The SBA is on a roll! It seems that ringing in the new year has invigorated the agency, prompting it to act on the various outstanding directives set forth in the National Defense Authorization Act for Fiscal Year 2013 (“NDAA”).
Last Thursday, the agency issued its long-awaited proposed rule on the expansion of the Mentor-Protégé Program. There were also proposed changes impacting the 8(a), HUBZone, and other small business programs. We gave you a sneak preview of that rule here, the day before it was issued. In addition to those proposed mentor-protégé changes, the SBA also recently rolled out a second proposed rule ,which included various changes to the small business regulations. Over the next several weeks, we will provide you with our take on various aspects of these two proposed rules. For purposes of this article, though, we’re going to focus on the changes to the affiliation regulations set forth in the December 29, 2014 proposed rule. These proposed changes would fundamentally alter the SBA’s analysis regarding the “ostensible subcontractor” rule, economic dependence, and “identify of interest” affiliation.
The rule proposes that a small business would be exempt from ostensible subcontractor affiliation where it subcontracts with a “similarly situated entity.” In fact, the rule proposes a complete overhaul of contractor performance requirements set forth in 13 C.F.R § 125.6. Rather than mandate the percentage of work a prime must perform, the revised 125.6(a) limits how much work a prime can subcontract to other contractors, a subtle but important distinction. Subcontracts issued to “similarly situated entities” are not counted toward the subcontracting limit. For example, under the proposed rule, an 8(a) contractor performing a general construction contract cannot subcontract more than 85% of the contract work to non-8(a) entities. Similarly, a SDVOSB prime contractor cannot subcontract more than 75% of a specialty construction contract to non-SDVOSB concerns. In these examples, the required 15% or 25% of the work would have to be performed by either the prime itself, or by the prime in combination with a “similarly situated entity” – i.e. a concern that is eligible for the same small business program as the prime. Strangely enough, the language of the revised regulation does not require any of the work to be self-performed by the prime, so long as the requisite percentage is performed by a combination of the prime and entities that are “similarly situated.” Consistent with this concept, the proposed revision to §125.6(b) creates an exception to ostensible subcontractor affiliation for prime contractors who subcontract in this manner. The revised rule would ensure that a prime that subcontracts a majority of its work will not be “affiliated” with its subcontractors, so long as its subcontractors are “similarly situated.”
The second major change to affiliation is the adoption of a bright line test based on economic dependence. Pursuant to the proposed rule (to be inserted at 13 CFR 121.103(f)(2)), if a concern derives 70% or more of its revenue from another company over a fiscal year, the SBA will presume that the concern is economically dependent on that company, and, therefore, that the two businesses are affiliated. It is not entirely clear from the language of the rule itself whether this will be considered a rebuttable presumption. But an SBA representative who spoke about the proposed rule last week at the National 8(a) Association’s Winter Conference indicated that it would be rebuttable.
The third major affiliation change set forth in the proposed rule relates to “identity of interest” affiliation under 13 CFR 121.103(f). In its current form, the regulation provides that:
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. Where SBA determines that such interests should be aggregated, an individual or firm may rebut that determination with evidence showing that the interests deemed to be one are in fact separate.
However, the current rule does not identify what types of family members are subject to the presumption identified in the rule. The proposed rule would clarify this. The revised regulation would state, in relevant part:
Firms owned or controlled by married couples, parties to a civil union, parents and children, and siblings are presumed to be affiliated with each other if they conduct business with each other, such as subcontracts or joint ventures or share or provide loans, resources, equipment, locations or employees with one another. This presumption may be overcome by showing a clear line of fracture between the concerns. Other types of familial relationships are not grounds for affiliation on family relationships.
This will certainly make it easier for contractors to tell if they are venturing into dangerous territory when doing business with a family member.
It is very important to keep in mind that these are just proposed changes. The final rule may vary, so pay attention. Comments to the rule are due February 27, 2015. We will keep you posted on the status of the final rule.
Edward T. DeLisle is a Partner in the firm and a member of the Federal Contracting Practice Group. Ed frequently advises contractors on federal contracting matters including bid protests, claims and appeals, procurement issues, small business issues and dispute resolution.
Maria L. Panichelli is an Associate in the firm’s Federal Contracting Practice Group. Her practice includes a wide variety of federal contracting and construction matters, as well as all aspects of small business procurement.