THE COMPANY YOU KEEP
Affiliation Implications For
Federal Set-Aside Contracts
May 2012
Presented by:
Gerald Ormiston
and
Jamie Ziegler
Liberty Mutual Surety
1
Presentation Goals & Disclaimer
 Designed to provide information about the Federal
Set-Aside contract programs and raise awareness of
potential risks when large business enterprises work
with small business enterprises on these programs.
 Presentation is not legal advice or risk management
advice for any individual or entity that is involved with
or is contemplating becoming involved with these
programs.
2
Topics for Discussion
I.
Why Understanding Risks in the Federal Set-Aside
Arena has Become Necessary
II. Overview of SBA Programs and Their
Administration
III. SBA Guidelines for Recognizing Improper
Affiliations
IV. Recognizing Improper Affiliations – You Be the
Judge
3
Goals for Allocating Federal Dollars
23% of Prime Contracts
For Small Businesses
77% Non-Qualified
Prime Contracts
Non-Qualified Prime
Contracts
Prime Contracts for Small
Business
21.7% S.D.B.
35.6% SB Set-Asides
SB Set-Asides
WOSB
HUBZone -SB
13% S.D.V.O-SB
SDVO-SB
SDBS
21.7% W.O.S.B
Source: SBA Website
www.sba.gov
13% HUBZone-SB
Congress Continues to Investigate
Fraud and Abuse in the Small
Business Set-Aside Arena
5
6
What are the Risks?
 Direct (to Surety)
■ Default termination on bonded set aside project
 Indirect (to Account)
■ Debarment
■ Forfeiture of affirmative claims
■ Civil/criminal penalties
7
Topics for Discussion
I.
Why Understanding Risks in the Federal Set-Aside
Arena has Become Necessary
II. Overview of SBA Programs and Their
Administration
III. SBA Guidelines for Recognizing Improper
Affiliations
IV. Recognizing Improper Affiliations – You Be the
Judge
8
II. Overview of SBA Programs and Their
Administration
 8(a) Business Development – Minority Small
Business Development (8(a) BD)
 Historically Underutilized Business Zone Program
(HUBZone)
 Small Disadvantage Business (SDB)
 Service-Disabled Veteran Owned Small Businesses
(SDVOSB)
 Women-Owned Small Business (WOSB)
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8(a) BD Program Basics
 Small Business unconditionally owned (51%) and
controlled by one or more socially and economically
disadvantaged individuals
 Subject to racial or ethnic prejudice due to
circumstances beyond their control
 Ability to compete has been impaired due to diminished
capital and credit opportunities compared to others in
same or similar line of business
 Good character
 Citizens of the United States (residency added)
 Demonstrate potential for success
13 CFR §§ 124.1-124.603
10
8(a) BD Program Basics
 Interested business files application with the SBA
certifying that it is a small business under the
applicable size standard
 8(a) Program personnel will verify qualifications prior
to award of a contract
 SBA involvement in award of the contract
 May sign primary contract with procuring agency and
subcontract with program participant
 Or may delegate authority to procuring agency to enter
into contract directly with program participant
13 CFR §§ 124.1-124.603
11
8(a) BD Program Basics
 Status awarded for 9 years from initial designation
 Primary NAICS code determines size
 Economically Disadvantaged
 Spousal income & retirement income not included (*)
 AGI = $250,000 initial & $350,000 continuing
 Assets (FMV) = $4 MM initial & $6 MM continuing
 Excessive Withdraws
 Officers salaries generally not included
 $250,000 if sales up to $1 MM
 $300,000 if sales $1 MM - $2 MM
 $400,000 if sales over $2 MM
13 CFR §§ 124.1-124.603
12
HUBZone Program Basics
 Principal office must be located within a designated
historically underutilized business zone
 35% of the business’ employees must reside in the
HUBZone
 Represent that the business will maintain 35%
employee residence throughout the duration of the
contract
13 CFR §§ 126.100-126.900
13
HUBZone Program Basics
 Apply to the SBA for certification
 Must be small within the applicable size standard for
the industry
 Important subcontracting guidelines for the HUBZone
participant
 Required to spend at least 50% of labor costs on its
own employees
 May subcontract 35% of the cost of the contract to
other HUBZone participants
 May not subcontract more than 50% to non-qualified
HUBZone small businesses
13 CFR §§ 126.100-126.900
14
Small Disadvantaged Business Basics
 Participants in 8(a) BD Program automatically eligible
 Receive certification from the procuring agency
 8(a) criteria apply to determine whether a firm
qualifies as a SDB except demonstrating the potential
for success is not required
 Entity can be a part-time entity but qualifying individual
must be full-time during part-time
 Removed the good character requirement
13 CFR §§ 124.1001-124.1014
15
Service Disabled Veteran Owned Small
Business (SDVO SB) Basics
 At least 51% unconditionally and directly owned by
one or more service-disabled veterans
 Management and daily operations must be controlled
by one or more service-disabled veterans
