On August 2, 2016, the Department of Defense (DoD) finalized a rule (81 Fed. Reg. 50635) implementing additional Defense Federal Acquisition Regulation Supplement (DFARS) regulations for the Detection and Avoidance of Counterfeit Electronic Parts in the DoD supply chain in the form of a new DFARS clause, 252.246-7008, Sources of Electronic Parts, and revisions to DFARS Subpart 246.8. As Venable reported last year when the amendment was proposed, this final rule will have immediate and important implications for how your company does business, regardless of whether you supply electronic parts and equipment to the federal government directly or you are a vendor anywhere in the government supply chain. The new Sources of Electronic Parts clause applies to all contracts, even those at or below the Simplified Acquisition Threshold (SAT) and contracts for the acquisition of commercial items, including commercial off-the-shelf (COTS) items, and must be flowed down to all subcontractors (except those that are the original manufacturer) as well. This final rule became effective immediately.
On the same day, DoD also issued a proposed amendment to the new DFARS clause 252.246-7008, Sources of Electronic Parts, that would make a contractor's selection of a "contractor-approved supplier" subject to review, audit, and approval by the Contracting Officer. Comments on the proposed amendment are due October 3, 2016.
Both the final rule establishing DFARS clause 252.246-7008 and the proposed amendment thereto are vitally important to vendors of electronic parts, who must now provide electronic parts to the federal government from one of three categories of sources and could have their choices reviewed as well as audited by their respective contracting officers.
DoD's Final Sources of Electronic Parts Rule
DoD's final rule further implements Section 818 of the National Defense Authorization Act (NDAA) for Fiscal Year (FY) 2012 (Pub L. 112-81), as modified by Section 817 of the NDAA for FY 2015 (Pub L. 113-291). Revised DFARS Subpart 246.8 and new DFARS clause 252.246-7008, Sources of Electronic Parts, apply to contractors and subcontractors at all tiers and create three categories of sources, depending on the circumstances, from which contractors must select suppliers of electronic parts:
- Category 1: A contractor must "obtain electronic parts that are in production by the original manufacturer or an authorized aftermarket manufacturer or currently available in stock from—(A) The original manufacturer of the parts; (B) Their authorized suppliers; or (C) Suppliers that obtain such parts exclusively from the original manufacturers of the parts or their authorized suppliers" (emphasis added).
- Category 2: If electronic parts are not available as provided in the first category, a contractor must "obtain electronic parts that are not in production by the original manufacturer or an authorized aftermarket manufacturer, and that are not currently available in stock from a source listed in [Category 1 above], from suppliers identified by the Contractor as contractor-approved suppliers" (emphasis added). Three conditions apply to this source of electronic parts: (i) Contractors must use established counterfeit prevention industry standards and processes to identify and approve contractor-approved suppliers; (ii) Contractors assume responsibility for the authenticity of parts provided by contractor-approved suppliers; and (iii) Contractors' selections of contractor-approved suppliers are subject to review and audit by the contracting officer. (Note the proposed rule below additionally requiring approval by the contracting officer.)
- Category 3: If a contractor (i) obtains an electronic part from a source other than those identified in Categories 1 and 2 because of nonavailability or from a subcontractor other than the original manufacturer that refuses to accept the flowdown of DFARS clause 252.246-7008; or (ii) cannot confirm that an electronic part is new or previously unused and that it has not been comingled in supplier new production or stock with used, refurbished, reclaimed, or returned parts, then the contractor must (A) promptly notify the contracting officer in writing; (B) be responsible for inspection, testing, and authentication; and (C) make documentation of inspection, testing, and authentication available to the Government upon request.
Contractors should bear in mind a few crucial aspects of the final rule:
- DoD removed the requirement that contractors use "trusted suppliers" that was included in the proposed rule. Instead, under Category 2, contractors can use a "contractor-approved supplier" (when the electronic parts are not in production and not currently available in stock), which is defined as "a supplier that does not have a contractual agreement with the original component manufacturer for a transaction, but has been identified as trustworthy by a contractor or subcontractor" (emphasis added). Critically, the final rule provides little guidance as to how to identify a supplier as "trustworthy," but rather merely states: "This term reflects that this is a supplier that is not authorized to sell the manufacturer's product, but the contractor has assessed and approved this supplier." Contractors should be particularly cautious and thorough when selecting contractor-approved suppliers, as those decisions are, at a minimum, subject to review and audit by the contracting officer and, potentially, approval as well, based upon DoD's proposed rule below.
