Commissions and Federal Contracts: A Primer
Can you pay someone a commission in exchange for helping your company obtain a federal contract? The answer–as with many questions in government contracting–is “it depends.”
If you’re thinking about offering a commission to an employee, independent contractor, or another company to help you obtain a federal contract, you aren’t alone. During my 15-plus years as a federal government contracts attorney, I helped many contractors understand the applicable rules and draft agreements to allow compliant commission-based relationships.
In this primer, I will first break down the key Federal Acquisition Regulation clause governing commissions. Next, I’ll cover a separate U.S. Small Business Administration regulation for participants in the SBA’s 8(a) Business Development Program. I’ll conclude by offering some tips, tricks, and strategies to help negotiate and maintain a compliant commission-based relationship.
Let’s get started!
A. THE COVENANT AGAINST CONTINGENT FEES
FAR 52.203-5 is called the “Covenant Against Contingent Fees.” I’ve always found the name a bit strange. Not only is it downright biblical, but the notion of asking contractors to enter into a “covenant” suggests–to me, at least–a zero-tolerance policy on commissions.
The FAR is absolutely stuffed with clauses, but FAR 52.203-5 is the only one using the term “covenant.” If the FAR Council had asked me to suggest a name for FAR 52.203-5, I would have offered the more nuanced “Restrictions on Contingent Fees” or even just “Policy on Contingent Fees.” As we’ll see, FAR 52.203-5 isn’t nearly as restrictive as its Old Testament name suggests.
The restrictions on commissions are set forth in paragraph (a), which reads:
(a) The Contractor warrants that no person or agency has been employed or retained to solicit or obtain this contract upon an agreement or understanding for a contingent fee, except a bona fide employee or agency. For breach or violation of this warranty, the Government shall have the right to annul this contract without liability or, to deduct from the contract price or consideration, or otherwise recover, the full amount of the contingent fee.
First things first: what exactly does the FAR mean by “contingent fee?” Does a commission arrangement even qualify?
Paragraph (b) provides this definition of “contingent fee”:
Contingent fee, as used in this clause, means any commission, percentage, brokerage, or other fee that is contingent upon the success that a person or concern has in securing a Government contract.
Clearly, then, a commission falls under the scope of FAR 52.203-5.
The “covenant,” though, has a pretty big exception. While the clause starts with the presumption that contingent fees aren’t allowed, it then states, “except a bona fide employee or agency.” In my view, those seven words are the key language, opening up a large (though not unlimited) loophole: you can pay a commission, so long as the commission goes to a “bona fide employee” or “bona fide agency.”
But what the heck do those terms mean? Let’s take a look.
1. Who is a “bona fide employee”?
Despite the general presumption against commissions, a contractor can give a commission to a so-called “bona fide employee.” FAR 52.203-5 defines a “bona fide employee” as follows:
Bona fide employee, as used in this clause, means a person, employed by a contractor and subject to the contractor’s supervision and control as to time, place, and manner of performance, who neither exerts nor proposes to exert improper influence to solicit or obtain Government contracts nor holds out as being able to obtain any Government contract or contracts through improper influence.
In my experience, there are two common mistakes contractors make when it comes to classifying an individual as a “bona fide employee.”
First, companies sometimes assume that an independent contractor–that is, someone the business is paying on a 1099 basis–counts as an employee. This is a dangerous misconception, not only for purposes of FAR 52.203-5 but also under Internal Revenue Service regulations. In fact, an employee and an independent contractor are different things, and conflating the two can land you in hot water.
The IRS provides a helpful overview of the differences. According to the IRS, the key differentiator between an employee and an independent contractor is not whether an individual receives a 1099 but “the degree of control and independence in this relationship.” An independent contractor acts, well, independently and is not subject to the same degree of supervision and control as an employee.