 Contractor self-certification
 It is an SDVO SB
 It is small under the applicable size standard
 Will meet the percentage of work requirements
 VetBiz Verification Program
13 CFR §§ 125.1-125.29
16
SDVOSB Status Verification
- www.vetbiz.gov
 Veterans Administration (VA) requirement to bid VA
SDVOSB set aside projects
 Contractors must be approved by VA and listed in
the VetBiz.gov Vendor Information Pages (VIP)
database
 Only applies to VA SDVOSB set aside projects
 Program does NOT evaluate Teaming Agreements
or other similar arrangements
April 3, 2012
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Women-Owned Small Businesses
Economically Disadvantaged Women-Owned
Businesses (EDWOSB)
 One or more women unconditionally and directly own at least
51% of the business
 Management and daily operations controlled by one or more
women
 EDWOSB
 Economically disadvantaged plus limitation on net worth –
750K in assets (excluding ownership of the business and
primary residence)
 Contractor self-certification
 Verified by third-party entity
13 CFR §§ 127.100-127.700
18
Self-Performance Requirements for
SBA-Managed Programs - Construction
 8(a) – perform 15% of the cost of the contract
(excluding materials) with its own employees
 SDVOSBC – spend 15% of labor costs on own
employees or another SDVOSBC
 HUBZone – spend 15% of labor costs with own
employees
 WOSB/EDWOSB – spend 15% of the cost of the
contract (excluding materials) with its own employees
13 CFR § 125.6
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Calculating Average Annual Receipts for
SBA Size Determination
 Receipts = total income + cost of goods sold
 Receipts do not include:
 Capital gains or losses
 Taxes collected or remitted
 Proceeds from transactions with affiliated entities
 Period of measurement
 In business for more than 3 years – 3 most recent
years divided by 3
 In business for less than 3 years – total receipts during
period of business divided by number of weeks in
business, multiplied by 52
13 CFR § 121.104
22
Topics for Discussion
I.
Why Understanding Risks in the Federal Set-Aside
Arena has Become Necessary
II. Overview of SBA Programs and Their
Administration
III. SBA Guidelines for Recognizing Improper
Affiliations
IV. Recognizing Improper Affiliations – You Be the
Judge
23
Affiliation Determination
 Affiliation Defined
 An affiliation exists when an entity controls or has the
power to control the other, or a third party or parties
controls or has the power to control both
 Totality of the circumstances analysis
(weighted averaging of several factors)
 Particularly fact-intensive and may produce different
results on a case-by-case basis
April 3, 2012
24
Affiliation Determination–
Exceptions from an Affiliation Finding
 Businesses will not be considered affiliated solely on
the basis of the following characteristics:
 Businesses owned by investment / development
companies qualified under the Small Business
Investment Act
 Businesses owned and controlled by Indian tribes,
Alaskan Native Corporations, Native Hawaiian
Organizations
 Businesses which lease employees from a common
organization
 Firms participating in the Federal Mentor / Protégé
Program
13 CFR § 121.103(b)
25
Consequences of an Affiliation Finding
 The combined size of the SBC and its affiliates
determine whether the SBC falls within the size
classification for a project
 Example: Project set-aside for businesses with $10 million
or less in annual revenue
 SBC with $8 million in revenue for FY2009 = Eligible
 SBC with $8 million in revenue but affiliated
with entity with $5 million in revenue for FY2009 = Ineligible
26
Consequences of an Affiliation Finding
 At the time of bidding, contractors must represent their
status as an eligible small business or a participant in
an SBA program
 Obtaining a small business set-aside by fraud or
misrepresentation may result in Inspector General
investigations, termination, debarment, suspension,
criminal or civil penalties [See, e.g., 15 U.S.C § 645]
27
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Factors to Weigh When Making an
Affiliation Finding
 The SBA considers
 Ownership Interest
 Management Control
 Newly Organized Concern Rule
 Employee and Family Ties
 Contractual Agreements (i.e. Teaming Agreements,
Joint Venture Agreements)
 Ostensible Subcontractor Rule
29
Ownership Interest /
Management Control
 Owning a majority of stock
 Power to control a majority of voting stock
 Own or control a combination of minority voting blocks
 Owning future stock interests
 Sharing officers, directors, managing members or
partners
 Profit-Sharing Agreements
13 CFR §§ 121.103(c)–(e)
30
Family Ties
 Family Influence
 Identity of Interest Rule
 Rebuttable presumption that family members have
identical interests and will be treated as affiliates
– May be rebutted by evidence showing that the family
members are estranged or that they have independent
economic interests creating a clear line of fracture between
the two entities.
