Federal agencies rely on both their general contracting authorities and the special authorities of the Small Business Act when contracting with small businesses. The general contracting authorities—the Armed Services Procurement Act (ASPA) of 1947 and the Federal Property and Administrative Services Act (FPASA) of 1949—grant defense and civilian agencies, respectively, broad authority to contract with any responsible firm, including small businesses. However, ASPA and FPASA do not authorize agencies to set aside contracts for small businesses, or conduct procurements in which only small businesses, or specific types of small businesses, may compete. Only the Small Business Act does this, authorizing agencies to set aside part or all of certain procurements for 1. small businesses; 2. women-owned small businesses; 3. service-disabled veteran-owned small businesses (SDVOSBs); 4. small businesses located in Historically Underutilized Business Zones (HUBZones) (HUBZone small businesses); and 5. small businesses owned and controlled by socially and economically disadvantaged individuals participating in the Small Business Administration's (SBA's) Minority Small Business and Capital Ownership Development Program (commonly known as the 8(a) Program) (8(a) firms). Although ASPA and FPASA do not authorize set-asides for small businesses, agencies may still "favor" small businesses in certain procurements conducted under their authority by using small-business status as an evaluation factor in negotiated procurements. A negotiated procurement is one in which the government awards the contract to the contractor whose offer represents the "best value" for the government in light of various factors established by the government and incorporated into the solicitation for the contract. Cost or price must be among these factors, but it need not be the primary factor or carry any specific weight in the overall award. Other factors may include contractors' past performance, compliance with the solicitation requirements, technical excellence, management capability, personnel qualifications, prior experience, and small-business status. Commentators sometimes call contracts that are awarded using firms' size as an evaluation factor "preference contracts" because they allow agencies to prefer various types of small businesses without setting aside a procurement for them. Not all contracts awarded to small businesses under ASPA and FPASA are preference contracts, however. Some contracts are awarded to small businesses using sealed bidding, with awards made solely on the basis of price and without consideration of firms' size. In other cases, agencies use negotiated procurements without evaluation factors focusing on firms' size. Contracts awarded under any authority—ASPA, FPASA, or the Small Business Act—count toward the government-wide and agency-specific goals for contracting with small businesses. The Business Opportunity Development Reform Act (BODRA) of 1988 requires the President to set government-wide goals for the percentage of federal contract and/or subcontract dollars awarded to various categories of small businesses. These goals must be equal to or exceed certain percentages specified in statute, as illustrated in Table 1 . A 1978 amendment to the Small Business Act similarly requires that agency heads, in consultation with the SBA, set agency-specific goals for the percentage of contract dollars awarded to the same categories of small businesses. These goals are to "realistically reflect the potential" of small businesses to perform federal prime contracts and subcontracts and thus vary among agencies. Commentators frequently note the government's failure to meet either government-wide or agency-specific goals, and some Members of Congress have suggested that the current government-wide goals are too low. Limitations on subcontracting have applied to contracts set aside for small businesses under the authority of the Small Business Act since 1986. These limitations result from statutory and regulatory provisions prohibiting agencies from awarding prime contracts to small businesses unless the small business performs a certain percentage of the contract work itself, instead of subcontracting it. The percentage that must be performed by the small business varies depending on the nature of the contract, as Table 2 illustrates. Prior to GAO's decision, no judicial or administrative tribunal appears to have addressed whether these limitations apply to preference contracts as well as set-asides. Certain contracts set-aside for "local firms," of any size, in disaster or emergency areas under the authority of the Stafford Act are also subject to limitations on subcontracting. These limitations require that similar percentages of work be performed by the "local firm," as opposed to subcontracted, on the types of contracts listed in Table 2 . However, these limitations are arguably unaffected by the GAO decision discussed here because they are not related to firm size. In its November 16, 2009, decision, GAO denied Washington-Harris Group's protest alleging that the Army National Guard Bureau improperly awarded a contract for case management and administrative services to Skyline Ultd Inc. The procurement had not been set aside for SDVOSBs. However, the solicitation had included an evaluation factor focusing on firms' SDVOSB status, as well as a statement that the source selection authority would "favorably view an offeror's Small Business status." Under the solicitation, firms' SDVOSB status and understanding of the requirements carried equal weight, and each was more important than any other evaluation factor. Price was the least important factor. For purposes of the solicitation, offers were considered to come from SDVOSBs if either (1) the prime contractor was an SDVOSB or (2) the offeror was a joint venture involving an SDVOSB firm that would perform more than 50% of the work. There was no dispute that Skyline proposed to perform less than 50% of the contract requirements. Washington-Harris Group argued that the solicitation and the Federal Acquisition Regulation (FAR) required SDVOSB contractors to perform at least 50% of the contract requirements in order to be evaluated favorably as an SDVOSB. Washington-Harris Group's reference to the FAR appears to have been to Part 19.14, which requires, among other things, that