SBA Size Protests and Appeals

As I have covered here before, every small business owner needs to be aware of the Small Business Administration’s (SBA) ostensible subcontractor rule.

In a nutshell, ostensible contractor affiliation occurs when a small business holds a prime contract – but a subcontractor hired for the job actually ends up controlling the work.  The SBA targets instances where the subcontractor (and not the small business prime) performs the “primary and vital” work of the contract.  Affiliation can also arise under the ostensible subcontractor rule if the small business is “unusually reliant” on its subcontractor.

The typical ostensible subcontractor rule violation involves a small business (prime contractor) and a large business (subcontractor).  For example, if the small business lacks the needed resources or expertise, it can find itself leaning on its large subcontractor to run the project to too great of an extent.  Anytime the large sub takes over a primary role on the project, there is danger of ostensible contractor affiliation.

However, in a recent decision, the SBA’s Office of Hearings and Appeals (OHA) drew out an important distinction in the law.  While the small prime/large sub relationship is more common, the ostensible subcontractor rule remains firmly in play even as between two small businesses.

The OHA decision arises out of a size protest filed in connection with a health services contract offered by the Florida Army National Guard.  After the SBA Area Office found the contract awardee small for purposes of the contract, the protester appealed and argued that the Area Office improperly failed to consider whether the awardee was affiliated with its proposed subcontractor under the ostensible subcontractor rule.

The Area Office based its decision on the size of the proposed contractor/subcontractor team.  Specifically, the Area Office reasoned that – because both firms were small for the purposes of the procurement – even if they formed a joint venture, affiliation by the ostensible subcontractor rule would not be found.  According to the Area Office, the SBA’s regulations intend for joint ventures to be treated as small as long as each of the joint venture members is small, without regard to the ostensible subcontractor rule.

On appeal, OHA disagreed with the Area Office.  OHA pointed out that the ostensible subcontractor rule does not include any exceptions for joint ventures where both members are small. To the contrary, the rule requires SBA to evaluate whether the firms are ostensible subcontractors; if they are, they will be considered joint venturers and affiliated for the purposes of a size determination.

OHA found that it could not accept Area Office’s conclusion that there had been no violation of the ostensible subcontractor rule because it never performed the required analysis.  Accordingly, OHA granted the appeal and ordered the Area Office to make a new size determination, including an examination of whether the participating firms were affiliated under the ostensible subcontractor rule.

 

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.

 

The baseline rule for SBA size protests is that a business’s size (for a receipts-based size standard) is determined by looking at the average annual receipts for the last three completed fiscal years.  But what if a contractor does not have a tax return on file for the most recent fiscal year?

A recent Small Business Administration (SBA) Office of Hearings & Appeals (OHA) decision answered that question in a remarkably succinct way:  It Doesn’t Matter.

The decision arises out of the appeal of an SBA area office determination that a contractor exceeded the size standard for a Department of Homeland Security Program Management, Administrative, Operations, and Technical Services set-aside contract.  The area office calculated the apparent-awardee’s size by looking to the contractor’s average annual receipts and utilizing tax returns from the three most recent fiscal years.  Because the contractor’s average annual receipts exceeded the procurement’s $14 million size standard, the SBA determined it was not small and could not be awarded the contract.

On appeal, the contractor argued that SBA should not have relied on its most recent tax return because the return was not filed with the IRS until several months after it self-certified as small for the contract.  Based on that evidence, the contractor proposed that the SBA area office should have looked to the three years’ worth of returns actually on file at the time of self-certification for its size determination.

OHA emphatically rejected the contractor’s position.  The decision states that it is “settled law” that tax returns filed after the date of self-certification may be used by the area office if the returns are available at the time of the size determination.

For a contractor focused on staying below the relevant size threshold, the focus of this opinion is clearthe lack of a filed tax return will not turn back the clock.

The proper measurement of your business’s receipts is the last three completed fiscal years immediately preceding self-certification – even if there is a filing extension or other reason that the most recent tax return is not yet on file at the time of self-certification.  The important question is whether the return is available at the time of the SBA’s review.

Moreover, even if a tax return is not available, the SBA area office can utilize any other available information (including regular books of account and audited financial statements) to support its size calculation.

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.

