The Expansion of the Business Systems Rule Beyond DoD

David M. Nadler, Justin A. Chiarodo, David Yang, and Stephanie M. Harden

David M. NadlerJustin A. ChiarodoDavid YangStephanie Marie ZechmannWith the potential for millions of dollars in withholdings on contract payments, Department of Defense (DoD) contractors have become all too familiar with the Business Systems Rule since it was first implemented in 2011. The Department of Energy (DoE) is now following in the steps of DoD and promulgating its own Business Systems Rule. On April 1, 2014, DoE issued a Notice of Proposed Rulemaking for its Business Systems Rule, which is largely modeled off of the DoD rule. This expansion of the Business Systems Rule beyond DoD warrants careful attention by contractors who may not have previously been covered, as effective and proactive compliance is essential to mitigating the risk of withholdings under the rule.

Overview of the DoD Business Systems Rule

The DoD Business Systems Rule permits DoD to withhold contractor payments on covered contracts if one or more “significant deficiencies” are found in any of the six business systems covered by the rule. The term “significant deficiency” is broadly defined as “a shortcoming in the system that materially affects the ability of officials of DoD and the Contractor to rely upon information produced by the system that is needed for management purposes”–a definition which leaves great discretion to the Contracting Officers responsible for determining system acceptability.

The current DoD rule applies to CAS-covered contracts (modified or full coverage) that contain the implementing clause found at DFARS 252.242-7005. DoD may withhold up to five percent for each disapproved system, with a 10 percent maximum on withholding when there are multiple disapproved systems. Once a final determination of system adequacy has been made, the contractor has 45 days to respond, during which time it can correct the deficiencies or submit a corrective action plan. Although withholdings will have already begun, if the Contracting Officer determines that the corrective action plan is acceptable, it can reduce withholdings to two percent.

Recent statistics underscore the importance of having effective compliance mechanisms in place. As of October 2013 DoD had withheld approximately $305.9 million in payments pursuant to the rule. Individual contractors have had multimillion dollar withholdings on their contracts–illustrating the potential for significant cash flow issues if systems are found to contain significant deficiencies.

The DoE Proposed Rule

The DoE proposed rule largely parallels the DoD rule. The DoE rule would apply to five of the six business systems currently covered by the DoD rule, only excluding the Material Management and Accounting system. Like the DoD rule, it provides for five percent withholding for each deficient business system, with a maximum of 10 percent withholding in total, and withholding may be reduced to two percent upon the submission of an acceptable corrective action plan.

As proposed, the DoE rule will apply to the following types of contracts when the implementing contract clause is included in the solicitation and contract:

  • contracts awarded to large businesses, including teaming arrangements, in support of capital asset projects (other than Management & Operating contracts), as prescribed in DoE Order 413.3B;
  • contracts awarded to large businesses, including teaming arrangements, for non-capital asset projects in which the total contract value exceeds $50 million, including options; and
  • prime contracts awarded to large businesses, including teaming arrangements, that total more than $10 million, including options, if the Contracting Officer determines that coverage would be in the best interest of the government—such as if significant estimating problems are believed to exist or the contractor’s sales are predominantly to the government.

The proposed rule, however, would not apply to DoE Management & Operating (M&O) contracts, which make up a large portion of DoE contracts, due to the special accounting and financing rules that currently apply to those contracts. However, DoE has indicated that it intends to propose a separate rule for M&O contracts at a later time.

Compliance Considerations

In light of the proposed rule, DoE contractors holding contracts likely to be covered by the final rule should begin taking steps to mitigate the risk of withholdings. Being proactive will be critical, given the short time frame for responding to a finding that a business system is inadequate. In particular, DoE contractors who expect that they will be covered should consider the following:

  • Review and evaluate all subject business systems to reduce audit risk. As part of the review, consider any audit information from other sources that may be useful in assessing whether issues are present and consider targeting resources to address any noncompliant or high risk areas.
  • Establish controls for monitoring compliance with the rule on a continual basis and provide for routine evaluation of all business systems expected to be covered by the rule.
  • Be proactive in addressing potential deficiencies and maintain documentation to allow for a quick response to any deficiencies found during a review.
  • Understand your potential exposure and have contingency plans in place for potential cash flow interruptions.

The DoE proposed rule can be found at 79 Fed. Reg. 18,415 (April 1, 2014).