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.