Morris, Manning & Martin LLP

01/20/2021 | News release | Distributed by Public on 01/19/2021 23:08

Legal Update

The start of a new year is often a good time for small business owners to reassess whether or not their company still qualifies as a small business. When re-evaluating, many businesses focus on their revenues from the most recently completed fiscal years, as those revenues generally use a standard to establish a company's size and eligibility for procurements. While it is important to look at revenues, it is also important to determine whether the company has any affiliates.

Last year, when applying for loans under the Paycheck Protection Program, many business owners from a variety of industries were introduced to the concept of affiliation for the first time as eligibility for the program depended on information concerning the applicant, as well as its 'affiliate(s).' Some businesses did not know if they had affiliates and were caught off guard by the question. Although affiliation may be a new concept, it is a concern that small businesses providing goods and services to the federal government should be aware of because affiliation may render the business ineligible for contracting programs and the award of contracts set-aside for small businesses-potentially devastating outcomes for a government contractor.

Broadly, affiliation occurs when one business has the ability to control another business, or when a third party has the power to control both businesses.[1] Control may arise through common ownership, management, or other relationships or interactions between two or more companies. Importantly, it does not matter if the ability to control is exercised-the key consideration is whether the power to control exists.[2] In this context, control may be affirmative or negative.[3] For example, if an owner holds a minority ownership interest in a company (i.e., less than 50%), but that minority owner has the ability under the company's bylaws, operating agreement, or shareholders' agreement to prevent the company from taking an action, that minority owner may have negative control. If that minority owner controls a separate company, the two companies may be affiliated because the minority owner (a third party) has the ability to control both businesses.

The hypothetical situation presented above is known as affiliation through common ownership and is one of several circumstances that the U.S. Small Business Administration's (SBA) regulations identify as a basis for affiliation.[4] Other bases of affiliation include common management, common ownership, familial affiliation, economic dependence, ostensible subcontractor relationship, and the newly organized concern rule. Each of these bases for affiliation will be explored and discussed in detail in subsequent legal updates in this series.

Why should a government contractor care about affiliation? When SBA determines a business's size, SBA combines the company's receipts with the receipts of any affiliate.[5] Likewise, for employee-based size standards, SBA adds the average number of employees of the business concern with the average number of employees of each affiliate.[6] If the combined receipts or employees exceed the applicable size standard, neither business is considered a small business under that size standard.

Typically, SBA makes a formal size determination if a company applies for a SBA contracting program or in response to a size protest. In both contexts, a finding of affiliation can be extremely problematic. Affiliation may affect a contractor's eligibility for a small business set-aside program, such as the 8(a) Business Development Program, the HUBZone Program, or the Woman-Owned Small Business Program. This is because all of SBA's socioeconomic set-aside programs include requirements concerning ownership and control. For example, to qualify as a service-disabled veteran-owned small business (SDVOSB), a service-disabled veteran must own and control the company.[7] If the company is affiliated with another business or a third party because that other business or third party controls the company seeking SDVOSB certification, it is unlikely that the company will satisfy the SDVOSB program requirements and either gain or maintain SDVOSB verification. Affiliation can also be problematic for businesses applying for a SBA contracting program if a finding of affiliation results in the business being other-than-small, as qualifying as a small business is also a requirement for SBA's contracting programs.

As noted above, a finding of affiliation may also result in a small business contractor being deemed ineligible for in small business set-aside procurements. When a contract is awarded as a set-aside contract, the awardee's size may be challenged in a size protest.[8] It is not uncommon for a disappointed offeror to argue that the awardee (or the apparent successful offeror) is affiliated with other companies and is therefore other-than-small. A size protest triggers a size determination by SBA. SBA will request extensive documentation and information from the protested company, including information about potential affiliates.[9] If SBA determines that the protested company is not small under the applicable standard-based on affiliation or on some other grounds-SBA's regulations provide that the contacting officer shall either not select the protested firm for award or terminate the award if award has been made.[10] Put another way, a finding of affiliation may result in the loss of a contract. In a world of increasing competition, losing a contract can materially impact a government contractor.

Importantly, a finding of affiliation is often avoidable if potentially problematic facts are proactively identified and addressed. For example, affiliation based on common ownership or management may be avoided by amending corporate documents, such as an operating agreement or bylaws. Likewise, affiliation based on a familial relationship may be overcome if the companies operate in a manner to create a clear fracture.[11] Taking these proactive steps requires understanding affiliation and the circumstances that may give rise to a finding of affiliation.

If you have any questions about this legal update or would like to better understand affiliation and avoid the consequences of an adverse size determination, please contact the MMM Government Contracts group.

[1]13 C.F.R. § 121.103(a)(1).

[2] Id.

[3]13 C.F.R. § 121.103(a)(3).

[4] 13 C.F.R. §§ 121.103(a)(2), 121.103(c).

[5]13 C.F.R. § 121.104(d)(1).

[6] 13 C.F.R. § 121.106(b)(4).

[7] 13 C.F.R. §§ 125.12, 125.13(a).

[8] 13 C.F.R. § 121.1001(a).

[9] 13 C.F.R. § 121.1008(c).

[10]13 C.F.R. § 121.1008(g)(2).

[11] 13 C.F.R. § 121.103(f)(1).