Today, we take a look at the culmination of a long fight over the size status of a joint venture competing for a Federal contract.  After losing battles at the Small Business Administration (SBA) Area Office and Office of Hearings and Appeals (OHA) – the joint venture finally won the war when the Court of Federal Claims (COFC) declared that SBA incorrectly applied the economic dependence test.

quick refresher on SBA economic dependence:  In a nutshell, the SBA will find two firms affiliated through economic dependence when a small business is dependent on another company for a disproportionate amount of its revenue.  Without a steady flow of business from its counterpart, the small business would be unable to survive (let alone thrive).  When one business is economically dependent on another, there is a presumption of affiliation.

That was precisely SBA’s finding with respect to the joint venture that teamed up to bid on a Department of Defense Missile Defense Agency support contract.  The SBA Area Office found the joint venture was “other than small” for purposes of the contract (and, therefore, ineligible for award).  OHA agreed, confirming that one of the joint venture partners was affiliated with a third entity (and therefore had to include that entity’s average annual receipts in its size calculation).  As a result of this affiliation, the joint venture partner was deemed to be a large business under the relevant size standard, thus disqualifying the joint venture.

Specifically, SBA found the two firms affiliated because the purported small business received more than 70% of its revenue from the third firm, thus creating an “identity of interest due to economic dependency.”  According to OHA’s decision, “as a matter of law, a firm that derives 70 percent or more of its revenue from another firm is economically dependent on that firm.”

On appeal to COFC, the joint venture argued that SBA misapplied the presumption of economic independence as a bright line rule – as opposed to a rebuttable presumption.  Here, the mitigating factors weighing against affiliation included the fact that the small firm had only been operating a short time and held a small number of contracts (which distorted the 70% figure relied on by OHA).  The joint venture also presented evidence of the firm’s attempts to diversify and expand to other sources of revenue.

The COFC was persuaded by these arguments and remanded size determination back to the Area Office for a new review.  In its decision, the court affirmed that the 70% standard  is highly indicative of economic dependence – but still not an absolute rule.  COFC determined that OHA failed to consider properly the mitigating factors presented.

This is a fascinating case study and a great example of a firm forcing SBA to faithfully apply its own regulations.  But – importantly – it also needs to be taken with a grain of salt and viewed as the exception to the rule.

The fact remains that there is a rock solid basis to support the SBA’s use of the 70% threshold as a standard for finding affiliation based on economic dependence – both in the regulations and in the case law.  If your business receives even close to 70% of its receipts from one business – there is a definite cause for concern.  This case confirms that your business has the ability to try and rebut the presumption of affiliation – but that can be a steep mountain to climb.

If you are concerned about your firm losing its size standard due to economic dependence – now is the time to think about proactive strategies for diversifying.  Relying on a winning rebuttal argument with the SBA is betting against the house.

Join me on Thursday, August 24, 2017 for lunch (11:30 am to 1:30 pm) and learn about the Small Business Administration’s All Small Mentor Protégé Program. The event is sponsored by Design-Build Institute of American Mid-Atlantic and will be held at Maggiano’s in Tysons Corner.

For months, we poured over the proposed and final rules – speculating about how the Program would look and operate.  Now it is here.  With the SBA accepting and processing applications at a healthy clip, there is no better time than the present to get up to speed.

During the event, we will walk through the basics of the All-Small Program, including the application and approval process.  We will also talk about big picture issues, including the Program’s general shield against affiliation and the most important questions for contractors (both large and small) considering taking the leap.

The event will also offer insights for contractors that have already investigated the Program.  For example, we will discuss the newly published requirements for mentor-protégé agreements and joint venture agreements formed between Program participants.  Careful consideration of the issues captured in these agreements can make the difference between a successful partnership . . . and the undesirable alternatives.

I hope that you can join us on the 24th.  I am happy to chat after the presentation about any specific questions facing your business.  If you can’t make the event, you can always contact me here to discuss your questions.

Government contractors looking to identify and mitigate indications of affiliation sometimes need look no further than their own family tree.

The Small Business Administration (SBA) assumes that two businesses owned and controlled by members of the same family are affiliated based on that family relationship alone.  It is up to the family members to rebut the presumption.

The SBA’s Office of Hearings and Appeals (OHA) reaffirmed this “Familial Identity of Interest” standard in spades in a recent decision.  OHA found two businesses affiliated based on the ownership and control of two brothers.  To be clear, the brothers did not co-own the businesses – each brother owned and controlled his own business.

The OHA decision is significant because it reaffirms the presumption of affiliation in such cases.  The businesses argued that they should not be considered affiliated because there is no evidence that either brother could control the other’s business.  OHA rejected this argument as immaterial.  There is no need for a finding of affirmative control when it comes to family relationships – the relationship alone is sufficient to create a presumption of identical interests.

So how do family members rebut the presumption of affiliation?

There are two generally recognized ways.  The first is to show that the family members are estranged.  Family members that are not in contact with each other are not presumed to share identical interests.  Obviously, this is a subjective question that will require at least some actual evidence to support the claim.

The second way to rebut the familial identity of interest is to show that there is no – or at least very little – involvement between the family businesses.  In the case under review here, the brothers shared some fairly significant overlap in their businesses, including ownership interests, contracts/subcontracts, and a common NAICS code.  OHA concluded that these shared interests went beyond the minimal contacts allowed in earlier decisions.

The bottom line:  Government contractors with close family members that own a business – particularly a business in the same general field on industry – need to proceed with caution.  The best practice is to conduct zero business between the two entities and document affirmative efforts to wall off any actual or perceived shared interest.  Even a small amount of interaction can start to tip the scale towards a finding of affiliation.