Government Contracts Monitor

Affiliation and Size: What Revenues Count in a Size Determination?

June 27, 2016

As most federal contractors are well aware, significant contracting opportunities are routinely set aside for small businesses, to the exclusion of large businesses. Confusion remains, however, concerning the concept of affiliation -- and how it can impact whether a given company is eligble for small business set-asides. The Small Business Administration (SBA) Office of Hearings and Appeals (OHA) addressed this issue in the recent Size Appeal decision in Size Appeal of Newport Materials, LLC, SBA No. SIZ-5733 (2016). More particularly, OHA discussed the circumstances under which a concern will be considered affiliated with other companies so that the size determination will be based on the combined average annual receipts of the concern and all its affiliates.

The size appeal was filed by RC&D, Inc. (RC&D), a disappointed offeror under an Air Force invitation for bids (IFB) procuring replacement and repair of roadways, curbing, and sidewalks. Under the IFB, the Air Force stated its intent to award a single Indefinite Delivery/Indefinite Quantity contract with a value up to $23 million. The procurement was set aside for small businesses under North American Industry Classification System (NAICS) Code 237310 (Highway, Street and Bridge Construction), with a size standard of $36.5 million in average annual receipts.

Despite the fact that RC&D’s size protest concerning the apparent awardee was deemed untimely, the SBA’s Area Director initiated a protest of Newport’s size. The investigation into Newport Materials’ size revealed that it is 100% owned by Richard A. DeFelice, who also owns 100% of three other business entities, and 50% of three more concerns. Additionally, Newport’s owner had previously owned 100% of a company called Four Acres Transportation, Inc. (Four Acres), which in 2015 became a wholly-owned subsidiary of one of Mr. DeFelice’s other companies, Newport Construction Corporation (Newport Construction). Finally, between 2010 and 2014, Newport Construction had engaged in a joint venture with another construction company and was entitled to 70% of the profits of that joint venture.

The SBA regulations make clear that “[c]oncerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both.” 13 CFR 121.103(a)(1). Because Mr. DeFelice owned 100% interest in four business entities (including Newport Construction), and 50% interest in three others, the SBA’s Area Office found all of the companies to be affiliated based on their joint control by a single individual. Due to this affiliation, the Area Office further held that the size determination for Newport Materials should be based on the receipts for all seven of the businesses, as well as Newport Construction’s joint venture and its subsidiary, Four Acres, in determining Newport Materials’ size. The Area Office determined that the combined receipts of all these business entities exceeded the size standard and rendered Newport Materials ineligible for award.

Newport Materials appealed this determination to OHA, essentially reiterating arguments rejected by the Area Office.

First, Newport Materials claimed that Four Acres’ receipts should be excluded from size calculations as inter-affiliate transactions because Four Acres’ exclusive purpose and source of revenue was to facilitate payroll activity for Newport Construction. On this point, OHA agreed with the Area Office, noting that, in order for the exclusion to apply, the companies in question must be able to file a consolidated tax return. However, since both Four Corners and Newport are S corporations, they are not ineligible to file a consolidated tax return. Second, though transactions between affiliates are excluded from receipts for size purposes, this exclusion applies only to transactions between the firm whose size is challenged (here, Newport Materials) and its affiliates—not transactions among affiliates of the challenged firm (here, Norfolk Construction and Four Acres). Because Newport Materials was not involved in the subject transactions, the exclusion does not apply. And since Four Corners became a subsidiary of Newport Construction after the transactions occurred, the exclusion would not apply in any case: the companies were not parent and subsidiary when the transactions occurred. Finally, Newport Materials argued that the purpose of the exclusion was to prevent multiple owners from benefitting from lower total receipts, which didn’t apply here because all the affiliates were owned by the same person. In response, OHA found that this policy argument relating to the intent of the exclusion was beyond the scope of its review. Ultimately, OHA upheld the Area Office’s size determination decision in full, and held that the combined average annual receipts of all the affiliated businesses here exceeded the $36.5 million size standard.

Small businesses can benefit significantly from the increased opportunities provided by set-asides, but only to the extent that they meet the letter of the law and the SBA’s regulations, and strictly qualify under the applicable size standard. Small businesses need to consider their circumstances – and how those circumstances impact their size under the regulations – before pursuing small business set asides. A miscalculation concerning affiliation (and the resulting average annual receipts) could mean the difference between qualifying for a set-aside and being eliminated from a competition that you otherwise would have won.