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FAR Council Releases Interim Rule Prohibiting Contracts with Entities that Use Equipment Made by Huawei, ZTE, and Others

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Update: on July 14, 2020, the Interim Rule was published in the Federal Register here.

On July 10, 2020, the Federal Acquisition Regulatory (“FAR”) Council released a prepublication version of an interim rule, FAR Case 2019-009 (the “Interim Rule”), amending the FAR to prohibit federal agencies from contracting with companies that use in their systems telecommunications equipment produced by Huawei Technologies Company, ZTE Corporation, or their affiliates; video surveillance and telecommunications equipment produced by Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, Dahua Technology Company, or their affiliates; or telecommunications or video surveillance services provided by such entities or using such equipment (“Covered Equipment and Services”). The Interim Rule takes effect August 13, 2020, and implements the statutory requirement set forth in Section 889(a)(1)(B) of the John S. McCain National Defense Authorization Act for Fiscal Year 2019,1 which is designed to protect against foreign intelligence threats. The Interim Rule ends speculation that the Government might give contractors more time to comply with Congress’s mandate, and poses substantial business and legal risks to contractors that use, or have incorporated, Covered Equipment and Services in their own internal systems and operations. At a high level, the release of the Interim Rule means that contractors have approximately one month to purge all such Covered Equipment and Services from their systems in order to remain eligible for federal contracts, including new task and delivery orders on existing indefinite delivery, indefinite quantity (“IDIQ”) contracts.

The statutory basis for the Interim Rule was enacted in August 2018 and sets forth a two-staged prohibition requiring agencies: (1) to stop procuring Covered Equipment and Services (for their own use) within one year; and (2) to stop contracting with entities that use Covered Equipment and Services in their own systems within two years. In August 2019, the FAR Council implemented the first prohibition with new regulations at FAR subpart 4.21, solicitation provisions at FAR 52.204-24 and 52.204-26, and a solicitation/contract clause at FAR 52.204-25. The Interim Rule now implements the second prohibition by amending several of these provisions and clauses, as well as related provisions in FAR Parts 1, 13, and 39 and certain commercial item and simplified acquisition clauses in Part 52.

First, the Interim Rule revises the prohibition at FAR 4.2102 to add subsection (a)(2) as follows:

On or after August 13, 2020, agencies are prohibited from entering into a contract, or extending or renewing a contract, with an entity that uses any equipment, system, or service that uses covered telecommunications equipment or services as a substantial or essential component of any system, or as critical technology as part of any system . . . This prohibition applies to the use of covered telecommunications equipment or services, regardless of whether that use is in performance of work under a Federal contract.

The Interim Rule adds similar language to the clause at FAR 52.204-25. The terms “substantial or essential component” and “critical technology” had been defined by the FAR Council last year when it implemented the first agency-focused prohibition, and the Interim Rule does not change these definitions. “Substantial or essential component” means “any component necessary for the proper function or performance of a piece of equipment, system, or service,” while “critical technology” is a broad concept that includes items on the United States Munitions List, certain items on the Commerce Control List, as well as nuclear equipment and other emerging and foundational technologies. Notably, the Interim Rule does not define the term “use,” but emphasizes that the prohibition applies even if the use of the Covered Equipment and Services is unrelated to the performance of the contract.

Second, the Interim Rule revises the solicitation provision at FAR 52.204-24. Specifically, new paragraph (d)(2) will require an offeror submitting a proposal to represent, after conducting a “reasonable inquiry,” whether it does or does not use Covered Equipment and Services. If the offeror answers “does,” it will be required to provide additional information in the “disclosure” paragraph at (e)(2). Thus, at present, it appears that the Government will perform a case-by-case determination of whether each specific use of Covered Equipment and Services is prohibited because the use is “as a substantial or essential component of any system, or as critical technology as part of any system.” As a result, even if the offeror believes its use of the Covered Equipment and Services is permissible, it still must disclose such use, and it could be excluded from the competition if the Government disagrees with the offeror’s assessment. The FAR Council stated in the Interim Rule that it is currently working on updating the System for Award Management to allow for an annual representation, after which only offerors responding in the affirmative would be required to provide offer-by-offer representations.

As mentioned above, the offeror’s representation is to be made after conducting a “reasonable inquiry” into whether it uses Covered Equipment and Services. Under the Interim Rule, a “reasonable inquiry” is “an inquiry designed to uncover any information in the entity’s possession about the identity of the producer or provider of covered telecommunications equipment or services used by the entity.” The Interim Rule explains that a “reasonable inquiry need not include an internal or third-party audit.” Even so, the FAR Council clearly intends that contractors will stand up a robust compliance program to implement the usage prohibition. The Interim Rule sets forth six steps that the FAR Council “assumes” will “most likely be part of the compliance plan developed by any entity”: Regulatory Familiarization; Corporate Enterprise Tracking (i.e., the reasonable inquiry process); Education (of purchasing/procurement and materials management professionals); Removal (of Covered Equipment and Services); Representation; and Development a Phase-out Plan and Submission of Waiver Information (if a waiver will be requested).