Let’s get back to FAR 52.203-5. The clause defines a “bona fide employee” as someone “subject to the contractor’s supervision and control.” Compare that to the IRS guidance, and it’s abundantly clear that an independent contractor doesn’t qualify because an independent contractor is not subject to the same level of control.
If you’re interested in paying an independent contractor on a commission basis, don’t panic! An independent contractor isn’t a “bona fide employee” but may qualify as a “bona fide agency,” that is, a one-person business. More on that below.
The second mistake contractors sometimes make is misunderstanding the scope of the term “improper influence.” It’s easy to assume that “improper influence” is limited to things like bribery and gratuities. Bribes and gifts undoubtedly qualify as an improper influence, but you’re not in the clear just because your employee won’t slip the Contracting Officer a suitcase of unmarked bills. “Improper influence” is more broadly defined as follows:
Improper influence, as used in this clause, means any influence that induces or tends to induce a Government employee or officer to give consideration or to act regarding a Government contract on any basis other than the merits of the matter.
In my experience, contractors sometimes mistakenly believe that so long as no cash or gifts exchange hands, it is fine for an employee to use his or her personal relationships to pursue federal contracts. Be wary if an employee says something like, “my aunt is the Contracting Officer” or “my golfing buddy is the COR.” These types of relationships have nothing to do with “the merits of the matter,” that is, the merits of the goods or services you wish to sell.
Although it arose in a different context, a 2020 bid protest decision issued by the U.S. Government Accountability Office offers a real-life cautionary tale on the potential problems posed when questions arise about whether a contract was awarded based on a personal relationship. In that case, Teledyne Brown Engineering, Inc., NASA was forced to cancel a $650 million contract after a protester complained that a NASA official heavily involved in the procurement process had a social relationship with an officer of the awardee–a relationship that, according to the GAO, involved a weekly social gathering for “camaraderie, friendship, dinner, and . . . competitive foosball.”
The bottom line: yes, a bona fide employee can be paid a commission to help you obtain a government contract. But before agreeing to such an arrangement, be sure that the individual is an employee, not an independent contractor, and that the individual does not propose to use improper influence–including personal relationships–to obtain contracts.
2. What is a “bona fide agency”?
FAR 52.203-5 also allows a contractor to pay a commission to a “bona fide agency.” Again, the question is–what qualifies?
The clause provides the following definition:
“Bona fide agency,” as used in this clause, means an established commercial or selling agency, maintained by a contractor for the purpose of securing business, that neither exerts nor proposes to exert improper influence to solicit or obtain Government contracts nor holds itself out as being able to obtain any Government contract or contracts through improper influence.
As with bona fide employees, bona fide agencies cannot exert or propose to exert “improper influence.” The broad definition of that term is the same as I discussed above, so watch out for relationships based on “competitive foosball” and other personal connections. A bona fide agency, like a bona fide employee, must pursue contracts based on the merits.
But what is an “established commercial or selling agency?” The term encompasses situations in which a commission is being paid to a non-employee. Typically, that non-employee is a formal legal entity, such as a limited liability company. However, it may also include an independent contractor–someone operating as a “business of one,” also known as a sole proprietorship.
Not every entity qualifies as an “established commercial or selling agency.” The clause’s language strongly suggests that the term is meant to encompass only those entities actively engaged in the business of helping their clients obtain contracts. An entity in an entirely different line of work–like the incumbent contractor for the contract you wish to pursue–may not qualify.
Unfortunately, the FAR does not provide any additional information to assist contractors in determining whether an entity qualifies as a “bona fide agency.” Interestingly, though, the FAR used to contain additional guidance to assist contractors in determining whether an entity is a “bona fide agency.” While this language is no longer in the FAR, it still may be useful for contractors to consider, and includes:
- The contingent fee “should not be inequitable or exorbitant when compared to the services performed or to customary fees for similar services related to commercial business.” For this reason, it may be helpful for a contractor to obtain quotes from several competing agencies to make sure that the proposed agreement is reasonable in the market.
