Government Contracts Monitor

OHA Clarifies Limited Effect of 2016 Changes to Joint Venture and Ostensible Subcontrator Rules

October 11, 2017

By: Lindsay Simmons

In May 2016, the Small Business Administration (SBA) revised its small business regulations to, among other things, amend 13 C.F.R. § 121.103(h) to expand the exclusion from affiliation for small business size status to allow two or more small businesses to joint venture for any procurement without being affiliated for purposes of that procurement requirement. SBA believed this change would encourage more small business joint venturing and small business participation in federal contracting while also better aligning with the NDAA provisions governing limitations on subcontracting, which do not count a small business prime contractor’s subcontracts to similarly situated entities towards their subcontracting limits. The recent decision by SBA’s Office of Hearings and Appeals (OHA) in Size Appeal of: Lost Creek Holdings, LLC d/b/a All-Star Health Solutions, SBA No. SIZ-5848 (August 28, 2017) explains the limits of the expanded exclusion.

The appeal involved size protests of two different contract awards to LifeHealth, LLC (LifeHealth) in which size protester, Lost Creek Holdings, LLC (All-Star), alleged that LifeHealth was affiliated with Dentrust Dental International, Inc. (Dentrust) based in part on the ostensible subcontractor rule. In each case, the cognizant SBA Area Office rejected those allegations because it found both LifeHealth and Dentrust to be small businesses and, therefore, even if it found them to be affiliated as joint venturers under the ostensible subcontractor rule, their joint venture also would be considered a small business under § 121.103(h)(3)(i). That rule provides that “[a] joint venture of two or more business concerns may submit an offer as a small business for a Federal procurement, subcontract or sale so long as each concern is small under the size standard corresponding to the NAICS code assigned to the contract.” According to the Area Office, this provision rendered the ostensible subcontractor analysis unnecessary.

In response to OHA’s request for Agency comments, the SBA’s Office of General Counsel (OGC) filed comments supporting the Area Office’s size determinations, citing § 121.103(h)(3)(i). OGC went on to assert that the most recent revision of § 121.103(h) no longer aggregates the size of joint venture participants. But OGC also conceded that SBA also should have changed § 121.103(h)(2), which still affiliates joint venturers for a given contract, and § 121.103(h)(4), which still affiliates a contractor with its ostensible subcontractor for that contract. OGC contended that those provisions should be disregarded as “vestiges” of a prior regulatory scheme.

OHA disagreed, relying primarily on § 121.103(h)(4) and the fact that such provision remains a valid, properly issued, regulation. On the latter point, OHA noted that such a regulation remains in full force and effect until amended, and OGC could not point to any authority that allows an agency to waive a regulation on the grounds that it is a “vestige” of an earlier regulatory scheme. Nor does OGC’s argument that the current ostensible subcontractor rule is a “vestige” hold water, since both the ostensible subcontractor rule and § 121.103(h)(3)(i) in their current form were issued in the same rulemaking -- indeed, on the same page. See 81 Fed. Reg. 34243, 34258 (May 31, 2016).

OHA went on to explain the import of § 121.103(h)(4), which states in part, “A contractor and its ostensible subcontractor are treated as joint venturers, and therefore affiliates, for size determination purposes.” In other words, their average annual revenues (or number of employees) must be combined and compared to the relevant size standard. Significantly, the same regulation also defines an ostensible subcontractor as “a subcontractor that is not a similarly situated entity . . . and performs the primary and vital requirements of a contract, or of an order, or is a subcontractor upon which the prime contractor is unusually reliant.” For purposes of SBA’s size regulations, a similarly situated entity “is a subcontractor that has the same small business program status as the prime contractor.” 13 C.F.R. § 125.1. For example, for a Women-Owned Small Business Program (WOSB) contract, like those at issue here, a similarly situated entity would be a subcontractor that has complied with the requirements of the WOSB program requirements in 13 C.F.R. Part 127.

In essence, the ostensible subcontractor rule explicitly provides that a finding of an ostensible subcontractor relationship between prime and subcontractor requires that they be deemed joint venturers and affiliated for size determination purposes. There are no exceptions, save for concerns found to be similarly situated entities. And because SBA was able to so clearly exclude one class of small business concerns (those concerns in the same small business program as the prime contractor) from the reach of the ostensible subcontractor rule, OHA concluded that SBA’s failure to take the opportunity to exclude all small business subcontractors from the rule's operation means that SBA did not intend to do so. For this reason, OHA concluded that the ostensible subcontractor rule remains in full force and effect, with its explicit requirement that firms deemed to be joint venturers under it are affiliated, whether or not both are small.

Further, OHA stated that the ostensible subcontractor rule is a “specific” provision, requiring a finding of affiliation only in those cases where a prime contractor is unusually reliant upon its subcontractor, or the subcontractor is performing the contract's primary and vital requirements. According to OHA, such a “specific” provision therefore controls over the “general” provision at § 121.103(h)(3)(i), which simply says a joint venture of two or more small businesses may submit an offer for “a Federal procurement” as long as each firm is small. For these reasons, OHA found that the Area Office clearly erred as a matter of law when it failed to perform an ostensible subcontractor analysis on LifeHealth. Under these circumstances, OHA was unable to consider OGC’s argument that there is no violation of the ostensible subcontractor rule (because there is nothing to review). Instead, OHA remanded the matter to the Area Office for two new size determinations to determine, among other things, whether LifeHealth has complied with the ostensible subcontractor rule and, if it has not, whether LifeHealth and Dentrust are, when aggregated, still small for the two procurements at issue here.

Obviously, the recent changes to the small business regulations require careful study, particularly with respect to affiliation based on joint ventures and/or the ostensible subcontractor rule. Indeed, even SBA did not correctly understand what it had wrought. The good news is that this decision clears up at least one former ambiguity -- when the ostensible subcontractor rule is involved, the expansion from the exclusion from affiliation for joint venturing only applies to similarly situated entities, not to any and all small businesses. 

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