In the Interest of National Security – Two New DFARS Rules Reinforce Increased Scrutiny For Chinese-Origin Supply Chains
Tuesday, August 30, 2022

Effective August 25, 2022, the U.S. Department of Defense (“DoD”) has issued two new changes to the Defense Federal Acquisition Regulation Supplement (“DFARS”) reinforcing national defense priorities that limit DoD contracts performed in China, and the DoD’s ability to acquire tantalum metals from China and other unfriendly countries such as a Iran, North Korea, and Russia. These rules continue the trend of further isolating targeted countries in U.S. supply chains that are deemed a potential national security threat.

1. Employment Transparency Regarding Individuals Who Perform Work in China

First is DFARS Case 2022-D010 (87 Fed. Reg. 52339), an interim rule implementing Section 855 of the 2022 National Defense Authorization Act, Pub. L. No. 117-81, (“NDAA”), which seeks to increase the U.S. Government’s visibility into DoD contracts involving work performed in China.

As required under Section 855, this interim rule imposes new pre- and post-award disclosure requirements on companies that employ one or more individuals performing work in China on any contract or subcontract for the DoD when that contract (or subcontract) exceeds $5,000,000 (a “Covered Contact”). This requirement, however, does not apply to: (1) DoD contracts or subcontracts that are for commercial products or commercial services, including Commercially Available Off-the-Shelf (“COTS”) products; or (2) contracts at or below the Simplified Acquisition Threshold (currently $250,000). Unless the DoD has granted a waiver (which is likely to be limited to classified-type information and national security priorities), every non-commercial contract valued above $5 million will include the new clauses DFARS 252.225-7057 (pre-award disclosures) and 252.225-7058 (post-award disclosures), effective immediately.

Under DFARS 252.225-7057, when submitting a bid or proposal for a Covered Contract, offerors now must disclose: (1) the total number of employees who will perform work on the Covered Contract in China, and (2) a description of the physical presence of the facility in China, including the street address, where work will be performed on the Covered Contract, etc. These disclosures must be made at the time the offeror submits its proposal. Importantly, this disclosure does not ask contractors to represent whether they will be using Chinese-sourced products or buying from a Chinese vendor; but the disclosure does focus on a contractor’s employees and the nature of those employees’ work in China. The rule is unclear whether this covers only actual “employees” or also “independent contractors.” But the national security policy behind this rule, as well as references in the interim rule to a company’s “workforce” and people who will be “perform[ing] work” in China, seems to indicate that the rule would be interpreted broadly. Perhaps this is an issue that DoD will clarify in the eventual final rule (which will likely be issued next year).

Under the second clause, DFARS 252.225-7058, contractors now will have an obligation to disclose this same information post-award on an annual basis if the contractor continues to employ one or more individuals who perform work in China. DFARS 252.225-7058 should be flowed down to subcontractors, provided they will be performing a “Covered Contract,” allowing the prime contractor to have the needed information to complete the annual report for the DoD

The DoD cites “urgent” and “compelling” reasons for issuing this interim rule, notably the risk of allowing “a nation that is not our ally” to gather sensitive information via the performance of these types of contracts. The DoD further notes that “[i]t is a matter of national security to be aware of the entities, contracts, and subcontracts that are exposed to such risks, so that mitigation strategies can be implemented.”

Comments on the interim rule will be accepted through October 24, 2022. In the meantime, however, it is critical for any contractors and subcontractors who are parties to, or who plan to submit proposals for, DoD Covered Contracts to be familiar with these requirements as this interim rule imposes a new statutory restrictions on the award, renewal, or extension of any Covered Contract. Further, offerors, contractors, and subcontractors must ensure they are maintaining accurate and accessible records of the information covered by these disclosures.

2. Restriction on Acquisition of Tantalum

Second is DFARS Case 2020-D007 (87 Fed. Reg. 52342), also effective August 25, 2022, which makes final a prior interim rule (originally published in September 2020), implementing Section 849 of the 2020 NDAA, Pub. L. No. 116-92, adding tantalum metals and alloys to the list of “covered materials” that are prohibited from being acquired from unfriendly countries such as China, Iran, North Korea, and Russia.

Tantalum is a chemical element that is used as a “heat-resistant high-strength material for rockets, missiles, and jet engines, as well as parts for control and regulation equipment,” but is primarily used to manufacture tantalum capacitors for aerospace, defense, and military industries.[1] As recognized by the DoD, “tantalum is an important element in the supply chain for the production of both DoD military systems and nonmilitary systems that DoD uses.”

Beyond tantalum metals and alloys, other covered materials included in Section 849 include: samarium-cobalt magnets; neodymium-iron-boron magnets; tungsten metal powder; and tungsten heavy alloy.

As has been the case since the interim rule was first published in September 2020, which updated DFARS 252.225-7052 to include tantalum, this final rule prohibits the acquisition of any “covered material” that is melted or produced in any of the prohibited countries (China, Iran, North Korea, Russia), by restricting purchase of any end-item manufactured in these countries that contains a “covered material.” As is commonly the case with these country of origin restrictions, there are exceptions. Most notably with regard to tantalum, electronic devices or COTS items that include less than 50% of tantalum by weight are not covered; but tantalum metals and tantalum alloys as an end-product are generally restricted. The clause also is generally not applicable to acquisitions at or below the Simplified Acquisition Threshold (currently $250,000). This clause should be flowed down to suppliers.

There are, of course, some differences between the final and interim rules, primarily relating to the definitions. In the final rule, DFARS 225.7018-2(c) was modified to clarify the manufacturing steps that are required for production of tantalum metals and alloys. Other language was modified to better match the precise statutory language in Section 849. But otherwise, there are few substantive changes to the final rule.

Though comments on the interim rule noted that this restriction inevitably will lead to higher prices, potential raw material shortfalls, and reduced profits for U.S. manufacturers, the DoD stands firmly that this rule is necessary as it is “a matter of national security” to reduce U.S. dependence on the covered countries. We have seen a similar dismissal of industry concerns in the agency response to the additional burdens imposed by the Section 301 national security tariffs on most commercial imports from China. Other industry comments raised concerns that the rule “will have negative impacts to international trade, increased administrative burden on industry, and increased costs to the government” due to increasing tantalum prices from non-covered countries, combined with the statutory requirement for the segregation of products that use tantalum in the commercial and defense industries. However, the DoD dismissed these concerns, anticipating “minimal impacts to international trade and minimal increased administrative burden on industry” as the “defense tantalum market is a small portion of the overall global market.” In the end, particularly where Congress has imposed this statutory requirement as a matter of policy, the increased cost and supply chain disruptions simply are something that the government buyer is going to have to bear as suppliers pass on higher costs – but these are burdens that the contracting community will have to address in the first place.

FOOTNOTES

[1] Want to learn more about tantalum? You can check out this site for background – Advanced Refractory Metals, What Are The Uses Of Tantalum And Its Alloys? Want to learn more about the periodic table of elements, generally? Take some time with this classic tune from humorist Tom Lehrer. (Tantalum is mentioned at about 1:18).

Lillia Damalouji also contributed to this article.

 

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