Section 889 Compliance Costs May Be Compensable – Think Carefully Before Signing a Bilateral Modification

By Published On: August 14, 2020

The restrictions of Section 889(a)(1)(B) went into full effect yesterday, August 13, 2020.  To mark the occasion, we thought it important to note for our clients and colleagues in the government contracting community that contractors very well may have rights to pass at least a portion of the considerable costs of Section 889 compliance back to the federal government, even under fixed price contracts.

Section 889(a)(1)(B) Obligations and Costs

As addressed in our recent blog post discussing the scope of Section 889(a)(1)(B), Congress has prohibited federal agencies from “enter[ing] into a contract (or extend[ing] or renew[ing] a contract) with an entity that uses any equipment, system, or services that uses covered telecommunications equipment or services as a substantial or essential component of any system.”[1]  Importantly, this prohibition applies regardless of whether the use is specifically in the performance of a government contract.[2]

Congress has broadly defined “covered telecommunications equipment and services,” encompassing, in particular, equipment or services offered by Huawei Technologies Company, ZTE Corporation, or any of their many affiliates or subsidiaries.[3]

This prohibition has been implemented in the Federal Acquisition Regulation (“FAR”) through (i) a new provision calling for contractors to certify compliance, after a “reasonable inquiry,”[4] through a representation to the contracting agency (FAR 52.204-24), and (ii) a new clause to be added to all government contracts making the underlying prohibition an express performance obligation (FAR 52.205-25).

Specifically, Contracting Officers have been directed to include FAR provision 52.204-24 and FAR clause 52.204-25 in all solicitations issued on or after August 13, 2020, and resultant contracts; as well as in solicitations issued before August 13, 2020, provided the award of the resulting contract occurs on or after August 13, 2020.[5]  Further, Contracting Officers are instructed to include the FAR clause prior to exercising an option or modifying an existing contract to extend its period of performance.[6]

Changes Clause

While Contracting Officers generally have the right to unilaterally modify contracts pursuant to the Changes Clause, FAR Clause 52.243-1, the government is generally liable for any additional performance costs incurred by the contractor as a result of the change.[7]

Within the framework of the Changes Clause, it is typically up to contractors to identify and assert the increased cost of performance, place the government on notice of those costs within 30 days of the change, and make their cases for additional payment through requests for equitable adjustments or formal contract claims.[8]

The July 14, 2020 federal register notice implementing 889(a)(1)(B) acknowledges that costs of compliance with FAR clause 52.204-25 will be substantial for both contractors and the government.[9]  As discussed further below, we encourage contractors to carefully evaluate their rights to compensation upon addition of FAR clause 52.204-25 to their contracts.

As contractors evaluate their rights, we believe it important to address two “quirks” of this new requirement and the manner of its implementation: (i) insertion of the clause coupled with the exercise of an option, and (ii) the possibility of the government asserting that this change constitutes a non-compensable sovereign act.

Changes in Contract Terms Coupled with the Exercise of Option Periods

We anticipate that some federal agencies might assert that when a contract modification is coupled with the exercise of an option, the change is not compensable.

We do not believe that such an assertion would be correct.  The change to the contract terms for the option period, priced in the first instance through the competitive award, remains a compensable change.[10]  The government’s unilateral option to extend the contract’s period of performance is a right only to extend the contract in its current form.[11]

While contractors may wish to balance their interests in encouraging the government to exercise contract option periods with their interests in resisting uncompensated additional work, such considerations are matters of negotiation.

Sovereign Acts vs. Contractual Acts

We also anticipate that some federal agencies might assert that Section 889 requirements represent sovereign acts that are not compensable under the Changes Clause.  Again, we believe such an assertion would be incorrect.

As a preliminary matter, when governmental action is “taken in the national interest and is public and general in application,” costs arising from incidental impacts to contractors are not compensable under the Changes Clause.[12]  In essence, in such situations, the government is acting in its governing capacity, not its contracting capacity.[13]

However, the sovereign acts doctrine applies only in very limited circumstances.  First, as stated above, the act in question must be public and general in application.  A “factor relevant to the ‘public and general’ inquiry is whether the governmental action applies exclusively to the contractor or more broadly to include other parties not in a contractual relationship with the government.”[14]  A “governmental act that obstructs a government contract is more likely to be regarded as incidental when the scope of the governmental act is sufficiently broad to affect parties having no connection to the contract.”[15]  The Federal Circuit has repeatedly held that the “sovereign acts defense is unavailable where the governmental action is specifically directed at nullifying contract rights.”[16]

Under current jurisprudence, Section 889(a)(1)(B) appears to fall outside the bounds of a sovereign act.  First, it is specifically targeted at government contractors, not the public at large.  Second, it is to be implemented directly through express textual changes to government contracts.  Had the federal government outright banned Huawei Technology Corporation from selling its goods and services within the United States, the result might be different, as the act would be public and general in nature.[17]  Instead, Congress chose to direct all federal contracting agencies to require contractors to remove such equipment and services from their use as an express condition and term of their government contracts.

