The President Invokes the Defense Production Act in Response to COVID-19

To help our clients navigate the coronavirus (COVID-19) crisis, Arnold & Porter has established a Coronavirus Task Force covering a wide range of issues and challenges. Subscribe to our "Coronavirus (COVID-19)" mailing list to receive our latest client Advisories and register for upcoming webinars.

Introduction

The President has invoked the Defense Production Act of 1950 (DPA) to support the COVID-19 response by giving the federal government priority over all other customers for items such as masks and ventilators. Assuming the authority is properly invoked to support each order, the DPA authorizes the President and the Secretary of Health and Human Services (HHS) in certain circumstances to compel prioritized sales of health resources to the US government, and even direct industry to allocate resources (materials, facilities, etc.) to meet US demand for healthcare supplies needed to respond to COVID-19. There are some exceptions to the DPA, but in many cases a company receiving a DPA order has little recourse other than to offer the closest practicable alternative and comply to the maximum extent possible. DPA orders and directives warrant immediate response and detailed record keeping from the recipient and their supply chain, at risk of severe, including criminal, penalties.

II. HHS Authority Under the DPA

The DPA gives the President a broad set of authorities to shape the industrial base to provide the government all essential materials and goods needed for the national defense. Although HHS has rarely invoked the DPA, the legal framework already exist for HHS to do so in response to COVID-19. President Obama delegated DPA authority over "health resources" to the HHS Secretary by Executive Order that is still in effect,¹ and HHS promulgated regulations implementing its DPA authorities.²

There are potential legal arguments that the current COVID-19 outbreak does not constitute a threat covered by the DPA definition of "national defense." Rejecting a DPA order relating to COVID-19 on that basis, however, could entail reputational and legal risks that warrant consideration.

Two aspects of the DPA are most relevant here: (A) authority to issue "rated orders" for supplies critical to national defense, which must be accepted and prioritized over non-rated orders, and (B) authority to issue "allocation orders" directing industry resource allocation, including with respect to use of materials and facility capacity.³

A. Rated Orders

Pursuant to the DPA, HHS may issue so-called "rated orders" that take priority over non-rated orders. If HHS issues a rated order, the recipient must (subject to limited exceptions) accept and prioritize that order's performance over any non-rated orders.⁴ Notwithstanding their priority, rated orders must be given the same prices, terms, and conditions as comparable non-rated orders.⁵

Rated orders will be designated as "DO-rated" or "DX-rated." DX-rated orders take priority over DO-rated orders. A recipient must accept or reject the order promptly: within 15 working days for DO-rated orders and 10 working days for DX-rated orders. Further, if "the rated order is placed for the purpose of emergency preparedness, a person must accept or reject a rated order and transmit the acceptance or rejection in writing or in an electronic format within two (2) days after receipt of the order if (1) the order is issued in response to a hazard that has occurred; or (2) the order is used to prepare for an imminent hazard."⁶

In narrow circumstances, a rated order either may or must be rejected. Almost all such circumstances reflect practical necessity and require the recipient to propose the closest possible alternative.⁷ The complete HHS regulation that identifies circumstances requiring and permitting rejection of an order is provided for reference as an appendix to this advisory. As a representative example:

A person shall not accept a rated order for delivery on a specific date if unable to fill the order by that date. However, the person must inform the customer of the earliest date on which delivery can be made and offer to accept the order on the basis of that date. Scheduling conflicts with previously accepted lower rated or unrated orders are not sufficient reason for rejection under this section.

As relevant here, a rated order may be rejected "if the person placing the order is unwilling or unable to meet regularly established terms of sale or payment," or if "the order is for an item not supplied or for a service not capable of being performed."⁸

Once a rated order is accepted, the company "must schedule operations, including the acquisition of all needed production items or services, in a timely manner to satisfy the delivery requirements of each rated order."⁹ "DO-rated orders must be given production preference over unrated orders, if necessary to meet required delivery dates, even if this requires the diversion of items being processed or ready for delivery or services being performed against unrated orders."¹⁰"Similarly, DX-rated orders must be given preference over DO-rated orders and unrated orders."¹¹

Priority ratings extend through the supply chain, as the recipient of a rated order must issue rated orders as needed to downstream suppliers. Companies "must use rated orders with suppliers to obtain items or services needed to fill a rated order" and "must use the priority rating indicated on the customer's rated order" unless otherwise directed by HHS.¹² "The priority rating must be included on each successive order placed to obtain items or services needed to fill a customer's rated order. This continues from contractor to subcontractor to supplier throughout the entire procurement chain."¹³

B. Allocation Orders

The DPA also provides broad Presidential authority (delegated to HHS for health resources) to direct industrial resource allocation. An allocation order may take different forms: (1) a "set-aside" that "requires a person to reserve materials, services, or facilities capacity in anticipation of the receipt of rated orders," (2) a "directive" that "requires a person to take or refrain from taking certain actions," including to "stop or reduce production of an item; prohibit the use of selected materials, services, or facilities; or divert the use of materials, services, or facilities from one purpose to another," or (3) an "allotment" that "specifies the maximum quantity of a material, service, or facility authorized for a specific use."¹⁴

As with rated orders, there are strict limits to the terms of sale:

A person shall not discriminate against an allocation order in any manner such as by charging higher prices for materials, services, or facilities covered by the order or by imposing terms and conditions for contracts and orders involving allocated materials, services, or facilities that differ from the person's terms and conditions for contracts and orders for the materials, services, or facilities prior to receiving the allocation order.¹⁵

