Proposed Climate Rule Presents Substantial Compliance Burdens on Federal Contractors
With Dave Yang and Macy Climo
On November 14, 2022, the Federal Acquisition Regulatory Council (“FAR Council”) issued a proposed rule that will have a sweeping impact on nearly all federal contractors. To implement the policies in Executive Order 14030 (Climate-Related Financial Risk) and Executive Order 14057 (Catalyzing Clean Energy Industries and Jobs Through Federal Sustainability), the FAR Council has proposed to amend the Federal Acquisition Regulation (“FAR”) to include new requirements under FAR Part 23 that will expand the climate-based representations under FAR 52.223-22 and FAR 52.212-3. The new rule will impose annual reporting requirements for greenhouse gas (“GHG”) emissions, which includes carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, nitrogen trifluoride, and sulfur hexafluoride. As proposed, the level of required reporting will be determined by a contractor’s revenue from federal contracts.
Major contractors (those that received over $50 million in federal contracts in the prior fiscal year) and significant contractors (those that received between $7.5 and $50 million during the prior fiscal year) will be required to report, in the System for Award Management (“SAM”), their Scope 1 and Scope 2 GHG emissions. Scope 1 emissions “include GHG emissions from sources that are owned or controlled by the reporting company.” Scope 2 emissions “include GHG emissions associated with the generation of electricity, heating and cooling, or steam, when these are purchased or acquired for the reporting company's own consumption but occur at sources owned or controlled by another entity.” Affected contractors may calculate emissions using the tool or their choice so long as it complies with the GHG Protocol Corporate Accounting and Reporting Standard.
Moreover, major, but not significant contractors, will also need to annually disclose their Scope 3 emissions, which “are emissions that are a consequence of the operations of the reporting entity but occur at sources other than those owned or controlled by the entity.” Scope 3 disclosures must be made pursuant to the CDP Climate Change Questionnaire within its current or prior fiscal year and must be made available on a publicly accessible website. Major contractors will also be required to establish science-based targets for reducing greenhouse gas emissions in line with “reductions that the latest climate science deems necessary to meet the goals” set by the Paris Agreement. These actions may be completed by the contractor itself or its immediate or highest-level owner (as those terms are currently defined in FAR 52.204-17 or FAR 52.212-3) and must be validated by the Science Based Targets Initiative.
Consequences under the proposed rule are significant. If a contractor fails to undertake these actions and make the required climate disclosures, it will be deemed to be nonresponsible and therefore ineligible for award (unless the contracting officer determines that "the noncompliance resulted from circumstances properly beyond the prospective contractor’s control” and the company makes a certain showing). Under the proposed rule, major and significant contractors must complete their Scope 1 and Scope 2 GHG emissions inventory within one year after the publication of the final rule, while major contractors will have two years to complete and comply with their Scope 3 and climate assessment and disclosure obligations.
Notably, the proposed rule also includes exceptions. Contractors under the $7.5 million threshold will be exempt from the rule. In addition, Alaska Native Corporations, institutions of higher education, nonprofit research facilities, state and local governments, or entities deriving 80% or more their annual revenues from federal management and operating contracts that are subject to agency annual site sustainability reporting requirements will also be exempt. Of note, while there is no small business exemption, major contractors that identify as small or are nonprofit organizations are exempt from the annual climate disclosure requirements and are not required to set science-based targets. There are, however, no exceptions for acquisitions for commercial products or commercial services or for acquisitions below the simplified acquisition threshold.
While climate requirements should not surprise publicly traded companies given the Securities and Exchange Commission’s March 21, 2022 proposed rule that incorporates some of the same requirements as the proposed FAR rule, the proposed FAR rule requires the use of CDP Climate Change Questionnaires and science-based targets regarding GHG reductions. As such, the FAR’s proposed rule adds requirements to contractors that are publicly traded.
The proposed rule raises several issues.
First, it is unclear whether the proposed rule is sustainable for smaller contractors. As acknowledged compliance costs for Scope 1 and Scope 2 requirements in the first year are estimated at between $24,724 and $63,868 and up to $458,703 for Scope 3 compliance. With inflation and supply chain costs at record levels, the uncertainty around whether these costs can be charged to the government, and no assurances that compliance costs will decrease in subsequent reporting years, the proposed requirements may be not sustainable, especially for smaller contractors.
Second, it is unclear whether the one-year grace period for Scope 1 and Scope 2 compliance or the two-year period for Scope 3 compliance under the proposed rule will be sufficient for implementation, and in the case of Scope 3 contractors, whether it will be enough time for them to obtain the representations from their supply chains that presumably will be needed for compliance assurance.
Third, besides responsibility concerns and eligibility to pursue federal opportunities, there may be heightened compliance concerns such as potential false statement or false claims risks if a contractor’s disclosed data is alleged to be inaccurate or misleading.
Finally, given the magnitude of the proposed rule’s impact on industry, it is conceivable that there could be challenges to the Administration’s efforts to implement this rule under the Federal Property and Administrative Services Act – a move that may be reminiscent of the challenges to the Administration’s COVID-19 rulemaking efforts that were also made pursuant to this statute. Any such challenges would likely subject contractors to the added cost impacts inherent in compliance uncertainties.
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