The Small Business Administration’s Office of Hearing Appeals (“OHA”) recently issued a ruling affirming the SBA’s termination of a contractor from participation in the 8(a) Business Development Program (“8(a) Program”). Yet the OHA’s opinion in The DESA Group, Inc., SBA No. BDPT-543 (2015), is notable not for this conclusion, but rather for the discussion that preceded it. Although the OHA ultimately affirmed the termination of the contractor from the 8(a) Program, it did so only on narrow grounds, and only after subjecting the SBA’s underlying determination to extended (and unusually pointed) criticism. For 8(a) Program participants and their mentors—a class of federal contractors that the SBA has recently proposed to expand—the ruling may serve as a useful roadmap on pushing back against potential overreaching by the SBA.

Background

The DESA Group, Inc. (“DGI”) was a admitted into the 8(a) Program in September 2010 based on the socially and economically disadvantaged status of its owner. In 2012, however, the SBA “received a tip that [the owner] did not actually work full-time at [DGI],” as required by SBA regulations, and instead worked for DESA Inc. (“DESA”), a company owned by her mother that had graduated from the 8(a) program in 1997. After an investigation, the SBA announced its intention to terminate DGI from the 8(a) Program as a result of several alleged violations of SBA regulations both before and after DGI was admitted to the program. DGI appealed this decision to the OHA.

Management and Control

In justifying the termination of DGI from the 8(a) Program, the SBA concluded that DGI’s various business connections to DESA demonstrated that DESA, and not DGI’s disadvantaged owner, had the power to control DGI. The SBA’s stated that it “did not believe” that DGI and DESA had disclosed their “real working relationship and intentions,” and it cited several facts in support of this conclusion, including:

  • DGI’s owner was the daughter of DESA’s owner;
  • Both companies were “present on each other’s LinkedIn and Facebook” pages;
  • Both companies referenced each other on their websites;
  • The owner of DGI was listed on DESA’s website as one of DESA’s “leaders”;
  • DGI’s owner earned between $7,000 and $10,000 annually from DESA; and
  • DGI’s website included “numerous references” to DESA’s accomplishments.

The SBA concluded that these facts showed that DGI and DESA were so interdependent that DGI’s owner, a socially and economically disadvantaged individual, could not have “maintain[ed] ownership, full-time day-to-day management, and control” over the company, as required by SBA regulations.

The OHA rejected this rationale. In a sharply worded decision, the OHA admonished the SBA for leaping to conclusions that were “simply not supported by the preponderance of the evidence.” The OHA acknowledged that the SBA had identified a “significant amount” of evidence showing a “business connection” between the two companies, but it stressed that evidence of a connection is not the same as evidence of control: “Connections are bilateral by definition. The fact that a connection exists between the companies offers no insight into who controls whom. . . . The exercise of control could run in either direction, or not at all.” According to OHA, the SBA had failed to appreciate this distinction:

[T]he SBA simply assumes that because the two companies had connections, [DESA] must be actively involved in the management of [DGI], and [DGI’s owner] must, therefore, not be managing [DGI] on a full-time basis. Piling inferences on inferences, SBA concludes that Petitioner must also therefore have changed its ownership or management structure without obtaining the required prior approval from SBA.

The OHA concluded that the SBA’s finding of “control” based on the facts listed above was arbitrary because “it infers a control dynamic that is not supported by the evidence.”[1]

A Pyrrhic Victory for Petitioner

After an eight-page discourse on the flaws in the SBA’s termination decision, the final two paragraphs of the OHA’s opinion uphold, almost grudgingly, the termination finding. The OHA acknowledged that in addition to the facts listed above, DGI also maintained an office in DESA’s headquarters, frequently served as a subcontractor to DESA (and vice versa), and earned approximately 40% of its revenue from DESA. The OHA concluded that these facts suggested “such dependence that [DGI] cannot exercise independent business judgment without great economic risk,” thereby establishing DESA’s control over DGI. See 13 CFR § 124.106(g)(4).

Although the OHA’s analysis ultimately did not benefit the petitioner in this case, the opinion may prove useful to other 8(a) participants in several respects. First, it serves as a strong reminder that an 8(a) participant’s affiliation with another entity does not necessarily give rise to an inference of control, even where there is strong circumstantial evidence of close business connections. Second, it also provides a useful contrast between connections that may or may not give rise to an inference of control, on the one hand, and those that almost certainly will support such an inference, on the other. Participants in the 8(a) program would be well-advised to bear in mind this distinction when structuring their relationships with affiliated companies.

