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April 2, 2020

Stroock Special Bulletin

By: Chris Griner, Jeffrey R. Keitelman, Seamus Curley, Kim Pagotto, Shannon Reaves, Gregory Jaeger, Christopher R. Brewster, Erin Bruce Iacobucci

Commercial enterprises capable of manufacturing equipment or providing services necessary to respond to COVID-19 should ready themselves to comply with the Defense Production Act.  The government is no ordinary customer, and compliance may require significant changes to business operations.  On March 27, 2020, President Trump directed the General Motors Company to accelerate production of ventilators in response to the COVID-19 pandemic.  In so doing, the President invoked the wartime authority granted him by the Defense Production Act (“DPA” or “the Act”), a Korean War-era law.  The President first authorized use of the DPA in an Executive Order (“EO”) dated March 18, 2020.  Although his initial reluctance to invoke the Act prompted criticism, its implementation less than 10 days after the EO raises the possibility that other commercial enterprises may be called into action to respond to the current crisis.  They may also be called to strengthen domestic preparedness for future, and even unknown, threats of a similar nature.

By way of background, the President’s March 18 EO authorized the United States Department of Health and Human Services (“HHS”) to use the DPA[1] to allocate and issue priority contracts and orders for health and medical resources necessary to meet “surge capacity and capability.”  Personal protective equipment and ventilators were expressly included as “resources.”  The President provided HHS flexibility to propose additional items.[2]

On March 27, 2020, invoking his DPA authority, the President directed the HHS Secretary to “use any and all authority available under the Act to require General Motors Company to accept, perform, and prioritize contracts or orders for the number of ventilators that the Secretary determines to be appropriate.”[3]  For both commercial as well as government contractors, the President’s directive highlighted the importance of reviewing the DPA and its requirements.

The DPA – How It Works.  In the interests of national defense (including emergency preparedness), the DPA authorizes the President and delegated agencies to prioritize contracts and orders (known as “rated orders”), allocate goods and services (“allocation orders”) and prevent hoarding.  Traditionally these authorities have been implemented through the Federal Priorities and Allocation System (“FPAS”), and require compliance by any person capable of performance (“recipients”).  Delegated agencies exercise their authorities through derivative regulations.  For example, the Federal Emergency Management Agency (“FEMA”) exercises authority through the Defense Priorities and Allocation System (“DPAS”) and HHS exercises its authority through the Health Resources Priorities and Allocation System (“HRPAS”).[4]  Failure to comply with FPAS orders is punishable by fine or imprisonment, or both.[5]  In addition to FEMA and HHS, other agencies with specific delegated authority include the Departments of Defense, Commerce, Agriculture, Energy (“DOE”) and Transportation.

The Act’s prioritization authority allows the federal government to ensure the availability of critical materials, equipment and services by granting certain contracts priority over competing interests, including other government or commercial contracts.  The Act’s allocation authority grants the President the authority to take control over the distribution of material, services and facilities.

President Trump is the first President to invoke the Act’s allocation authority since the Cold War.  Nevertheless, the prioritization authority has been used frequently, especially in connection with terrorism prevention and disaster preparedness (e.g., prioritized contracts have been used by the FBI in connection with its Terrorist Screening Center; the U.S. Army Corps of Engineers in connection with its New Orleans Hurricane and Storm Damage Risk Reduction System Program; FEMA to provide housing units, food, water and electricity in Puerto Rico in 2017; and DOE to ensure that emergency supplies and natural gas continued in California in connection with potential electrical blackouts.)  The COVID-19 pandemic is now added to the list of qualifying circumstances.

Typically, prioritization is achieved through a contract clause in a government contract, which allows a federal agency to issue rated orders under the contract.  Thus, although a government contract might not involve DPAS-ordered work at first, the contract will nevertheless allow the government to convert the contract work to DPAS-ordered work — through the issuance of rated orders — if qualifying circumstances arise (e.g. the current pandemic, a war or a natural disaster). [6]

Rated orders require recipients to give specified government contracts or orders preferential treatment.  There are two types: DX-rated orders and DO-rated orders.  Typically, rated orders are issued for items in current production.  Allocation orders are used when there is an “insufficient supply of a material, service, or facility to satisfy national defense requirements through the use of the priorities authority.”

There are three types of allocation orders: Set-asides, Directives and Allotments.  “Set-asides” require recipients to reserve materials, services or facility capacity in anticipation of rated orders.  “Directives” require recipients to take, or refrain from taking, certain actions, including stopping or reducing production or diverting resources to different uses.  “Allotments” specify the maximum quantity of a material, service or facility that is authorized for specific use.

