Today, we take a look at the culmination of a long fight over the size status of a joint venture competing for a Federal contract. After losing battles at the Small Business Administration (SBA) Area Office and Office of Hearings and Appeals (OHA) – the joint venture finally won the war when the Court of Federal Claims (COFC) declared that SBA incorrectly applied the economic dependence test.
A quick refresher on SBA economic dependence: In a nutshell, the SBA will find two firms affiliated through economic dependence when a small business is dependent on another company for a disproportionate amount of its revenue. Without a steady flow of business from its counterpart, the small business would be unable to survive (let alone thrive). When one business is economically dependent on another, there is a presumption of affiliation.
That was precisely SBA’s finding with respect to the joint venture that teamed up to bid on a Department of Defense Missile Defense Agency support contract. The SBA Area Office found the joint venture was “other than small” for purposes of the contract (and, therefore, ineligible for award). OHA agreed, confirming that one of the joint venture partners was affiliated with a third entity (and therefore had to include that entity’s average annual receipts in its size calculation). As a result of this affiliation, the joint venture partner was deemed to be a large business under the relevant size standard, thus disqualifying the joint venture.
Specifically, SBA found the two firms affiliated because the purported small business received more than 70% of its revenue from the third firm, thus creating an “identity of interest due to economic dependency.” According to OHA’s decision, “as a matter of law, a firm that derives 70 percent or more of its revenue from another firm is economically dependent on that firm.”
On appeal to COFC, the joint venture argued that SBA misapplied the presumption of economic independence as a bright line rule – as opposed to a rebuttable presumption. Here, the mitigating factors weighing against affiliation included the fact that the small firm had only been operating a short time and held a small number of contracts (which distorted the 70% figure relied on by OHA). The joint venture also presented evidence of the firm’s attempts to diversify and expand to other sources of revenue.
The COFC was persuaded by these arguments and remanded size determination back to the Area Office for a new review. In its decision, the court affirmed that the 70% standard is highly indicative of economic dependence – but still not an absolute rule. COFC determined that OHA failed to consider properly the mitigating factors presented.
This is a fascinating case study and a great example of a firm forcing SBA to faithfully apply its own regulations. But – importantly – it also needs to be taken with a grain of salt and viewed as the exception to the rule.
The fact remains that there is a rock solid basis to support the SBA’s use of the 70% threshold as a standard for finding affiliation based on economic dependence – both in the regulations and in the case law. If your business receives even close to 70% of its receipts from one business – there is a definite cause for concern. This case confirms that your business has the ability to try and rebut the presumption of affiliation – but that can be a steep mountain to climb.
If you are concerned about your firm losing its size standard due to economic dependence – now is the time to think about proactive strategies for diversifying. Relying on a winning rebuttal argument with the SBA is betting against the house.
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