New DFARS Clauses Require Defense Contractors to Disclose Work Performed in China

New DFARS Clauses Require Defense Contractors to Disclose Work Performed in China

August 29, 2022, Covington Alert

On August 25, 2022, the Department of Defense (“DOD” or “the Department”) published — with immediate effect — two new Defense Federal Acquisition Regulation Supplement (“DFARS”) clauses requiring defense prime contractors and subcontractors to disclose any work in China on certain DOD contracts. Under the interim rule, the DOD is prohibited from awarding or extending certain new contracts if a contractor fails to disclose its use of workers in China in performance of a covered DOD contract. Although there is no prohibition on DOD awarding a covered contract to an entity that makes a disclosure, the Department can rely on a variety of authorities to exclude certain contractors and products that represent supply chain risks, especially if the products or services involve information technology.

The new DFARS clauses implement section 855 of the National Defense Authorization Act (“NDAA”) for Fiscal Year 2022, which directed the DOD to require two-phase disclosures from certain contractors: an initial disclosure at the time a contractor submits a bid or proposal for a covered contract and an annual disclosure for the Government’s fiscal year 2023 (and again in fiscal year 2024) from any contractor that holds a covered contract during the fiscal year. The DOD implemented this provision with two new corresponding clauses, a solicitation clause and a contract clause:

• DFARS 252.225-7057, Preaward Disclosure of Employment of Individuals Who Work in the People’s Republic of China; and
• DFARS 252.225-7058, Postaward Disclosure of Employment of Individuals Who Work in the People’s Republic of China.

The disclosure requirements apply to “covered contracts,” which include any DOD prime contract or subcontract with an expected value in excess of $5 million — except for contracts for commercial products or services.[1] And the disclosure requirements apply to “covered entities,” which are (unsurprisingly) contractors performing work on a covered contract in the People’s Republic of China.

The preaward disclosure (DFARS 252.225-7057) requires covered entity offerors to identify at the time of submission of an offer for a prime contract the proposed use of workforce in China on the contract (unless the DOD grants a national security waiver). If any such activities are contemplated, the offeror also must identify the total number of individuals who will perform work in China and provide a description of the physical presence (including street address(es)) in China where work will be performed. This disclosure also covers any subcontract that meets the covered contract definition (that is, any subcontract for noncommercial products or services in excess of $5 million). As such, primes and higher-tier contractors will likely need to evaluate whether to require disclosures from prospective subcontractors in order to support their DOD proposals, at least where the potential subcontract may be considered a covered contract.

The new clauses raise a number of questions on how the DOD plans to implement the disclosure requirements on the ground, and we hope the Department offers clarification in its final rule concerning these new clauses. The open questions include:

• What does it mean to be “performing work” in China on a covered contract? The definition of “covered contractors” notes that performing work in China can include leasing or owning real property in China that is used in the performance of a covered contract, but neither the new DFARS clauses nor the NDAA appear to provide any other guidance on what it means to “perform work.” The question of what it means to be performing work on a certain contract (as opposed to performing work spread across multiple contracts or supporting the enterprise overall) is likely to vex many contractors without further guidance.
• The preaward disclosures must include “[t]he proposed use of workforce on a covered prime contract or subcontract, if the Offeror employs one or more individuals who perform work in the People’s Republic of China.” Taken literally, this would require description of the entire proposed use of workforce on the contract (not just use of workforce in China), and would be triggered even if the offeror employs individuals performing work in China that is unconnected to the relevant contract. We do not think this is what the DOD intended, and would suggest this as another point for clarification in the final rule.
• The postaward disclosures are required “for the Government’s fiscal years 2023 and 2024.” The clauses do not provide any guidance on when during the fiscal year the disclosures should be made, in what format, or to whom.

As these new clauses start to appear in solicitations and contracts, defense contractors would do well to keep in mind how the disclosures may interact with other recent DOD initiatives. Key considerations include:

• Contractors should ensure that any disclosures under this interim rule are consistent with the representations they are making under Section 889 (Federal Acquisition Regulation (“FAR”) 52.204-24 and -26; DFARS 52.204-7016 and -7017), as well as the reporting obligations under FAR 52.204-25 and DFARS 52.204-7018. To the extent that employees of a contractor that is in privity with the Government are using telecommunications equipment in China (whether for a DOD contract or any other reason), this disclosure could implicate Section 889 concerns.
• The full extent of what the DOD plans to do with the information it receives from these new clauses is uncertain. If information technology is being provided to the Government, there are authorities that would permit the Government to exclude contractors from procurements and even to remove products from the Government’s existing supply chains. See, e.g., DFARS 252.239-7018 (DOD Supply Chain Risk); 41 C.F.R. Part 201-1 (Federal Acquisition Security Council Authority); 10 U.S.C. § 3252 (Supply Chain Risk Requirements). Contractors need to understand how these new disclosure obligations fit within the Government’s overall China strategy when establishing their compliance programs and when considering where to expand their manufacturing and software development activities.
• A failure to provide the required disclosures could potentially open contractors up to False Claims Act liability under an implied certification or fraud in the inducement theory of liability.

The issuance of an interim rule that is effective immediately is consistent with other DOD actions relating to China and the significant concerns that the Department has with hardening its supply chain. The DOD is accepting public comments on the interim rule through October 24, and we can hope that questions raised through the public comment process will cause DOD to further clarify the rule.

As mentioned, the underlying requirements stem from the NDAA from last year. The NDAA is somewhat unusual in that it does not prohibit the DOD from entering into contracts with contractors using China-based workforce to perform, but does prohibit the Department from entering into contracts with such contractors unless they disclose the use of China-based workforce. The NDAA then requires the Secretary of Defense to provide congressional defense committees with semi-annual briefings starting next January summarizing the relevant disclosures the DOD receives. In addition to relying on current exclusion authorities, it is certainly possible that the disclosure requirement (and associated congressional briefings) could lead at some future date to an outright prohibition.

If you have any questions concerning the material discussed in this client alert, please contact the members of our Government Contracts and CFIUS practices.