Defense Department Proposes to Expand Applicability of Electronic-Counterfeit-Parts Regulations; Tens of Thousands of Contractors and Subcontractors—Including Small Businesses—Affected

Defense Department Proposes to Expand Applicability of Electronic-Counterfeit-Parts Regulations; Tens of Thousands of Contractors and Subcontractors—Including Small Businesses—Affected
September 22, 2015

It has long been a goal of the Federal government to eliminate counterfeit parts—parts of unknown (and likely false) origin and uncertain reliability—from the procurement supply chain. But these efforts have picked up pace in recent years, imposing significant compliance obligations on holders of Federal contracts and their subcontractors.

In response to Congressional legislation, the Department of Defense (“DOD”) promulgated regulations in 2012 that required certain providers of electronic parts to establish a counterfeit-part-detection-and-avoidance system. See DFARS § 246.870. Proper sourcing, traceability, and documentation are key aspects of any such system. But the burden was somewhat confined particularly as it relates to small businesses and commercial contractors because those 2012 regulations applied only when the contractor was subject to the Cost Accounting Standards (“CAS”).

DOD now wants to eliminate the CAS exception, and, as a result, many more contractors and subcontractors may become subject to the electronic-counterfeit-parts rules. See 80 Fed. Reg. 56939 (Sept. 21, 2015), DFARS Case 2014-D005. In a notice published in the Federal Register on September 21, 2015, DOD seeks public comment on a proposal to revise the Defense Federal Acquisition Regulations Supplement to make the electronic-counterfeit-parts rules applicable to substantially all DOD contractors, including not only those at “all tiers,” including subcontractors, but also small businesses, suppliers of commercial-off-the-shelf (“COTS”) items and those contractors performing contracts below the simplified-acquisition threshold (“SAT”). The new proposed rule has the potential to add significant compliance burdens to many companies that have not had to comply by virtue of the exceptions. In fact, DOD itself estimates that this rule change may affect more than 30,000 small businesses alone. Comments on the proposed rule are due by November 21, 2015.

The proposed new rule is further evidence of a clear trend that the Government is more committed than ever to eliminate counterfeit goods from the Federal procurement system. The rule is also consistent with a related proposed rule change to the Federal Acquisition Regulation—regarding “non-conforming” goods—that remains pending. See 79 Fed. Reg. 33164 (June 10, 2014), FAR Case 2013-002 (titled “Expanded Reporting of Nonconforming Supplies”). This other rule, if adopted, also seeks to expand the coverage of a rule that would require Federal contractors to report to the Government any non-conforming good—including electronic counterfeit goods.

Whether the rule takes effect in its proposed form remains to be seen, but contractors that provide electronic goods to the Government—even as pass-through entities—should begin to plan for new compliance requirements and additional procedures to satisfy these requirements. Such self-protective measures might entail, for instance, new purchasing terms and conditions that would require downstream suppliers to certify their electronics parts are genuine and have been properly inspected to assure their authenticity or that would provide warranty and indemnity protection to the purchasing company in the event that such parts are later found to be counterfeit. For companies who are “middle tier” contractors in the Federal supply chain and who may not have the internal technical (or financial) resources independently to detect counterfeit parts, the only viable solution may be to shift, to some reasonable degree, the risks of inclusion of such counterfeit parts to those businesses who have supplied them, which will certainly require careful attention both to the purchasing company’s terms and conditions and purchase order forms and to the vendor’s terms and conditions and sales forms in the future.