Recipients can receive rated or allocation orders either directly as a prime contractor or indirectly as a supplier through contractual flow-down requirements.  Recipients must be mindful of whether rated orders are for “national defense” or “emergency preparedness,” and whether they are rated as allocation orders, “DX” orders or “DO” orders.[7]  The exact nature of an FPAS order and its rating will determine how a recipient must sequence order deliveries and the response time a recipient will have to acknowledge receipt of an FPAS order.  Acknowledgement times can vary from six hours to 15 days from receipt.[8]

Complying with an FPAS order could require recipients to adjust their business operations substantially.  For example, compliance may require recipients to use existing inventories, flow down priorities to suppliers for items, packaging and services (other than employment), maximize current production capacity to meet delivery dates, and potentially reallocate production capabilities to fulfill an FPAS order.  Recipients may not discriminate against rated orders by charging special rates or imposing non-commercial terms and conditions.[9]  Accordingly, recipients may need to cancel or delay lower or unrated orders (including existing orders) to prioritize delivery of a higher rated order.  Importantly, by regulation, recipients are protected against claims of damages or penalties for any act (or failure to act) that is the direct or indirect result of compliance with an FPAS order.  There is thus protection for companies that may need to delay performance of or cancel other contracts, including commercial contracts, in order to comply with an FPAS order. [10]

Although the full set of DPA authorities is broad, the DPA has its limits — in particular, geographic ones.  Both U.S. businesses as well as U.S. subsidiaries of foreign businesses are subject to the FPAS, but their foreign suppliers are not.[11]  U.S. companies dependent on foreign supply chains may be challenged to meet delivery dates and quantity requirements if foreign supplies are limited or depleted.  One foreign supply dependency for the U.S. healthcare industry that has been highlighted during the COVID?19 crisis is the U.S.’s reliance on China for medical equipment and pharmaceuticals.[12]

Companies that find themselves the recipient of an FPAS order, or of a flow-down requirement involving an FPAS order, should consult with counsel to ensure compliance with FPAS and related requirements.  This is particularly true if the recipient anticipates difficulties in meeting the FPAS order’s delivery and timing requirements; there are options under the law for companies that find themselves in such circumstances, provided the company meets certain requirements.

Finally, the invocation of the DPA in response to the COVID-19 crisis highlights the essential role of the health sector in national security and the criticality of supply chains — even for low-tech products such as surgical masks and gowns.  As a consequence, foreign investment in U.S. businesses critical to a U.S. COVID-19 response (or any future similar health crisis) could face additional scrutiny under other DPA authorities like the Committee on Foreign Investment in the United States (“CFIUS”); the implications of the DPA for CFIUS reviews is discussed in our recent Stroock Alert.  In any event, the lessons of this crisis can be expected to have a significant impact on foreign investments reviews going forward.

If you have any questions concerning the DPA or its potential application in foreign investment reviews, please do not hesitate to contact us.

__________________________________________

For more information:

Chris Griner

Jeff Keitelman

Seamus Curley

Kim Pagotto

Shannon Reaves

Gregory Jaeger

Tatiana O. Sullivan

Christopher R. Brewster

Erin Bruce Iacobucci

[1] Public Law 81-774, or 50 U.S.C. §§4501 et seq.

[2] Executive Order of March 18, 2020, “Prioritizing and Allocating Health and Medical Resources to Respond to the Spread of Covid-19,” available at: https://www.whitehouse.gov/presidential-actions/executive-order-prioritizing-allocating-health-medical-resources-respond-spread-covid-19/; and 45 C.F.R. §101.20.

[3] Presidential Memoranda of March 27, 2020, “Memorandum on Order Under the Defense Production Act Regarding General Motors Company,” available at: https://www.whitehouse.gov/presidential-actions/memorandum-order-defense-production-act-regarding-general-motors-company/.

[4] HRPAS is authorized to cover health resources pursuant to Section 101(c) of the DPA, as delegated to HHS by Executive Order 13603, “National Defense Resources Preparedness,” March 16, 2012; 45 C.F.R. §§101 et al.

[5] See 45 C.F.R. § 101.74; 15 C.F.R. 700.74.

[6] See “The Defense Production Act of 1950: History, Authorities, and Considerations for Congress,” Congressional Research Service (Updated March 2, 2020).

[7] Id. at § 101.33-34 & 62.

[8] See id. at § 101.32; See also 15 C.F.R. § 700.12 -13 (discussing similar requirements under the Defense Priorities and Allocation System (DPAS)).

[9] Funding may be available to recipients who experience financial hardship complying with a FPAS order. 45 C.F.R. at § 101.33, 50, 53-54.

[10] 50 U.S.C. § 4557.

[11] See 50 U.S.C. § 4552, § 4562; see also Bureau of Industry and Security, “The Defense Priorities and Allocations System Training Course,” April 26, 2017.

[12] Stroock Special Bulletin, “COVID-19, CFIUS and the Defense Production Act,” March 26, 2020, available at: https://www.stroock.com/news-and-insights/covid-19-cfius-and-the-defense-production-act/.

This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.