Government Subcontractors Must Perform “Commercially Useful Function”

Do you think your subcontractors’ Disadvantaged, Minority, and/or Women Business Enterprise (D/M/WBE) certifications are the ticket to meeting D/M/WBE participation goals on government contracts? Think again.

When performing on government contracts, prime contractors and D/M/WBE subcontractors must adhere to a wide array of regulations, statues, rules, policies, and procedures. This article explores one important aspect of performing on government contracts: D/M/WBEs must perform a “commercially useful function”.

Prime contractors performing government contracts are responsible for ensuring that their D/M/WBEs perform commercially useful functions. A D/M/WBE performs a commercially useful function when it is responsible for the execution of the work of its contract and is carrying out its responsibilities by actually performing, managing, and supervising the work involved.

State and local agencies have adopted the USDOT DBE regulations’ definition of commercially useful function. The USDOT DBE regulations identify certain key factors that should be analyzed by agencies when determining whether a DBE has performed a commercially useful function.

Amount of work subcontracted by the DBE and whether it is consistent with normal industry practice
Whether the amount the DBE is paid under its contract is commensurate with the work it is actually performing and the credit claimed for its performance of the work
When the DBE furnishes materials, the DBE must be responsible for negotiating the price of the materials, for determining the quality and quantity of the materials, ordering the materials, and paying for the materials
Whether the DBE’s role is limited to that of an extra participant in a transaction, contract, or project through which funds are passed in order to obtain the appearance of DBE participation

When evaluating whether a D/M/WBE performs a commercially useful function, government agencies generally consider five areas of operation: (1) management and supervision; (2) equipment; (3) workforce; (4) materials and supplies; and (5) performance. Each of these areas of operation are addressed below.

Management and Supervision

The D/M/WBE must manage the work that it has been contracted to perform. Specifically, the D/M/WBE must perform the following functions:

Schedule work operations
Order equipment, materials, and supplies
Prepare and submit payrolls
Hire and fire employees

Equipment

The D/M/WBE must own or lease the equipment required to perform its contract. If the D/M/WBE leases equipment, the following requirements must be met:

D/M/WBE cannot lease equipment from the prime contractor or its affiliates
Lease must be consistent with standard industry practice and at competitive rates
Lease must specify the terms of the agreement
D/M/WBE must control the operation of all leased equipment

Workforce

The D/M/WBE must have its own regular workforce. Additionally, D/M/WMEs cannot share employees with non-D/M/WBEs, particularly the prime and its affiliates; and they must be responsible for the payroll and labor compliance requirements for all employees.

Materials and Supplies

The D/M/WBE must be responsible for the material and supplies it uses in the performance of its contracts. This is demonstrated where the D/M/WBE performs the following tasks:

Negotiating the price of materials
Determining the quality and quantity of materials
Ordering materials
Receiving invoices for materials
Paying for materials

Performance

The D/M/WBE must maintain responsibility for the performance, management, and supervision of a distinct element of the work by assuming financial risks appropriate for the amount of work to be performed, and performing within its certification specialty areas.

When red flags are raised involving these five areas of operation, government agencies will likely initiate an investigation to determine whether they are the result of D/M/WBE fraud, such as front and pass-through schemes.

Common characteristics of D/M/WBE front schemes are false representation of D/M/WBE ownership and a D/M/WBE being paid a small sum of money to use the company in the scheme. D/M/WBE pass-through schemes, on the other hand, tend to be more convoluted. The role of the D/M/WBE is limited to that of an extra participant on a contract through which funds are passed in order to obtain the appearance of D/M/WBE participation. In this case, the prime contractor performs the work of the D/M/WBE with its own forces, runs the payroll through the D/M/WBE to create the illusion that employees are working for the D/M/WBE, pays the D/M/WBE a small sum, and uses the D/M/WBE’s name on invoices, trucks, and/or equipment. The D/M/WBE does not complete the contracted work, sells its certification status to another company that completes the work, and allows use of its name on invoices, trucks, and/or equipment.

It is the responsibility of prime contractors to ensure that their subcontractors are performing a commercially useful function on government contracts. You cannot simply rely on their certification status as a D/M/WBE. You also cannot rely on their approval by government agencies to be utilized as a D/M/WBE subcontractor. Agencies will seek to determine whether your approved and certified firms are performing a commercially useful function. If they are not, you may not receive D/M/WBE credit for their performance which could result in your noncompliance to the D/M/WBE participation goal on your contract. It could also result in a formal investigation of your company, its employees and subcontractors that result in severe penalties, which may include contract or subcontract termination, suspension, debarment, decertification, payment withholding, fines, and criminal investigation and/or prosecution.

Seyfarth’s Government Contracts Practice Group has experience in assisting government contractors and consultants to ensure that their D/M/WBEs perform a commercially useful function. We have conducted compliance training sessions for contractors and subcontractors; prepared contract compliance manuals; and monitored D/M/WBE contract participation on government contracts. We have also represented government contractors, consultants and agencies in federal, state and local debarment and suspension proceedings, including administrative hearings, and settlement negotiations and agreements. Please join us for our complimentary breakfast meeting at Seyfarth on March 18, 2014 at 9:30a.m.C.S.T. where we will discuss “Contract Compliance and Management”. We will discuss the requirements for performing a commercially useful function and the reporting requirements of the City of Chicago, Cook County and State of Illinois.

Anita J. Ponder is a partner and Allison B. Maloney is counsel in Seyfarth’s Government Contracts Practice Group. Anita J. Ponder chairs Seyfarth’s Government Contractors Business Forum (GCBF), which provides government contractors information about new government procurement regulations, laws, rules, policies, legislation, business resources, legal developments, and government contract opportunities. The kickoff meeting for the 2014 GCBF Program Series is Friday, March 21, 2014. If you would like further information, please contact your Seyfarth Shaw attorney, Anita J. Ponder at aponder@seyfarth.com or Allison B. Maloney at amaloney@seyfarth.com.