- The agency “should have adequate knowledge of the contractor’s products and business, as well as other qualifications necessary to sell the products or services on their merits.” The focus on the merits, of course, ties back to the prohibition of improper influence.
- The contractor and the agency “should have a continuing relationship or, in newly established relationships, should contemplate future continuity.” In other words, the government is suspicious of one-and-done contingent fee arrangements. Such arrangements are more likely to be based on a personal relationship rather than the agency’s ability to promote the contractor’s business more broadly.
- “The agency should be an established concern that has existed for a considerable period or be a newly established going concern likely to continue in the future.” Again, this factor concerns the government’s suspicion about one-contract-only contingent fee arrangements.
- The government will look more favorably upon the agency if it “represents the contractor in [both] Government and commercial sales.” Again, a broader business development relationship shows that the agency is legitimately engaged in that business and not using improper influence to pursue a specific contract. Of course, not all contractors even engage in commercial business, and like the other factors, this is just a consideration–not a requirement.
For better or for worse, there is no bright-line rule to allow contractors to determine whether an entity qualifies as a bona fide agency. That said, in my opinion, it is a good idea to keep these five factors in mind when developing a commission-based relationship. Below, in my “tips and tricks” section, I’ll offer some suggestions to bake some of these factors into your written agreements with selling agencies.
3. Violations of the Covenant Against Contingent Fees
A violation of the Covenant Against Contingent Fees won’t lead to a biblical “smiting,” but the consequences can still be severe. Violating the clause is a breach of contract, entitling the government to terminate for default. Additionally, the clause allows the government to “deduct from the contract price or consideration, or otherwise recover, the full amount of the contingent fee.”
Although it isn’t specifically addressed in the clause itself, a violation could also lead to liability under the False Claims Act. FAR 52.203-5 requires the contractor to warrant (or certify) that its contingent fee arrangements, if any, are compliant. As is the case with any other representation or certification, a contractor could find itself in hot water under the FCA if the certification is untrue.
4. Covenant Against Contingent Fees: Summary
In sum, the FAR’s Covenant Against Contingent Fees does not impose a blanket prohibition on the payment of commissions to individuals or entities helping a contractor obtain federal government contracts. Instead, the clause starts with the presumption that such arrangements are impermissible but allows them so long as the commission is paid to a “bona fide employee” or “bona fide agency.” To avoid potential problems under the clause, contractors should take steps to help ensure that their relationships qualify–something I’ll address in more detail in the “Tips & Tricks” section below.
B. SPECIAL RULES FOR 8(A) CONTRACTS
The Covenant Against Contingent Fees appears in most federal contracts. However, contractors pursuing work under the SBA’s 8(a) Business Development Program must abide by two additional restrictions found outside the FAR, in 13 C.F.R. § 124.4. Importantly, these restrictions are in addition to the requirements imposed by FAR 52.203-5, which also applies to most 8(a) contracts.
First, the SBA requires that any commission related to an 8(a) contract (or, more broadly, to the 8(a) Program itself) be “reasonable.”
The compensation received by any packager, agent or representative of an 8(a) applicant or Participant for assisting the applicant in obtaining 8(a) certification or for assisting the Participant in obtaining 8(a) contracts, or any other assistance to support program participation, must be reasonable in light of the service(s) performed by the packager, agent or representative.
Unfortunately, the SBA provides no formal guidance to assist contractors in understanding when a fee is, or is not, reasonable. Obtaining multiple quotes may help establish that a fee is market-based. The best way to ensure compliance, however, is to check with the 8(a) company’s SBA representative.
Second, the SBA regulations prohibit a common commission structure. The regulations state:
In assisting [an 8(a) Program] Participant obtain one or more 8(a) contracts, a packager, agent or representative cannot receive a fee that is a percentage of the gross contract value.
This prohibition can cause trouble for 8(a) companies because many (and in my experience, most) people and entities who assist companies in obtaining contracts expect to be paid a percentage of the gross value. Such arrangements are acceptable under the Covenant Against Contingent Fees but disallowed when the contract in question is an 8(a) contract.
