additionally, the commercial T&M contracts 
need clauses for refunds or price reduction so the Government can 
recoup overages identified in the audit.
    Comment: Remove the restriction that limits the Government's access 
to records to those listed in the contract because the Government 
should not limit its access to records.
    Response: The rule permits, but does not require, contracting 
officers to have access to contractor employees. While such access may 
not be a standard commercial practice, the Councils believe employee 
interviews may be necessary in some cases to verify the hours claimed 
by the contractor. According to one commenter in response to the ANPR, 
requiring access to contractor employees is a standard commercial 
practice for T&M contracting. The provisions for access to contractor 
employees are no broader than what is currently provided for under non-
commercial T&M contracts. FAR 52.215-2, Audit and Records--Negotiation, 
provides the Government the right to examine and audit all records and 
other evidence sufficient to reflect properly all cost claimed to have 
been incurred or anticipated to be incurred directly or indirectly in 
performance of the contract. The Government routinely conducts employee 
interviews and other audit procedures to verify that labor costs at 
contractor locations having fixed-price, cost-reimbursement, incentive, 
non-commercial time-and-material and labor hour, commercial, or price 
redeterminable contracts are charged to the correct contract and not 
inappropriately shifted to the flexibly priced Government contracts. 
Employee interviews are part of DCAA's normal surveillance of 
Government contracts and are required by DCAA's Mandatory Annual Audit 
Requirements (MAARs). The Government should not have to allege 
wrongdoing to interview contractor employees when their labor hours are 
included on invoices submitted to the Government. The Councils do not 
believe that SARA or FASA requires the Government to make payments 
based on actual hours incurred without being able to verify the 
employees actually worked the hours charged. The Councils have 
carefully considered existing requirements for T&M contracts as well as 
differences between commercial and non-commercial contracts. The 
Councils believe that the rule provides the proper balance between the 
need to verify compliance with contract terms and the need to minimize 
access to contractor records. Finally, the Councils believe the 
oversight provided in the rule will provide sufficient information to 
verify the validity of amounts claimed on the contract without the 
oversight requirements in FAR and CAS that are imposed on noncommercial 
T&M/LH contracts.
    Comment: Define the term ``original timecards'' broadly enough to 
encompass both paper-based and electronic timecards because many 
companies use electronic timecards.
    Response: The Councils revised the final rule to provide access to 
original timecards (paper-based or electronic).
    Comment: Provide contracting officers specific guidance regarding 
what prime oversight efforts are adequate for subcontracts listed in 
the contract and reimbursed at the schedule rates. Contracting officers 
may lack the expertise or time to assess the existence or quality of a 
contractor's mechanism to oversee the qualifications and hours worked 
by subcontractor employees. The only way to substantiate qualifications 
and hours worked is through examination of payrolls and resumes for 
each subcontractor.
    Response: The prime contractor is responsible for the oversight of 
its subcontractors. When requested by the Government, the contractors 
are required to substantiate invoices (including any subcontractor 
hours reimbursed at the hourly rate in the schedule) by evidence of 
actual payment, individual daily job timecards, records that verify the 
employees meet the qualifications for the labor categories specified in 
the contract, or other substantiation specified in the contract. 
Contracting officers can seek the advice of the cognizant audit office 
when needed. Training would be more appropriately addressed in agency 
training materials.
Withholds
    Comment: Explicitly state contracting officers cannot withhold on 
commercial T&M/LH contracts because some contracting officers may elect 
to withhold even though the practice is not specifically allowed by the 
payment clause.
    Response: We do not contemplate withholds in commercial contracts 
but there may be circumstances, at the contracting officer's 
discretion, where withholds are appropriate.
Contractor Purchasing System Review (CPSR)
    Comment: The proposed rule prohibits contractors with firm fixed-
price (FFP) or FFP with economic price adjustment (EPA) contracts from 
obtaining approved purchasing systems thereby creating a ``class of 
contractor'' that can never obtain an approved purchasing system. This 
new class of contractors will have more oversight in terms of 
subcontractor approval and approval of subcontract modifications. These 
contractors are currently exempt from the subcontract approval 
process--an exemptions supported by FASA and FARA.
    Comment: Do not impose CPSR on commercial contractors because doing 
so may deter commercial companies from doing business with the 
Government. Commercial contractors may not perform sufficient 
Government business to justify the establishment of a CPSR.
    Response: The objective of a contractor purchasing system review 
(CPSR) is to evaluate the efficiency and effectiveness with which the 
contractor spends Government funds. The review provides the cognizant 
contracting officer a basis for granting, withholding, or withdrawing 
approval of the contractor's purchasing system. Under the existing FAR 
requirements, the Government does not review a contractor's purchasing 
system if all the contractor's Governments sales are commercial FFP and 
FFP EPA contracts. The same is true if all a contractor's Government 
sales are non-commercial competitively awarded firm-fixed-price and 
competitively awarded fixed-price with economic price adjustment 
contracts. For these types of contracts, the Government has no reason 
to evaluate the efficiency and effectiveness with which the contractor 
spends Government funds since the amounts paid to the contractor are 
not affected by the efficiency and effectiveness of the contractors' 
purchasing practices. The

