In the Interests of National Security – Two New DFARS Rules Strengthen Increased Surveillance of Chinese Sourced Supply Chains | Sheppard Mullin Richter & Hampton LLP

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

1. Employment Transparency Regarding People Doing Work in China

The first is DFARS Case 2022-D010 (87 Fed. Reg. 52339), an interim rule implementing Section 855 of the National Defense Authorization Act of 2022, Pub. L. No. 117-81, (“NDAA”), which is intended to increase US government visibility into DoD contracts involving work performed in China.

As required by section 855, this interim rule imposes new pre- and post-award disclosure requirements for companies that employ one or more individuals performing work in China under any DoD contract or subcontract where that contract (or subcontract) exceeds $5,000,000 (a “covered contact”). This requirement, however, does not not apply to: (1) DoD contracts or subcontracts that are for commercial products or commercial services, including commercially available (“COTS”) products; or (2) contracts at or below the simplified vesting threshold (currently $250,000). Unless the DoD has granted a waiver (which will likely be limited to classified type information and national security priorities), every non-commercial contract over $5 million will include the new 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, bidders must now 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 street address, where work will be performed on the covered contract, etc. This information must be provided at the time the Offeror submits its proposal. Importantly, this disclosure does not ask entrepreneurs to indicate whether they will use products of Chinese origin or whether they will buy from a Chinese supplier; but the disclosure Is focus on a contractor’s employees and the nature of those employees’ work in China. The rule is unclear whether this only covers 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 the people who will “perform[ing] labour” in China, seems to indicate that the rule would be interpreted broadly. This may be an issue that the DoD will clarify in the eventual final rule (which will likely be released next year).

Under the second clause, DFARS 252.225-7058, contractors will now be required to disclose this same post-award information on an annual basis if the contractor continues to employ one or more individuals who perform work in China. . DFARS 252.225-7058 must be forwarded to subcontractors, provided they are performing a “covered contract,” allowing the prime contractor to have the information necessary to complete the annual report for the DoD

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

Comments on the interim rule will be accepted by October 24, 2022. In the meantime, however, it is essential that all contractors and subcontractors who are parties to or intend to submit proposals for contracts covered by the DoD familiarize themselves with these requirements, as this interim rule imposes new statutory restrictions on the award, renewal, or extension of any Covered Contract. In addition, Offerors, contractors and subcontractors must ensure that they keep accurate and accessible records of the information covered by these disclosures.

2. Restriction on acquisition of tantalum

The second is DFARS Case 2020-D007 (87 Fed. Reg. 52342), also effective August 25, 2022, which finalizes an earlier interim rule (originally issued September 2020), implementing Section 849 of the NDAA 2020, Pub. L. No. 116-92, adding tantalum metals and alloys to the list of “covered materials” prohibited from acquiring from hostile countries such as China, Iran, North Korea and Russia.

Tantalum is a chemical element used as a “high-strength heat-resistant material for rockets, missiles and jet engines, as well as parts for control and regulation equipment”, but is mainly used to make tantalum capacitors for the aerospace, defense, and military industries.[1] As the DoD acknowledges, “Tantalum is an important part of the supply chain for the production of DoD military systems and non-military systems used by the DoD.”

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

As has been the case since the interim rule was first issued 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 one of the prohibited countries (China, Iran, North Korea, Russia), restricting the purchase of any finished product produced in these countries that contains a “covered material”. As is often the case with these country of origin restrictions, there are exceptions. Specifically with respect to tantalum, electronic devices or COTS items containing less than 50% tantalum by weight are not covered; but tantalum metals and tantalum alloys as the end product are generally restricted. The clause is also generally not applicable to acquisitions at or below the simplified acquisition threshold (currently $250,000). This clause should be passed on to suppliers.

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

Although comments on the interim rule noted that this restriction will inevitably lead to higher prices, potential shortages of raw materials and reduced profits for U.S. manufacturers, the DoD strongly believes that this rule is necessary because it is “a matter of national security” to reduce U.S. dependence on Covered Countries. We have seen a similar rejection of industry concerns in the agency’s response to the additional charges imposed by Section 301 national security tariffs on most commercial imports from China. Other industry comments raised concerns that the rule “will have negative impacts on international trade, increased administrative burden for industry and increased costs for government” due to the increased tantalum prices from countries not covered, combined with the legal requirement to separate products using tantalum in the commercial and defense industries. However, the DoD dismissed these concerns, anticipating “minimal impacts on international trade and minimal increase in administrative burden on industry” as “the defense tantalum market represents only a small portion of the overall global market. “. Ultimately, especially when Congress has imposed this legal requirement as a matter of policy, increased costs and supply chain disruptions are simply something the government buyer will have to bear because suppliers pass on higher costs – but these are burdens that the contracting community will need to address in the first place.

Conclusion If you have any questions about these new rules or other supply chain restrictions, please contact a member of our supply chain management team, including the authors.

FOOTNOTES

[1] Want to know more about tantalum? You can consult this site for more information – Advanced refractory metals, what are the uses of tantalum and its alloys? Want to know more about the periodic table of elements, in general? Take some time out with this classic song from comedian Tom Lehrer. (Tantalum is mentioned at about 1:18).

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