Amendments to small-business development program affect joint ventures, the ostensible subcontractor rule, and ownership changes

Numerous changes to the Small Business Administration's (SBA) 8(a) program regulations go into effect on May 30, 2023, affecting the rules related to joint ventures, the ostensible subcontractor rule, limitations on subcontracting, and changes to ownership. The SBA released this final rule change on April 27, 2023, which it initially announced on September 9, 2022.

Overview

Among the changes, the SBA has clarified the Ostensible Subcontractor Rule, as set forth in 13 C.F.R. § 121.103(h)(2), which allows for a finding of affiliation between a prime contractor and subcontractor when the entities are not similarly situated and (1) the subcontractor performs the "primary and vital requirements of a contract," or (2) the prime contractor is "unusually reliant" on the subcontractor. The new rule retains the above language but now includes factors that the SBA will consider when evaluating affiliation under the Ostensible Subcontractor Rule.

For general construction contracts, the SBA has now clarified that the "primary and vital requirements of a contract" are the management, supervision, and oversight of the project, including coordinating work of various subcontractors, but not the actual construction work to be performed. This clarification brings the rule directly in line with the type of work generally performed by prime contractors. Notably, this clarification only addresses the first factor of the rule, and prime contractors may still be found to be unusually reliant on a subcontractor even if that subcontractor is not performing management, supervision, or oversight on the project.

The SBA declined to align the rule directly with the limitations on subcontracting set forth in 13 C.F.R. § 125.6 for general construction contracts. However, for specialty trade construction, service, or supply contracts, the new rule confirms that affiliation under the Ostensible Subcontractor Rule will not be found if the prime contractor can show it and any similarly situated subcontractors meet the limitations on subcontracting in 13 C.F.R. § 125.6. That is, prime contractors performing specialty trade construction, service, or supply contracts who are in compliance with 13 C.F.R. § 125.6 should be able to avoid an ostensible subcontractor finding.

Compliance and Subcontracting Limitations

While the above changes are generally positive for contractors and allow for greater clarity for regulatory compliance, the SBA's new rule also adds teeth to 13 C.F.R. § 125.6 by requiring contracting officers, where applicable, to evaluate a contractor's compliance with the limitations on subcontracting as part of the contractor's past performance review. Under the prior regulations, a contractor's failure to comply with the limitations on subcontracting could be raised in its performance review; now 13 C.F.R. § 125.6(e) requires an agency to evaluate compliance.

The new rule also requires the agency to consider, following a request to the contractor, whether any extenuating or mitigating circumstances affected the contractor's compliance. While such circumstances will be evaluated on a case-by-case basis, they generally include emergency or rapid response requirements, changes in entity status for a similarly situated subcontractor, force majeure events, and changes to the contract scope that arose during the course of performance. Without such extenuating circumstances, which must be accepted by the contracting officer and a reviewing official, a contractor who failed to meet the limitations on subcontracting requirements cannot receive a past performance rating of satisfactory or higher for this evaluation factor or subfactor.

These new consequences greatly increase the risk for contractors who fail to comply with the limits and/or fail to provide adequate justification in the event of a failure.

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