Contractors seeking to avoid affiliation under the Ostensible Subcontractor Rule know the soundbite:  Your firm must self-perform the “primary and vital” contract requirements.

A small business prime contractor must zero in on the essential objective of its contract and make sure to perform those requirements with its own employees.  If those requirements are subcontracted out to others, the SBA will have all the ammunition it needs to find affiliation.

While the “primary and vital” requirements test is the most commonly cited metric for the Ostensible Subcontractor Rule, a recent Small Business Administration Office of Hearings & Appeals decision reminds us that there is another factor to consider.  Namely, affiliation can also arise under the Ostensible Subcontractor if the small business prime contractor is unusually reliant on its subcontractor.

The SBA considered a General Services Administration custodial, landscaping, and grounds maintenance services contract set aside for small businesses.  On the facts presented in the appeal, it appears that the small business prime contractor would meet the requirement to perform the contract’s primary and vital requirements by, among other things, providing custodial services and controlling all contract management activities

Digging deeper, however, the SBA determined that the primary and vital issue was irrelevant to the final analysis.

According to the SBA, the Ostensible Subcontractor Rule is “disjunctive” – which is to say that the contractor must perform the primary and vital requirements AND cannot be unduly reliant on its subcontractor.  The inquiries are totally independent and a black mark on either is enough to tip the scales towards affiliation.

So, getting back to the appeal, the SBA looked at the small business’s relationship with its subcontractor and found a textbook example of over-reliance:

  • The subcontractor was the incumbent contractor on the project, but ineligible to submit its own proposal on the restricted set-aside contract
  • The small business prime planned to staff its part of the contract almost entirely with the subcontractor’s former employees
  • The proposed project manager previously served with the subcontractor on the incumbent contract, and
  • The small business prime lacked its own experience and needed the subcontractor to successfully perform (including a stated intent to sub-out 49% percent of the work to one entity)

Cumulatively, these factors were enough for the SBA to find affiliation based on the Ostensible Subcontractor Rule (and, specifically, the prohibition against undue reliance).  No further inquiry into performance of the primary and vital requirements was necessary.

Small business owners need to be aware of the simple, proactive measures that are available right now to avoid headaches down the road.

One prime example is properly maintaining your SAM.gov profile.  Taking the time to properly check (and periodically re-check) your SAM.gov reps and certs can help to establish and maintain your eligibility in the SBA’s socio-economic programs (like the Women-Owned, Service-Disabled, and HUBZone programs).

For example, a recent SBA size protest considered the case of whether an apparently woman-owned small business was disqualified from receiving a WOSB set-aside contract award based on incorrect information in its SAM profile.  The protest allegations included that the profile included inconsistent representations concerning the business’s size status and WOSB qualifications.

The SBA did not disagree with the basis of the protest – the SAM profile was inconsistent and did not accurately reflect the correct size status for the set-aside contract.  Nevertheless, the SBA denied the protest (and the subsequent appeal), finding that the awardee met the WOSB requirement of being at least 51% owned and controlled by one or more women (regardless of the conflicting SAM representations).

So, is the lesson here that SAM reps and certs don’t matter as long as you meet the SBA’s criteria?  Definitely not.

First, it should go without saying that small businesses should not actively open the door to size protests.  Even if you prevail on the protest (and the potential appeal), you will still have spent valuable time, money, and other resources defending against a preventable action.  It is much more advisable to bolster your company’s size status from all challenges and at every turn.

Second, I do not take this recent opinion as a blank check from the SBA to ignore SAM.gov reps and certs.  If you follow size protest decisions, you’re well aware that the SBA determines issues like affiliation using a “totality of the circumstances” test.  In other words, even if one size issue alone does not establish affiliation – it is still possible that that one issue, when combined with a number of other indicators, could still result in a finding of affiliation.

With that said, I think it is possible that a failure to properly manage a SAM.gov profile – when combined with other issues or facts – could lead to the SBA taking a longer look at your business’s size status in connection with a size protest.  In fact, it already has.

Small business owners must always be mindful of what it means to be “small” in the world of government contracting.  After all, losing that small business size status means losing direct access to the lucrative world of set-aside contracts and the SBA’s socio-economic programs.