[[Page 74675]]

proposed rule did not impose a CPSR requirement but simply recognized 
that contractors who otherwise have approved purchasing systems require 
less oversight of their subcontractors because the contractor's overall 
system provides adequate controls and procedures to protect the 
Government. However, the Councils revised the rule to eliminate the 
subcontract consent requirement which means subcontracts for T&M 
contracts awarded pursuant to FAR Part 12 will be excluded from CPSRs.
Cost Accounting Standards (CAS)
    Comment: Do not apply CAS and other onerous Government-only 
requirements to commercial T&M/LH contracts because doing so is counter 
to acquisition reform legislation that envisions the Government 
purchasing more like its commercial counterparts. Congress exempted 
commercial item contracts from CAS; however, the CAS Board only 
exempted FFP and FFP EPA contracts. Agree the Councils lack the 
authority to make CAS changes but recommend the Councils implement the 
statute and treat T&M contracts as covered by the existing CAS 
exclusions.
    Response: The decision as to whether CAS applies to commercial T&M/
LH contracts rests with the CAS Board. The Councils have limited the 
imposition of other Government-only requirements to the maximum extent 
practicable. The Councils do not believe commercial T&M/LH contracts 
are currently exempted by any CAS exemption and therefore cannot simply 
waive the requirements of CAS.
Total Cost
    Comment: The rule establishes a notification procedure much like 
the limitation of cost and limitation of funds clauses for non-
commercial items. Since this rule involves contracts for commercial 
items, suggest it instead refer to ``Total Price.''
    Response: While the rule relates to commercial T&M/LH contracts, 
some material and ODC will be reimbursed at ``cost'' not ``price.'' 
Therefore, the Councils did not revise the title as suggested.
General Comments
    Comment: Do not support the rule in its present form.
    Comment: In a number of areas, the proposed rule simply imports 
into this commercial items regulation many of the terms and conditions 
already used by the Government when purchasing non-commercial T&M/LH 
contracts. This action results in the inclusion of provisions that are 
significant departures from standard commercial practices, contrary to 
the spirit of FASA and in violation of FAR 12.301(a)(2) that require 
commercial item contracts to only include those clauses determined to 
be consistent with customary commercial practices. Other provisions of 
the rule extend the Government's audit and oversight inappropriately 
and unnecessary. Deeply concerned that the proposed rule will undercut 
the intent of SARA by creating what effectively amounts to a 
prohibition on the use of T&M contracts. The rule adds significant 
administrative burden, procedural complications, and certain 
significant financial disincentives. Recommend the Councils reconsider 
the entire approach to T&M contracting and the expansive rulemaking in 
the proposed rule. Also, recommend the Councils hold additional public 
meetings to provide the public additional opportunities to explain the 
submitted comments. Recommend delaying issuance of a final rule until 
the Acquisition Advisory Panel has released its report and 
recommendations since there may be a conflict between their 
recommendations and this rule.
    Response: The Councils reviewed public comments and held two public 
meetings, obtaining a very complete picture of the views of interested 
parties on this rule, and have determined it is appropriate to go 
forward with a final rule. It is highly unlikely that further comments 
or public meetings would provide any information or opinions not 
already provided and evaluated.
    Comment: Concur.
    Comment: Industry does not prefer T&M contracts and would avoid 
them for IT work.
    Response: T&M/LH contracts represent the highest contract type risk 
and industry, like the Government, avoids using them to the maximum 
extent practicable. However, there are circumstances when these 
contract types are needed and used.
    Comment: The main difference between the commercial market and the 
rule is the rule only requires the contractor to use its ``best 
efforts'' to perform within the ceiling. There is no consumer in the 
commercial market that would blindly allow a car repair shop to work on 
their car for up to $1,000 without any guarantee that the car will be 
fixed.
    Response: T&M/LH contracts, commercial and non-commercial, are 
``best effort'' contracts that can only be used when it is not possible 
at the time of placing the contract or order to accurately estimate the 
extent or duration of the work or to anticipate costs with any 
reasonable degree of certainty. If it is possible to estimate the 
extent or duration of work or anticipate costs with a reasonable degree 
of certainty, T&M/LH contracts should not be used.
    Comment: The use of the term ``schedule'' may be confusing to some 
who understand it to refer to MAS or FSSs contracts. The subcontract 
reimbursement provisions that permit reimbursement of subcontracts at 
the hourly rates prescribed in the schedule could be interpreted to 
mean there are separate subcontract rates on MAS contracts. Clarify the 
final rule the term is not meant to connote MAS contracts.
    Response: The term is used throughout the FAR and widely understood 
by contracting professionals. The Councils are unaware of any issues 
with its interpretation and does not believe changing the term could be 
confusing to contracting professionals.
    This is not a significant regulatory action and, therefore, was not 
subject to review under Section 6(b) of Executive Order 12866, 
Regulatory Planning and Review, dated September 30, 1993. This rule is 
not a major rule under 5 U.S.C. 804.

