My question is, at this point can the customer and CO determine that the Agencies "mandatory source" technically cannot meet the renewal requirement and now move onto "other non-mandatory sources"?
Answer based on the information provided in the question:
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See FAR Part 8, FAR 8.004, and FAR Subpart 8.7 You may, but consider the following: Is this an option exercise or a contract follow-on? What is the dollar value of the change in scope? Does the Contracting Officer consider this change in scope to be a cardinal change? Can the maintenance contract be awarded as a separate contract? Are there any other mandatory sources? See order of precedence for mandatory sources. If not, you may want to pursue a waiver to go with a non-mandatory source.
If this is an option, you could exercise the option with the original scope, and subcontract the maintenance later.
You could consider terminating for the convenience of the Government or letting the contract expire and re-procuring the requirement with the new scope.
The changes clause does not allow for an increase in scope, but rather only changes within the general scope of 1) drawings, designs, or specifications when the supplies to be furnished are to be specially manufactured for the Government in accordance with the drawings, designs or specifications, 2) method of shipping or packing, or 3) place of delivery.
Further, if adding the maintenance work to the operational service contract will substantially increase the dollar value of the original contract, you may be looking at a Cardinal Change. The Cardinal Change rule applies where a change in the work is beyond the contemplation of the parties at the time the contract was negotiated / and substantially different from what was original competed.
Ultimately, make sure you coordinate with your contracting officer and agency’s legal counsel.