If the recipient of an allocation order is not able to comply, it must immediately notify HHS of "the extent to which compliance is possible," "give the reasons why full compliance is not possible," and continue to comply "with the order to the fullest extent practicable" until notified by HHS that the order has been changed or cancelled."¹⁶

To be clear, HHS has never utilized this allocation authority,¹⁷ and, according to the Congressional Research Service, the US has not invoked it in a circumstance since the end of the Cold War.¹⁸ And there are prerequisites: an allocation order is permitted only where rated orders cannot fulfill the national defense requirement, and any HHS determination to issue an allocation order is subject to Presidential approval. Allocation orders are to be applied proportionately across industry. That is they will be: "distributed equitably among the suppliers of the materials, services, or facilities being allocated and not require any person to relinquish a disproportionate share of the civilian market."¹⁹

III. Liability, Record Keeping & Audit

Failure to comply with the DPA is subject to criminal penalty,²⁰ and HHS has authority to audit and investigate records to ensure compliance.²¹ The regulations impose record keeping and retention requirements: "Persons are required to make and preserve for at least three years, accurate and complete records of any transaction" associated with the DPA and HHS regulations.²² Records must be made available for examination by HHS on demand.²³ Although no specific method of record keeping is specified, "records must be maintained in sufficient detail to permit the determination, upon examination, of whether each transaction complies" with the relevant obligations.²⁴

The DPA and HHS regulations provide immunity from damages and penalties resulting from compliance with the DPA:

No person shall be held liable for damages or penalties for any act or failure to act resulting directly or indirectly from compliance with a rule, regulation, or order issued pursuant to this chapter, notwithstanding that any such rule, regulation, or order shall thereafter be declared by judicial or other competent authority to be invalid.²⁵

IV. Conclusion

With certain exceptions, the DPA provides the US government broad authority to compel prioritized sale of health resources and to dictate industrial resource allocation in order to serve US national defense requirements. Companies must be careful to respond to any rated order or allocation order immediately. If an order cannot be satisfied, the recipient should fully document the impediments and promptly communicate those reasons to the issuing authority. Companies must maintain detailed, comprehensive records relating to all orders for at least three years that are sufficient to demonstrate compliance in the event of a future audit or investigation.

For additional information about the DPA, see the recent Arnold & Porter Advisory: Prepare, Communicate, Document, and Segregate—A Government Contractor's Guide to Addressing Performance Disruptions and Delays Related to COVID-19.

***

45 C.F.R. § 101.33 - Acceptance and Rejection of Rated Orders

(a) Mandatory acceptance.

(1) Except as otherwise specified in this section, a person shall accept every rated order received and must fill such orders regardless of any other rated or unrated orders that have been accepted.

(2) A person shall not discriminate against rated orders in any manner such as by charging higher prices or by imposing different terms and conditions than for comparable unrated orders.

(b) Mandatory rejection. Unless otherwise directed by HHS for a rated order involving all forms of health resources:

(1) A person shall not accept a rated order for delivery on a specific date if unable to fill the order by that date. However, the person must inform the customer of the earliest date on which delivery can be made and offer to accept the order on the basis of that date. Scheduling conflicts with previously accepted lower rated or unrated orders are not sufficient reason for rejection under this section.

(2) A person shall not accept a DO-rated order for delivery on a date which would interfere with delivery of any previously accepted DO- or DX-rated orders. However, the person must offer to accept the order based on the earliest delivery date otherwise possible.

(3) A person shall not accept a DX-rated order for delivery on a date which would interfere with delivery of any previously accepted DX-rated orders, but must offer to accept the order based on the earliest delivery date otherwise possible.

(4) If a person is unable to fill all of the rated orders of equal priority status received on the same day, the person must accept, based upon the earliest delivery dates, only those orders which can be filled, and reject the other orders. For example, a person must accept order A requiring delivery on December 15 before accepting order B requiring delivery on December 31. However, the person must offer to accept the rejected orders based on the earliest delivery dates otherwise possible.

(c) Optional rejection. Unless otherwise directed by HHS for a rated order involving all forms of health resources, rated orders may be rejected in any of the following cases as long as a supplier does not discriminate among customers:

(1) If the person placing the order is unwilling or unable to meet regularly established terms of sale or payment;

(2) If the order is for an item not supplied or for a service not capable of being performed;

(3) If the order is for an item or service produced, acquired, or provided only for the supplier's own use for which no orders have been filled for two years prior to the date of receipt of the rated order. If, however, a supplier has sold some of these items or provided similar services, the supplier is obligated to accept rated orders up to that quantity or portion of production or service, whichever is greater, sold or provided within the past two years;

(4) If the person placing the rated order, other than the US Government, makes the item or performs the service being ordered;

(5) If acceptance of a rated order or performance against a rated order would violate any other regulation, official action, or order of the HHS issued under the authority of the DPA or another relevant statute.

(d) Customer notification requirements.

(1) Except as provided in paragraph (e) of this section, a person must accept or reject a rated order in writing or electronically within fifteen (15) working days after receipt of a DO-rated order and within ten (10) working days after receipt of a DX-rated order. If the order is rejected, the person must give reasons in writing or electronically for the rejection.

(2) If a person has accepted a rated order and subsequently finds that shipment or performance will be delayed, the person must notify the customer immediately, give the reasons for the delay, and advise of a new shipment or performance date. If notification is given verbally, written or electronic confirmation must be provided within five (5) working days.

(e) Exception for emergency response conditions. If the rated order is placed for the purpose of emergency preparedness, a person must accept or reject a rated order and transmit the acceptance or rejection in writing or in an electronic format within two (2) days after receipt of the order if:

(1) The order is issued in response to a hazard that has occurred; or

(2) The order is issued to prepare for an imminent hazard.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.