Small Business Administration and SBA affiliation rules regarding identity of interest challenges can be complex and confusing when litigating in a small business size protest case. Governed under 13 CFR 121.103, affiliation in federal procurement and SBA regulations can be found under a variety of circumstances. For example, a major dispute arises when your competition files an SBA small business size appeal due to identity of interest.
Common is a size protest case, the SBA has a strong presumption of affiliation when you are doing business with other family members. Your first response would be that your family members have a legal right to conduct business like anyone else. How can the SBA penalize you because a family member also chose to form his or her own business? Although the argument is a sound one, the real issue is how does the SBA apply the rule in your specific situation or set of facts?
Examples of Relevant SBA Affiliation Rules Under 13 CFR 121.301
- Affiliation based on ownership (13 CFR 121.301(f)(1)). Businesses are affiliated if one entity or person “owns or has the power to control more than 50 percent of the concern’s voting equity.” Also, if you are considered a minority shareholder, the SBA can find that you are in control of the business if you can exercise what the SBA refers to as “negative control.” This means do you have the dormant power to block actions in the organization or some other form of control that may not be readily obvious. The SBA looks deeply into your documents during a size protest investigation.
- Affiliation arising under stock options, convertible securities, and agreements to merge (13 CFR 121.301(f)(2)). If stock options, convertible securities, or an agreement to merge has a “present effect on the power to control the business,” then there is affiliation. The emphasis here is on “present effect.”
- Affiliation based on management (13 CFR 121.301(f)(3)). If you are an officer, managing member, partner, or other principal of an entity also “controls the management of one or more other concerns,” SBA affiliation rules may hurt you. The SBA may also find affiliation through common management if a you or the business also controls the board or management of another company.
- Affiliation based on identity of interest (13 CFR 121.301(f)(4)). The SBA will also find business affiliation if “there is an identity of interest between close relatives / family members” and they are found to have “identical or substantially, identical business or economic interests.”
The underlying reason why the rules are available to the SBA is to make sure that taxpayer dollars are not being unlawfully passed on the family members or those who control other businesses that operate in the same industry.
What is a Business Concern? 13 CFR 121.105.
The Small Business Administration first determines if you meet the definition of a small business concern under 13 CFR 121.105. You can be eligible for assistance if your company is a small business entity that is:
- organized for profit,
- with a place of business located in the United States,
- and which operates primarily within the United States or which makes a significant contribution to the U.S. economy through payment of taxes or use of American products, materials or labor.
Types of Business Control Under SBA Affiliation Rules
Many companies appeal decisions simply because there might not be obvious control in the business. The SBA often finds affiliation through negative control.
Tip: Business control may be affirmative or negative.
Tip: Make sure your operating agreements and partnership agreements do not leave any possibility that another person can control the business or that you can control another business entity.
Tip: The clear way to avoid these costly mistakes is to have an experienced professional or government small business lawyer to assess your facts.
Tip: If you wait until the appeal stage, your chances of prevailing can be impaired simply because the appeal lawyer cannot change the facts already review by the SBA.
Watch for the SBA’s Smoking Gun When it Looks for Affiliation
When all else fails, SBA affiliation rules allow a finding of business affiliation through the totality of the circumstances analysis. This analysis only comes to fruition when affiliation cannot be found through the other legal methods either under 13 CFR 121.103 or 13 CFR 121.105. The SBA can find affiliation based on the totality of the circumstances even though no single factor alone may be sufficient to constitute affiliation.
What Happens to Your Company If the SBA Finds Affiliation?
If SBA determines that affiliation exists either through identity of interest or some other reason, your company will not be a small business under the procurement at issue. In addition, your company would be barred from representing itself as a small business under the specific NAICS code for future contracts. The exception being that SBA OHA reverses the SBA’s size determination after you file an appeal or the SBA conducts another size determination and finds your company other than small.
