The Defense Production Act’s Impact on Government Contractors and Commercial Companies

On March 18, 2020, President Trump signed an Executive Order, invoking his authority under the Defense Production Act of 1950 (“DPA”), to prioritize and allocate all health and medical resources in the United States (“U.S.”) to respond to the spread of COVID-19. The DPA provides the president with an array of authorities to shape the national defense preparedness programs and to take appropriate steps to maintain and enhance the domestic industrial base. Numerous government contractors (mostly contractors serving the military) are already familiar with the concepts of “Priorities and Allocations” and have been required for years to prioritize DX-rated orders over DO-rated orders, and DO-rated orders over unrated orders.  But, for many government contractors and commercial companies, the U.S. Government’s priorities and allocations system may be completely foreign.  Since rated contracts could have a significant impact on how certain government contractors and commercial companies – especially those with the ability to manufacture gloves, gowns, face masks, eye protection, other protective gear, and respirators, etc. — conduct their business in the coming year, it’s important to understand the potential impact of the DPA.

Although President Trump has independent DPA authority, he immediately delegated his DPA authority to the Secretary of Health and Human Services (“HHS”) to “require performance of contracts or orders… with respect to all health and medical resources needed to respond to the spread of COVID-19 within the United States.” Thus, it is now the job of the Secretary of HHS to determine the proper nationwide priorities and allocation of all health and medical resources, including controlling the distribution of such materials (including applicable services) in the civilian market, for responding to the spread of COVID-19 in the U.S. HHS will exercise its DPA authority through existing regulations in the form of the Health Resources Priorities and Allocations System (“HPAS”). The HPAS functions similarly to the priorities and allocations systems managed by other executive agencies — such as the Defense Priorities and Allocations System (“DPAS”) at the U.S. Department of Commerce, the Agriculture Priorities and Allocations System at the U.S. Department of Agriculture, the Energy Priorities and Allocations System at the U.S. Department of Energy and the Transportation Priorities and Allocations System at the U.S. Department of Transportation.

Presidential authorities under the DPA fall into three categories: (1) Priorities and Allocations; (2) Expansion of Productive Capacity and Supply; and (3) General Provisions.

• Priorities and Allocations: Under the DPA, the president may require companies to prioritize performance under contracts or orders deemed “necessary to promote the national defense” over and above any other existing or future contract or order, and to require acceptance and performance of such contracts or orders in preference to other existing or future contracts or orders. And, the president may also allocate materials, services and facilities as deemed necessary or appropriate to promote the national defense.  With respect to the COVID-19 pandemic, the DPA prohibits hoarding of materials designated as “scarce materials” or materials the supply of which would be threatened by such accumulation. Specifically, no person or company shall accumulate designated material in excess of the reasonable demands of business, personal or home consumption, or for the purpose of resale at prices in excess of prevailing market prices. Penalties include fines of not more than $10,000 or imprisonment for not more than one year, or both.
• Expansion of Productive Capacity and Supply: Under the DPA, the president may now promote the expansion of domestic production capacity and supply of industrial resources, critical technology items and essential materials needed for national defense. The financial incentives for so doing include guaranteeing loans for financing any contractor, subcontractor, provider of critical infrastructure, or other person or company in support of production capabilities or supplies necessary for the national defense; offering loans to private businesses creating, maintaining, expanding, protecting or restoring capacity, developing technological processes, or producing essential materials; direct purchases and purchase commitments; and procurement and installation of equipment in private industrial facilities.
• General Provisions: Among the numerous general provisions, the DPA provides that a company cannot be held liable for damages or penalties for any act or failure to act resulting directly or indirectly from compliance with a rated contract.  It should be noted, however, that courts have found that the U.S. Government does not have an obligation to reimburse a company for potential lost profits attributable to nonperformance of unrated contracts – worth noting since it’s possible that performance of a rated contract may result in a company’s lost profits on an unrated contract due to its performance of a rated contract.

Upon receipt of a rated contract, government contractors and commercial companies should become familiar with the following concepts:

• Identifying a Rated Contract: Rated contracts will generally include at least four elements:
  •  A priority rating (e.g., DO-HR or DX-HR which explains the priority of the order for companies with numerous rated orders – a DX rating is assigned to those programs of the highest national priority);
  •  A specific required delivery date or dates;
  •  A signature certifying that the rated order is authorized and regulatory requirements are being followed; and
  •  A statement that the rated order is certified for national defense use or is placed in support of emergency preparedness requirements.

Rated contracts may come directly from the U.S. Government or they may come from prime contractors or higher tier subcontractors holding rated contracts or subcontracts.  Subcontractors must also comply with rated orders, but when receiving a rated subcontract, subcontractors can and should ask the prime contractor to verify that the prime contract is indeed rated and that the subcontract is necessary to fulfill the prime contract’s requirements.  The subcontract should include at least the elements described above.

• Identifying the DPA Authority. It may also be helpful to identify the DPA authority being exercised, i.e., which priorities and allocations system has triggered the rated contracted and/or which agency has issued the prime contract.  While DPA authority has been delegated and in some instances sub-delegated—for example, the DPAS can be used by the Departments of Commerce, Defense, Energy, Homeland Security and the U.S. General Services Administration—not every agency directly holds its own DPA authority.
• Accepting or Rejecting a Rated Order. A company that is subject to a priorities system generally must reject a rated contract if it is unable to satisfy the contract by the date specified (except that scheduling conflicts do not constitute an inability to fill the order, unless with another, higher or identically rated contract).  In such cases, the company must offer to fill an order on the earliest acceptable date.  A company generally may reject a rated contract on various other specified grounds, including if:
  • The prime contractor or higher level subcontractor placing the order is unwilling or unable to meet regularly established terms of sale or payment;
  • The contract is for an item that the receiving company does not supply or a service that the receiving company is unable to perform, with some exceptions for recent provisions of supplies or services; or
  • The prime contractor or higher level subcontractor placing the rated order (as opposed to the U.S. Government) makes the item or performs the service being ordered.
• Flowing Down Requirements of a Rated Contract. Companies may and, under HPAS (which will be the predominant priorities and allocations system during the COVID-19 crisis), are required to flow down the rating on their contract to any suppliers in order to obtain items or services needed to fulfill the rated contract—at whatever level those supplies are in the procurement supply chain.
• Negotiating Terms of a Rated Contract. A company receiving a rated contract is prohibited from charging higher prices or by imposing different terms and conditions on its business partners than it would for comparable non-rated orders.  And, the company which placed the rated order must be willing and able to meet regularly established terms of sale or payment. In other words, the companies must continue to deal with each other in good faith and fair dealing even though the negotiations involve a rated order.
• Mitigating Losses for Breach of Commercial and Non-Rated Contracts. As explained above, rated contracts must now be prioritized over non-rated contracts—even if this results in companies breaching contract obligations entered into on a commercial or non-rated contract. Government contractors and commercial companies making any of the necessities that the US needs to buy to respond to the spread of COVID-19 should consider attempting to re-negotiate the terms (especially dates of delivery) of their commercial or non-rated government contracts to factor in that such commercial or non-rated contracts were negotiated prior to the unforeseen event of issuance of President Trump’s Executive Order for responding to the spread of COVID-19.