Rated Orders Under the Defense Production Act: Beware of Compliance Risks

In the wake of the (coronavirus) COVID-19 pandemic, federal agencies are starting to use their delegated authority under the Defense Production Act ("DPA"), 50 U.S.C. § 4511 and the related Executive Order 12919 to place priority-rated orders with industry. Under the Federal Priorities and Allocation System ("FPAS"), fulfillment of a rated order must take precedence over all unrated government or commercial orders when necessary for the contractor to meet the order's delivery requirements. The authority to place rated orders (and allocate materials, services and facilities) is delegated as follows:

1. the secretary of the U.S. Department of Agriculture with respect to food resources, food resource facilities, and the domestic distribution of farm equipment and commercial fertilizer
2. the secretary of the U.S. Department of Energy with respect to all forms of energy
3. the secretary of the U.S. Department of Health and Human Services with respect to health resources
4. the secretary of the U.S. Department of Transportation with respect to all forms of civil transportation
5. the secretary of the U.S. Department of Defense with respect to water resources
6. the secretary of the U.S. Department of Commerce for all other materials, services, and facilities, including construction materials; this authority also applies to defense

See 7 C.F.R. Part 789, (Agriculture), 10 C.F.R. Part 217 (Energy), 45 C.F.R. Part 101 (Health), 49 C.F.R. Part 33 (Transportation), 15 C.F.R. Part 700 (Commerce).

While the use of rated orders enables the country to quickly meet its national defense, energy and emergency preparedness needs, it also places increased compliance risks on the nation's contractors.

Cognizance of and adherence to the FPAS priority requirements is imperative. Not only do the regulations charge anyone who receives a rated order with knowledge of the FPAS regulations, willful violations of DPA/FPAS are considered criminal acts under 50 U.S.C. § 4513, and reckless disregard could result in civil actions and possible treble damages under the False Claims Act ("FCA"), 31 U.S.C. § 3729 et seq. As demonstrated by the sizable uptick in procurement-related fraud cases in the wake of the 2008 financial crisis and recent disasters, post-pandemic enforcement, whether criminal or civil, is inevitable. The U.S. Department of Justice (DOJ) already issued a memo emphasizing its need to "remain vigilant in detecting, investigating, and prosecuting wrongdoing related to the crisis" and directing U.S. attorney's offices to prioritize the detection, investigation and prosecution of all criminal conduct related to the current pandemic." From acceptance to performance, contractors should therefore be wary of the following types of FPAS requirements ripe for post-pandemic enforcement efforts.

Acceptance and Pricing

Contractors are required to accept rated orders for products sold by the contractor, and failure to do so, unless for an exempted reason, can result in fines or imprisonment. If a contractor is unable to meet the agency's required delivery date, it can reject the order; however, it is unacceptable for a contractor to reject a rated order on account of delivery requirements for previously placed unrated orders. This is true without exception; FPAS does not consider whether previously placed orders are for the contractor's most important customer, or the failure to meet the unrated order may impact further work pipeline. Contractors also must not falsely represent to the agency their ability to meet delivery dates. (Note: The words "immediately" or "as soon as possible" do not constitute a delivery date for purposes of establishing a valid rated order.)

Contractors may reject rated orders if they are unable to meet the required delivery date; however, they must provide the earliest date on which delivery can be made. Again, inability to meet delivery dates because of prior production requirements may not be considered when formulating alternative delivery dates. Accurate reporting to the agency of production timelines is critical.

Contractors receiving rated orders must also be mindful of their obligation not to discriminate against rated orders in any way. Discrimination occurs by, for example, charging unjustifiably higher prices than similar unrated orders. Contractors should identify comparable sales and granularly document any basis for deviation (e.g. increased overtime requirements to meet delivery schedule, shipping premiums on supplies). Charging higher prices to offset costs associated with unrated orders or to profit from the governments urgency is not permissible. Discrimination also includes imposing less favorable terms and conditions such as warranties, discounting, or adjacent support vis-à-vis unrated orders.

Performance

Contractors must provide the appropriate level of priority in fulfilling orders. This means rated orders must be completed ahead of non-rated orders, regardless of whether they are commercial or government orders, if required to meet the rated order's delivery date. Reordering of production schedule is not required if the contractor can satisfy the agency's required delivery date without modification to production schedule.

Contractors should also adhere to priority among rated orders; for example, orders identified with a "DX" rating take precedence over "DO" rated orders, priority directives take preference over DX orders, and allocation directives take preference over all. Within each category, preference must be provided to the order with the earliest receipt date.

Contractors are required to flow down the priority rating to any subcontractor or supplier by placing rated suborders. Prime contractor liability for subcontractor acts is always a point of contention in procurement fraud cases. When it comes to FPAS, the same tension exists. Prime contractors should document their efforts to alert the subcontractor and any downstream suppliers to the rating and ensure downstream compliance with the priority system. This includes the nondiscrimination provisions: suppliers may not discriminate against a prime contractor's rated order in any manner, including price or terms and conditions.

Contractors must acquire needed production items in a timely manner to satisfy the delivery requirements. A knowing failure to maintain sufficient inventory to meet rated order requirements could be a basis for enforcement if maintaining inventory levels are within the providence of the contractor's purchasing abilities. (Note: contractors are permitted to use rated suborders to backfill inventory expended during performance of a rated order.)

Discrimination is also a performance concern; a contractor's use of lesser quality components in a rated order or providing expedited shipping for a nonrated order to make up for delays on those orders might be considered discrimination.

Delays and Changes

In the event the contractor cannot meet the delivery date, the contractor must immediately notify the agency and provide the reasons for the delay. Full and accurate descriptions of the basis for delay must be provided.

Requests for price increases will be subject to the standard changes clauses of the contract or order. Enforcement risks associated with such certified claims are on par with standard government contracts. Contractors must, as they would with any claim, adequately and accurately support the request for price increase.  

Closeout and Records Retention

Contractors are required to maintain records "in sufficient detail to permit the determination, upon examination, of whether each transaction complies with the" FPAS regulations or action. This may mean that contractors should suspend standard document destruction and maintain additional documentation. Not only does the increased records retention ensure compliance with the regulation, contractors are well advised to keep track of their compliance efforts for at least six years on rated orders in the event of an audit or inspection, discussed below, or potential enforcement action under the FCA.

Audits, Inspections and Investigations

The FPAS regulations specially provide for audits and investigations to ensure compliance with FPAS. The authority is broad and includes not only the right to examine records, but also to conduct interviews of employees or agents, make system evaluations and even seek compulsory process and inspection warrants. The ability to collect documents and conduct interviews is akin to the Civil Investigative Demand (CID) authority used under the FCA and is regularly used in cases brought by relators (i.e. whistleblowers) or the DOJ.

In cases where the government determines a contractor has inadvertently failed to comply with FPAS, the contractor may be notified in writing of the noncompliance. Contractors that fail to rectify the noncompliance going forward are considered to be willfully violating the DPA and may be subject to criminal prosecution.

FPAS regulations also prohibit persons from "soliciting, influencing or permitting another person to" violate DPA/FPAS, to conspire to commit or "omit any act required by" DPA/FPAS. The regulations further provide that "[n]o person shall deliver any item if the person knows or has reason to believe that the item will be accepted, redelivered, held, or used in violation of the Defense Production Act, this part, or an official action. In such instances, the person must immediately notify the Department of Commerce that, in accordance with this section, delivery has not been made." These provisions create enforcement risk for companies seeking to or obtaining goods or services that are known to be subject to prioritization under a rated order ahead of any such order. 

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 your responsible Holland & Knight lawyer or the author of this alert for timely advice.