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June 24, 2016

Supreme Court Makes Rule of Two Mandatory at VA And Broadly Defines "Government Contract"

Arnold & Porter Advisory

The Department of Veterans Affairs (VA) must apply its “Rule of Two” to foster contracting with Veteran-owned small businesses across the board, and not merely for purposes of meeting its small-business contracting goals. In a June 16, 2016 opinion, a unanimous Supreme Court held that small business contracting set-asides imposed by the Veterans Benefits, Health Care, and Information Technology Act of 2006 (the “2006 Act,” codified at 38 U.S.C. § 8127) are mandatory, apply even when the VA has already met its annual small business contracting goals, and extend to Federal Supply Schedule (FSS) purchase orders. See Kingdomware Techs. v. United States, No. 14-916, 597 U.S. ___ (June 16, 2016).1 Additionally, in potentially important dicta, the Court stated that FSS purchase orders are unmistakably “contracts” under the common law and the FAR.

Mandatory Application of the VA’s Rule of Two

The 2006 Act requires the VA to establish annual goals for contracting with veteran owned (VOSB) and service-disabled veteran owned (SDVOSB) small businesses.[[N: See 38 U.S.C. § 8127(a)(1)(A) (“[T]he Secretary [of Veterans Affairs] shall . . . establish a goal for each fiscal year for participation in Department contracts (including subcontracts) by small business concerns owned and controlled by veterans who are not veterans with service-connected disabilities.”); 38 U.S.C. § 8127(a)(1)(B) (“[T]he Secretary shall . . . establish a goal for each fiscal year for participation in Department contracts (including subcontracts) by small business concerns owned and controlled by veterans with service-connected disabilities.”)]] The provision at issue in Kingdomware was 38 U.S.C. § 8127(d), which states:

[F]or purposes of meeting the goals under subsection (a)...  a contracting officer of the Department shall award contracts on the basis of competition restricted to small business concerns owned and controlled by veterans if the contracting officer has a reasonable expectation that two or more small business concerns owned and controlled by veterans will submit offers and that the award can be made at a fair and reasonable price that offers best value to the United States.2

This two-competitor benchmark is commonly referred to as the “Rule of Two.” Upon completion of a market study confirming the benchmark has been satisfied, competition restricted only to VOSBs and SDVOSBs displaces the norm of full and open competition.

Since passage of the 2006 Act, the VA had interpreted § 8127(d), and in particular the emphasized language above, as freeing the Department to employ full and open competition once its VOSB and SDVOSB contracting goals for a given fiscal year had been met. This policy led to several bid protests at the Government Accountability Office (GAO). Although GAO consistently held that the VA was required to follow the Rule of Two regardless of whether it had already met its annual contracting goals, the VA declined to follow GAO’s non-binding recommendations.3

In the procurements at issue in Kingdomware, the VA procured IT services for four medical centers through the Federal Supply Schedule. Since the VA had met its annual contracting goals, it proceeded to a full and open competition without attempting to satisfy the Rule of Two requirements. Kingdomware, an SDVOSB, protested and prevailed before the GAO, but the VA declined to implement GAO’s recommendation.4 Kingdomware subsequently re-protested in the Court of Federal Claims, which supported the VA’s interpretation of the statute.5 After a split panel of the Court of Appeals for the Federal Circuit affirmed,6 the Supreme Court agreed to hear the case.7

Before the Federal Circuit, and at the petition for certiorari stage, the government had relied primarily upon its interpretation of the Rule of Two being limited to the “purposes of meeting the [Department’s annual] goals.” The Court, however, dismissed this language as merely prefatory, and found that the subsequent “shall” clause in § 8127(d) formed an unmistakable directive:

Congress’ use of the word “shall” demonstrates that § 8127(d) mandates the use of the Rule of Two in all contracting before using competitive procedures. Unlike the word “may,” which implies discretion, the word “shall” usually connotes a requirement.8

The unanimous result in Kingdomware has likely slammed the door shut upon the VA’s assertion of discretion in administering the Rule of Two under the 2006 Act. However, it remains to be seen how the Department implements the Court’s clear and concise instruction. For its part, the Court declined to address whether the Department in the future need only search the FSS for eligible Veteran-owned small businesses, or whether it “must conduct a broader search” beyond the FSS.9

What Is a Government Contract? A Potential Sleeper Issue for Federal Contractors

Much of the discussion regarding Kingdomware since the Court granted certiorari last June has focused on the parties’ disputed interpretation of § 8127(d) and the applicability of the Rule of Two. However, dicta arising from alternative arguments made by the government in support of the VA’s position may have more far-reaching consequences.

