The Civilian Agency Acquisition Council and Defense Acquisition Regulations Council have published a final rule in the December 12, 2006 Federal Register amending the FAR to clarify payment procedures for Time-and-Material (T&M) and Labor-Hour (LH) contracts for non-commercial items. This final rule becomes effective February 12, 2007.

Summary – The new rule states that subcontracts and interdivisional transfers for services that comply with the labor hour requirements of the contract are to be paid at the labor rates specified in the contract regardless of whether the individual is an employee of the prime contractor, a subcontractor or an affiliate of the prime contractor.

The rule also states that subcontracts for incidental services are to be reimbursed at the actual subcontract price, plus allowable indirect costs. For interdivisional transfers, recovery is limited to the actual rates or commercial prices of the division performing the work.

Synopses – The requirements of the final rule are below. The entire text can be found in the Federal Register dated December 12, 2006 (Volume 71, Number 238, Pages 74656-74667) or on-line at www.access.gpo.gov.

FAR 16.307, Contract clauses – Amended to specify that the Allowable Cost and Payment Clause is included in T&M contracts and is only applicable to the portion of the contract that provides for the reimbursement of materials at actual cost and related indirect costs.

FAR 16.601, Time-and-material contracts – The definitions for direct labor have been amended to include, for labor that meets the labor category qualifications of a category specified in the contract, labor (1) performed by the contractor, (2) labor performed by a subcontractor, and (3) labor transferred between divisions, subsidiaries or affiliates under common control.

The definition for materials now includes (1) direct materials, including supplies transferred between divisions, subsidiaries or affiliates under common control, (2) subcontracts for supplies and incidental services for which there is not a labor category specified in the contract, (3) other direct costs (e.g., incidental services for which there is not a labor category specified in the contract, travel, computer charges, etc.), and (4) applicable indirect costs.

FAR 52.232-7, Payments under time-and-material and labor-hour contracts – Defines subcontracts for labor as part of the definition of labor, if the subcontracted labor meets the requirements of the prime contract for labor hours.

It also clarifies that when a contractor furnishes its own materials that meet the definition of commercial items the price to be paid shall be the contractor's established catalog or the market price.

FAR 52.232-7 specifically states that the Government does not pay profit or fee to the prime contractor on materials (except for commercial items or as provided for in FAR 31.205-26, Material costs. The recovery of profit or fee is accomplished as a part of the labor hour portion of the contract.

The clause has also been amended to include the application of the Prompt Payment Act for interim payments under time-and-material and labor-hour contracts.

The final rule incorporates three new solicitation provisions that direct how proposals address subcontract labor.

1. Applies to the acquisition of non-commercial items based on adequate competition. Requires each offeror to indicate for each labor rate in the proposal whether it is a rate that applies to employees of one company or if it is a blended rate that applies to employees of more than one company.

2.  Applies to the acquisition of non-commercial items not based on adequate price competition. Requires the offeror to establish separate individual rates for prime contractor employees, subcontractor employees and employees of affiliates of the offeror.

3. Applies to the acquisition of commercial items and requires each offeror to identify for each proposed labor rate whether the rate applies to prime contractor, subcontractor or affiliate employees.

An interim rule with request for comments (on or before February 12, 2007) has been issued by the Department of Defense (DFARS Case 2006-D030) requiring the use of alternate (2) above for all DoD procurements.