U.S. Government Imposes National Security-Driven Procurement Restrictions on Federal Government Contractors that Will Impact Their Supply Chain

Amidst widening discord with China on a variety of trade, national security, and human rights issues, the Trump Administration has taken immediate action to restrict federal government contractors from relying on goods and services from certain prominent Chinese vendors.

On July 14, the Department of Defense, the General Services Administration, and the National Aeronautics and Space Administration collectively issued an interim final rule implementing the supply chain restrictions of section 889(a)(1)(B) of the 2019 National Defense Authorization Act (“NDAA”).  Consequently, as of August 13, 2020,  the U.S. Government will be prohibited from entering into contracts or placing orders with companies that use telecommunications technology or services provided by Huawei, ZTE, and certain other Chinese companies.  The government took this action despite industry calls for delays in implementation.

The rule is not as expansive as it could otherwise have been: it is limited to restrictions at the prime contract level.  In a signal of potential future action, however, the rule seeks public comment on whether the prohibition should be expanded to any affiliates, parents, or subsidiaries of contractors.  Such an expansion would significantly increase the scope of due diligence responsibilities and potentially bar a wide swath of companies from contracting with the government.  Public comments on possible expansion and other aspects of the rule are due by September 14, 2020, and the government has indicated that there will be further rulemaking in this area.

Any entity contracting with the federal government should carefully evaluate the restrictions of the rule and assess whether they have sufficient supplier due diligence processes to allow them to make the certifications regarding use of telecommunications equipment and services.  Companies that supply federal government contractors will also need to be prepared to address questions from their customers.

As noted in our previous alerts (here and here), Section 889 of the 2019 NDAA imposes restrictions on government procurement related to “covered telecommunications equipment or services.”  The NDAA defines “covered telecommunications equipment or services” to include telecommunications equipment or services provided by Huawei Technologies Company, ZTE Corporation, Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, and Dahua Technology Company, as well as their subsidiaries and affiliates.  The NDAA also authorizes the Secretary of Defense to designate additional Chinese companies as providing covered telecommunications equipment or services. 

Subsection (a)(1)(B) of Section 889 bars the federal government from contracting with any entity that “uses any equipment, system, or service that uses covered telecommunication equipment or services as a substantial or essential component of any system, or as critical technology as part of any system.”  Importantly, the definition of “use” extends “regardless of whether that usage is in performance of work under a Federal Contract.”  As such, the contractor will need to consider whether it uses such equipment and services in activities wholly unrelated to the goods or services being provided in any given government contract.

The rule amends the Federal Acquisition Regulation and will restrict:

• Solicitations issued on or after August 13, 2020, and resulting contracts;
• Solicitations issued before August 13, 2020, provided that award of the resulting contract occurs on or after August 13, 2020; and
• Future orders made pursuant to existing indefinite delivery contracts.

The restrictions apply to contracts for commercially available off-the-shelf items, as well as micro-purchase contracts.

 At the moment, the rule applies restrictions only “at the prime contractor level to an entity that uses any equipment, system, or service that itself uses covered telecommunications equipment or services as a substantial or essential component of any system.”  This is welcome news for companies with large corporate structures.  However, that relief may be short lived, as the rule seeks public comment on whether “to expand the scope to require that the prohibition . . . appl[y] to the offeror and any affiliates, parents, and subsidiaries of the offeror that are domestic concerns.”

The rule requires the entity contracting with the government to represent or certify “whether they use covered telecommunications equipment or services, or use any equipment, system, or service that uses covered telecommunications equipment or services.”  The rule further provides than an “entity may represent that it does not use covered telecommunications equipment or services . . . if a reasonable inquiry does not reveal any such use.” 

But what this means is not well-defined.  “A reasonable inquiry is an inquiry designed to uncover any information in the entity’s possession—primarily documentation or other records—about the identity of the producer or provider of covered telecommunications equipment or services by the entity.”  While the rule notes that a “reasonable inquiry need not include an internal or third-party audit,” it does not further flesh out the minimum standards for a “reasonable inquiry.”  Federal contractors will thus need to consider implementing diligence protocols that can stand up to this standard, bearing in mind that they may need to be able to substantiate representations provided in certifications.

The rule allows the head of the relevant government agency to grant limited one-time waivers on a case-by-case basis.  The process and requirements for receiving a waiver, however, are onerous.   

A waiver applicant must provide a compelling reason to be granted additional time to comply with the restrictions and must provide “a full and complete laydown of the presence of [covered equipment] in the entity’s supply chain, and a phase-out plan to eliminate such covered telecommunications equipment or services from the entity’s systems.”  In addition to other requirements, an agency can only grant a waiver if the Office of the Director for National Intelligence determines that it “does not have existing information suggesting that the waiver would present a material increase in the risk to U.S. national security.”  Finally, if an applicant clears all these hurdles, the agency granting the waiver must notify the appropriate congressional committees and provide those committees the laydown of covered telecommunications equipment and the phase-out plan provided by the waiver applicant.

Although industry continues to press Congress for legislative relief, the growing tensions with China and the focus on 5G and telecommunications security make it likely that the restrictions will go into effect on August 13.  The U.S. Government’s willingness to take a hard line in implementing Section 889 will pose significant challenges for any entity contracting with the government.  Suppliers to federal government contractors will also face new questions about whether they procure from covered telecommunications equipment.  Careful diligence and supply chain planning will be key to mitigating the risk of lost contracting opportunities and False Claims Act or False Statements Act exposure for inaccurate representations.   

The release of the interim rule is likely to be one of a suite of new supply chain restrictions.  Most notably, the Department of Commerce recently submitted a draft final rule to the Office of Management and Budget to implement Executive Order 13873, Securing the Information and Communications Technology and Services Supply Chain.  The rule could prohibit the use of certain Chinese technology in the United States, and the Department of Commerce has not indicated what changes it has made to the version of the rule that was released in late 2019, which was met with near unanimous criticism from industry.  Because OMB coordination is the final stage before a rule is issued, we will likely soon have answers as to how aggressive the government will be in imposing new restrictions on Chinese technology.  But if the recent heated rhetoric and diplomatic disputes with China are any indication, companies should prepare for further constraints on U.S.-China trade in the telecommunications sector.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Lisa Monaco, an O’Melveny partner licensed to practice law in the District of Columbia and New York, Greta Lichtenbaum, an O’Melveny partner licensed to practice law in the District of Columbia, John Dermody, an O’Melveny counsel licensed to practice law in California and the District of Columbia, and David J. Ribner, an O’Melveny counsel licensed to practice law in New York and the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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