Legal Protections for Subcontractors on Federal Prime Contracts: In Brief
Released: 2015-12-18T00:00:00

T his report provides an overview of the payment and other protections for subcontractors on certain federal prime contracts under the Miller Act, the 1988 amendments to the Prompt Payment Act, and the Small Business Act. Congress enacted these statutes to give subcontractors rights and remedies they would not otherwise have because of legal doctrines relating to sovereign immunity, privity of contract, and freedom to contract.

Payment and other protections for subcontractors on federal contracts are of perennial interest to Members and committees of Congress, in part, because many subcontractors are small businesses, and it is the "declared policy of the Congress that the Government should aid, counsel, assist, and protect, insofar as is possible, the interests of small business concerns."

The Miller Act

A Depression-era enactment named after its sponsor, Representative John Elvis Miller of Arkansas, the Miller Act creates a federal remedy for subcontractors who "furnish[] labor or material in carrying out work provided for" in certain federal construction contracts. Absent the Miller Act, such subcontractors would generally have to rely on breach of contract actions against the prime contractor under state law to recover payments due to them because of the operation of the legal doctrines of privity of contract and sovereign immunity. Although working pursuant to a subcontract under a federal contract, subcontractors generally cannot enforce the payment or other terms of the contract or subcontract against the federal government because there is no privity of contract, or direct contractual relationship, between the subcontractor and the government. The subcontractor's contract is with the prime contractor, as is the government's contract; there is no contract between the subcontractor and the government. Additionally, because the government has sovereign immunity and cannot be sued without its consent, the subcontractor cannot place a mechanic's lien on the improved property, as it potentially could with a private construction project.

The Miller Act requires that, before any contract of more than $150,000 is awarded for the construction, alteration, or repair of a "public building or public work of the Federal government," the contractor furnish two bonds to the government. The first of these is a performance or completion bond, which would compensate the government for any defects in the contractor's performance under the contract. The second is a payment bond, which would assure that certain persons who supply labor or materials used in carrying out the work provided for in the contract receive payment. Both bonds become legally binding upon award of the contract, and their "penal amounts," or the maximum amounts of the surety's obligation, must generally be 100% of the original contract price plus 100% of any price increases.

The act further authorizes "[e]very person that … furnished labor or material" in carrying out work provided for in the contract who was not paid in full within 90 days of completing performance to bring a civil action on the payment bond for the amount due. However, "[e]very person," as used here, has been construed to include only first- and second-tier subcontractors. Lower-tier subcontractors are excluded, as are "materialmen" or other parties who supply materials or labor without a contract. These exclusions are partly based on policy considerations and partly based on the definition of "subcontractor." Prime contractors would have greater difficulties in protecting themselves from liability to remote tiers of subcontractors or materialmen than they would in protecting themselves from liability to first- or second-tier subcontractors. Materialmen are excluded because the usage of "subcontractor" in the building trades includes only "one who performs for or takes from the prime contractor a specific part of the labor or material requirements of the original contract." The term "thus exclude[s] ordinary laborers and materialmen."

Within one year of completing performance, first- and second-tier subcontractors seeking payment on a Miller Act bond must file suit in the name of the United States in the federal district court for the area where the subcontractor provided labor or services under the contract. They must also provide the prime contractor with notice served in the same manner as a summons, or by any other means that provides written, third-party verification of delivery to the contractor at its place of business or primary residence. Failure to provide proper notice may bar recovery from either the prime contractor or the surety. Assuming proper notice, the amount a subcontractor may recover if it prevails in the litigation is generally based on the contract amount for the goods or services or, if no amount is specified in the contract, the amount that a person in the subcontractor's position at the time and place the services were rendered would have spent completing those services. However, after performance is completed, subcontractors may waive in writing their right to bring a civil action, in which case no recovery may be made on the bond.

Contractors that fail to obtain performance bonds as required under the Miller Act are in breach of their contract with the government and could potentially be terminated for default by the government. However, the subcontractor cannot recover from the government for the prime contractor's failure to obtain a bond, or its failure to obtain a sufficient bond.

The Prompt Payment Act

Enacted in response to agencies' widely reported delays in paying their bills, the Prompt Payment Act of 1982, as amended, generally requires federal agencies to pay interest on any payments they fail to make by the date(s) specified in the contract, or within 30 days of receipt of a "proper invoice," if no date is specified in the contract. This act originally applied only to payments made by the government to prime contractors, although it encompassed payments under all types of contracts (e.g., manufacturing, construction, service). However, the Prompt Payment Act was amended in 1988 to extend certain payment protections to subcontractors on federal construction contracts, in part, because agencies' continued practice of paying late created particular difficulties for subcontractors on construction projects. At the time when these amendments were adopted, subcontractors reportedly performed 80% of the work on construction projects, and subcontractors on construction contracts generally do not get paid until the prime contractor has been paid. Without the 1988 amendments, or similar contract terms, prime contractors would generally be free to agree to whatever payment terms they wish with their subcontractors and would not necessarily pay their subcontractors as quickly.

