For the first time in nearly a decade, GAO in Knudsen Systems, Inc. sustained a protest challenging an agency’s decision to set aside a procurement for small businesses.  The decision involves the so-called “Rule of Two”:  under FAR 19.502-2(b), agencies must set aside for small businesses a procurement with an anticipated dollar value of more than $150,000 where the agency’s market research demonstrates there is a reasonable expectation at least two responsible small business offerors can meet the agency’s requirements at a fair market price.

Rule of Two protests can come in two flavors.  The more common variety is a small business challenging an agency’s failure to conduct adequate market research and issue a procurement as a small business set aside pursuant to the Rule of Two.  The less common variety involves an “other than small” protester alleging the procurement should be competed on an unrestricted basis, and that an agency’s decision to set aside the procurement is not supported by a rational Rule of Two analysis.  Over nine years ago, GAO sustained such a protest in Triad Isotopes, Inc., concluding that the agency’s market research was insufficient to support the agency’s conclusion that it would likely receive quotes from at least two responsible small business concerns at a fair market price.  In Triad, GAO noted that an agency’s analysis must address not only the existence of small businesses that might submit proposals but also their capability to perform the contract.  That analysis may also require consideration of whether the nonmanufacturer rule applies to the procurement.  (The nonmanufacturer rule generally requires that, in procurements set aside for small businesses, if the awardee does not manufacture the product itself, it must provide products from a domestic small business manufacturer or processor—or obtain a waiver of the requirement.)  As explained in Triad, if the nonmanufacturer rule applies to the procurement, then the agency’s assessment must consider the companies’ ability to comply—small businesses unable to comply with the nonmanufacturer rule may not be considered capable of performing the contract.

 GAO’s recent decision in Knudsen Systems, Inc. involves similar facts.  In Knudsen, the Navy sought to buy SONAR equipment under a small business set-aside.  The Navy believed initially that a nonmanufacturer rule waiver had been issued for the equipment and, accordingly, the agency’s Rule of Two market research included sources-sought notices that (incorrectly) advised potential offerors that the nonmanufacturer rule did not apply.  After receiving information from three small businesses indicating that they could meet the solicitation’s requirements at a fair market price, the agency decided to set aside the procurement for small businesses. 

In the midst of the procurement, the Navy learned that the nonmanufacturer rule waiver did not apply to the procurement—i.e., the nonmanufacturer rule did apply.  The Navy amended the solicitation to include the nonmanufacturer rule but decided that the procurement would remain a small business set-aside.

 Knudsen was a small business offeror who planned to supply equipment it sourced from a Canadian manufacturer but, following the Navy’s solicitation amendment to include the nonmanufacturer rule, could no longer bid on the procurement.  Knudsen filed a protest with GAO, challenging the Navy’s decision to conduct the procurement as a small business set-aside.  Knudsen argued the Navy’s Rule of Two analysis was flawed because it failed to consider the “capability” of small businesses to comply with the nonmanufacturer rule.  GAO agreed, noting that the Navy’s initial decision to set aside the procurement for small businesses was premised on an erroneous assumption (that the procurement was eligible for a nonmanufacturer rule waiver), which resulted in flawed market research.  In the end, GAO sustained the protest because there was “no support for the contracting officer’s assumption that any of the companies identified in the market research report were capable of performing the amended solicitation requirements.”

We would like to thank Cherie J. Owen, Consultant, for her contribution to this alert.