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Study: Nearly one-third of small contractors report ‘bait and switching’

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For Eric Basu, stories of being wronged on contracting work go on and on. There was a time his San Diego-based defense company, Sentek Global, joined as a subcontractor to a larger, prime contractor that wanted Sentek on board in part, Basu suspects, because his business fulfills a state set-aside requirement for veteran-owned companies. After the prime won the bid, Basu said they stopped returning his calls.

Then there’s the time he said he negotiated a 50/50 split for another contract and wrote a white paper that contributed to the winning bid — and was cut off again. Another time, a prime agreed to give Sentek 50 percent of the work on a contract, and he ended up with 15 percent.

“I’ve gotten used to it,” he said. “You run into people who aren’t deliberately unethical and some who are unethical on purpose. I try not to do business with those people more than once.”

Basu is not alone in his caution. Nearly a third of subcontractors reported having at some point been “stiffed” on a contract with a prime, according to a recent American Express survey. For the report, AmEx surveyed 740 small federal contractors. While the practice raises ethical issues, it’s not illegal: Contracting regulations don’t mandate that a prime firm must stick with any particular sub.

Subcontracting is often an attractive option for small firms looking for a piece of a big contract. The report found that nearly half of active small firm contractors have successfully pursued subcontracting as a procurement strategy, and these businesses derive an average of 25 percent of their procurement business from subcontracts.

But for many, being listed as a subcontractor on a winning bid sometimes results in disappointment rather than new business. The survey found that 29 percent of small firms have been victims of “baiting and switching,” in which a prime contractor wins a bid with a specific subcontractor but then either uses a different sub in the execution of the contract, or simply keeps the work for themselves.

Switching subcontractors can occur for a variety of reasons. Sometimes a prime simply finds a subcontractor that will perform the job for less than the price offered by the original subcontractor.

“Anecdotally you hear that it happens, but it turns out is a very big challenge for small businesses who are getting involved in federal contracting,” said Julie Weeks, an AmEx research adviser and author of the report.

From the prime’s perspective, replacing a subcontractor sometimes just makes sense for a particular project. For example, a prime may list a sub because its status as a woman-owned, minority or disadvantaged business will fulfill a contracting set-aside requirement. But after the award, the prime may realize the subcontractor doesn’t have the specific skills or capacity to meet the requirements of the order.

“Sometimes the government or a customer might require some very sophistocated subject matter expertise, for example,” said Ray Bjorklund, chief knowledge officer with the government-contractor software company Deltek. “While a small business might have very talented people and the capacity for doing some of the work, that small company may not be able to deliver that kind of expertise.”

And sometimes, Bjorklund said, it’s simply because the prime contractor prefers to keep the entire contract for themselves -- an increasingly common side effect of reduced government spending.

Legal action a double-edged sword

One way small businesses can avoid being victims of bait-and-switch, experts say, is by signing clear teaming agreements with primes they bid with.

“You can have a mandatory provision that says that if you are awarded the prime contract, you shall award me a subcontract for this specific amount,” said Terry Murphy, chairman of the government contracts practice group at Kaufman & Canoles. “Then you have a binding legal agreement that is enforceable because it is a breach of contract.”

But some primes won’t agree to such specific language, knowing that they’ll want to reserve the right to swap out a contractor if someone better—or cheaper—comes along for a particular order.

“Instead, the prime will say they’ll use ‘their best efforts’ or ‘endeavor’ or ‘negotiate in good faith’ to give them the work,” Murphy said. “That’s how the prime protects itself from a claim by the sub.”

And for many small companies, there’s a trade-off between suing to get promised work and maintaining good relations with a potential future prime partner.

“If a big contractor has these business opportunities, they’ll tell the sub, ‘I’ll make it up to you next time,’ ” Murphy said.

Taking legal action can also get expensive for a small firm. Basu did sue one prime he said had cut him off after promising him work, but he spent $50,000 in fees to recover $30,000 in invoices.

Dona Storey, a contracting consultant who is also a former federal contractor, said she once was stung by a big construction company that refused to recoup her labor costs when the project was delayed.

“It was the one detail I forgot to negotiate,” she recalls.

At the time, she couldn’t afford an attorney, so she let it go. Now, in her consulting role, she recommends extensively detailed teaming agreements that leave nothing to chance.

“I would lay out the work we’re going to do, how much we’re going to do, the contingencies, the assumptions,” she said. “As a small business, I want to do a great job and put on a happy face, but this is my business, not my hobby.”

New legislative and regulatory changes may make it harder to drop subcontractors.

One bill, which has passed the House, would penalize contractors that fail to file reports outlining their subcontracting plans and would also notify government agencies when there’s a discrepancy between the subcontractor a prime had planned to work with and the one they actually used.

The Small Business Administration, meanwhile, is working on a proposed rule that would allow contracting officers to denote changes in subcontractors or late payments in a contractor’s past performance record, which could impact their future contracts.

“That’s the real hammer,” Murphy explained. “In contracting, past performance is critical.”

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