The 1988 amendments require that every construction contract awarded by a federal agency contain clauses obligating the prime contractor to (1) pay the subcontractor for "satisfactory performance" under the subcontract within seven days of receiving payment from the agency and (2) pay interest on any amounts that are not paid within the proper time frame. The contract must also obligate the prime contractor to include similar payment and interest penalty terms in its subcontracts, as well as require its subcontractors to impose these terms on their subcontractors. This latter provision, requiring subcontractors to impose the terms on their subcontractors, ensures that the payment and interest penalty requirements "flow down" to all tiers of subcontractors. The prime contractors would have obligations to any first-tier subcontractors, who would have obligations to second-tier subcontractors, who would have obligations to third-tier subcontractors, etc.

The 1988 amendments do, however, allow contractors and higher-tier subcontractors to negotiate terms permitting them to retain or withhold payment from subcontractors or lower-tier subcontractors without incurring interest penalties. "Retainage" is generally said to occur when a contractor holds back a specified percentage (often 10%) of each progress payment otherwise due under a construction contract as a routine matter, or because of the subcontractor's failure to perform. Retainage can be seen as a type of withholding. However, the term "withholding" can also be used more broadly to describe the nonpayment of contract amounts because of debts of the contractor outside of the contract. Contractors withholding funds under a contract subject to the Prompt Payment Act must generally provide both the procuring agency and the subcontractor with written notification of withholding, and the amount withheld cannot exceed the amount specified in this notice. Contracting parties often agree to retainage and withholding in order to encourage timely completion of the contract and ensure full understanding between the parties regarding the terms of completion.

Because the payment and interest clauses of the contract apply only to the parties, the federal government's obligations run only to the prime contractor. Prime contractors have the duty to pay subcontractors, and subcontractors have the duty to pay lower-tier subcontractors. The federal government cannot be interpleaded as a party to any disputes between contractors and subcontractors over late payments or interest, and contractors' obligations to pay subcontractors also cannot be passed on to the federal government in any way, including by contract modifications or cost-reimbursement claims.

Obama Administration Payment Policies

In 2011-2012, the Obama Administration issued guidance that supplements the requirements of the Prompt Payment Act as to the payment of small business contractors and subcontractors. Initially, this guidance called for agencies to pay small business contractors within 15 days of receipt of a proper invoice. However, subsequent guidance sought to address payment of small business subcontractors by calling for agencies to "accelerate payments to all prime contractors, in order to allow them to provide prompt payments to small business subcontractors."

Subsequently, in November 2013, the Administration amended the Federal Acquisition Regulation (FAR) to implement the accelerated payment policy as to small business subcontractors . As amended, the FAR requires that agencies' prime contracts include terms that obligate the contractor,

[u]pon receipt of accelerated payments from the Government, [to] make accelerated payments to its small business subcontractors under this contract, to the maximum extent practicable and prior to when such payment is otherwise required under the applicable contract or subcontract, after receipt of a proper invoice and all other required documentation from the small business subcontractor.

The FAR amendment also requires that agencies' contracts include terms which obligate prime contractors to incorporate similar language in their subcontracts with small businesses (including those for the acquisition of commercial items), thereby binding themselves to make accelerated payments to their subcontractors. However, agencies are not required to pay interest on any payments that are not made within "accelerated" time frames, unlike with "late" payments under the Prompt Payment Act. In addition, because they lack privity of contract with the government, small business subcontractors generally cannot hold agencies accountable if the prime contractor fails to incorporate the requisite clauses in its subcontracts, or fails to make accelerated payments pursuant to such clauses.

The FAR has not been similarly amended to address "accelerated" payments to small business contractors , although the general policy of accelerating payments to such entities remains in effect.

The Small Business Act

Section 8(d) of the Small Business Act provides several different protections to subcontractors that qualify as "small businesses" pursuant to the act, by generally requiring prime contractors to (1) agree to subcontract certain percentages of the work to be performed under federal contracts to various types of small businesses; (2) make "good faith efforts" to work with the subcontractors whom they "used" in preparing their bids or proposals; and (3) notify the contracting officer of the federal agency that awarded the contract in writing if payment to a subcontractor is late or reduced.

Subcontracting Plans

Amendments made to Section 8(d) of the Small Business Act in 1978 established the "Small Business Subcontracting Program," a program designed to benefit certain prospective subcontractors on federal prime contracts. The requirements of this program vary depending upon the anticipated value of the contract. Contracts valued at over $150,000 and performed within the United States must generally include two clauses pertaining to subcontracting with small businesses. The first of these clauses articulates federal policies regarding subcontracting with small businesses and timely payment of subcontractors:

It is the policy of the United States that small business concerns, small business concerns owned and controlled by veterans, small business concerns owned and controlled by service-disabled veterans, qualified [Historically Underutilized Business Zone] HUBZone small business concerns, small business concerns owned and controlled by socially and economically disadvantaged individuals, and small business concerns owned and controlled by women shall have the maximum practicable opportunity to participate in the performance of contracts let by any Federal agency, including contracts and subcontracts for subsystems, assemblies, components, and related services for major systems. It is further the policy of the United States that its prime contractors establish procedures to ensure the timely payment of amounts due pursuant to the terms of their subcontracts with small business concerns, small business concerns owned and controlled by veterans, small business concerns owned and controlled by service-disabled veterans, qualified HUBZone small business concerns, small business concerns owned and controlled by socially and economically disadvantaged individuals, and small business concerns owned and controlled by women..