- Contractors must use Category 1 suppliers if the electronic part is in production or currently available in stock. DoD clarified that this means that "even if there is a demonstrated, immediate need for a part in production with a lead time, contractors do not have the option to seek the part from other than a Category 1 source." The flip side of this coin is that contractors can only use Category 2 suppliers (contractor-approved suppliers) when the electronic part is not in production and is not currently available in stock from a Category 1 source. Thus, DoD warns that contractors must make a "good faith" effort to determine whether an electronic part is available from a Category 1 source. Contractors would be wise to use their best efforts to use Category 1 sources, as using Category 2 sources could very well result in added costs (and of course such decisions are subject to review and audit by the contracting officer). Contractors should document their attempts to determine whether a part is available from a Category 1 source.
- Traceability: If a contractor is not the original manufacturer or an authorized supplier, the contractor must (i) have risk-based processes that enable tracking of electronic parts from the original manufacturer to final acceptance by the government; (ii) be responsible for inspection, testing, and authorization in accordance with applicable industry standards; and (iii) maintain documentation of traceability or the inspection, testing, and authorization. The documentation must be available at the government's request.
- Contractors and subcontractors still must comply with these requirements if they (i) are authorized to purchase electronic parts from the Federal Supply Schedule (FSS), (ii) are purchasing electronic parts from suppliers accredited by the Defense Microelectronics Activity, or (iii) are requisitioning electronic parts from government inventory/stock under DFARS clause 252.251-7000, Ordering from Government Supply Sources. Notably, when a contractor orders from Government Supply Sources, the government is responsible for the authenticity of requisitioned parts. If such a part is found to be counterfeit or suspected to be counterfeit, the government is responsible for promptly replacing the part at no charge and will consider an adjustment in the contract schedule to the extent the counterfeit or suspected counterfeit part caused a delay in performance. Additionally, the cost of required inspection, testing, and authentication of requisitioned parts can be charged as a direct cost.
- DFARS clause 252.246-7008 must be flowed down to subcontracts (including those for commercial items that are for electronic parts or assemblies containing electronic parts) unless the subcontractor is the original manufacturer.
- The Sources of Electronic Parts requirements apply to contracts at or below the Simplified Acquisition Threshold and to contracts for the acquisition of commercial items, including COTS items.
Venable previously reported on the requirement that contractors subject to the cost accounting standards who supply the government with electronic parts must develop a counterfeit electronic parts avoidance and detection system in accordance with DFARS clause 252.246-7007, Contractor Counterfeit Electronic Part Detection and Avoidance System. The new Sources of Electronic Parts rule largely maintains the substantive aspects of that clause. Notably, though, the new rule amends DFARS clause 252.246.7007 to provide that, in addition to potential disapproval of the purchasing system by the contracting officer and/or withholding of payments, the failure by the contractor to maintain an acceptable counterfeit electronic part detection and avoidance system now may affect the allowability of the costs of counterfeit electronic parts or suspect counterfeit electronic parts and the cost of rework or corrective action that may be required to remedy the use or inclusion of such parts. The final rule also amends DFARS clause 252.246-7007 to incorporate, as one of the criteria required for a contractor's counterfeit electronic part detection and avoidance system, the traceability requirements set forth in the new Sources of Electronic Parts rule.
DoD's Proposed Rule on Approval of Contractor-Approved Suppliers
As a supplement to DoD's final rule establishing DFARS clause 252.246-7008, DoD has additionally proposed an amendment to that clause, which would implement Section 885(b) of the NDAA for FY 2016 (Pub. L. 114-92). As indicated above, when contractors have elected to use contractor-approved suppliers as the source of electronic parts under Category 2, their selections are subject to review and audit by the contracting officer. DoD's proposed new rule would make such selections subject to approval by the contracting officer. Notwithstanding this requirement, under the proposed amendment, a contractor would be permitted to proceed with the acquisition of electronic parts from its contractor-approved supplier unless otherwise notified by DoD.
Contractors should consider the risks arising from any decision to proceed with the acquisition of electronic parts from a contractor-approved supplier without receiving DoD approval.
Comments on the proposed amendment are due October 3, 2016.
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For more information on how the final and proposed regulations might impact your business, or to better understand the requirements regarding counterfeit electronic parts, please contact Paul Debolt, Keir Bancroft, Michael Francel, or any of the other attorneys in Venable's Government Contracts Practice Group.