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Three Steps to Prepare for Enhanced Buy American Scrutiny

Prepare now for enhanced Buy American scrutiny soon to come.

As discussed in a previous industry note, the President recently issued an EO titled “Executive Order on Ensuring the Future Is Made in All of America by all of America’s Workers.” The purpose of the EO is to use the terms and conditions of Federal procurements “to maximize the use of goods, products, and materials produced in, and services offered in, the United States.”

The Biden Administration left the old Buy American regime largely intact but gave the Federal Acquisition Regulatory Council (FAR Council) six months to promulgate new rules intended to implement the EO. So, what can industry do now to manage the next six-months of uncertainty and begin to prepare for the new rules to come?

Consider following these three steps to prepare:

(1) conduct a baseline country of origin analysis of your supply chain and manufacturing processes;

(2) confirm the domestic origin of your supplies under the “component test” or through a substantial transformation analysis; and

(3) plan to adapt to the new “value added” rules when they are finalized.

Step One: Conduct a Baseline Review of Your Supply Chain and Manufacturing Processes from a Country of Origin Perspective.

First, conduct a country of origin (COO) review of your supply chain elements and manufacturing processes. The previous regime of easy waivers led to a rational, supply-chain apathy as it pertains to domestic preference regulations. But this regime is coming to a close. A sophisticated COO analysis, encompassing your entire supply chain, now constitutes critical, minimal preparation for the EO’s implementation.

Canvass suppliers to determine the COO of their products. Consider requesting Buy American certifications now and as part of your annual representations and certifications query to suppliers. In addition to preferences such as material specifications, costs, transportation modes, and delivery timelines, develop a complimentary preference for U.S.-sourced supplies and those that qualify as “designated country” in origin (essentially, signatories to the World Trade Organization Agreement on Government Procurement (the WTO GPA)). Once you have conducted this review, you can capture the value of qualifying supplies through lock-in contracts.

Map your manufacturing processes in detail. Oftentimes, seemingly non-qualifying product lines can sometimes be transformed into qualifying domestic products with modest manufacturing adaptations and depending on the manufacturing process employed.

In particular, how many unique steps do your processes involve and how complex are they?  What level of technical skill do they require? What costs are incurred in the various manufacturing processes and what value do various processes add to the finished product? You may be happily surprised to find that existing product lines already qualify as domestic end products, even where they consist of large numbers of “foreign” components. As discussed below, a manufacturing process that is complex, involves a high level of technical skill, is costly, and adds value to the final product, is more likely to produce a qualifying end product for Buy American purposes.

Step Two: What’s Old is New.

Big changes are soon to come, but the old Buy American rules still apply for now. Presently, contractors either (i) satisfy the domestic end product “component test” or (ii) benefit from a Buy American waiver if they can establish their products are manufactured entirely in, or substantially transformed in, a designated country.

Under the still-current “component test,” qualifying an end product as “domestic” involves a two-part process: first, the end product has to be manufactured in the U.S.; second, the cost of an end product’s components “mined, produced, or manufactured” in the U.S. must meet or exceed newly revised domestic-content requirements, 95% for iron and steel end products and 55% for all other end products.

Historically, most contractors were rationally oblivious to all of this math. It usually didn’t apply to them. Instead, pursuant to the WTO GPA, most industry actors were eligible for a complete waiver of the effects of various Buy American pressures. They only needed to show that their end products originated, or were substantially transformed, in a WTO-GPA member country. Today, the reality of global supply chain diversity means products are comprised of parts from all over the world. In order to be deemed products of a waiver-qualifying designated country, therefore, products must generally be substantially transformed in a designated country.

Courts, boards of contract appeals, and particularly U.S. Customs and Border Protection (CBP) have each addressed the question of what constitutes substantial transformation. The test for determining whether a substantial transformation has occurred is whether an article emerges from a manufacturing process with a new name, character, or use, different from that possessed by the article prior to processing. As a general observation, a manufacturing process that is complex, involves a high level of technical skill, is costly, and adds value to the final product, is more likely to result in a qualifying substantial transformation.

While companies can self-certify their compliance, CBP has statutory authority to issue final determinations respecting substantial transformation. In doing so, CBP considers the totality of the circumstances and makes determinations on a case-by-case basis. (While a thorough treatment of substantial transformation is beyond the scope of this note, the concept is discussed more fully here, a CBP COO determination in which phalanx successfully argued for the substantial transformation of various Canadian-origin technology products.)

Re-visiting these rules will help you get through the next six months. But the Biden Administration has threatened to “modernize” this regime, in which it believes prior administrations issued waivers “with impunity.” So, with waivers under increased scrutiny and more rulemaking to come, what can industry do now to better prepare for the new normal?

Step three: Plan to Adapt to the new Buy American Rules.

Industry should prepare now for the new rules to come. Deploying powerful planning processes now will yield dividends tomorrow. But industry will need to think outside the “component test” box.

The new rules will be designed to qualify domestic end products by measuring the “value” that is added to the product through “U.S. based production or U.S. job supporting economic activity.” This second element is novel, and the term isn’t defined in the EO. It’s up to the FAR Council to give it life. But, at a minimum, the new rule appears to foreshadow a more sophisticated definition of domestic content that takes all allocable (U.S. job supporting) economic activity into account and doesn’t rely myopically on the cost of a product’s constituent components.

Take, for example, Independent Research & Development (IR&D) and Bid and Proposal (B&P) costs.  IR&D covers the full spectrum of R&D activities, including expansion of basic knowledge, exploitation of scientific discoveries, improvement of existing technologies, and creation of new ones. Closely linked, B&P costs reflect the burden contractors incur, at their own expense, to develop and support specific technical proposals, solicited and unsolicited, to potential customers. Both IR&D and B&P are components of a company’s overhead expense.

Unambiguously including the IR&D and B&P costs in those costs properly allocable to a product’s final value for Buy American purposes would have two benefits. It would (1) allow industry to more fully leverage current U.S.-based labor and economic activities, and (2) create a marginal incentive for industry actors to relocate qualifying cost centers to the U.S. If the FAR Council adopts this approach, industry actors will re-envision their supply chains; Buy American calculations might reflect the sum of the value of U.S. domestic components and the allocated value of U.S. labor, IR&D and B&P costs, for example.

The new rules will create winners and losers. Don’t take the next six months sitting down. To prepare for the Buy American future to come, conduct a baseline COO analysis of your supply chain and manufacturing processes, confirm your supply chain status under the present rules, and plan now to develop the supply chain flexibility necessary to adapt to the new rules when they arrive.