Because percentage-of-gross arrangements are prohibited, 8(a) companies must find other payment structures. In my opinion, the following structures should be compliant, provided the overall amount paid is reasonable:
- A success fee, such as $10,000 for each contract successfully awarded as a result of the consultant’s efforts.
- An hourly rate for the consultant’s work. Although not a compliance matter, it is wise to put a cap on hours anytime you agree to an hourly rate.
- A hybrid consisting of a flat monthly fee, such as $3,000, plus a success fee for each contract awarded.
- A tiered success fee, such as $5,000 for any contract below the Simplified Acquisition Threshold and $10,000 for any contract above it. But be careful: if the tiers are too narrow (say, a new tier for each $1,000 increase in the contract price), it starts to look an awful lot like a backdoor percentage-of-profit arrangement.
- A percentage of the profits, as opposed to a percentage of the gross. Most bona fide employees and agencies reject this structure, though, since the employee or agency does not control the contract’s profitability.
If there is any doubt whether a proposed fee structure is compliant, an 8(a) company should consult its SBA representative–before signing on the dotted line.
C. A FEW TIPS AND TRICKS
In my career as a federal government contracts lawyer, I helped draft and negotiate many agreements with bona fide agencies and employees. Here are a few tips, tricks, and suggestions for contractors considering commission-based relationships:
- An agency will often send the contractor a proposed agreement to formalize the relationship. Do not assume that the proposed agreement is up to snuff when it comes to complying with FAR 52.203-5 and 13 C.F.R. § 124.4. Maybe it’s just me, but in my experience, the majority of agreements I reviewed from selling agencies were poorly written and had no language specifically intended to aid in FAR and SBA compliance. Review these documents closely, and if your resources allow, consider asking an experienced government contracts attorney to take a look.
- Ask the employee or agency to certify that they meet the requirements of FAR 52.203-5. A statement like, “Consultant represents and certifies that it is a bona fide agency, as the term is defined in FAR 52.203-5,” can help protect you by shifting some of the compliance burden to the employee or agency. In the event the government audits the relationship, you now have the argument, “they told me they complied.”
- Similarly, include language in the agreement prohibiting the employee or agent from using improper influence. This statement might read something like, “Consultant agrees that, in the performance of the services contemplated by this agreement, it will neither exert nor propose to exert improper influence, as the term is defined in FAR 52.203-5.”
- Make the employee or agency put its money where its mouth is by including an indemnity provision, under which the employee or agency agrees to indemnify the contractor for any liabilities, claims, etc. associated with a violation or alleged violation of FAR 52.203-5 or 13 C.F.R. § 124.4.
- Remember that an independent contractor is not a bona fide employee. You should negotiate an agreement with such a person as a bona fide agency instead.
- If possible, get multiple quotes before signing a deal. This helps ensure that the arrangement passes muster under the Covenant Against Contingent Fees (and 13 C.F.R. § 124.4 if 8(a) contracts are involved). Of course, it also helps make sure you’re getting a fair price!
D. SOME FINAL WORDS
Contrary to a common misconception, it is not per se impermissible to pay a commission to an individual or entity in exchange for helping your company obtain federal government contracts. The reality is much more nuanced and depends on whether the relationship complies with FAR 52.203-4, and in some cases, 13 C.F.R. § 124.4. Keep this primer in mind, and if possible, seek individualized legal assistance from an experienced government contracts attorney, and you’ll be on your way to a compliant commission-based relationship.
Nothing contained in this article is to be considered as the rendering of legal advice for specific cases, and readers are responsible for obtaining such advice from their own legal counsel. This article is intended for educational and information purposes only. Although the author strives to present accurate information, the information provided in this article is not guaranteed to be accurate, complete, or up-to-date. Reading this article does not establish an attorney-client relationship with the author.