SBA SIZE PROTEST LAW: SBA Size Determination Protests & Appeals - Attorneys

Affiliation


General Rules on Affiliation

SBA Size protests are often based on alleged affiliation.  If two businesses are affiliated with each other, the SBA will combine their revenue to determine if they meet the size standard applicable to the procurement.

Business concerns are affiliated if one has the potential to control the other.  The SBA may examine “the totality of the circumstances” to determine if affiliation exists. 13 C.F.R. 121.103(a)(5)

General Rule - Power to Control.  Business concerns are affiliated if one has the potential to control the other.  (13 CFR §§ 121.103(c)(1))  There are several grounds upon which affiliation can be found.  (13 C.F.R. § 121.103(c) through (h))  While the evidence may not establish affiliation under any specific ground, the totality of the circumstances may still support a determination of affiliation. (13 C.F.R. § 121.103(a)(5))

Identity of Interest.  Two or more persons with an “identity of interest” are affiliated.  Affiliation based upon identity of interest may be found among entities with substantially identical business or economic interests, common investments, or that are economically dependent through contractual or other relationships. 13 CFR § 121.103(f).  An identity of interest is found where common interests establish "a relationship that bespeaks a concert of purpose and effort" and "cause the parties to act in union for their common benefit." H.L. Turner Group., Inc., SIZ-4896, at 6 (2008).  Family members are presumed to have an “identity of interests.”

Overcoming Presumption of Affiliation based on Identity of Interest.  Affiliation based upon identity of interest may be challenged by showing a “clear line of fracture” between the family members or entities with an identity of interest.  Tech. Support Servs., SIZ-4794, at 17 (2006).

Control of Management. Affiliation arises where one or more officers, directors, managing members, or partners who control the board of directors and/or management of one concern also control the board of directors or management of another concern. 13 C.F.R. § 121.103(e). Common management affiliation does not require total control of a concern, just the ability to exert “critical influence” or to exercise “substantive control over a concern's operations.” Active Deployment Systems, SBA No. SIZ-5216, at 6 (2011).

Control of the Board.  An entity may control a concern through its board of directors. 13 C.F.R. § 121.103(e). Control may be either affirmative or negative.  The ability to prevent a quorum or block action by the board of directors or shareholders.  National Welders Supply Co., Inc., SIZ-4315, at 7-8 (1998).

Negative Control.  Rights to consent to encumber assets, amend or terminate leases, purchase equipment, increase employee compensation, and incur debt may constitute “negative control.”  EA Engineering, Science, and Technology, Inc., SIZ-4973 (2008).

Common Ownership.  Pursuant to 13 CFR § 121.103(c)(1), the following entities are presumed to control a company and are therefore affiliated: (1) Entities that own or control 50 percent or more of a concern's voting stock, and (2) Entities that own or control a block of voting stock which is large compared to other outstanding blocks of voting stock.    Shareholders that fall within these categories are per se affiliated with the company – the presumptions of control are not rebuttable.  Although the regulation is framed in terms of voting stock, it is applied to LLC members with voting rights or other rights of control.  DMS Facility Services, LLC, SBA No. SIZ-4913 (2008).  Thus for purposes of our analysis, stock ownership is the equivalent to LLC membership ownership.

Treatment of Options and Convertible Securities In determining ownership for purposes of size determination, SBA considers stock options, convertible securities, and agreements to merge to have a present effect on the power to control a concern. SBA treats options, convertible securities, and agreements as though the rights granted have been exercised.  13 CFR § 121.103(d).

Single Largest Minority Shareholder Rule This rule recognizes that all concerns must be controlled by someone or by some group.  This includes a block of affiliated shareholders who together hold the single largest minority share that is "large compared to other outstanding blocks of voting stock."  Ownership blocks include shareholders possessing an identity of interest.  There is no bright line rule.  Rather, the SBA examines power of the holdings in fact, percentage difference between the single largest minority shareholder and other blocks of voting stock, as well as other indicia of control. 

Relatively Equal Minority Shareholders If  two or more entities each own or control less than 50 percent of a concern's voting stock, and such holdings are approximately equal in size, and the aggregate of these minority holdings is large as compared to any other stock holding, SBA presumes that each such minority owner has control. This presumption may be rebutted by showing that control does not exist.  13 C.F.R. § 121.103(c)(2). Illustrative holdings include the following:

  • Equal distribution of voting power among three minority stockholders established control by all three where no minority owner could establish policy and execute management decisions, or negatively block action favored by a majority of the stockholders or management."  Zygo Corp., SBA No. SIZ-2514, at 6 (1986).
  • Where largest minority owners held 46 and 37 percent, disparity of 10%  coupled with an ownership stakes approaching 50% precluded finding that ownership is approximately equal as to trigger presumption of control by smaller owner pursuant to 13 C.F.R. § 121.103(c)(2).  The Woods Hole Group, Inc., SBA No. SIZ-5009 (2008).
  • Where 40% and 35% owners presumed to both control concern, presumption of control by 40% owner was not rebutted by showing that power to control was remote and nonexclusive. Allied Technical Services Group, LLC, SBA No. SIZ-5373 (2012).
  • Interests of 32.5% and 32.3%, with the remainder held by 31 shareholders. each had power to control because, although singularly unable enact or block corporate action, together wielded great influence over company affairs by alliance. Ceramatec, Inc., SBA No. SIZ-3040, at 6 (1989).