The end result of the SBA affiliation rules is making a finding that your revenues or number of employees exceed the size standard about. The SBA will count the annual receipts, the number of employees in addition to that for all of the domestic and foreign affiliates, regardless of whether the affiliates are organized for profit.
SBA Affiliation Rules – Presumption with Family Members
Many contractors are unaware that family relationships create a rebuttable presumption of affiliation. Even if the qualifying member may not control the business outright, he or she conceivably might do so if their interests were combined with those of the family members. See Size Appeal of SolarCity Corporation, SBA No. SIZ-5257 (2011).
By considering the ability of the family members to collectively control the business, you may not win an appeal if you simply focus on one person. For example, under SBA affiliation rules, if you show that others own enough stock in a family-owned small business, it may create the clear fracture needed to overcome the presumption of identity of interest, 13 CFR 121.103(f).
In a size appeal, although risky, you might be barred from arguing affiliation through family relationships if the issue was somewhat discussed in the initial size determination. Under SBA rules, it is not unlawful for the SBA to consider other issues not raised in the initial size protest, as SBA size protest rules expressly permit investigation of matters “not raised in the protest.” 13 CFR§ 121.1009(b).
SBA Affiliation Rules when Family Members Share Identity of Interest
The SBA affiliation rules can find you affiliated if family members share interests in the business. This is especially common when fathers and sons appear to share an identity of interest (common in construction firms). SBA size rules presume a violation under 13 CFR 121.103(f). The applicable regulation states that affiliation may arise among two or more persons with an identity of interest.
Individuals or firms that have identical or substantially identical business or economic interests (such as family members, individuals or firms with common investments, or firms that are economically dependent through contractual or other relationships) may be treated as one party with such interests aggregated.
You must be aware that if SBA affiliation rules find that such interests should be aggregated, you or your company can rebut that determination by showing that the interests deemed to be one are in fact separate. 13 CFR 121.103(f).
Tip: SBA Rules Governing Affiliation – You should look at at both 13 CFR 121.103 and 13 CFR 121.301 for guidance.
Tip: Courts have found that three common investments in another business entity(alleged affiliate) are insufficient to justify a finding of an identity of interest between the parties. The protestor or SBA must find that there is evidence of other ties or business cooperation, that support the conclusion that the parties share identical or substantially identical business or economic interests. See the case of Size Appeal of Lajas Industries, Inc., SBA No. SIZ-4285 (1998) (ruling that “the family tie between cousins is far removed and not within the scope of the [identity of interest] regulation, unless sufficient additional evidence establishes another type of identity of interest, such as extensive involvement with each other’s business affairs.”
How Do You Defend Against SBA Affiliation For Family Members and Identity of Interest?
Affiliation Defense – Clear Line of Fracture
SBA affiliation rules governing identity of interest have a defense that a clear line of fracture exists if your family members have no business relationship or involvement with each other’s business concerns or the family members are estranged. See Size Appeal of Hal Hays Constr., Inc., SBA No. SIZ-5217, at 6 (2011). However, as a practical matter, even if there is a small business dealing between you and another family member, SBA affiliation rules may allow treatment of both businesses as one entity. There simply is no “magic bullet” for an answer since facts are different in each case. See if you meet the SBA Mentor Definition.
Some factors to consider when arguing there is a clear line of fracture between family businesses:
- No similar customer lists
- Different lines of business
- Absence of family member purchases into the business
- No common owners or managers
- Do not share employees or facilities
- Minimal amount of business or economic activity between the two firms
- No financial help, loans, or subcontracting
Common Investments & Identity of Interest Arguments are not Necessarily Easy to Prove in OHA Size Appeals
When considering 13 CFR 121.103(f) SBAOHA has recognized that identity of interest through common investments requires more than a single joint investment. Size Appeal of Manroy USA, LLC, SBA No. SIZ-5244, at 4 (2011); Size Appeal of Eagle Pharms., Inc., SBA No. SIZ-5023, at 9 (2009). In addition OHA has also ruled that “common investment only in the challenged firm is not enough to support a finding of affiliation based upon common investments.” See Size Appeal of Summit Techs. & Solutions, Inc., SBA No. SIZ-5132, at 6 (2010). Find out the difference between teaming agreements and joint ventures.
