Earlier this week, the Department of Defense (“DoD”) issued a proposed rule to revise (and make stricter) the unique sourcing requirements applicable to certain photovoltaic devices that are used in the performance of DoD contracts.  Specifically, unless an exception under the Trade Agreements Act applies or a contractor secures a waiver based on public interest or unreasonable cost, the proposed rule would require photovoltaic devices provided under a covered contract to be both manufactured in the United States and made “substantially all” from components or materials that are also mined, produced, or manufactured in the United States.  DoD contracts covered by the proposed rule involve the provision of photovoltaic devices that are—within the United States—either (i) installed on DoD property or in a DoD facility or (ii) reserved for the DoD’s exclusive use for their full economic life.  Although the proposed rule does not apply to contracts under which the DoD directly acquires photovoltaic devices as end products, it does extend to energy savings performance contracts and power purchase agreements under which the DoD effectively acquires electricity produced by photovoltaic devices that are installed and managed by contractors.  As we have previously discussed, these contracts represent significant opportunities, especially given the DoD’s continued focus on securing sources of renewable energy.

The proposed rule implements new sourcing requirements set forth in the National Defense Authorization Act for Fiscal Year 2015, which overlap with existing requirements established in the National Defense Authorization Act for Fiscal Year 2011 that are contained largely in DFARS 252.225-7017.  Although the new requirements are largely consistent with existing requirements, which make the Buy American Act applicable to photovoltaic devices provided under similar contracts, the new requirements contain key differences that may complicate existing supply chains.  Importantly, the DoD has interpreted the new requirements to foreclose existing exceptions and waivers on which contractors may currently rely to provide photovoltaic devices that are manufactured outside the United States or made from foreign components.  In addition, whereas existing requirements apply only when both the DoD has reserved the exclusive use of a photovoltaic device and the device is to be installed on DoD property or in a DoD facility, the new requirements apply when either condition is satisfied.  As a result, a number of contracts will suddenly be subject to new sourcing requirements under the proposed rule, including contracts under which the DoD does not have an exclusive right to power generated from a photovoltaic device installed on DoD property or in a DoD facility, such as when a contractor is authorized to export power produced by such a device to a commercial grid, as well as contracts which have a term that is less than the full economic life of such a device.

The proposed rule mirrors existing requirements in that the primary effect of the current application of the Buy American Act to covered photovoltaic devices is to require contractors to ensure that the devices are manufactured in the United States.  Although existing requirements also technically require covered photovoltaic devices to be made “substantially all” from components or materials that are mined, produced, or manufactured in the United States, this requirement has been waived under existing regulations, as described below.  The proposed rule also mirrors existing requirements in that it recognizes a significant exception to contractors’ obligation to ensure that covered photovoltaic devices are manufactured in the United States by making the proposed rule’s application subject to the Trade Agreements Act, which provides an exemption from the Buy American Act’s requirements under contracts valued above certain dollar thresholds and requires contractors to provide photovoltaic devices that are “substantially transformed” in an authorized country, such as Canada, the United Kingdom, or Italy.  The application of the “substantial transformation” test under the Trade Agreements Act dramatically increases the number of available sources of supply as it focuses on the point at which a photovoltaic device is transformed into a new and difference article of commerce rather than the origin of its components or its final point of assembly.  Thus, under both the proposed rule and existing requirements, without considering other limitations on imports, a contractor could provide a photovoltaic device that is substantially transformed in an authorized country—such as the United Kingdom—from components manufactured in an otherwise unauthorized country—such as Malaysia.  DoD’s previous clarification that the relevant test focuses on the final place of substantial transformation remains unaffected by the proposed rule.

However, because the National Defense Authorization Act for Fiscal Year 2015 merely imposes key obligations from the Buy American Act and, unlike existing requirements, does not make the Buy American Act directly applicable to covered contracts, the proposed rule does not recognize other exceptions that currently apply to existing requirements.   In particular, the proposed rule does not recognize the waiver of the Buy American Act for components of commercially available off-the-shelf items, which the DoD has interpreted to apply to components of all photovoltaic devices covered by existing requirements.  Thus, in circumstances in which the Trade Agreements Act does not apply, contractors will be forced to trace the origin of the components of each photovoltaic device to ensure that “substantially all” of the components—which has been interpreted to mean more than fifty percent of component costs—have been manufactured in the United States.

More importantly, as the Trade Agreements Act will likely apply to the majority of covered contracts given the relatively high value of energy savings performance contracts and power purchase agreements, the proposed rule does not recognize general exceptions to the Buy American Act for (i) photovoltaic devices manufactured in other countries with which the United States has reciprocal defense procurement agreements, such as Turkey and Egypt, (ii) other foreign photovoltaic devices that are available at a cost that is less than the cost of domestic photovoltaic devices after a fifty percent adjustment to the foreign devices’ cost, and (iii) photovoltaic devices that are substantially transformed in the United States but potentially assembled in another country or made with foreign components in circumstances in which the Trade Agreements Act applies.  Although the proposed rule provides the DoD with authority to effectively implement these exceptions on a case-by-case basis, contractors will need to be cognizant of the circumstances in which a waiver can be requested and ensure that they actively pursue waivers when required.

The proposed rule will likely have a minimal impact on contractors that source photovoltaic devices through relatively uncomplicated supply chains that involve countries covered by the Trade Agreements Act.  However, contractors that have supply chains that source items from other countries or rely on existing exceptions to the Buy American Act should consider the impact of the proposed rule on their existing practices, especially considering complications that can arise in determining the origin of photovoltaic devices that include wafers, cells, and modules manufactured or assembled in different countries.