Widely Held Ownership.  If there are no blocks of ownership that are large compared to other outstanding blocks of ownership, and ownership is “widely held,” SBA will deem the Board of Directors and CEO or President to have the power to control the concern in the absence of evidence to the contrary. 

Affiliation Based on Family Relationship

OHA’s long-standing precedent is that 13 C.F.R. § 121.103(f) creates “a rebuttable presumption that family members have identical interests and must be treated as one person, unless the family members are estranged or not involved with each other’s business transactions.” Size Appeal of Osirus, Inc., SBA No. SIZ-4546 (2003)  This presumption may be rebutted by demonstrating that a clear line of fracture exists between the two companies.

The regulation concerning affiliation due to family relationship, 13 CFR § 121.103(f), provides:

Affiliation may arise among two or more persons with an identity of interest. Individuals or firms that have identical or substantially identical business or economic interests (such as family members, individuals or firms with common investments, or firms that are economically dependent through contractual or other relationships) may be treated as one party with such interests aggregated.

This regulation does not require that the firms have common ownership or common management to be considered affiliates. However, in the Size Appeal of GPA Technologies, Inc., SIZ-5307 (December 7, 2011), OHA held that “a minimal amount of economic or business activity” between two companies does not trigger affiliation under the identity of interest rules due to a family relationship.  Rather, OHA noted that “the presumption of affiliation may be rebutted with factors which would render the application of the regulation unjust or inequitable under the circumstances.”

Whether business dealings between two companies are minimal when deciding if a clear line of fracture exists, should be dependent on whether the business activity allows one company to control the other.  This is the essence of affiliation.  In the GPA Technologies case, the SBA Area Office argued that affiliation existed between two companies owned by family members given their continuous subcontracting history and use of common employees.  OHA disagreed with the Area Office’s position and focused on the element of control instead:

I disagree. The key concept of affiliation is whether one firm controls or has the power to control the other. 13 C.F.R. § 121.103(a)(1); see also Size Appeal of LGS Mgmt., Inc., SBA No. SIZ-5160, at 3 (2010) (“[C]ontrol is always the principal question when addressing affiliation.”). The concept behind affiliation based upon identity of interest is that the persons or entities in question will act in concert or as one because of their commonality of interests. Size Appeal of Bob Jones, SIZ-4059, at 5. If the subcontracting between the concerns in question amounts to a small percentage of each firm’s revenue, it provides little incentive for the firms to act in concert or as one, and it offers no basis on which to conclude that one firm can control the other. Size Appeal of Manroy USA, LLC, SBA No. SIZ-5244, at 3, 5 (2011) (finding no identity of interest where a common investment generated only a small portion of each party’s revenues and noting “there is simply no evidence that [the challenged firm and its alleged affiliate] can control one another or that a third party can control both entities”); Size Appeal of EA Eng’g, Science, and Tech., Inc., SBA No. SIZ-4973, at 10 (2008) (finding no identity of interest where the challenged firm derived less than 2% of its revenue from its alleged affiliate).

Accordingly, I conclude that a subcontracting relationship that represents only a small portion of each firm’s business does not preclude a finding of clear fracture. This is especially so in the face of evidence that there is no common ownership or common management between the firms, that they have different facilities, and that they operate in different lines of business with different customers. This is consistent with the precedent in Bob Jones and Henderson, which found clear fracture between the firms at issue despite some minimal business involvement.

The above holding is significant because it allows some business to occur between two companies owned by family members.  The amount of business must be minimal so it does not influence the way either business operates.  It is also important to show a clear line of fracture such that the two companies  do not share common ownership or common management; they do not share common office space or provide financial support to each other.

 

SBA Form 355

The company receiving a protest will be required to complete a SBA Form 355.  This form requires disclosure of financial information of the company and its owners.  It is designed to divulge information relevant to possible affiliation.

To test for possible affiliation in your company, complete a mock Form 355 to see where your vulnerabilities lie.  You can then take proactive steps so restructure the company to reduce the risk of an adverse size determination.   This is particularly important since the SBA size determination will look at the company’s condition on the date it submitted a proposal or bid.  It will therefore be too late to take corrective action after a protest is filed.

 

 

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