"In the middle of every difficulty lies opportunity." 

--Albert Einstein

The McNamara-O'Hara Service Contract Act ("SCA") of 1965 is a law that requires the payment of specified minimum wage rates and fringe benefits to employees working on U.S. Government service contracts and subcontracts in the United States. While the goal of the law is straightforward – to prevent service workers from becoming the casualties in the competitive wars between Government contractors – the implementation of the law is anything but simple. In particular, the SCA presents pitfalls for contractors who prepare their proposals in ignorance of what the Act requires and how it works in practice. 

The SCA applies to “[e]very contract . . . entered into by the United States or the District of Columbia in excess of $2,500 . . . whether negotiated or advertised, the principal purpose of which is to furnish services in the United States.” When a federal agency intends to award a contract that is covered by the SCA, it must notify the U.S. Department of Labor (“DOL”), which must then issue one or more wage determinations (“WDs”). A WD is a document that covers a specified geographical area – sometimes one county and sometimes an entire state -- and lists the minimum wages and benefits that the contractors in that territory must pay to dozens of classes of employees. The WD becomes a part of the solicitation and, later, of the awarded contract. 

Bidding Below Cost 

The first rule that would-be contractors must remember is that the SCA does not dictate what a contractor should bid, only what a contractor must pay covered employees. Therefore, “[A]n offer for a fixed-price contract submitted at a price that appears lower than the cost of wage rates applicable pursuant to the Service Contract Act is nonetheless acceptable where the offer does not take exception to, or otherwise evidence an intent by the offeror to violate, the requirements of the Service Contract Act.” Akal Security, Inc., B-261996, 95-2 CPD ¶ 216, 96-1 CPD ¶ 33. In other words, if a contractor chooses for whatever reason to bid at a loss or to finance the contract with its profits, that is not a basis for disqualifying the contractor’s offer or bid. 

Collective Bargaining Agreements & The Successor Contractor Rule  

There are two ways that the Department of Labor can determine the wages and benefits payable under a given contract. One way is by surveying prevailing wages for the applicable trades in the contract’s geographic market. Alternatively, under Section 4(c) of the SCA, a contractor that replaces a contractor that was subject to a collective bargaining agreement (“CBA”) is required to pay its employees not less than the wage rates and fringe benefits that the predecessor would have had to pay under the collective bargaining agreement. This includes the obligation to pay any prospective increases provided by such agreement.  

This means, of course, that a bidder must inquire before pricing its bid or offer whether a CBA exists. A copy of the applicable CBA usually can be obtained from the contracting agency or from the union. Note that the so-called successor contractor rule is limited to wages and fringe benefits. Successor contractors are not required to adopt the seniority systems, grievance procedures, expense reimbursement, or work rules in the predecessor's CBA. See Clark v. Unified Services, Inc., 659 F.2d 49 (5th Cir. 1981). It makes sense to have counsel examine the incumbent’s CBA before you bid to determine what parts of the CBA are binding on you and which are just work rules or other nonbinding requirements. This analysis can be very complex.  

The requirement for a successor contractor to pay in accordance with a predecessor’s CBA is not contingent upon incorporation of a WD based upon the predecessor's CBA into the successor's contract. The only caveat is that the procuring agency and, therefore, the bidders must be timely notified of the existence and contents of the CBA. 29 C.F.R. § 4.1(b).  Your own CBA does not affect the wages that you must pay under the SCA, unless, of course you happen to be the predecessor contractor. Be aware that the Department of Labor (“DOL) regards each option period as a new contract for SCA purposes. Accordingly, a contractor can be its own successor (or predecessor), such that the CBA that the contractor negotiated during one year of its contract will become the basis for its SCA obligations in later years of its contract. (Even in the first year, if your CBA requires higher wages or benefits than the predecessor’s CBA you must pay those higher wages as a matter of contract and labor law.) 

What to Include in Your Bid or Proposal: Vacation Pay  

A bidder who will be taking over an existing workforce should investigate the seniority of that workforce. The reason for this is that vacation benefits are a fringe benefit normally set by the WD and it is common for the number of vacation days to vary based upon the number of years of service the employee has. For example, many WDs allow one week (i.e., 5 days) of vacation after one year of service. Accordingly, if the employee has less than one year of service, under such a WD he or she would not be eligible for any vacation. If that employee quit after one-half year, there would be no obligation to pay that employee any monies for accrued vacation under the SCA. (However, state law such as in California may require different treatment of the employee.)  

Moreover, the period for each year's service is measured by the anniversary date of the employee's starting date (i.e., a year plus one day). Unless prohibited by state law, vacation benefits are reported, for the purpose of issuing WDs, on a vesting rather than an accrual basis. The contractor for whom the employee is working at the time the vacation right vests must provide the full benefit to which the employee is entitled based upon the length of continuous service with the present contractor and with predecessor contractors at the same Federal facility. The contractor must provide the benefit either in vacation time or payment before the employee's next anniversary date, before completion of the contract, or before the employee terminates, whichever is first. See W.H. Admin. Opinion Letter dated Feb. 23, 1990. This DOL interpretation prevents employees from accruing unused vacation, holding the time in a leave bank, and carrying it forward into subsequent years of service. 

