Photo of Amy Laderberg O'SullivanPhoto of Olivia Lynch

As we have previously addressed, the Small Business Administration’s (SBA) final rule, Small Business Government Contracting and National Defense Authorization Act of 2013 Amendments, has implemented numerous changes to small business contracting contained in the National Defense Authorization Act of 2013 (FY2013 NDAA).  Below we discuss an important change to one affiliation test as well as newly introduced exclusions from affiliation.  On the whole, these changes make it easier for small businesses to work together without risking a finding of affiliation.

Affiliation is a central component of SBA’s regulations: in determining a concern’s size, SBA counts the receipts, employees, or other measure of size of the concern whose size is at issue and all of its affiliates (domestic and foreign).  In other words, these tests and (and exemptions or exclusions) affect whether SBA finds a concern to be small or other than small based on its relationships with other concerns.

Ostensible Subcontractor Rule – New, Significant Exemption for Similarly Situated Entities

SBA is revising the ostensible subcontractor rule to account for “similarly situated entities,” a concept which—as we have discussed previously—has been introduced as part of SBA’s new method of determining whether small businesses comply with the limitations on subcontracting requirement on set-aside contracts.  A “similarly situated entity” is defined in 13 C.F.R. § 125.1 as “a subcontractor that has the same small business program status as the prime contractor.”  Similarly situated entities must also be small for the NAICS code that the prime contractor assigned to the subcontract the subcontractor will perform.

Currently, SBA’s affiliation rules provide that a subcontractor who either performs the majority of the primary and vital requirements of a contract or whom the prime contractor is unusually reliant upon may be considered a joint venturer with the prime contractor and, thus, affiliated with the prime contractor for size purposes. This is referred to as the “ostensible subcontractor” rule, and is a common affiliation trap on many size protests.

In the final rule, SBA is excluding all “similarly situated” subcontractors from affiliation under the ostensible subcontractor rule at 13 C.F.R. § 121.103(h) – a major change from the prior regulatory scheme that incentivizes teaming between small businesses.

Changes to the Affiliation Test Based on Economic Dependence

The affiliation test at 13 C.F.R. § 121.103(f) discusses the circumstances in which an identity of interest between two or more persons leads to affiliation among those persons and aggregation of their interests. The final rule divides paragraph (f) into two and provides additional guidance on these two separate tests.

First, SBA clarifies in paragraph (f)(1) the types of relationships between individuals that will create a presumption of affiliation due to an identity of interest. A presumption of affiliation exists for firms that conduct business with each other and are owned and controlled by persons who are married couples, parties to a civil union, parents and children, and siblings.  Since SBA is implementing precedent from the SBA’s Office of Hearings and Appeals (OHA) that had previously interpreted this regulation, SBA was not inclined to go beyond the precedent and, for example, create a broader presumption of affiliation for any familial relationship or for grandparents and cousins, as suggested by some commentators.

Second, SBA has added a fixed percentage to the presumption of affiliation based on economic dependence also based on OHA precedent.  Now, under 13 CFR § 121.103(f)(2), if a concern in question derives 70% or more of its revenue from another firm over the previous three fiscal years, SBA will presume that the one firm is economically dependent on the other and, therefore, that the two firms are affiliated.  Presumption of affiliation based on economic dependence may be rebutted by a showing that despite the contractual relations with another concern, the concern at issue is not solely dependent on that other concern.  In commentary to the final rule, SBA states that having a rebuttable presumption is meant to ensure that start-ups and other companies operating in a unique industry are not adversely affected by this change.

In addition, SBA has clarified that it will not find affiliation between two concerns owned by an Indian Tribe, Alaska Native Corporation (ANC), Native Hawaiian Organization (NHO) or Community Development Corporation (CDC) based solely on the contractual relations of the two concerns.  The Small Business Act and SBA’s rules clearly recognize that ANC, NHO, CDC, and Tribally-owned concerns will provide assistance to sister entities, and SBA does not feel that it makes sense to find affiliation based on economic dependence among such concerns.

Affiliation of Joint Ventures – New Exclusion for Small Business Joint Venturers

SBA has also added a key exclusion from affiliation for certain small business joint ventures. Currently, there is an exclusion affiliation for an 8(a) protégé firm that joint ventures with its SBA-approved mentor for any small business procurement as well as an exclusion from affiliation between two or more small businesses that seek to perform a small business procurement as a joint venture where the procurement is bundled or large. (A large procurement is one that greater than half the size standard for a procurement assigned a NAICS code with a receipts-based size standard and greater than $10 million for a procurement assigned a NAICS code with an employee-based size standard.)

In the final rule, SBA amends 13 C.F.R. § 121.103(h) to broaden the exclusion from affiliation for small business size status to allow a joint venture of two or more business concerns to submit an offer as a small business for a Federal procurement, subcontract or sale so long as each concern is small under the size standard corresponding to the NAICS code assigned to the contract. Among other reasons for making this change, SBA explains that it better aligns with the new provisions of the NDAA governing the limitations on subcontracting, which allow a small business prime contractor to subcontract to as many similarly situated subcontractors as desired.  This change will create new opportunities for joint ventures, devoid of affiliation risk, under set-aside procurements.  In light of these changes, it remains to be seen how many small businesses choose to “go it alone” as a prime contractor versus seeking out permissible joint venture options to enhance technical capabilities, cost advantages, and greater experience.