Coronavirus May Compel Companies to Do Business with the Federal Government Under Defense Production Act

On March 18, 2020, President Donald Trump signed an executive order invoking and delegating the authorities of the Defense Production Act (DPA) to the secretary of the U.S. Department of Health and Human Services (HHS) to provide critical health and medical resources to respond to the spread of coronavirus (COVID-19). Under the authority of the DPA, HHS can issue "rated orders" compelling businesses to provide health and medical resources in front of all other customer orders, with a short response time and tight delivery deadline. Companies that have never done business with the federal government but that manufacture medical devices and supplies, including ventilators, masks and gloves, should ensure their personnel are aware of the president's executive order and obligations under the DPA.

What is the DPA?

The DPA was first established in 1950 in response to production needs during the Korean War. It replaced and superseded certain war powers, which had been used to compel production during World War II. Under the authority of the DPA, the U.S. Department of Commerce has established the Defense Priorities and Allocation System (DPAS). Under DPAS, certain federal agencies, including the U.S. departments of Defense, Health and Human Services, Homeland Security – including FEMA – and Energy, can issue DPAS-rated orders to ensure timely availability of supplies and services to meet national defense and emergency preparedness activities.

The DPA contains several component parts, including the following:

• Title I, Priorities and Allocations, permits the president or delegated agencies to compel companies to provide the government with materials and services deemed necessary for the national defense and establishes a priority system for the fulfilment of those orders.
• Title III, Expansion of Productive Capacity and Supply, allows the government to provide incentives and financial support to the domestic industrial base to create or expand the production and supply of critical materials and goods. The incentives and financial assistance can include loans, loan guarantees, direct purchases and purchase commitments, and the authority to procure and install equipment in private industrial facilities.
• Title VII, General Provisions, contains a number of important provisions, including key definitions for the DPA. It also establishes several distinct authorities, including the authority to establish voluntary agreements with private industry. It also provides authority to block proposed or pending foreign corporate mergers, acquisitions or takeovers that threaten national security, as well as the authority to employ persons of outstanding experience and ability and to establish a volunteer pool of industry executives and experts to advise or serve the government.¹

The March 18 executive order only expressly invokes the Title I "Priorities and Allocations " authority, although other aspects of the DPA are likely to come into play as the COVID-19 response unfolds. What this means is HHS has the authority to 1) issue "rated orders" for critical supplies and services, which must be accepted and prioritized over non-rated orders, and 2) issue "allocation orders" directing allocation of health and medical resources. While the executive order provides HHS with the authority to both prioritize and allocate, it should be noted that allocation authorities have not been used since the end of the Cold War.²

Under the Title I of the DPA, the president can require that performance under contracts or orders necessary to promote the national defense or emergency preparedness shall take priority over performance under any other contract or order. Therefore, if fulfillment of an unrated order interferes with fulfillment of a rated order, businesses must reschedule unrated orders to ensure timely performance of a DPAS-rated order. The effect of a rated order flows down the entire supply chain. That is, businesses that receive a rated order must place rated orders with their subcontractors and suppliers to ensure expedited delivery of materials, components and supplies needed to fulfil a rated order.

If the business normally sells the ordered material or service, then acceptance of a rated order is mandatory³; however, there are four grounds for mandatory rejection.

• If the contractor is unable to fill the order by the specified date, it must inform the customer of the earliest date on which delivery can be made and offer to accept the order on the basis of that date.
• If accepting a DO rated order would interfere with delivery of any previously accepted DO or DX rated orders, the contractor must offer to accept the order based on the earliest delivery date otherwise possible.
• If accepting a DX rated order for delivery on a date which would interfere with delivery of any previously accepted DX rated orders, the contractor must offer to accept the order based on the earliest delivery date otherwise possible.
• If a contractor is unable to fill all the rated orders of equal priority status received on the same day, the contractor must accept, based upon the earliest delivery dates, only those orders which can be filled and reject the other orders.⁴

