Where are the major defense contractors? Clarification or Confusion: Subsection (d) of 10 U.S.C. 2371b

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In 2000, an amendment to Other Transaction for Prototype Authority (then section 845, currently section 2371b, title 10, U.S. Code) was included in NDAA 2001 that added what is now a sub-section (d). The amendment was intended to provide clarity on when the authority should be used.  The addition of requirements outlined in sub-section (d) and their implementation resulted in a major change in the way prototype OT authority was used in DOD.  Instead of encouraging more efficient ways of doing business on the part of traditional defense contractors one of the amendments stated goals, it discourages defense contractors from participating in OTs.

At the time the amendment was enacted major defense projects involving major defense contractors were being conducted as prototype OTs. These included all the most significant programs in air, land, sea, and space environments. Some of these involved innovative business arrangements.

The sub-section currently reads, in pertinent part, as follows:

(d) Appropriate Use of Authority.—

(1) The Secretary of Defense shall ensure that no official of an agency enters into a transaction (other than a contract, grant, or cooperative agreement) for a prototype project under the authority of this section unless one of the following conditions is met:

(A) There is at least one nontraditional defense contractor or nonprofit research institution participating to a significant extent in the prototype project.

(B) All significant participants in the transaction other than the Federal Government are small businesses or nontraditional defense contractors.

(C) At least one third of the total cost of the prototype project is to be paid out of funds provided by parties to the transaction other than the Federal Government.

(D) The senior procurement executive for the agency determines in writing that exceptional circumstances justify the use of a transaction that provides for innovative business arrangements or structures that would not be feasible or appropriate under a contract, or would provide an opportunity to expand the defense supply base in a manner that would not be practical or feasible under a contract.

Clarification or confusion?  The amendment purported to clarify when the authority should be used. Adding the up-front requirement for significant participation by a non-traditional contractor (originally defined in a complicated and arcane fashion) or 1/3 cost sharing was hardly a clarification. Because of the FAR system and cost principles, cost sharing is very difficult for traditional defense contractors. A finding of exceptional or special circumstances by an agency’s senior procurement executive also permitted use of the authority. The cost sharing requirement was seriously misguided (as it relates to traditional defense contractors) but encouragement of non-traditional participation seems laudatory. It has proved difficult, however, for defense contractors to find roles for significant participation by non-traditional contractors prior to agreement award.

According to the legislative history the statute was intended to encourage “more efficient ways of doing business with traditional defense contractors” (Sen. Rpt. 106-292). The practical limitations of paragraphs (A), (B) and (C) leaves SPE approval as the primary means of accomplishing “more efficient ways of doing business” for traditional defense contractors. Based on the best information available to me, only one SPE special circumstances authorization has been granted in many years. Section 803 of NDAA 2001 as implemented by DOD has proved a failure based on its stated intent. Instead of spurring new ways of doing business among traditional defense contractors and increasing efficiency subsection (d) has continued to constrain the big players in DOD’s industrial base to business as usual and discouraged them from participating in OT prototype projects.

The problem – the confusion – outlined above can be remedied by proper use of the SPE approval authority. While exceptional or special circumstances might take any of a variety of forms, there are some that come to mind that should result in automatic SPE approval. Projects structured in a manner outside the standards of Part 16 of the FAR (FAR contract structures that vary from Part 16 examples require a formal deviation) should qualify. A prototype OT project funded through fixed milestone payments based on observable technical achievements or reimbursed at IR&D rates rather than fully burdened rates should pass SPE muster on an automatic basis. In fact DOD could issue a blanket policy authorizing this. In other instances the approval process might slow things down but various techniques certainly could be explored that met the legislative intent to encourage “more efficient ways of doing business with traditional defense contractors.”

Conclusion: Subsection (d) of Other Transactions Prototyping authority (section 2371b, title 10, U.S. Code) as implemented by DOD has had the effect of discouraging major defense contractors from participating in OT prototype projects. Very few major defense contractors participate in OT projects. When they do the projects are typically of modest size and impact. Despite many recent changes in OT legislation, Congress has made only minor changes in sub-section (d). Much of the negative impact of sub-section (d) on major defense contractors can be remedied by improved implementation. This primarily relates to the way (d) (1) (D) is applied.

Immediate actions to take: Service SPE’s should notify contracting activities that certain innovative contracting techniques constitute “exceptional circumstances”, are encouraged, and will be approved when submitted. Among these are payments based on achieving observable milestones and reimbursable arrangements made at less than fully burdened rates. Review and approval must be expeditious. Solicitations should permit use of OTs in addition to procurement contracts and contain provisions encouraging traditional defense contractors to include new approaches to improving efficiencies in their proposals. Service SPE’s should encourage traditional defense contractors to submit proposals to engage in OT projects that incorporate approaches such as those mentioned, co-funding with third party financing, or other innovative business arrangements.

Future actions to take: DOD policy should be developed that recognizes techniques that meet the statutory definition of “exceptional circumstances” and “innovative business arrangements” while encouraging industry to develop additional approaches.

An additional note: An amendment to sec. 2371b in NDAA 2018 added the category of “non-profit research institution”  to non-traditional in sub-sec. 2371b(d)(1)(A). Thus, if a consortium management firm happens to be a non-profit research institution (at least one is) it will be involved to a significant extent in any sub-agreement. In that case major defense contractors (or other traditional contractors) will not fall under the cost-sharing requirement of (d) (1) (C) or the SPE exceptional circumstances determination of (d) (1) D). It behooves DOD to select non-profit research institutions as consortium management firms; and, likewise traditional contractors to seek out consortia OTs managed by such firms.

Written by Richard L. Dunn