Taking a closer look at the facts, “[T]he common investments of the persons must be substantial, either in number of individual investments, or in total value, in order to find that there is an identity of interest between the investors.” See Size Appeal of Tenax Aerospace, LLC, SBA No. SIZ-5701, at 11 (2015). Read more about Signs of Being Under Investigation (Federal).
The Area Office has wide discretion when considering two parties can share an identity of interest given the specific facts of your case. Although OHA has made clear that one common investment is not legally sufficient enough to support a finding of identity of interest in a small business size protest case.
Arguing that SBA OHA has taken the position that two common investments are necessarily insufficient will not prevail on appeal because OHA has emphasized that “more than one” common investment must exist. See Size Appeal of The H.L. Turner Group, Inc. SBA No. SIZ-4896, at 5 (2008) (“Identity of interest may be found among those who have common investments in more than one concern.”); Size Appeal of Cytel Software, Inc., SBA No. SIZ-4822, at 5 (2006) (“This Office has held that an identity of interest may be found among those who have common investments in more than one concern, whose common business interests cause the parties to act in union for their common benefit.”). See also, Size Appeal of W. Harris, Government Services Contractor, Inc., SBA No. SIZ-5717.
If you have common investments in more than one company, it could be problematic on litigation in your size appeal case to OHA.
- When considering whether there is an identity of interest, OHA has looked at whether the common investments are “substantial,” either in the number of individual investments or in their total value. Remember that investments can also be argued as substantial in value.
- If other individuals with which you have common investments qualify, your company may also be affiliated with those companies
- SBA Area’s position must only be rational given the record. If the investments relate to and can be argued as having “identical or substantially identical business or economic interests,” as contemplated by 13 C.F.R. § 121.103(f), then a small business government contractor could very well have a hard time when appealing its case to OHA.
13 CFR 124.109
Special rules for ANCs. Small business concerns owned and controlled by ANCs are eligible for participation in the 8(a) program and must meet the eligibility criteria set forth in 13 CFR 124.112 to the extent the criteria are not inconsistent with this section. ANC-owned concerns are subject to the same conditions that apply to tribally-owned concerns, as described in paragraphs (b) and (c) of this section, except that the following provisions and exceptions apply only to ANC-owned concerns
Under 13 CFR 124.109 (b) Tribal eligibility. In order to qualify a concern that it owns and controls for participation in the 8(a) BD program, an Indian Tribe must establish its own economic disadvantaged status under paragraph (b)(2) of this section. Once an Indian Tribe establishes that it is economically disadvantaged in connection with the application for one Tribally-owned firm, it need not reestablish such status in order to have other businesses that it owns certified for 8(a) BD program participation, unless specifically requested to do so by the AA/BD. An Indian Tribe may request to meet with SBA prior to submitting an application for 8(a) BD participation for its first applicant firm to better understand what SBA requires for it to establish economic disadvantage. Each Tribally-owned concern seeking to be certified for 8(a) BD participation must comply with the provisions of paragraph (c) of this section.
When writing a proposal for government contracts, you must seriously consider any family relationships when subcontracting work. You must also make sure that you understand the facts and potential hurdles before you submit a bid to the government. SBA affiliation rules can create very dangerous outcomes. You must think things through.
Many small businesses can avoid identity of interest problems by understanding and applying facts that can offset the SBA’s conclusions. If you submitted additional facts that can solve suspicions or create a rebuttal under SBA Program law, you can increase your success in the event of an appeal.
For more information or help with SBA affiliation and identity of interest rules under 13 CFR 121.103 & 13 CFR 121.301, call our SBA size standards protest lawyers at 1-866-601-5518.