Joseph J. Petrillo | Federal Contract Law: Who will protect small business from the SBA?

Joseph J. Petrillo

The Small Business Administration is supposed to be the advocate for small contractors, but sometimes it seems to be more of an obstacle. SBA regulations can be a tangled web. It can even be hard to figure out whether your company is a small business.

The rules start out simply enough. For each contract, the government chooses a size standard from a list published by SBA. The list is organized using five-digit codes from the North American Industry Classification System. Each code has an associated size standard. To be small, manufacturing companies must have fewer than a specified number of employees. Service businesses need to fit under a ceiling on annual receipts, averaged over the past three years.

To keep out the small subsidiaries of large corporations, the rules include all 'affiliates' of a company when counting employees or receipts. So the subsidiary has to include its parents' and siblings' employees or revenue, as the case may be.

Affiliates are basically companies under common control. Also, joint ventures are affiliated for the specific procurement they are bidding on. But an 'ostensible subcontractor' also counts as an affiliate if the prime is 'unduly reliant' on it or if it will perform 'primary or vital requirements.'

A clear and definite test for this would be nice, but instead SBA uses a complex, seven-factor analysis. Usually, no one factor is determinative, so a bidder often can't tell in advance whether a proposed subcontract will run afoul of this rule.
The factors themselves can be puzzling. For instance, Congress permits a small business receiving a set-aside contract to subcontract up to 50 percent of the labor cost. However, when applying the 'ostensible subcontractor' test, SBA sometimes counts subcontracts in the 37- to 49-percent range as negative factors, even though they are permitted.

Other factors create a Catch-22. For instance, SBA prefers that the subcontractor perform one or more discrete tasks. But this increases the risk of reliance by the prime on the subcontractor for those tasks.

Also, it is customary for incumbents to join a team in bidding for a government contract, and most consider this a plus for that team. But SBA thinks subcontracting with an incumbent contractor is always suspect under the 'ostensible subcontractor' rules.

One way to avoid such problems has been for a small business in the 8(a) program to enter into a 'mentor-prot'g' relationship with another company. Such relationships require prior approval by SBA. If approved, the mentor can assist the prot'g', and the two can bid as a joint venture on set-asides, which would otherwise constitute an affiliation.

However, a recent ruling by SBA's Office of Hearing and Appeals, Technical Support Services, SIZ-4751, Feb. 6, 2006, destroys this once-safe harbor. In that case, SBA ruled that the mentor-prot'g' relationship was itself proof of a continuing connection between two family members, one in the mentor and the other in the prot'g' business. SBA declared the two companies affiliated.

But why would a company volunteer as a mentor unless it intended to do business with the prot'g'? Under the SBA precedent, however, such activities are evidence of a continuing relationship and maybe an affiliation resulting in loss of the prot'g's small-business status. Now, the prot'g' has a powerful incentive not to team with its mentor. And without the prospect of a business relationship, there is no reason to be a mentor.

SBA needs to keep large businesses out of the programs reserved for small ones. But it need not handicap a bona fide small concern that wants to do business with a large one. And it definitely should not leave questions of size status up in the air with vague rules.

Joseph J.Petrillo is a lawyer with the Washington law firm of Petrillo & Powell. E-mail him at jp@petrillopowell.com.

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