Keep an Eye Out for Bilateral Modifications Waiving Rights to Compensation

Given the above-described limitations on federal agencies forcing altered contract performance without providing adequate compensation, it will not be surprising to soon see agencies suggesting that contractors execute bilateral modifications to add the obligations of FAR 52.204-24 and 52.204-25 (as updated, effective August 13, 2020) and request that the contractor waive any rights to compensation.  Even if merely uncertain whether the modification is compensable, federal contracting agencies may well employ such a “belt and suspenders” approach.

We, therefore, encourage contractors to carefully consider any bilateral modifications incorporating the obligations of Section 889(a)(1)(B) (likely by “updating” FAR 52.204-24 and 52.204-25 to the August 2020 versions) before signing them.  In particular, we encourage contractors to evaluate whether to strike language that might suggest the modification is agreed upon “without compensation,” “with no further consideration,” or other language to similar effect.

This is not to suggest that contractors should refuse to perform the additional obligations, as such refusal could lead to termination of the contract. Rather contractors should clearly assert their right to compensation for the additional cost of performance resulting from the change.

Certainly, each contractor’s circumstances are different, from specific contract language to business goals.  We hope this blog offers useful information for those wondering how they will find the means to comply with these broad new requirements in the midst of the COVID-19 pandemic and associated economic environment.

Authors

If you have any questions about this blog post, please do not hesitate to contact the author, Scott S. Sheffler (ssheffler@ftlf.com).


[1] 2019 National Defense Authorization Act, Pub. L. 115-232 (Aug. 13, 2018), § 889.

[2] FAR 52.204-25(b)(2).

[3] Sec. 889, supra note 1.  In addition, “covered telecommunications equipment or services” includes “video surveillance and telecommunication equipment, when used for public safety, government facility security, security of critical infrastructure, or other national security purposes,” “produced by Hytera Communications Corporation, Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, . . . Dahua Technology Company” or any subsidiary or affiliate of the aforementioned.  Further, the definition includes telecommunications or video services provided by any of the aforementioned entities.

[4] “Reasonable inquiry” is defined in FAR 52.204-25 as “an inquiry designed to uncover any information in the entity’s possession about the identity of the producer or provider of covered telecommunications equipment or services used by the entity that excludes the need to include an internal or third-party audit.”

[5]  85 Fed. Reg. 42665.

[6] Id.  Specifically, the federal notice states “[w]hen exercising an option, [Contracting Officers] should consider modifying  . . . existing contract[s] to add the clause in a sufficient amount of time to both provide notice for exercising the option and to provide contractors with adequate time to comply with the clause. “   It is anticipated that Contracting Officers will modify existing contracts first, bilaterally, then second unilaterally.

[7] FAR 52.243-1.

[8] Id.

[9] 85 Fed. Reg. 42665, 42671-72.

[10] See Lockheed Martin IR Imaging Systems, Inc. v. West, 108 F. 3d 319 (Fed. Cir. 1997).

[11] Robertson & Penn, Inc., ASBCA No. 55625 at 6 (Sep. 3, 2008) (citing FAR 17.207).

[12] ANHAM FZCO LLC., ASBCA No. 58999 (November 13, 2018); Altanmia Commercial Marketing Company, ASBCA No. 55393, 09-1 BCA ¶ 34,095. (emphasis added).  If raised as an affirmative defense, the Government bears the burden of proof.  Id.

[13] Horowitz v. U.S., 267 U.S. 458, 461 (1925).  The “sovereign acts doctrine . . balances the Government’s need for freedom to legislate with its obligation to honor its contracts . . . [.]” U.S. v. Winstar Corp., 518 U.S. 839, 896 (1996).

[14] Conner Bros. Const. Co., Inc. v. Geren, 550 F.3d 1368, 1375 (Fed. Cir. 2008).

[15] Id. 

[16] Id. at 1374 (citing City Line Joint Venture v. United States, 503 F. 3d 1319, 1323 (Fed. Cir. 2007); Centex Corp. v. United States, 395 F. 3d 1283, 1308 (Fed. Cir. 2005).

[17] Whether such a ban might be legal is a matter well outside the scope of this blog post.


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