As an alternative to the VA’s statutory interpretation argument, discussed above, the government asserted for the first time at the merits stage before the Court that FSS “purchase orders” are not government “contracts” and, therefore, that the 2006 Act does not apply to them.10 The Court found that the VA had "forfeited" this argument by not raising it in the courts below, but went on to opine that “the Department’s forfeited argument fails in any event.”11

Writing in dicta, the Court observed that FSS purchase orders meet both the common law definition of a contract, and the specific definition of a government contract found at FAR § 2.101.12 Interestingly, the Court chose to contrast the “mutually binding obligations” created by the FSS order at issue with the terms of the underlying FSS umbrella contracts, which “give[] the Government the option to buy, but . . . do[] not require the Government to make a purchase or expend funds.” The Court observed that as these terms were left open by the FSS umbrella contracts, they were subject to negotiation and determination in the orders under the FAR.13

The Court’s discussion of FSS orders as clearly being contracts could implicate other areas of federal contracting law where Congress, the FAR Council, the courts, and GAO have made careful distinctions between multiple-award vehicles, individual orders under those vehicles, and government contracts generally. In recent years, there have been multiple high-profile disputes touching upon these thorny distinctions. See, e.g., SRA Int’l, Inc. v. United States, 766 F.3d 1409, 1413 (Fed. Cir. 2014) (holding no Court of Federal Claims jurisdiction over protests involving FAR subpart 16.5 task and delivery orders); PricewaterhouseCoopers Pub. Sector, LLP v. United States, 126 Fed. Cl. 328, 346 (2016) (distinguishing SRA and finding Court of Federal Claims jurisdiction over protests involving FAR subpart 8.4 FSS orders like those at issue in Kingdomware).

The Court implied that any instrument that “creates mutually binding obligations: for the contractor, to supply certain goods or services, and for the Government, to pay” must be read as a contract under the FAR.14 This might even implicate future disputes concerning the sometimes fine distinctions between procurement contracts, grants, and cooperative agreements—compare Hymas v. United States, 810 F.3d 1312, 1327-29 & n.9 (Fed. Cir. 2016) (cooperative agreement), with CMS Contract Mgmt. Servs. v. Mass. Hous. Fin. Agency, 745 F.3d 1379, 1385-86 (Fed. Cir. 2014) (procurement contract)—as well as disputes regarding non-FAR “other transactions authority,” for example under 10 U.S.C. § 2371.

In reviewing Kingdomware, contractors and their counsel should pay attention to this sleeper issue alongside the clearer holding regarding the Rule of Two. If other government contracting decisions pick up on this aspect of Kingdomware, it may well be that the most lasting legacy of this case is not tied to a changeable Congressional VA contracting mandate, but rather to a broad, catholic definition of what is a “government contract” by the highest court in the land.

  1. Available here.

  2. 38 U.S.C. § 8127(d) (emphasis added).

  3. See, e.g., In re Aldevra, No. B-406205, 2012 CPD ¶ 112 (Mar. 14, 2012).

  4. See In re Kingdomware Techs., No. B-406507, 2012 CPD ¶ 165 (May 30, 2012).

  5. See Kingdomware Techs. v. United States, 107 Fed. Cl. 226 (2012).

  6. See Kingdomware Techs. v. United States, 754 F.2d 923 (Fed. Cir. 2014).

  7. See Kingdomware Techs. v. United States, 576 U.S. ___, 135 S. Ct. 2857 (2015) (granting petition for certiorari). The Court began its subsequent merits decision with a discussion of the VA’s assertion the case was moot because the procurement at issue had been completed in May 2013. The Court found that Kingdomware would likely be awarded future contracts if its interpretation of the 2006 Act prevailed, but might be unable to challenge the Department’s interpretation of the Act since VA procurements are often fully performed in less time than it takes for a given challenge to reach the Court. The Court found this circumstance fit the traditional exception to mootness for controversies that are “capable of repetition, yet evading review.” Id. at 7 (citation and internal quotation marks omitted).

  8. Kingdomware Techs. v. United States, No. 14-916, 597 U.S. ___ (June 16, 2016), slip op. at 8-9 (citations omitted).

  9. See id. at 9 n.4. The Court was not asked to address, and did not address, the Small Business Act’s separate Rule of Two requirement. See 15 U.S.C. 644(j); FAR § 19.502-2(b). The Small Business Act’s Rule of Two requirement, which is substantially similar to the VA’s requirement, has been construed as inapplicable to orders placed under the FSS. See, e.g., In re Aldevra, No. B-411752, 2015 CPD ¶ 339 (Oct. 16, 2015).

  10. See id. at 11. The government also argued that (a) the point of the FSS is to streamline acquisition, so requiring a Rule of Two market survey would undermine that purpose and “hamper mundane purchases,” and (b) that the VA had previously determined through its own rulemaking that the Rule of Two requirements were not applicable to FSS orders, and that the Department’s determination should be afforded deference under Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843-44 (1984). The Court rejected each of these alternative arguments. See id. at 12.

  11. Id. at 11 (citation omitted).

  12. See id. at 11 (citing FAR § 2.101; Black’s Law Dictionary (10th ed. 2014)).

  13. Id. (citing FAR § 8.405-4). The Court also rejected the government’s argument that FSS orders, unlike government contracts generally, are limited to simplified acquisitions. The Court observed that the FSS procurements at issue were not for de minimis purchases but, rather, for “complex information technology services over a multiyear period.” Id. at 12.

  14. See id. at 11.