Even if one of the grounds of rejection applies, a contractor is not relieved from fulfilling the order but must offer to accept the order based on the earliest delivery date possible. Additionally, there are circumstances in which a contractor may reject a rated order. For instance, the contractor may reject the order if the person placing the order – i.e., HHS – is unwilling or unable to meet regularly established terms of sale or payment.⁵ The DPA and HHS's implementing regulations also criminalize discrimination in pricing in response to rated orders; contractors are generally barred from charging higher prices or by imposing different terms and conditions than for comparable unrated orders. However, there may be flexibility to negotiate pricing higher than a contractor's established rates if acceptance of a rated order results in accelerated production schedules or similar circumstances that result in increased costs.

Compliance with rated orders is important because willful failure to perform is considered a criminal violation that subjects the people involved in the violation to up to one year of imprisonment and a fine of up to $10,000. The DPA limits a contractor's liability when fulfilling a rated order. Specifically, the DPA provides that a contractor is not liable for damages or penalties for any actions taken to comply with governing rules, regulations and orders, including any rules, regulations or orders later declared legally invalid. However, the DPA does not provide blanket tort immunity for liability to injured third parties or immunity from Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) liability or antitrust liability.

As noted above, other Titles of the DPA authorize the government to provide incentives when issuing rated orders. For example, the DPA authorizes the president to provide loans, direct purchases and other incentives to boost the production of critical goods and essential materials.  Additionally, two provisions in the DPA direct the president to accord special preference to small businesses when issuing contracts under DPA authorities. Specifically, the DPA directs the president to "accord a strong preference for small business concerns which are subcontractors or suppliers, and, to the maximum extent practicable, to such small business concerns located in areas of high unemployment or areas that have demonstrated a continuing pattern of economic decline, as identified by the Secretary of Labor."⁶

What if COVID-19 Impacts My Ability to Fulfill a Rated Order?

As states and local governments continue to issue orders mandating closures of schools, office buildings and facilities, requiring citizens to shelter in place and close down businesses to prevent the spread of COVID-19, this may create friction in a contractor's abilities to fulfill rated orders. Companies that have been affected by these mandates should evaluate whether they have alternative locations to fill a rated order. Alternatively, companies should determine if each state or local government's order contains any exception that would allow the company to remain open. For instance, an order may exempt essential businesses from closure mandates; however, each order may broadly or narrowly define the definition of "essential." Companies should carefully review each state or local government order to determine its applicability and seek advice of legal counsel if there are any uncertainties or ambiguities. Additionally, if a contractor cannot meet a rated order schedule deadline, the contractor or subcontractor is required to notify the customer immediately, give the reasons for the delay and advise of a new shipment or performance date.

Conclusion

Businesses that supply essential health and medical resources needed to respond to the spread of COVID-19, including personal protective equipment and ventilators, should start preparing their personnel in the event they receive a rated order. Businesses that receive rated orders will have a short turnaround time in which they must accept or reject the rated order, rearrange other customer needs and coordinate with subcontractors and suppliers to ensure timely performance of the rated order. Businesses that willfully fail to perform face heavy fines and potential jail time. Understanding the implications of the president's executive order and the DPA will help contractors ensure they are positioned to provide much-needed medical supplies in a timely fashion.

DISCLAIMER: Please note that the situation surrounding COVID-19 is evolving and that the subject matter discussed in these publications may change on a daily basis. Please contact the author or your responsible Holland & Knight lawyer for timely advice.

Notes

¹ The Defense Production Act of 1950: History, Authorities, and Considerations for Congress, CRS (Updated March 2, 2020).

² The Defense Production Act of 1950: History, Authorities, and Considerations for Congress, CRS (Updated March 2, 2020).

³ 45 C.F.R. § 101.33(a).

⁴ 45 C.F.R. § 101.33(b).

⁵ 45 C.F.R. § 101.33(c).

⁶ 50 U.S.C. § 4518; Section 108(a) of the DPA.