Limitations on Subcontracting, often abbreviated as LOS, are federal contracting rules that set boundaries on the amount of work a prime contractor can subcontract to other entities when performing under a small business set-aside contract. These limits ensure that the small business prime contractor performs a substantial portion of the work and that the benefits of the contract flow primarily to the designated small business category.
The LOS requirement exists to maintain the integrity of federal small business programs and to prevent large companies from capturing set-aside work indirectly through excessive subcontracting.
The Purpose of the LOS Requirement
Small business set-aside contracts are intended to give eligible small firms the opportunity to perform significant work, build capacity, and gain valuable experience. Without LOS requirements, small business primes could subcontract most of the work to larger firms, defeating the purpose of the set-aside.
Key objectives of the LOS rule include:
- Ensuring that small businesses perform the core work on contracts awarded to them.
- Supporting the development of small business capabilities.
- Preventing large businesses from using small firms as pass-through entities.
- Maintaining fair competition within the small business contracting community.
The Regulatory Basis for LOS
LOS rules are established in the Small Business Act and implemented through the Federal Acquisition Regulation and Small Business Administration regulations, specifically 13 CFR 125.6. These regulations outline the percentage thresholds for subcontracting based on the type of contract and define how compliance is measured.
Contracting officers are required to include the applicable clauses in solicitations and contracts whenever LOS applies.
Applicability of LOS
The LOS requirement applies to:
- Contracts that are set aside for small businesses under any small business program, including 8(a), HUBZone, Service-Disabled Veteran-Owned Small Business, and Women-Owned Small Business programs.
- Both full and partial set-asides.
- Prime contracts awarded to small businesses for services, supplies, construction, or specialty trade construction.
It does not apply to unrestricted contracts or to large businesses.
LOS Thresholds by Contract Type
The exact subcontracting limits depend on the nature of the contract:
- Services Contracts: The prime contractor may not pay more than 50 percent of the amount paid by the government to firms that are not similarly situated entities, excluding the cost of materials.
- Supply Contracts: The prime contractor may not pay more than 50 percent of the amount paid by the government to firms that are not similarly situated entities, with the cost of materials excluded from the calculation.
- General Construction Contracts: The prime contractor may not pay more than 85 percent of the amount paid by the government to firms that are not similarly situated entities, excluding the cost of materials.
- Specialty Trade Construction Contracts: The prime contractor may not pay more than 75 percent of the amount paid by the government to firms that are not similarly situated entities, excluding the cost of materials.
These thresholds are calculated based on the total amount the government pays to the prime contractor.
The Concept of Similarly Situated Entities
A key concept in LOS compliance is the definition of a similarly situated entity. A similarly situated entity is a subcontractor that:
- Has the same small business program status as the prime contractor for the specific procurement.
- Qualifies as small for the NAICS code assigned to the subcontract.
Work performed by similarly situated entities does not count toward the subcontracting percentage limit. This allows small businesses to team with other small businesses in the same program category without penalty.
Measuring Compliance
Compliance with LOS is measured over the life of the contract and is based on the amount the government pays to the prime contractor. Contracting officers and auditors may review invoices, payment records, and subcontract agreements to ensure the prime is not exceeding the allowable subcontracting percentage.
Prime contractors must maintain records demonstrating how they track compliance, including clear identification of work performed by similarly situated entities versus other subcontractors.
Consequences of Non-Compliance
Violating the LOS requirement can lead to serious consequences, including:
- Termination of the contract for default.
- Liquidated damages equal to the greater of $500,000 or the amount paid to noncompliant subcontractors beyond the allowed limit.
- Suspension or debarment from federal contracting.
- Negative past performance ratings.
Because of these potential penalties, contractors must carefully monitor their subcontracting levels throughout contract performance.
Best Practices for Maintaining LOS Compliance
Prime contractors can manage LOS compliance effectively by following best practices such as:
- Developing a clear work allocation plan before contract performance begins.
- Keeping detailed and updated records of subcontractor payments.
- Identifying and confirming the size and program status of all subcontractors.
- Using project management tools to track cumulative subcontracting percentages.
- Reviewing LOS compliance periodically throughout contract execution.
These steps help ensure that contractors remain compliant and avoid last-minute surprises during audits or closeouts.
Example Scenario
A HUBZone-certified small business wins a $2 million service contract set aside for HUBZone firms. Under the LOS rule, the business must perform at least 50 percent of the work itself or through other HUBZone-certified small businesses. The company subcontracts 30 percent of the work to another HUBZone firm and 25 percent to a large business. Because only the work performed by the large business counts toward the LOS limit, the contracting officer calculates that the company subcontracted 25 percent to a non-similarly situated entity, which is well below the 50 percent threshold, and the contractor is in compliance.
The Role of Contracting Officers
Contracting officers play a key role in enforcing LOS requirements. They must:
- Include the correct FAR and SBA clauses in solicitations.
- Review prime contractor compliance plans.
- Monitor performance to ensure the LOS percentage limits are not exceeded.
- Take corrective action if non-compliance is identified.
Clear communication between contracting officers and contractors is essential for maintaining compliance.
Conclusion
Limitations on Subcontracting are a critical safeguard in federal small business contracting. They ensure that small business prime contractors perform a meaningful portion of the work on set-aside contracts and that the benefits of these opportunities flow primarily to small businesses. By understanding the thresholds, properly identifying similarly situated entities, and maintaining accurate records, contractors can remain compliant while building capacity and delivering value to federal customers.