The second of these clauses embodies the contractor's agreement to carry out the aforementioned policy "to the fullest extent consistent with the efficient performance of this contract," as well as cooperate in any studies necessary to determine the extent of its compliance.

Contracts in excess of $700,000 ($1.5 million for construction contracts) that offer subcontracting possibilities generally must also incorporate a subcontracting plan that includes the following:

"[s]eparate percentage goals" for subcontracting with small businesses, veteran-owned small businesses, service-disabled veteran-owned small businesses, HUBZone small businesses, small disadvantaged businesses, and women-owned small businesses; a statement of the total dollars planned to be subcontracted and the total dollars planned to be subcontracted to small businesses; a description of the principal types of supplies and services to be subcontracted; and assurances that the contractor will (1) include terms relating to the government's policy of promoting contracting with small businesses in all subcontracts that offer subcontracting opportunities and (2) require all subcontractors receiving subcontracts valued in excess of $700,000 ($1.5 million for construction) that are not themselves small businesses to adopt their own subcontracting plans.

Contractors on these "larger" contracts are also required by Small Business Administration (SBA) regulations to provide pre-award written notification to unsuccessful small business offerors on all subcontracts valued at over $150,000 for which a small business concern received a preference. This notification must include the name and location of the apparently successful offeror and its small business status, if any. "Large" prime contractors are encouraged, but not required, to provide similar notice to offerors for subcontracts valued at less than $150,000.

The contracting officer has discretion in determining whether particular contracts require a subcontracting plan, and the percentage goals for particular contracts need not correspond to the procuring activities' goals for the percentage of contract and/or subcontract dollars awarded to various categories of small businesses. However, any subcontracting plan that is required constitutes a material part of the contract, potentially allowing the contractor to be terminated for default if it fails to substantially perform in accordance with the requirements of the plan. Additionally, the contract must include a clause requiring the contractor to pay liquidated damages of an "amount equal to the actual dollar amount by which the contractor failed to achieve each subcontracting goal" if the contractor fails to make a good faith effort to comply with the plan. Agencies are also required to consider contractors' performance vis-à-vis their subcontracting plans when evaluating their past performance, determining whether prospective contractors are responsible, and making source selection decisions in certain negotiated procurements.

If such percentage goals were not contained in the subcontracting plan, prime contractors would generally be free to subcontract with whomever they wish, and various categories of small businesses would not necessarily have this opportunity to obtain federal contract dollars. However, although subcontracting plans are intended to benefit small businesses, these businesses are not parties to the contract between the government and the contractor, and they generally cannot enforce its terms against the prime contractor. Only the government may generally do so.

Good Faith Efforts to Work with Subcontractors "Used" in Bids or Proposals & Notification of Late or Reduced Payments

The 111 th Congress expanded the payment and other protections for small business subcontractors under Section 8(d) of the Small Business Act when it enacted the Small Business Jobs Act (SBJA) of 2010. Among other things, the SBJA amended Section 8(d) to require that prime contracts incorporating subcontracting plans also include terms obligating the contractor to:

make a good faith effort to acquire articles, equipment, supplies, services, or materials, or obtain the performance of construction work from the small business concerns used in preparing and submitting … the bid or proposal, in the same amount and quality used in preparing and submitting the bid or proposal,

and provide the contracting officer with a written explanation whenever it fails to do so. In addition, the SBJA amended Section 8(d) to require that prime contractors with subcontracting plans notify the contracting officer in writing if they pay a subcontractor a reduced price, or if payment is more than 90 days past due on a contract for which the federal agency has paid the prime contractor. Contracting officers are also required to consider any "unjustified failure" by a prime contractor to make full or timely payments to a subcontractor in evaluating the contractor's performance, and note any "history" of unjustified failures to make full or timely payment in the Federal Awardee Performance and Integrity Information System (FAPIIS).

Regulations promulgated by SBA to implement these provisions of the SBJA further bar prime contractors from restricting subcontractors' ability to "discuss[] any material pertaining to payment or utilization with the contracting officer," apparently with the intent of promoting reporting by subcontractors in the event that prime contractors fail to provide the requisite notices. However, the preface to these regulations also makes clear that SBA does not view the SBJA as requiring contracting officers to involve themselves in disputes regarding reduced or late payments, or regarding whether particular subcontractors were "used" in preparing bids or proposals. Instead, SBA envisions contracting officers factoring contractors' failure to work with small businesses "used" in their bids or offers, or unjustifiable late or reduced payments, into contractors' performance evaluations.