As noted above, WDs will generally require a successor contractor to provide vacation benefits to an employee who had one year of continuous service under the predecessor contractor. DOL regulations provide that: “The term ‘continuous service’ does not require the combination of two entirely separate periods of employment. Whether or not there is a break in the continuity of service so as to make an employee ineligible for a vacation benefit is dependent upon all the facts in the particular case. No fixed time period has been established for determining whether an employee has a break in service. Rather the reason(s) for an employee's absence from work is the primary factor in determining whether a break in service occurred. 29 C.F.R. § 4.173(b). 

The regulations further provide that a break-in-service does not occur in the following cases: an employee granted leave, a strike after which employees return to work, an interim period between contracts during which Government employees are performing the contract work, and a facility closed for three months for renovations. 29 C.F.R. § 4.173(b)(1)(i)-(iv).  In Industrial Maintenance Service, Inc., the (now-defunct) Board of Service Contract Appeals found that a break-in-service had not occurred, despite a facility's being closed for renovations for eleven months. BSCA No. 92-22 (April 5, 1993). 

What to Include in Your Bid or Proposal: Fringe Benefits  

SCA WDs include prevailing fringe benefits for the various classes of service employees. Such fringe benefits include medical or hospital care, pensions on retirement or death, compensation for injuries or illness resulting from occupational activity, insurance, vacation and holiday pay.  

What’s “Bona Fide”?  

For a contractor to discharge its obligations, the fringe benefits given must be “bona fide.” “Bona fide” fringe benefits are those that "require the employer who extends such a benefit . . . to incur a present cost or the risk of a future cost." Thus, the test of a "bona fide" fringe benefit is "cost incurred" by the employer and not "benefit received" by the employee.  Trinity Services, Inc. v. Marshall, 593 F.2d 1250 (D.C. Cir. 1978). Under 29 C.F.R. § 4.171, a "bona fide" fringe benefit is defined as a legally enforceable obligation that meets the lengthy and detailed criteria set forth therein. 

Health & Welfare Benefits 

WDs can include one of two entirely different health and welfare ("H&W") figures. The odd numbered (so-called because those wage determinations have an odd number) H&W figure is a fixed amount for every hour of work up to 40 hours per week. The odd numbered H&W payment is made for all hours paid for up to 40 hours per week or 2,080 hours per year, including vacation, holidays, sick pay and any other hours paid for. This payment had to be made (in cash or fringes or a combination) for every pay period for every employee. The odd numbered H&W is currently $4.54 per hour effective July 5, 2019.  

The even numbered (so-called because the wage determinations have an even number) H&W measures is also currently $4.54 an hour, but it is paid on a different basis. It is based on the average per hour worked across the nonexempt SCA covered workforce. This is an average rate per hour and counted straight time and overtime hours worked, not hours paid for. Thus, vacation, holiday and sick pay are not counted. Also, the requirement is only for an average of all H&W payments -- in cash or fringes -- to all SCA covered employees working contract-wide. Thus, some employees could receive more or less than the average, even possibly zero, and the requirement for the average payment could be met. 

Self-insurance programs 

Unfunded self-insured fringe benefit plans (other than fringe benefits such as vacations and holidays which by their nature are normally unfunded) under which contractors make "out of pocket" payments to provide benefits as expenses may arise, rather than making irrevocable contributions to a trust or other funded arrangement, are not normally considered "bona fide" plans or equivalent benefits for purposes of the Act.

However, a contractor may request approval by the Administrator of an unfunded self-insured plan in order to allow credit for payments under the plan to meet the fringe benefit requirements of the Act. In considering whether such a plan is bona fide, the Administrator will consider such factors as whether it could be reasonably anticipated to provide the prescribed benefits, whether it represents a legally enforceable commitment to provide such benefits, whether it is carried out under a financially responsible program, and whether the plan has been communicated to the employees in writing. The Administrator in his/her discretion may direct that assets be set aside and preserved in an escrow account or that other protections be afforded to meet the plan's future obligation.  

Even if an unfunded self-insurance plan qualifies as "bona fide", it does not mean that the fringe benefit requirements are met. Only payments actually made by the employer can be counted, not the value of the plan. And, while all payments made for employees under the plan can be counted against the current $4.54 average hourly requirement, only payments made for an individual employee can be counted against the odd numbered H&W. Accordingly, prudent employers who self-insure should set up a bona fide trust wrapper and prepay their actuarial premium equivalents into the trust for each employees subject to odd numbered wage determinations so there is an identifiable cost incurred for that worker. This thereby can satisfy the SCA H&W requirement.  

What If the WD Doesn’t Have All of the Necessary Jobs?  

When a WD included in a solicitation or contract omits one or more categories of service employees that the contractor intends to employ under its contract, the contractor must classify the employees so as to derive appropriate wage rates and fringe benefits to be paid the employees. This is called “conformance.” The classification chosen must provide a reasonable relationship between the unclassified employees and the classifications listed in the WD, based on an appropriate level of skill comparison. The regulations state that "a pay relationship should be maintained between job classifications based on the skill required and the duties performed". 29 C.F.R. § 4.6(b)(2)(iv). 

