On December 10, 2010, we updated you on a controversial proposed regulation that would allow the Department of Defense (“DoD”) to withhold payments from contractors. Comments on the revised proposed rule were accepted until January 3, 2011. The DoD revised the proposed rule based on the comments it received and issued an interim rule with a request for comments. The interim “Contractor Business Systems” rule is effective as of May 18, 2011; it will be located at DFARS 252.242-7005.

The interim rule removed the $50 million contract threshold. Contractors covered by the interim rule are those that are subject to the Cost Accounting Standards under 41 U.S.C. Chapter 15, as implemented at 48 CFR 9903.201-1. The interim rule does not apply to small businesses.

Generally, the rule permits contracting officers to withhold payments when a contractor’s business system contains significant deficiencies. Covered contractor business systems may include accounting systems, earned value management systems, estimating systems, material management and accounting systems, property management systems, and purchasing systems. Monies can be held from interim payments under cost-reimbursement, incentive type, time-and-materials and labor-hour contracts, as well as from progress payments and performance-based payments.

Under this interim rule, withholdings are intended to be a good faith estimate of the potential risk of loss posed to the government by the deficient business system. The amount of the withholding is limited to 5% for one or more significant deficiencies in any single contractor business system or 10% for significant deficiencies in multiple contractor business systems. A significant deficiency is defined as a “shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes.” If a significant deficiency is found, the contractor has 30 days to respond to the initial determination.

Contractors should expect to see contracting officers amending some existing solicitations to include this clause, as it must be included in all contracts to be awarded on or after August 16, 2011. Comments on the interim rule will be accepted until July 18, 2011. The entire interim rule may be reviewed at 76 Fed. Reg. 28856.