The Commercially Useful Function Test and Penalties for Noncompliance with Project DBE

• Author: By Gretchen M. Ostroff
• Pages: 25-32

THE CONSTRUCTION LAWYER 25Winter 2020

Gretchen M. Ostroff

Published in The Construction Lawyer, Volume 40, Number 1 Winter 2020. © 2020 American Bar Association. Reproduced with permission. All rights reserved. This information or any portion

thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

The Commercially Useful Function Test

and Penalties for Noncompliance with

Project DBE Goals

By Gretchen M. Ostroff

DISADVANTAGED BUSINESSES

Gretchen M. Ostroff is Project Counsel at Dragados

USA, Inc., assigned to the I-64 Hampton Roads Bridge-

Tunnel Expansion Project, in Norfolk, Virginia.

A contractor who focuses

primarily on municipal

and state construction

may find itself subject to

different rules for engaging

disadvantaged businesses as

federal dollars are infused

into local road construction

projects. While most states

and some municipalities have

their own small business

contracting programs,

when the Federal Highway

Administration (FHWA) even partially funds a project,

contractors must comply with the Federal Department

of Transportation’s Disadvantaged Business Enterprise

(DBE) rules. With the change from state to federal

regimes comes new aspects of compliance, two of which

are restrictions on which disadvantaged subcontractors

can be counted toward the project DBE goal and the

consequences of not achieving the goal. To that end, this

article explores application of the “commercially useful

function” test from 49 C.F.R. § 26.55(c) to disadvantaged

subcontractors in privity with the contractor, including

in the framework of federal and state court decisions

evaluating commercially useful function in both criminal

and civil contexts. This article also analyzes the potential

consequences of failing to achieve the established goal,

including what it means under 49 C.F.R. § 26.53(f) to

engage in “good faith efforts” to demonstrate compliance,

the penalties for DBE noncompliance in selected states,

and recommendations for contractors on post-award

DBE utilization.

To Which Projects Does the Federal DBE Program Apply?

The Federal DBE Program regulations, codied in 49

C.F.R. Part 26, apply to projects that receive funding

from the Federal Department of Transportation (DOT).

1

These projects include federal-aid highway, transit, and

airport projects.2 However, projects to be performed

entirely outside of the United States (including its

territories, possessions, Puerto Rico, Guam, and the

Northern Marianas Islands) are not required to have DBE

programs.

3

Owners are prohibited from receiving nancial

assistance from DOT until they have an approved DBE

program in place.4 Therefore, states and localities that

desire to receive (and continue to receive) FHWA funding

for road construction typically adopt their own DOT-

approved DBE program, with associated annual goals,

prior to letting federally funded contracts out for bid.

The specic goals applicable to a given project will be set

forth in the solicitation and become binding contractual

obligations on the contractor upon award.

The Commercially Useful Function Test

To prevent contractors from circumventing the intent

of the DBE regulations by using sham DBEs, DOT

imposes rules as to which subcontractors count toward

a project DBE goal. In particular, the project gets

credit for DBE participation only when a subcontractor

performs a “commercially useful function” (CUF). “The

basic premise behind CUF is that DBEs perform their

contract with their own resources, independently of the

prime contractor.”5 Although no standard denition or

formula for CUF exists, the regulations, DOT, and courts

have provided guidance on the factors to consider when

assessing whether an entity is performing a CUF.

Code of Federal Regulations Guidance on CUF

Section 26.55(c) of title 49 C.F.R. sets forth the CUF

requirement. It provides that a DBE performs a CUF

when it

•

[I]s responsible for execution of the work of the

contract and is carrying out its responsibilities by

actually performing, managing, and supervising the

work involved [and]

•

Is “responsible, with respect to materials and

supplies used on the contract, for negotiating

price, determining quality and quantity, ordering

the material, and installing (where applicable) and

paying for the material itself.”

Further, perfor mance of CUF is evaluated with

regard to “the amount of work subcontracted, industry

practices, whether the amount the rm is to be paid

under the contract is commensurate with the work it is

actually performing, and the DBE credit claimed for its