Under its statutory authority, the Small Business Administration (SBA) establishes size standards by type of economic activity, or industry, under the North American Industry Classification System (NAICS). For contracts set aside for small businesses, offerors must not exceed the size standard, measured by number of employees or average annual revenue, for the primary NAICS code specified in the solicitation. For a business concern with affiliates, SBA regulations require that the annual average receipts for the past five complete fiscal years or the number of employees of the affiliates be added to those of the concern when calculating size for self-certification to participate in small business set-asides. Businesses are considered affiliates when one concern controls, or has the power to control, the other, or when a person or concern controls, or has the power to control, both. Concerns may exercise direct or negative control over one another. When an owner with a minority interest has the power to block ordinary actions essential to business operations, that owner is said to have negative control. Negative control mandates a finding of affiliation for purposes of size determination under SBA regulations. It does not matter whether control is actually exercised, as the ability to control is sufficient for affiliation purposes.
In Swift & Staley, Inc. v. United States, 159 Fed. Cl. 494 (2022), aff'd, 2022-1601, 2022 WL 17576348 (Fed. Cir. Dec. 12, 2022), the Court of Federal Claims (COFC) found reasonable the SBA Office of Hearing and Appeals’ (OHA) finding of affiliation through negative control. The Department of Energy (DOE) issued the underlying small-business set-aside solicitation in February 2020 for facility support services at the Paducah gaseous diffusion plant in Kentucky. The applicable size standard established a $41.5 million annual revenue limit. The incumbent-protester had been performing the solicited services at the plant since 2005. In 2015, the protester formed a populated joint venture (JV) with another firm to provide services at a different diffusion plant in Ohio. When the protester’s average annual receipts were combined with those of the JV, the protester exceeded the size limitation for the Paducah solicitation and was thus considered other than small and ineligible for award. Notwithstanding its ownership interest in the JV, the protester did not add the JV’s average annual receipts to its own when calculating its size and self-certified as small in response to the Paducah solicitation.
The SBA OHA determined that the incumbent was required to add the JV’s average annual receipts as an affiliated entity because the JV’s operating agreement gave it the power to exert negative control over the JV. Specifically, the incumbent had the ability to exercise negative control over the JV because the JV’s operating agreement provided it the power to prevent a quorum. Additionally, the incumbent could also exert negative control by blocking ordinary actions essential to the JV’s operations. In resolving the protest, the COFC began its analysis by noting that under 13 C.F.R. § 121.103(a)(5) the SBA considers the totality of the circumstances in determining whether affiliation exists, even when no single factor is sufficient to constitute affiliation. The JV operating agreement required all members to be present at the member meetings, either in person or by proxy. Therefore, the incumbent-protester, which was one of only two JV members, could block a meeting of the members from occurring by preventing a quorum if it declined to attend or participate via proxy. In this regard, SBA regulations state that negative control exists when a minority shareholder has the ability to prevent a quorum.
The COFC held that the OHA’s finding that the incumbent could exercise negative control over the JV based on its power to prevent a quorum was not arbitrary or capricious. The Court rejected the incumbent-protester’s arguments that the JV did not hold member meetings and even if member meetings were held, they would not address actions essential to the JV’s daily operations. The COFC explained that it was of no consequence whether a concern actually exercised its ability to control, so long as the power to control exists. The protester could also exercise negative control over the JV, as its prior written consent was required for the JV to take ordinary actions essential to its operations. These actions included commencing any litigation, entering real property leases with payments of more than $12,000 during any calendar year, issuing any equity incentives, and any pledge or other encumbrance of a JV property valued at more than $10,000. Since the protester could block the JV from taking ordinary actions by withholding its approval, the COFC held that the OHA reasonably concluded that affiliation existed through negative control.
For procurements set-aside for small businesses, SBA regulations require that the average annual revenue or the number of employees of a concern’s affiliates be included for size determination. Concerns are affiliated if either one controls or has the ability to control the other directly or negatively. Per SBA regulations, negative control exists in, but is not limited to, situations where a minority shareholder has the ability, under the concern’s governing documents, to prevent a quorum or otherwise block action by its board of directors or shareholders. In the case described above, the incumbent-protester had the ability to exercise negative control over the JV because it could both prevent a quorum at member meetings and block ordinary actions essential to the JV’s operations. Notably, however, a minority owner’s control over extraordinary actions, such as those intended to protect its investment, does not, by itself, result in a finding of negative control. Ultimately, once concerns are deemed to be affiliated through negative control, their average annual revenues or number of employees must be combined to determine whether they exceed the applicable size standard for a contract set aside for small businesses. In this regard, it is of no consequence whether a concern actually exercises its power to control, so long as the ability to control exists.
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.