[1] The SBA also justified its termination of DGI’s participation in the 8(a) Program on the independent ground that DGI’s owner had made a false statement in her initial program application, in violation of 13 CFR § 124.303(a)(1). DGI’s owner conceded that one aspect of her application response was technically untrue, but she argued that it was a reasonable and honest mistake. The SBA, however, noted that Section 124.303(a)(1) does not require that a statement be knowingly false, and it concluded that whether the misstatement was an honest mistake was irrelevant to its analysis. On appeal, the OHA disagreed, declaring that “[t]he policy rationale for including an intentionality element should be self-evident,” as an intentional lie is “compelling evidence of poor character and integrity” while an honest mistake “shows little more than simple carelessness.” It therefore concluded that SBA erred in failing to consider the possibility that the misstatement in the 8(a) application was an honest mistake.

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Photo of Jennifer Plitsch Jennifer Plitsch

Jennifer Plitsch leads the firm’s Government Contracts Practice Group, where she works with clients on a broad range of issues arising from both defense and civilian contracts including contract proposal, performance, and compliance questions as well as litigation, transactional, and legislative issues.

She…

Jennifer Plitsch leads the firm’s Government Contracts Practice Group, where she works with clients on a broad range of issues arising from both defense and civilian contracts including contract proposal, performance, and compliance questions as well as litigation, transactional, and legislative issues.

She has particular expertise in advising clients on intellectual property and data rights issues under the Federal Acquisition Regulations (FAR) and obligations imposed by the Bayh-Dole Act, including march-in and substantial domestic manufacturing. Jen also has significant experience in negotiation and compliance under non-traditional government agreements including Other Transaction Authority agreements (OTAs), Cooperative Research and Development Agreements (CRADAs), Cooperative Agreements, Grants, and Small Business Innovation Research agreements.

For over 20 years, Jen’s practice has focused on advising clients in the pharmaceutical, biologics and medical device industry on all aspects of both commercial and non-commercial agreements with various government agencies including:

  • the Department of Veterans Affairs (VA);
  • the Department of Health and Human Services (HHS), including the Biomedical Advanced Research and Development Authority (BARDA), the National Institutes of Health (NIH), and the Centers for Disease Control (CDC);
  • the Department of Defense (DoD), including the Defense Threat Reduction Agency (DTRA), the Defense Advanced Research Projects Agency (DARPA), and the Joint Program Executive Office for Chemical Biological Defense (JPEO-CBRN); and
    the U.S. Agency for International Development (USAID).

She regularly advises on the development, production, and supply to the government of vaccines and other medical countermeasures addressing threats such as COVID-19, Ebola, Zika, MERS-CoV, Smallpox, seasonal and pandemic influenza, tropical diseases, botulinum toxin, nerve agents, and radiation events. In addition, for commercial drugs, biologics, and medical devices, Jen advises on Federal Supply Schedule contracts, including the complex pricing requirements imposed on products under the Veterans Health Care Act, as well as on the obligations imposed by participation in the 340B Drug Pricing program.

Jen also has significant experience in domestic sourcing compliance under the Buy American Act (BAA) and the Trade Agreements Act (TAA), including regulatory analysis and comments, certifications, investigations, and disclosures (including under the Acetris decision and Biden Administration Executive Orders). She also advises on prevailing wage requirements, including those imposed through the Davis-Bacon Act and the Service Contract Labor Standards.

Photo of Michael Wagner Michael Wagner

Mike Wagner helps government contractors navigate high-stakes enforcement matters and complex regulatory regimes.

Combining deep regulatory knowledge with extensive investigations experience, Mr. Wagner works closely with contractors across a range of industries to achieve the efficient resolution of regulatory enforcement actions and government…

Mike Wagner helps government contractors navigate high-stakes enforcement matters and complex regulatory regimes.

Combining deep regulatory knowledge with extensive investigations experience, Mr. Wagner works closely with contractors across a range of industries to achieve the efficient resolution of regulatory enforcement actions and government investigations, including False Claims Act cases. He has particular expertise representing individuals and companies in suspension and debarment proceedings, and he has successfully resolved numerous such matters at both the agency and district court level. He also routinely conducts internal investigations of potential compliance issues and advises clients on voluntary and mandatory disclosures to federal agencies.

In his contract disputes and advisory work, Mr. Wagner helps government contractors resolve complex issues arising at all stages of the public procurement process. As lead counsel, he has successfully litigated disputes at the Armed Services Board of Contract Appeals, and he regularly assists contractors in preparing and pursuing contract claims. In his counseling practice, Mr. Wagner advises clients on best practices for managing a host of compliance obligations, including domestic sourcing requirements under the Buy American Act and Trade Agreements Act, safeguarding and reporting requirements under cybersecurity regulations, and pricing obligations under the GSA Schedules program. And he routinely assists contractors in navigating issues and disputes that arise during negotiations over teaming agreements and subcontracts.