Key Point:
The rebuttable presumption that family members have identical
interests arises from the family relationship itself, not from the
members involvement with each other’s business transactions.
Gallagher Transfer & Storage Co., SBA No. SIZ-4295 (1998)
13 CFR § 121.103(f)
31
Employee Ties
 Former Key Employee Influence
 Newly Organized Concern Rule – when former officers,
directors, principal stockholders, managing members or
other “key employees” form new business and receive
assistance from former employer there is a rebuttable
presumption that entities are affiliates
 May be rebutted by demonstrating “a clear line of
fracture” between the two entities
Key Point:
Prevents large businesses from creating “spin off” firms
which appear to be small and independent, but are, in fact,
an extension of the large business [Field Support Services
Inc., SBA No. 4176 (1996)]
13 CFR § 121.103(g)
32
Subcontracts
 An affiliation is found under the ostensible
subcontractor doctrine when a small business is in
essence, performing as a subcontractor to a large
business that is nominally a subcontractor on the
project
 The small business general contractor is therefore
“unusually reliant” on the large subcontractor
13 CFR § 121.103(h)(4)
33
Subcontracts
 The large subcontractor performs “primary and vital”
requirements of the contract
 Contract management
 Control of Project Funds
 Technical responsibilities
 Large percentage of actual labor
 Teaming Agreements
 Financial and bonding assistance
 Large subcontractor is the incumbent contractor
13 CFR § 121.103(h)(4)
34
Subcontracts
 An Ostensible Subcontractor affiliation may be found
during contract performance
 A new regulation closed a “loophole” in which a small
business contractor could submit an offer proposing
that it will perform primary and vital portions of the
contract and then subcontract the entire contract after
award
 Now, a contractor no longer may annually certify it is
a small business when a subcontractor assumes
primary and vital tasks during contract performance
13 CFR § 121.404(g)(4)
35
Teaming Agreements
 Defined in the Federal Acquisition Regulations (FAR)
as a potential prime contractor agreeing with one or
more other companies for them to act as a
subcontractor under a Government contract
 The FAR recognizes teaming arrangements may offer
the best combination of performance, cost and
delivery
 The Government will accept the validity of teaming
arrangements provided they are fully and timely
disclosed
FAR 9.601 – 9.603
36
Teaming Agreements
 Teaming Agreements will be reviewed to determine whether it
creates an affiliation under the ostensible subcontractor rule
 Issues Considered in the Affiliation Review
 Delineation of the proposed division of work and compliance
with the performance thresholds
 The proportion of skills, knowledge and experience brought
to the contract by each team partner
 Who will manage the day-to-day functions
37
Teaming Agreements
 Issues Considered in the Affiliation Review (continued)
 Whether terminology is used in the agreement that would
indicate the parties have entered into an impermissible joint
venture (i.e., “we”, the “Team”)
 The extent to which the subcontractor was involved in the
contract proposal
 If, and how, profit is distributed (profit sharing is red flag for
an affiliation)
38
Joint Venture Agreements
 Parties to a Joint Venture are considered affiliated with
each other
 Three exceptions:
 Each entity is “small” and the contract is greater than half
the assigned size standard
 A Joint Venture of at least one 8(a) participant and one or
more other small businesses
 A Joint Venture consisting of a mentor and protégé
39
13 C.F.R 121.103(h)
Joint Venture Agreements
 Temporary and Limited Purpose, Not on a Continuing
or Permanent Basis
 Three Contracts over two-year span (SBA tracks)
 The number of contracts is determined at the time of offer
 Example - if a JV has had two contracts in two years and
then submits three offers, the JV will not violate the rule
