On March 25, the Department of Defense (DoD) issued a proposed rule to implement part of the National Defense Authorization Act for FY 2016, particularly Section 885(a). The objective of this proposed rule is to address the allowability of contractor costs of counterfeit parts or suspect counterfeit parts and the cost of any rework or corrective action that may be required to remedy the use or inclusion of such parts. According to the proposed rule, such costs may be allowable if:

• The parts were obtained by the contractor/subcontractor in accordance with the regulations described at section 818(c)(3) of the NDAA for FY 2012, as amended (such regulations will be published as a final rule under DFARS Case 2014-D005).
• The contractor discovers the counterfeit electronic parts or suspect counterfeit electronic parts.
• The contractor provides timely notice to the government.

By way of background, in late September 2015, the DoD issued a proposed rule that would revise its regulations pertaining to counterfeit electronic parts. DFARS Case 2014-D005. That rule would amend DFARS 246.870, Contractors’ Counterfeit Electronic Part Detection and Avoidance Systems, and create a new DFARS clause at 252.246-70XX titled Sources of Electronic Parts. The new clause would apply to all DoD contractors and subcontractors, at all tiers, that provide electronic parts or assemblies containing electronic parts, including acquisitions for commercial off-the-shelf items. Our discussion of that proposed rule can be accessed here. The rule is in process under DFARS Case 2014-D005, Detection and Avoidance of Counterfeit Parts—Further Implementation, to implement section 818(c)(3) of the NDAA for FY 2012.

According to DFARS 246.870, contractors that are subject to the cost accounting standards and that supply electronic parts or products that include electronic parts, and their subcontractors that supply electronic parts or products that include electronic parts, are required to establish and maintain an acceptable counterfeit electronic part detection and avoidance system. Failure to do so may result in disapproval of the purchasing system by the contracting officer and/or withholding of payments.

This latest proposed rule, which will amend DFARS cost principle 231.205-71, will apply to all DoD prime contractors and subcontractors with cost contracts. Its objective is to address the allowability of costs related to the detection and correction of counterfeit parts, but only if the contractor or subcontractor has complied with DFARS 246.870. The current version of DFARS 231.205-71 provides that these types of costs are “unallowable” unless the contractor (1) has an approved system to detect and avoid counterfeit parts and suspect counterfeit electronic parts; (2) the counterfeit electronic parts or suspect counterfeit electronic parts are government-furnished property; and (3) the contractor provides timely notice to the government. The DoD expects the impact of this proposed rule to be beneficial to contractors because it will expand the allowability of costs for counterfeit parts or suspect counterfeit parts and the cost of rework or corrective action that may be required to remedy the use or inclusion of such parts.

This proposed rule implements section 885(a) of the NDAA for FY 2016 (Pub. L. 114-92) and is available here. Comments on the rule may be submitted on or before May 24, 2016.