In the past, we’ve discussed the SBA’s rules on affiliation – in short, the rules that determine whether you actually own and control your small business.  A finding of affiliation between two companies means that the firms are viewed by the SBA as a single entity for purposes of determining size.  Even a very small business can lose its size status if it is affiliated with another company (or multiple companies) that push it over the size threshold.

49949741 - connected group concept as many different ropes tied and linked together as an unbreakable chain as a community trust and faith metaphor for dependence and reliance on trusted partners for team and teamwork support and strength.

In addition to paying attention to active connections that could lead to a finding of affiliation, a recent SBA opinion reminds us that small business owners also need to avoid ostensible contractor affiliation (a current hot topic at the SBA and the reason behind many affiliation determinations).

In a nutshell, ostensible contractor affiliation occurs when a small business holds a prime contract – but a subcontractor hired for the job actually ends up controlling the work.  Specifically, the SBA targets instances where the subcontractor (and not the small business prime) performs the primary and vital work of the contract.  Affiliation can also arise under the ostensible subcontractor rule if the small business is unusually reliant on its subcontractor.

Take, for example, the SBA’s recent holding.  A small business was awarded an Army contract for waste management services.  In its proposal, the small business committed to performing all contract management services, including operations, customer service, and billing.  However, it subcontracted out to another business the work of diversion, disposal, and management of solid waste.  The SBA determined those waste management services to be the essential requirements of the contract and, therefore, found affiliation under the ostensible contractor rule.

As in all cases of affiliation, the finding had damaging effects, as the original contract awardee now exceeded the size standard of a small business and lost the contract.

This case should lead us to a practical question:  How do I avoid becoming affiliated under the ostensible subcontractor rule?  Fortunately, there are quite a lot of steps that you can take:

  • Focus on the kinds of work and the percentage of prime contractor performance.  In our sample case, it is not too controversial to suggest that waste management services are “primary and vital” to a waste management contract.  However, for other contracts, the essential work that should be performed by the small business prime contractor might not be as obvious.  In all cases, take the time in advance to think about the primary services being performed and whether the prime contractor is performing a reasonable percentage of that work (in addition to the required percentage of self-performance under the SBA’s limitation on subcontracting).  If the subcontractor is performing most or all of the heavy lifting, it is a warning that you might have an ostensible subcontractor problem.
  • Preparation, Preparation, Preparation.  From the outset, your proposal should give the appearance that the small business prime contractor is in control – even if it is already working with a proposed subcontractor.  Adhering to traditional prime and subcontractor roles (rather than approaching from the position of a partnership) can enhance the appearance that the small business is controlling the essential work of the contract.
  • Show Them the Money.  One of the hallmarks of ostensible contractor relationships is profit sharing.  Any non-traditional method of payment will suggest a lack of control to the SBA.  If you hold a prime contract and affiliation is a concern, you should pay your subcontractors like traditional subs.

Like so many issues when it comes to the SBA and affiliation, the ostensible contractor rule exists on a sliding scale.  There is no cure-all for avoiding affiliation, and the SBA will look to multiple factors in weighing the “totality of the circumstances.”

With that in mind, affiliation should always be at the top of your list.  Once a proposal is submitted, it is very difficult to un-tangle the prime and sub relationship.  The focus should be on preparing a proposal that places the small business prime firmly in control and includes proactive measures to ensure sufficient performance of the primary and vital work for the contract.

Under the Small Business Administration’s regulations, two firms may partner as a joint venture to perform a small business set-aside contract, provided that each partner is a small business under the size standard assigned to the contract.  But, a recent SBA decision highlights the fact that simply entering into a joint venture does not excuse each member of the joint venture from SBA scrutiny over affiliation.

In this recent case, a U.S. Department of Defense, Missile Defense Agency contract for business operations support was awarded to a joint venture composed of two (allegedly) small businesses.  Following a size protest, the SBA took a closer look at each member of the JV and didn’t like what it found.

41803629 - businessman reading documents with magnifying glass concept for analyzing a finance agreement or legal contract

While one of the JV partners was in fact small, the other had a problem.  Specifically, citing to the economic dependence rule, the SBA found that the second firm derived more than 70% (and, in fact, close to 100%) of its business from one source (a large business) over a three year period.  Based on this dependence, the SBA determined that the firms are affiliated.