even if it receives all three contracts for a total of 5 contracts
 Permissible to Create More Than One Joint Venture
 The same two (or more) entries may create additional
joint ventures, and each new JV may be awarded three
contracts
 A long-standing inter-relationship between the same JV
partners increases the chances of an affiliation finding
40
13 C.F.R 121.103(h)
8(a) Joint Ventures
 An 8(a) may partner with one or more other small
businesses to perform an 8(a) contract
 JV Agreement must be approved by the SBA before
contract award
 An 8(a) / SBC Joint Venture is permissible only:
 When the 8(a) participant lacks the capacity to perform
the contract on its own
 The agreement is fair and equitable
 The 8(a) participant will substantially benefit from the Joint
Venture
41
13 C.F.R 124.513
8(a) Joint Ventures
 The JV Agreement must state:
 The purpose of the Joint Venture
 The 8(a) is the managing partner
 The project manager is an employee of the 8(a)
 The 8(a) must own at least 51% of the JV if it is a
separate legal entity
 8(a) must receive proportionate share of profits
 Performance responsibilities
 The equipment, facilities and resources contributed by
each partner
42
8(a) Joint Ventures
 Size Requirements:
 At least one 8(a) in the JV must be less than one-half the
size standard assigned to the contract, and
 For a contract with a revenue-based size standard, the
contract exceeds one-half the size standard; or
 For a contract with an employee-based size standard, the
contract exceeds $10 million
43
8(a) Joint Ventures
 New Performance of the Work Requirements as of February 2011
 The prior regulation required an 8(a) to perform “a
significant portion of the contract”
 Current regulations require the 8(a) to perform 40%
of the work performed by the JV:
 The 8(a) must do more than administrative functions
 Unpopulated Joint Venturers - when both the 8(a) and non-8(a)
partners are technically subcontractors, the amount of work
performed by the partners will be aggregated and the work by the
8(a) must be at least 40% of the work done by all partners
 Populated Joint Venturers - the non-8(a) JV partner, or any
affiliates, may not be a subcontractor to the JV, unless approved
by the SBA
44
13 C.F.R 124.513(d)
8(a) Joint Ventures
New Annual Reporting Requirement
 The 8(a) partner must report annually to the
SBA how the performance of the work
threshold is being met for each contract
8(a) Mentor/Protégé Joint Ventures
 A Feature of the 8(a) Program
 Purpose
 Enhance the capabilities of the protégé and improve its
ability to compete
 No affiliation due to the mentor / protégé agreement
or assistance provided
 Must enter into written agreement subject to SBA
review
 Relationship will be annually reviewed by the SBA
13 CFR § 124.520
46
8(a) Mentor/Protégé Joint Ventures
 Mentors
 Can be a non-profit or an 8(a) BD graduate
 Generally only one protégé at a time, need SBA approval &
never more than three
 Demonstrate favorable financial health
 Protégés
 Developmental stage OR never received 8(a) contract OR ½
applicable NAICS code (not during last 6 mos.)
 Generally one mentor at a time (different NAICS code)
 Approved written agreement, one point of contact, support for at
least one year & significant consequences
13 CFR § 124.520
47
8(a) Mentor/Protégé Joint Ventures
 New annual reporting requirements
 Protégé must report to the SBA on the mentor’s assistance
each program year
 Annual certification whether any changes to the agreement
 New consequences of the mentor not providing the stated plan
of assistance
 Termination of the mentor / protégé relationship
 Firm will be ineligible to mentor for two years
 SBA may recommend the procuring agency issue stop work
order for each mentor / protégé JV contract
 SBA may consider failure to be a basis for debarment
13 CFR § 124.520(H)
Contractual Relationships–
Other Consequences
 Will the rights and obligations of the “small business”
entity be enforceable if the entity was actually
ineligible for the set-aside contract?
