Government Contracts Monitor

Court Overturns SDVOSB Decertification

November 4, 2014

The Court of Federal Claims recently determined, for the second time in two years (see our March 2013 blog: Due Process is Alive and Well), that the Department of Veterans Affairs (VA) failed to provide due process to a Service-Disabled Veteran-Owned Small Business (SDVOSB) in connection with its eligibility decertification. The Court also ruled that VA’s Office of Small and Disadvantaged Business Utilization (OSDBU) misapplied VA’s “unconditional ownership” regulations in determining that the SDVOSB’s Operating Agreement would impermissibly cause ownership benefits to vest in non-veterans. The Court set-aside the OSDBU’s decertification decision, and directed the VA to (i) restore the company as an approved and certified SDVOSB, (ii) reinstate the company in the VetBiz VIP database, and (iii) consider the company’s apparent low bid in response to the instant solicitation. AmBuild Company, LLC v. United States, COFC No. 14-786C.

The case arose out of a SDVOSB set-aside solicitation. AmBuild Company LLC (AmBuild) was the apparent low bidder, duly certified as a qualified SDVOSB. The second low bidder, Welch Construction, Inc. (Welch), protested both AmBuild’s size and its SDVOSB eligibility. SBA considered and denied the size protest and the VA determined that the SDVOSB eligibility protest was without merit.

However, VA’s Center for Verification and Eligibility (CVE) sua sponte considered an ownership issue not raised by either Welch or the contracting officer. Specifically, CVE determined, based upon AmBuild’s 2011 Operating Agreement, that AmBuild’s owner was not an “unconditional owner” as required by 38 C.F.R. § 74.3(b) because the “Involuntary Withdrawal” provision of that agreement “include[d] numerous conditions that are outside of [the owner’s] control, which would force [him] to sell his ownership interest ….” CVE did not notify AmBuild that it was investigating the impact of these provisions, or provide AmBuild an opportunity to comment. CVE decertified AmBuild on this basis, declared AmBuild ineligible for award and removed AmBuild from the VetBiz website.

AmBuild appealed to the OSDBU Executive Director, challenging (i) the lack of notice, and (ii) that CVE had relied on the 2011 Operating Agreement, rather than a superseding 2014 Agreement that AmBuild had provided to CVE. The OSDBU, citing to VA’s revised 38 C.F.R. § 819.307(e), permitting status determinations to be based on the “totality of circumstances,” determined that certain provisions in the 2014 Agreement relating to events outside the owner’s control impermissibly infringed upon his unconditional ownership and, therefore, denied AmBuild’s appeal. AmBuild then filed a bid protest at the Court, challenging both VA’s lack of due process and the OSDBU’s substantive ruling.

The Court sustained AmBuild’s protest on both grounds and issued an injunction setting aside the OSDBU’s decertification decision. First, the Court rejected VA’s argument that the revised regulation permitted VA to “cast aside” the required due process notice and opportunity to comment, stating that the “totality of the circumstances” language “simply designates a standard of review;” it does not abrogate VA’s procedural due process obligations. The Court also rejected VA’s alternative argument that the notice of CVE’s decertification decision and right to appeal satisfied VA’s due process obligations, terming this argument “wholly unconvincing.” The Court pointed out that the grounds on which the OSDBU ruled – the 2014 Agreement – were different from those cited by CVE – the 2011 Agreement.

Second, the Court held that the OSDBU’s decertification decision “was arbitrary and capricious and not in accord with VA’s regulations.” Specifically, the Court stated that the prohibition on provisions potentially causing ownership benefits to go to another set forth in the second sentence of 38 C.F.R. § 74.3(b) is qualified by the proviso in the third sentence that “[t]he pledge or encumbrance of stock or other ownership interest as collateral, including seller-financed transactions, does not affect the unconditional nature of ownership if the terms follow normal commercial practices and the owner retains control absent violations of the terms.” Thus, the Court stated that “the regulation sets forth prohibited arrangements that would cause ownership benefits to vest in non-veterans, while accommodating and providing exceptions for normal commercial arrangements.”

The Court examined the provisions identified by the OSDBU, and determined that each was a standard provision used in normal commercial dealings. Indeed, the Court noted that the “Involuntary Withdrawal“ provisions of the 2014 Operating Agreement appeared to be boilerplate taken from statutory default provisions governing LLCs that are found in the laws of many states. Specifically, the Court stated that the clause providing for involuntary withdrawal in the event of an adjudged bankruptcy or insolvency is “a standard commercial arrangement,” and noted that the statutory default rule in many states is that the bankruptcy of a member in a LLC results in an involuntary withdrawal. Similarly, the Court stated that the clause providing for the transfer of ownership “on account of a court order or otherwise by operation of law” deals with “normal commercial practices,” and merely states the legal reality that exists regardless of what is stated in the Agreement. The clause thus describes “a circumstance amounting to an ‘encumbrance of stock or other ownership interest,’ 38 C.F.R. § 74.3(b), albeit by operation of law, that ‘does not affect the unconditional nature of ownership’ within the meaning of the Section, id.”

This decision is important for all SDVOSBs and VOSBs for several reasons: (1) it reaffirms that a decertified SDVOSB or VOSB can seek judicial review and obtain relief on an expedited basis. (2) it reconfirms that SDVOSBs and VOSBs are entitled to due process notice and the opportunity to comment on all issues under consideration in an eligibility protest or other decertification proceeding, (3) it clarifies that the “totality of circumstances” language in 38 C.F.R. § 819.307(e) simply designates a standard of review, and does not entitle the OSDBU to rely upon previously undisclosed grounds to decertify anyone, and (4) it clarifies the interpretation and application of the “unconditional ownership” requirements in 38 C.F.R. § 74.3(b). Hopefully, the VA also will take note of these points in future decertification proceedings.