B. Regulatory Flexibility Act

    The Regulatory Flexibility Act, 5 U.S.C. 601, et seq., applies to 
this final rule. The Councils prepared a Final Regulatory Flexibility 
Analysis (FRFA), and it is summarized as follows:
    1. Statement of need for, and objectives of, the rule.
    This final rule revises the Federal Acquisition Regulation to 
allow contracting officers to award Time and Material and Labor Hour 
(T&M/LH) contracts when procuring commercial items. This FAR case 
was initiated to implement Section 1432 of the National Defense 
Authorization Act for Fiscal Year 2004 (Pub. L. 108-136).
    2. Summary of significant issues raised by the public comments 
in response to the Initial Regulatory Flexibility Analysis (IRFA), a 
summary of the assessment of the agency of such issues, and a 
statement of any changes made in the proposed rule as a result of 
such comments.
    Thirteen (13) comments were received from the public in response 
to the proposed rule. One of the most significant areas of 
controversy in the proposed rule issued for public comment concerned 
the matter of labor provided by subcontractors. The proposed rule 
required that the prime contractor be reimbursed at actual cost for 
all subcontractors providing labor under the contract, unless a 
subcontractor was specifically authorized under the prime contract 
by inclusion on a list of subcontractors to be reimbursed at the 
prime contract labor hour rate. Public commenters complained that 
this procedure created major administrative burdens and, because 
reimbursement at actual cost did not permit

[[Page 74676]]

prime contractors to obtain profit of those subcontracts, it would 
significantly reduce the use of subcontractors. The commenters 
pointed out that the subcontractors at issue are commonly small 
businesses.
    The final rule eliminates this feature regarding payment of 
labor subcontractors at actual cost and use of a list of approved 
subcontractors. The final rule provides that a prime contractor can 
provide qualifying labor hours under the contract through use of 
subcontractors and the government will pay the prime contract labor 
hour rate, without use of any pre-authorization list in the 
contract. Prime contractors will be able to include profit on this 
labor and there will be no special administrative approvals 
required. The final rule approach eliminates the part of the 
proposed rule that was most objectionable to small entities.
    3. Description of, and an estimate of the number of, small 
entities to which the rule will apply or an explanation of why no 
such estimate is available.
    This rule will apply to small and large entities that accept 
Time-and-Material or Labor-Hour contracts for commercial items. 
Because this rule is the first FAR authorization for use of these 
types of contracts for commercial items, no history is available on 
the number of awards made to small businesses. However, the Federal 
Procurement Data System (FPDS) data from FY 2004 show that small 
businesses received approximately 50 percent of the 42,840 
noncommercial item T&M/LH awards made and approximately 30% of the 
$17 Billion obligated under those awards.
    4. Description of the projected reporting, recordkeeping, and 
other compliance requirements of the rule, including an estimate of 
the classes of small entities which will be subject to the 
requirement and the type of professional skills necessary for 
preparation of the report or record.
    The rule would require contractors to maintain records to 
support invoices presented to the Government for payment. Such 
records would include original timecards, the contractor's 
timekeeping procedures, distribution of labor, invoices for 
material, and so forth. These are standard records maintained by any 
company, large or small, and the fact that the contract would 
require that these records be made available to the Government 
should not place any additional record keeping burden on the entity.
    5. Description of steps the agency has taken to minimize 
significant economic impact on small entities consistent with the 
stated objectives of applicable statutes, including a statement of 
the factual, policy, and legal reasons for selecting the alternative 
adopted in the final rule and why each of the other significant 
alternatives to the rule considered by the agency was rejected.
    Public comments submitted in response to the proposed rule were 
reviewed and substantial policy adjustments to the rule were made as 
a result. One of the most significant areas of controversy in the 
proposed rule issued for public comment concerned the matter of 
labor provided by subcontractors. The proposed rule required that 
the prime contractor be reimbursed at actual cost for all 
subcontractors providing labor under the contract, unless a 
subcontractor was specifically authorized under the prime contract 
by inclusion on a list of subcontractors to be reimbursed at the 
prime contract labor hour rate. Public commenters complained that 
this procedure created major administrative burdens and, because 
reimbursement at actual cost did not permit prime contractors to 
obtain profit of those subcontracts, it would significantly reduce 
the use of subcontractors. The commenters pointed out that the 
subcontractors at issue are commonly small businesses.
    The final rule eliminates this feature regarding payment of 
labor subcontractors at actual cost and use of a list of approved 
subcontractors. The final rule provides that a prime contractor can 
provide qualifying labor hours under the contract through use of 
subcontractors and the government will pay