 Recent decision held that an affiliated large
subcontractor could not enforce provisions of its
agreement with a small business who obtained a setaside contract in violation of the SBA Regulations
Morris-Griffin Corp. v. C&L Serv. Corp., 731 F.Supp. 2d
488 (E.D. Va. 2010) order vacated (Dec. 7, 2011).
 Potential implications for sureties
49
Weighing the Risks
 Has there been a SBA certification approval?
 Has the small business entity provided the
Government with documentation defining its
relationship with the larger entity?
 Is the relationship between the small business entity
and the larger entity an approved relationship, i.e.
Mentor/Protégé?
50
Topics for Discussion
I.
Why Understanding Risks in the Federal Set-Aside
Arena has Become Necessary
II. Overview of SBA Programs and Their
Administration
III. SBA Guidelines for Recognizing Improper
Affiliations
IV. Recognizing Improper Affiliations – You Be the
Judge
51
IV. Recognizing Improper Affiliations
You be the Judge
 Case 1
 U.S. Air Force contract for mission hardware and
software training, support and logistics management.
 The contract was set aside for SDVO SBC’s.
 Company A, the low bidder, was a subcontractor on the
predecessor contract.
 Company A is a SDVO SBC.
 Company B, a large business, is the incumbent prime
contractor for the predecessor contract.
52
IV. Recognizing Improper Affiliations
You be the Judge
 Case 1
 Company A submits a proposal, self-certifying as an
SDVO SBC, identifying itself as the prime contractor,
and Company B, the large contractor, as a
subcontractor and teaming partner.
 Company A’s proposal refers to A and B as a “team”
that offers a low-risk option because Company B’s
knowledge and personnel retention will offer a
seamless transition.
 The logos of both companies appear on almost every
page of the proposal.
53
IV. Recognizing Improper Affiliations
You be the Judge
 Case 1
 Company A will adopt techniques and approaches developed
by Company B during the predecessor contract.
 Company A plans to retain Company B’s incumbent
workforce, its facility lease, and Government furnished
equipment.
 The Teaming Agreement provides that Company B must
consent to Company A soliciting employees.
 Company A’s program manager will be primarily responsible
for managing the contract.
 Company A will not receive financial assistance from
Company B.
 Company B has the option to terminate the Teaming
Agreement to bid for the contract if the set-aside requirement
is removed.
54
IV. Recognizing Improper Affiliations
You be the Judge
 Case 1
 Holding
 Company A is not affiliated with Company B
 Company A will be performing primary and vital contract
requirements and will be primarily responsible for
managing the work.
 Although Company A is adopting certain techniques and
approaches from Company B, Company A was already
acquainted with them from being the incumbent
subcontractor.
 Company A is not usually reliant on Company B for its
workforce because Company A will be independently
retaining and managing the employees.
Spiral Solutions & Tech., Inc., SBA No. 5279 (Sept. 15,
2011).
55
IV. Recognizing Improper Affiliations
You be the Judge
 Case 2
 Solicitation issued by the Department of the Army for a
contractor to perform public works services at Fort
Hood, Texas.
 The contract was set-aside for SDVO SBC’s.
 Company A and Company B formed a joint venture to
bid on the project.
 Company A is a SDVO SBC, Company B is not.
 The Joint Venture Agreement indicates that Company
A and Company B will each appoint one managing
director and the two will make all decisions by mutual
agreement.
56
IV. Recognizing Improper Affiliations
You be the Judge
 Case 2
 The JV Agreement provides for an employee of
Company A to serve as project manager, but did not
state the name of that employee.
 The JV Agreement also indicates that Company A will
share 51% of the net operating income and net
operating losses of the joint venture.
 Lastly, the JV Agreement contains a statement that the
parties will comply with the SBA Regulations, rather
than delineating each party’s responsibilities.
