In procurements set aside for small businesses, the Small Business Administration (SBA) regulations require that the average annual revenue or the number of employees of affiliated firms be added to determine whether a concern meets the applicable size standard. Per 13 C.F.R. § 121.103(e), affiliation based on common management arises where one or more officers, directors, managing members, or partners who control the board of directors or management of one concern also control the board of directors or management of one or more other concerns. While a finding of total control is not necessary for the SBA to find affiliation between firms with common management, the relevant officer(s), director(s), managing member(s), or partner(s) must exercise critical influence or possess the ability to exercise substantive control over operations. Control may be direct or negative, with negative control defined as the ability of a minority interest owner, under the concern’s governing documents, to prevent a quorum or otherwise block actions by its board of directors or shareholders. Notably, minority shareholders will not be deemed to have the ability to exercise negative control in situations where a majority shareholder has the power to call a shareholders’ meeting and, at that meeting, remove any and all directors, with or without cause. In such cases, the SBA will not find common management affiliation through the minority shareholders, even when they occupy key executive positions.
In SBA No. SIZ-6218, a size appeal decision issued on June 6, 2023, the SBA Office of Hearings and Appeals (OHA) reversed the size determination by SBA Area Office III, implicating the issue of affiliation by common management. The Department of Veterans Affairs (VA) issued the underlying request for proposals (RFP) for home health equipment rental services to serve an estimated 1,500 veterans in Central Florida under the North American Industry Classification System (NAICS) code 532283 with a $35 million applicable size standard. Following the submission of proposals, the agency provided a pre-award notification to the protester, identifying the apparently successful offeror. In the size-protest that followed, the SBA Area Office determined that the apparently successful offeror was affiliated through common management with two other businesses in which its Vice President, together with his brother, held majority ownership interests and exercised control. The Vice President and his brother owned a 49% ownership interest in the apparently successful offeror, with the President enjoying a majority 51% ownership interest. The Area Office determined that the Vice President and his brother, who were presumed to have an identity of interest based on familial relationships and common investments, had the power to block a quorum and thus exercised negative control over the apparently successful offeror. Accordingly, the Area Office determined that the apparently successful offeror was affiliated with the two other businesses owned and controlled by its Vice President and his brother through common management.
The apparently successful offeror appealed the size determination at the OHA. The Appellant argued that it could not be affiliated with the two businesses owned by its Vice President and his brother through common management because its President, as the majority owner, possessed the singular power to exercise full control over the Appellant concern. Therefore, the Appellant concern took the position that affiliation through common management did not apply because it was not controlled by the same person or persons as each of the other two businesses. The OHA agreed, noting that the Appellant concern's bylaws clearly stated that the majority shareholder constitutes a quorum, and the President owned 51% of the concern. In addition to the majority ownership interest, the bylaws provided the President with the power to call special meetings and to remove a director, with or without cause. The President also had the ability to fill such vacancies by appointing new directors at the special meeting in which the removal was effectuated. The OHA cited its previous precedent, in which it has consistently held that, where a majority shareholder has the power to call a shareholders’ meeting and, at that meeting, remove any and all directors, with or without cause, it is the majority shareholder, not the directors, who controls the concern. Under such circumstances, any control by the directors is merely illusory. Therefore, the Vice President and his brother could not exercise negative control because it was the President that controlled the Appellant concern, and any control by the Vice President and his brother was merely illusory. Consequently, the Appellant concern could not be affiliated with the other two businesses through common management, even though the Vice President occupied a key executive position in each of the firms.
Affiliation by common management arises when one or more officers, directors, managing members, or partners who control the board of directors or management of one concern also control the board of directors or management of one or more other concerns. Such affiliation by common management requires the same person or persons to exercise direct or indirect control by wielding critical influence or possessing the ability to exercise substantive control over both concerns. Notably, simply having common key employees does not establish affiliation. Contractors should be mindful that the SBA considers the ability to exercise negative control over a firm as satisfying the critical influence requirement. However, as demonstrated in the size-appeal described above, in situations where a majority shareholder constitutes a quorum, has the power to call a shareholders’ meeting and, at that meeting, remove any and all directors with or without cause, it is only the majority shareholder who controls the firm, with any control by the directors merely illusory. Consequently, negative control cannot exist in such a scenario, and any findings of affiliation by common management through negative control are erroneous. Ultimately, control of both concerns, whether direct or negative, by the same person(s) remains the key consideration to determine whether firms are affiliated by common management for size determination purposes.
This Federal Procurement Insight is provided as a general summary of the applicable law in the practice area and does not constitute legal advice. Contractors wishing to learn more are encouraged to consult the TILLIT LAW PLLC Client Portal or Contact Us to determine how the law would apply in a specific situation.