a clause containing the limitations on subcontracting discussed in Table 2 (Clause 52.219-27) be incorporated in all solicitations. GAO rejected Washington-Harris Group's arguments regarding the solicitation because the solicitation distinguished between SDVOSB prime contractors and SDVOSB joint venturers and required only the latter to perform more than 50% of the work. It also rejected the argument that the FAR clause containing the limitations on subcontracting applied to this procurement. GAO reached this conclusion because the FAR states that Clause 52.219-27 is required only when "[o]ffers are solicited only from service-disabled veteran-owned small business concerns [and] [o]ffers received from concerns that are not service-disabled veteran-owned small business concerns shall not be considered." Given this language, GAO concluded that the clause did not apply to this procurement because the procurement was not set aside for SDVOSBs. Because Clause 52.219-27 did not apply to the procurement, it found that the agency did not improperly evaluate Skyline favorably as an SDVOSB when awarding the contract even though Skyline proposed to subcontract over 50% of the work on the contract. GAO did not directly address the differences between the general contracting authorities and the Small Business Act in its decision. It also did not address contracting with small businesses that are not SDVOSBs. However, because contracts awarded under the general contracting authorities cannot be set aside for SDVOSBs while those awarded under the authority of the Small Business Act can be, and because the same limitations on subcontracting apply to other types of small businesses as apply to SDVOSBs, GAO's decision can arguably be construed to mean that limitations on subcontracting do not apply to any non-disaster and non-emergency "preference contract" awarded to any type of small business under the general contracting authorities. Some commentators have suggested that GAO's decision could result in agencies using more preference contracts and fewer set-asides . Such a shift from set-asides to preference contracts would not necessarily result in the government paying higher prices. While greater subcontracting generally tends to increase costs because each tier of subcontractors imposes additional overhead costs, recent legislation may help ensure that the government is aware of and does not compensate certain costs. For example, Section 866 of the Duncan Hunter National Defense Authorization Act for FY2009 imposed "limitations on tiering of subcontractors" by requiring that the FAR be amended to "minimize the excessive use … of subcontractors, or of tiers of subcontractors, that add no or negligible value" by non-defense agencies. The amendments to the FAR required by Section 866 took effect on October 14, 2009, and require contractors to "provide information on indirect costs and profit/fee and value added with regard to the subcontract work" when over 70% of the total cost of the work to be performed under the contract will be subcontracted. The amendments also bar contractors from receiving indirect costs or profits/fees on work performed by subcontractors when the contractor "add[ed] no, or negligible value." Similar requirements already applied to defense agencies under Section 852 of the John Warner National Defense Authorization Act for FY2007, and in a memorandum dated December 23, 2009, the Director of Defense Procurement and Acquisition Policy announced that the Department of Defense would delete its agency-specific regulations implementing Section 852 and comply with the government-wide regulations implementing Section 866. Ignoring costs, any shift that might occur could potentially have both benefits and drawbacks. On the one hand, increased use of preference contracts could result in increased contracting with small businesses because agencies could award contracts to firms that would have lacked the capacity to perform the required percentage of the work on a set-aside contract. Increased contracting, in turn, could result in the government, as a whole, and individual agencies performing better on their goals for contracting with small businesses. On the other hand, increased use of preference contracts could limit small businesses' development because they would no longer be effectively required by the limitations on subcontracting to develop the in-house resources to perform certain set-aside contracts. This may be a particular concern with 8(a) firms because the 8(a) Program is, in part, intended to help small businesses owned and controlled by socially and economically disadvantaged individuals develop. Agencies could also potentially use preference contracts to steer work to preferred subcontractors, who are not competitively selected.

Summary: This report discusses Washington-Harris Group, a protest filed with the Government Accountability Office (GAO) alleging, among other things, that an agency improperly awarded a "preference contract" to a service-disabled veteran-owned small business that proposed to subcontract a greater percentage of work on the contract than allowed under the Small Business Administration's limitations on subcontracting. GAO denied the protest, in part, because it found that limitations on subcontracting apply only to contracts "set aside" for small business, not to preference contracts. A preference contract is one awarded in an unrestricted competition in which firms' small-business status is an evaluation factor, while a set-aside is a procurement in which only small businesses may compete. Limitations on subcontracting are statutory and regulatory provisions that require small businesses to perform certain percentages of the work on federal prime contracts themselves, rather than subcontract it to other firms. GAO's decision appears to be a case of first impression and can arguably be construed to mean that existing limitations on subcontracting are inapplicable to non-disaster and non-emergency contracts awarded to any type of small business under the general contracting authorities. Commentators have suggested that the decision may result in increased use of preference contracts by federal agencies. The federal government awarded $96.8 billion in prime contracts and subcontracts to small businesses in FY2009 through set-asides and other contracting vehicles.