57
IV. Recognizing Improper Affiliations
You be the Judge
 Case 2
 Holding
 The bidding Joint venture is ineligible for the project
because the JV Agreement did not meet the
requirements of the SBA Regulations in the following
ways:
1) Company A is not designated as the managing venturer,
and in fact, splits the decision-making between the
venturers;
2) A specific project manager for Company A was not
named;
3) While the JV Agreement addressed net operating income
losses, it did not establish Company A would receive 51%
of net profits, as required;
4) The agreement did not specifically define the
responsibilities of each venture partner.
Hana-JV, SBA No. VET-227 (February 22, 2012).
58
IV. Recognizing Improper Affiliations
You be the Judge
 Case 3
 Invitation for bids issued for the production of marine
deck cranes set aside for small businesses.
 This procurement is the third in a series of prior
purchases of identical cranes. Company A was
previously awarded the second procurement.
 Company B was a subcontractor of Company A on the
second procurement and performed approximately 55%
of that contract’s value.
59
IV. Recognizing Improper Affiliations
You be the Judge
 Case 3
 Company A has been in the same line of business for
28 years. It has its own shop and engineering
personnel.
 Company A prepared its own bid.
 Company A will be manufacturing cranes with
Company B’s design. Company A and Company B
have a licensing agreement which allows Company A
to utilize and manufacturer the cranes and provides for
Company B to lend Company A its personnel to assist
with the manufacturing and installation.
60
IV. Recognizing Improper Affiliations
You be the Judge
 Case 3
 The licensing agreement also provides Company B with
first preference to sell components to Company A
which Company A chooses to purchase rather than
manufacturer itself.
 Company A and Company B will not be sharing profits
and do not have a teaming agreement.
 Company B agreed to indemnify the bond for Company
A for a fee. In the event of liability, Company A and
Company B will contribute in proportion to their
respective manufacturing levels.
61
IV. Recognizing Improper Affiliations
You be the Judge
 Case 3
 Holding:
 Company A and Company B are NOT affiliated.
Company A and Company B have a legitimate contractorsubcontractor relationship. Company A is capable of
controlling the contract and performing the work with its
own resources. The companies will not be sharing
profits. Company A had the autonomy to either create its
own design or deal with and obtain the design of any firm
it so chose. With respect to the bonding assistance,
Company A is using its own financial resources to obtain
the bond and entered into an arms-length transaction to
obtain assistance from Company B. Lake Shore, Inc.,
SBA No. 2632, 1987 WL 93594 (S.B.A. 1987).
62
IV. Recognizing Improper Affiliations
You be the Judge
 Case 4
 Army Corps of Engineers small business set-aside
contract for dredging.
 Company A, a small business, was the successful
bidder.
 Company B is owned and controlled by the brother and
adult son of Company A’s majority shareholder.
 Company A leases office space from Company B at fair
market value in an arm’s length transaction.
63
IV. Recognizing Improper Affiliations
You be the Judge
 Case 4
 The two companies do business together. For example,
Company B accounted for about 10% of Company A’s
gross receipts in the previous year.
 Both companies use the same NAICS codes, which
encompasses civil engineering construction, dredging,
and surface cleanup.
 However, each company works in a different subset of
that code and each has a different specialty. Company
A works mainly in marine contracting and mechanical
dredging, while Company B largely performs tunneling
and underground work.
64
IV. Recognizing Improper Affiliations
You be the Judge
 Case 4
 The two companies do not share common
management or common directors and are distinct
corporate entities. The family members are not officers
or directors of each others’ companies.
 The majority shareholder of Company A is the sole
indemnitor for the company’s bonds.
 Company A owns all of its own equipment.
 None of the family members live in the same
household.
65
IV. Recognizing Improper Affiliations
You be the Judge
 Case 4
 Holding:
 The two companies are affiliated under the identity of
interest rule. Company A did not present evidence that
sufficiently rebuts the presumption of identical interests
from the familial relationship between owners of
Company A and Company B. Company A was also
heavily dependent on Company B for work, which is also
an indicia of affiliation. L&S Industrial & Marine, Inc., SBA
No. SIZ-4978, 2008 WL 3995863 (S.B.A. 2008).
66
Questions?