Small Business Certification a Thorny Issue

By John Stafford and Ryan Bradel
The ever-evolving small business government contracting landscape presents myriad ethical quandaries for small businesses seeking set-aside and sole source contracts.

Rules governing eligibility for various small business programs are becoming more complex with amendments and case law interpretation. Hence, whether a firm is eligible for a particular small business program or procurement often presents a thorny question.

Small business government contracting programs generally rely upon a contractor’s self-certification. To compete, a company usually only needs to certify — with no government verification — that it meets a small business program’s requirements.

Notable exceptions include the Small Business Administration’s 8(a) business development program and Historically Underutilized Business Zone (HUBZone) program and the Department of Veterans Affairs’ Veterans First contracting program for Veteran-Owned and Service-Disabled Veteran-Owned Small Businesses.

The 8(a) and HUBZone programs require eligibility certification by the Small Business Administration before the business can bid on any 8(a) or HUBZone set-aside contract with any agency.

The Veterans First program requires a veteran-owned or service disabled status to be verified by Veterans Affairs before the company is eligible to bid on the VA’s set-aside contracts.

In any event, under the self-certification regime, enforcement of the criteria for small business programs only occurs after the fact, when either a competitor or the contracting officer submits protests to the SBA to determine whether eligibility criteria have been met.

Under self-certification, enforcement of the criteria for small business programs only occurs after the fact, when either a competitor or the contracting officer submits protests to the SBA to determine whether eligibility criteria have been met.

It often is unclear, on the front end, whether a company meets small business set-aside criteria, creating a dilemma as to whether self-certification is justified. More to the point, the evolving eligibility rules, and how those rules are interpreted, actually encourage small businesses to take aggressive positions concerning eligibility criteria and, in effect, “roll the dice” as to the outcome of any subsequent protest.

Two small business eligibility rules, which seem especially susceptible to such aggressive interpretations, are the ostensible subcontractor rule and rules requiring ownership and control by a certain individual, particularly when applied to veteran-owned and service-disabled veteran-owned small businesses. 

The ostensible subcontractor rule holds that when a small business prime contractor subcontracts the “primary and vital requirements” of a government contract or is “unusually reliant” on such a subcontractor, the two companies are deemed “affiliated” for purposes of combining their sizes and determining set-aside contract eligibility.

The Small Business Administration examines a number of factors in assessing affiliation under the ostensible subcontractor rule, including the planned division of labor between the two companies in contract performance, inter-company financial arrangements — for example, assistance in obtaining bonds or loans — and how the proposal presents the relationship between the two companies.

Evolving interpretations of these factors invite companies to push the envelope when self-certifying small business eligibility. For example, if the proposal used the term “team” to describe the planned relationship between the two companies in performing the contract, the Small Business Administration, at first tended to deem an ostensible subcontractor relationship to exist. More recently the SBA has recognized that procuring agencies often favor the term “team” in evaluating proposals, and hence has ruled that the term is not necessarily indicative of an ostensible subcontractor relationship.

Also amorphous in application is the rule requiring a service-disabled veteran to own and control the small business concern. The rules deem ownership to mean the service-disabled veteran unconditionally owns at least 51 percent of the company, and control means both the long-term decision making and day-to-day company management and administration by the service-disabled veteran.

For the service-disabled veteran to be in control of the company, minority investors cannot have negative control, i.e., the right to veto any business decisions. A dilemma arises when the service-disabled veteran needs equity financing, and investors condition their loan or investment, which triggers negative control.

SBA has applied the negative control rule strictly and has found that a veteran-owned and service-disabled veteran-owned small businesses is not controlled by the service-disabled veteran when the minority investor can veto even relatively minor business decisions. The SBA also has disqualified a company if the service-disabled veteran, in replacing any managing member or director, must secure approval from any other managing member or director.

Companies seeking equity financing in their service disabled status continue to challenge the SBA by pushing the boundaries it will allow, with increasingly exotic minority investor ownership and management arrangements. Without absolute company control by the service-disabled veteran, however, the company’s status remains vulnerable to challenge.

Historically, authorities have allowed parties to advance novel, even aggressive, interpretations of existing law. However, pursuing such challenges is not without cost. Some experts have expressed concern about language in the Small Business Jobs Act of 2010, which could lead to a finding of criminal misrepresentation of status for contractors that self-certify as “small.” 

The line between “novel, aggressive” and “criminally unfounded” is not always clear. Just how novel is an interpretation that crosses the criminal line? “Novel” means unprecedented. There are questions on whether a company should be subjected to criminal liability simply because it self-certified itself as an eligible small business based on a new or unprecedented interpretation that is challenged by a competitor’s size protest.

As it stands, so long as standards remain hazy, the challenge simply is to navigate without actually exceeding the good faith, outer edge of audacity.

Finally, apart from criminal liability and exposure to the expense of prosecuting and defending size challenges, a company’s reputation for fair dealing is critically important. The government customer must always know that a company knows and abides by the small business definition ground rules; and, further, that while a firm may be a tough, perhaps even aggressive competitor, that it can always fully support any position it takes in pursuing, or defending against, challenges in competition.

John G. Stafford is a shareholder and Ryan C. Bradel is an associate in Greenberg Traurig LLP’s government contracts practice group. The views expressed are solely those of the authors.

Topics: Business Trends, Defense Contracting, Defense Contracting, Defense Contracting

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