A contractor may obtain guidance for arriving at conforming rates from the way jobs are rated under the Federal pay system or from other WDs issued for the same general locality. In addition, one may rely on standard wage and salary administration practices that rank various job classifications by pay grade pursuant to point schemes or other job factors. Conforming rates may be established by indexing (adjusting) the prior year's conforming rate by the average increase or decrease in wages for classifications contained in the contract. Thus, rates may be conformed by looking at similar occupational categories, and increases in the rate may be extrapolated thereafter by looking at average increases under the WD. 

Ideally, a contractor should do an informal mini-conformance as part of its pricing of its bid. In any case, a contractor must institute its conforming rates procedures before employing a person in the missing job classification. Within 30 days after that, the contractor must prepare a written report of the proposed action concerning the conforming rates for the unclassified employees for submission of the Contracting Officer. The contractor must also discuss the proposed conforming rates with the unclassified employees or their representatives, and address any agreement or disagreement in its report. A contractor normally should use Standard Form 1444, "Request for Authorization of Additional Classification and Rate," in requesting approval of conforming rates. 

Next, the contracting officer is required to submit the contractor's report, along with the agency's recommendations, to the Wage & Hour Administrator for review. The regulations state that the Administrator then approves, modifies, or disapproves the proposed rates within 30 days, and that decision is transmitted to the contractor, who in turn must give a copy to affected employees. The contractor must then pay those employees in accordance with the Administrator's determination. Should the contractor disagree with the Administrator's decision, it may appeal the decision to the Department of Labor's Administrative Review Board (“ARB”). 

Implications for Proposal Pricing  

The difficulty in arriving at conforming rates is that a contractor must attempt to second-guess the Administrator because the Administrator may determine that a higher wage rate and level of benefits than the contractor bid is appropriate. If that occurs, the contractor must pay that higher rate without a contract price adjustment. Sterling Services, Inc., ASBCA No. 40475, 91-2 BCA ¶ 23,714. Therefore, a prudent contractor will do its own mini-conformance internally before bidding and make a conservative projection of what DOL is likely to do after award of the contract.  Note that DOL will refuse to conform rates where there is a job classification in the WDs that it believes arguably covers the work under the contract, even though the contractor believes the appropriate classification has been omitted. 

Price Adjustments  

The SCA regulations require that DOL issue a new WD prior to the exercise of a contract option, on the annual anniversary date of a multi-year contract subject to annual appropriated funds, and every two years in the case of a multi-year contract not subject to annual appropriated funds. See 29 C.F.R. §§ 4.4, 4.145. When the new WD is incorporated into a contract, the fixed priced contractor is entitled to a price adjustment for increased wages and fringe benefits caused by the new WD. FAR §§ 52.222-43 and 52.222-44. There are several things to know about the Price Adjustment clause. 

Pursuant to the FAR, a price adjustment includes only increased wages and fringe benefits, not overhead, G&A and profit. (For some reason, contractors frequently litigate this well-established rule, a waste of valuable resources.) In contrast, in the absence of a contract clause providing for a price adjustment, the contractor might be entitled to an equitable adjustment, including overhead and profit, as a "constructive change." See Geronimo Service Co., ASBCA No. 14686, 70-2 BCA ¶ 8540.  In addition, if a WD is added to a contract for the first time in the middle of a contract year, the resulting price adjustment should include overhead, General and Administrative (“G&A”) costs, and a reasonable profit. E.g., Lockheed Support Systems v. U.S., 3 W.H. Cas. 2d 785 (Fed. Cl. 1996).  However, if the contract always contained a WD, but the contractor was not in compliance with it, there is no price adjustment allowed for coming into compliance. 

The Warranty Provision 

Because contractors are entitled to price adjustments when new WDs are incorporated into the contract, contracts containing the SCA Price Adjustment Clause require contractors to warrant “that the prices in this contract do not include any allowance for any contingency to cover increased costs for which adjustment is provided under this clause.” FAR 52.222-43(b). The purpose of this warranty is to prevent double recovery of nonexempt employee labor escalation costs. Under the clause, the contractor will get an “inequitable adjustment” to cover escalation in wages and fringe benefits required by the new WD in the option years or at least every two years.  

Since this escalation will not include incremental overhead, G&A and profit, it follows, therefore, that contractors generally should consider including in their offers a contingency for these items. In additional, offerors should account for wage and fringe benefit escalation costs for their exempt employees, who are not subject to the price adjustment clause. 

Conclusion 

The SCA presents some very complicated issues in pricing any proposal. Contractors bidding on U.S. Government service work are well advised to get assistance in preparing their proposals to take maximum advantage of the intricacies of the Act.

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This blog was adapted from a joint effort originally prepared with the assistance of Shlomo D. Katz, counsel now with Brown Rudnick LLP. Appreciation is noted for his effort. However, any inaccuracies or ambiguities are the responsibility of Abrahams Wolf-Rodda , LLC and not Mr. Katz.