This is bad news not only for the (now no longer small) firm, but also the JV itself.  Because each member of the JV is not small, the SBA determined that the JV is not small for purposes of this procurement.  In other words, the JV lost the contract.

This case highlights two important points.  First, it is essential for small businesses to understand the SBA’s rules on affiliation and be confident in their size.  Size protests unfold quickly, so information about your business’s size should be at your fingertips — and nothing should come as a surprise.  Second, the case reinforces the importance of smart teaming on government contracts.  If you pick the wrong dance partner, you could find your time and effort in pursuing (and even winning) a contract award is ultimately wasted.

If you are interested, you can learn a lot more about smart and strategic teaming in this presentation.

 

Our Blog often covers issues associated with government contracts protests (like, for example, protests at the GAO, Court of Federal Claims, and size protests at the SBA).  The point of those posts is to highlight ways that disappointed offerors can “get back in the game” by challenging an improper award made to another business.

But, occasionally, we’re reminded that the best practice (whenever possible) is to avoid the need for a protest altogether.  By focusing on the details and learning how to serve up timely proposals that check all of the government’s boxes, you’ll put yourself in a position to win more contract awards and avoid the need to file protests on the back end.

21052889 - tape measure with measure twice cut once text isolated on white with copy space.

Take the recent opinion from the GAO denying a protest over the post-deadline submission of pricing data.  In that case, the protester was eliminated from the procurement when it used a draft agency document to submit its pricing information, rather than the final revised version of the form later circulated by the agency.

The protester offered a number of equitable arguments against its elimination.  It used a form that was provided by the government, just not the most recent version.  And, in any event, it included all of the key pricing information.  At a minimum, shouldn’t the agency allow an interested offeror to correct this deficiency by simply substituting the correct form?

The GAO rejected all of these arguments out of hand.  It held that the agency acted reasonably in deciding to reject the offer — it would be unfair (GAO surmised) for the agency either to accept an offer based on different pricing assumptions (the draft form) or allow one offeror the special privilege of revising its offer after the deadline for proposals (on the corrected form).  As the GAO pointed out, the agency specifically cautioned all offerors that only the revised pricing form would be accepted.

Putting together a proposal in response to an agency solicitation can be a time-consuming and expensive proposition.  Protect that investment by developing a system for checking (and double-checking) your work.  Sometimes, a new or fresh set of eyes will be able to pick up on mistakes or omissions, or perhaps better see the requirements from the agency’s perspective.

Taking the time to get it right can help minimize the frustrating experience of missing out on a contracting opportunity due to easily avoidable mistakes.

Small business owners have lots of items on their to-do lists.  In addition to actually running the business, there are many administrative tasks required to make sure that you meet the applicable small business size standards and maintain those standards year-after-year (in order to avoid, or at least minimize, vulnerability to an SBA size protest).

Among the (sometimes admittedly) tedious tasks associated with remaining eligible for small business contract awards is registering in the required government databases.  Over the past five years, this process has been considerably streamlined by the rollout of the System for Award Management (www.SAM.gov).  SAM is a no-cost, government website where contractors must register and provide certain identifying information about their business.

One of the areas covered by a SAM profile is a business’s size – and specifically whether it qualifies as “small” under the applicable size standards.

The importance of paying proper attention to your SAM profile was highlighted in a recent SBA size protest concerning a small business set-aside contract for the lease of two bucket trucks at Marine Base Camp Lejune, North Carolina.

In the protest, a disappointed offeror argued that the awardee did not meet the size qualifications required by the contract.  Although the SBA’s Office of Hearings and Appeals (OHA) found that the protest lacked real specificity (and therefore was subject to being dismissed) – it nevertheless sustained the protest.

41803629 - businessman reading documents with magnifying glass concept for analyzing a finance agreement or legal contract

Why did a protest lacking in specifics get OHA’s attention?  It pointed out that the awardee’s SAM profile itself stated that the contractor is not “small” under the contract size standard.  That fact alone was enough for OHA to send the protest back to the SBA area office for further review.

This story should serve as a helpful reminder that even basic information should be reviewed periodically.  The attention to detail will pay off with less headaches in the long run.