The Interim Rule has broad application. It applies to solicitations for new contracts, new orders under existing IDIQ contracts, and options and extensions of existing contracts and orders.  Because the national security risks the Interim Rule aims to address exist regardless of contract type and size, it applies to all contracts, including contracts below the simplified acquisition threshold and contracts for commercial items (including commercially available off-the-shelf (COTS) items). Furthermore, while the Interim Rule states that the prohibition on using Covered Equipment and Services will not “flow down” to subcontractors, it warns contractors that the required “reasonable inquiry” must include an examination of the contractor’s relationships with subcontractors and suppliers to determine whether the contractor uses the supplier or subcontractor’s Covered Equipment and Services. In addition, the FAR Council announced in the Interim Rule that it is considering a potential expansion of the prohibition to all of an offeror’s affiliates, parents, and subsidiaries that are domestic concerns, with an effective date no later than August 13, 2021. If implemented, this would be a significant expansion of the usage prohibition that will require contractors to either remove all Covered Equipment and Services from the systems of their affiliates (to include entities not engaged in government contracting), or to decline to seek new business with the U.S. Government.

The Interim Rule provides a discretionary process for agencies to issue waivers for entities that are not in compliance after the August 13, 2020 effective date. With that said, the prospect of obtaining a waiver appears bleak, as the waiver process is onerous for both contractors and agencies. Under the process outlined in the Interim Rule (and added to FAR 4.2104), the head of an executive agency may grant a one-time waiver on a case-by-case basis, and waivers will expire no later than August 13, 2022. To request a waiver, an offeror must provide (1) a compelling justification for additional time to implement the usage prohibition, (2) a full and complete laydown of the presences of Covered Equipment and Services in its supply chain, and (3) a phase-out plan to eliminate the Covered Equipment and Services from the offeror’s systems. Moreover, before granting a waiver, agencies must undertake several steps, including appointing a senior official responsible for overseeing supply chain risk, establishing and participating in interagency sharing of relevant supply chain risk information, and notifying and consulting with the Office of the Director of National Intelligence (“ODNI”) on the issue of the waiver request. Agencies may only grant waiver requests after confirming — either via direct inquiry or consultation of existing guidance or briefings — that ODNI does not have existing information suggesting that the waiver would present a material increase in risk to U.S. national security. A waiver granted by one agency will not necessarily improve a contractor’s chances of being granted a waiver by a second agency on an unrelated procurement, and agencies may reasonably choose not to initiate the waiver process in the first place where mission needs do not permit time to undertake the process. Separately, the Director of National Intelligence may grant a non-time-limited waiver if the Director determines it is in the interest of U.S. national security.

The consequences of non-compliance with the Interim Rule are serious. For example, if an offeror is unable to represent that it does not use the Covered Equipment and Services in the manner prohibited by the statute and Interim Rule, it will be excluded from competitions for new contracts and task/delivery orders (in the absence of a waiver). As a contractual matter, engaging in a prohibited use of Covered Equipment and Services while performing a contract that includes the newly revised FAR 52.204-25 can cause an agency to decline to exercise options to extend the contract or, in the case of an IDIQ contract, decline to issue new task or delivery orders. Moreover, if the contractor makes an inaccurate representation to the Government regarding its use of the Covered Equipment and Services, it could face liability under the False Claims Act, as well as suspension or debarment from government contracting.

Given these risks, contractors should act now to educate their personnel, conduct the “reasonable inquiry” required by the Interim Rule, and work to remove Covered Equipment and Services from their systems as soon as practicable. While it is possible that certain provisions of the Interim Rule could change when the FAR Council issues a final rule, the Interim Rule is effective on August 13, 2020, and contractors can expect to see the new versions of FAR 52.204-24 and 52.204-25 in solicitations and contract modifications even before that date.

Finally, contractors interested in providing input for consideration in the formation of the final rule should submit comments in response to the Interim Rule, which will be due 60 days after its publication in the Federal Register. The Interim Rule identifies several specific issues about which the FAR Council seeks public input, although comments need not be limited to those issues. The V&E attorneys listed below are available to answer questions regarding the Interim Rule and assist with compliance.

1 See 41 U.S.C. § 3901 note prec., Prohibition on Certain Telecommunications and Video Surveillance Services and Equipment, https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title41-chapter39-front&num=0&edition=prelim.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.