On November 6, 2015, the Department of Veterans Affairs (“VA”) issued a proposed rule (the “Proposed Rule”) to clarify the byzantine verification process for veteran-owned small businesses (“VOSB”) and veteran-owned service-disabled veteran-owned small businesses (“SDVOSB”)1 who want to participate in the VA’s Veterans First Contracting Program.  VA Veteran-Owned Small Business Verification Guidelines, Proposed Rule, 80 Fed. Reg. 68,795 (to be codified at 38 C.F.R. Part 74). The Proposed Rule revises a 2013 advanced notice of proposed rulemaking and considers 39 public comments received in response to the prior notice.  Comments on the latest proposed rule are due on or before January 5, 2016.

Under the Veterans First Contracting Program, the VA offers set-asides and sole source opportunities to certified VOSB and SDVOSB firms.  Unfortunately, the program has struggled to gain a foothold in the government procurement landscape because its VA-administered regulations are confusing and the set-aside opportunities are limited to VA procurements.  At the same time, the Government Accountability Office and the VA’s Office of the Inspector General have targeted the program for pervasive fraud, and stakeholders have criticized the verification program as unnecessarily rigorous when compared against other socio-economic programs administered by the Small Business Administration (“SBA”).

As a result, through its Proposed Rule, the VA “seeks to find an appropriate balance between preventing fraud . . . and providing a process that would make it easier for more VOSBs to become verified.”  The VA attempts to strike this balance by significantly amending the VOSB ownership regulations to make them easier to understand, and bringing many of the requirements in line with SBA interpretations of similar requirements under similar programs.

For example, the current regulations require a veteran to own “unconditionally” his or her interest in the company.  Over the years, the VA has used this provision to restrict common business practices, such as a minority owner’s right of first refusal to purchase the veteran’s shares.  The Proposed Rule would move away from this restriction and permit “commercially reasonable” restrictions on a veteran’s interest—consistent with long standing SBA rules on these types of limitations.

Similarly, the proposed changes to the VA’s definition of “control” at 38 C.F.R. § 74.4 are intended to counter the VA’s prior blanket insistence that the veteran have “unconditional” control over all aspects of the business.  Under the Proposal Rule, “[t]he veteran(s) upon whom eligibility is based must have control over all decisions of the governing body, with the exception of extraordinary business decisions.” These extraordinary business decisions include “acceptance of new capital contributions, addition of members to an LLC or partnership, amendment of an operating or partnership agreement in a manner that materially alters members’ rights, material amendments to bylaws, issuance of additional shares of capital stock, and the sale or lease of all or substantially all of a concern’s assets.”  The SBA has long permitted these types of minority protection provisions in its small business programs.

These changes to the ownership and control provisions are critical to attracting investment in VOSBs.  Under the current rule, minority owners are prohibited from receiving even a modicum of protection in their investment.  While the new rules still restrict the minority owners’ ability to exert control over the VOSB, they bring the program’s minority owners’ rights more in line with similar SBA socio-economic programs.

In addition to the changes to the control and ownership provisions, the Proposed Rule also would remove the onerous “community property” regulation, currently codified at 38 C.F.R. § 74.3(f).  This regulation applies only to married veterans living in certain states and essentially requires those veterans to obtain the consent of his or her spouse to establish a SDVOSB or VOSB.  Explaining the proposed change, the Proposed Rule states that “in administering the program, this requirement was found to be unduly burdensome on veterans” and that “this provision does not significantly reduce the risk of fraud, waste and abuse in the program.”

Some things would stay the same.  For example, like the current rule, the Proposed Rule requires that veterans own at least 51% of each class of interest in the company.  However, the Proposed Rule goes further and clarifies that VOSB’s organizing documents must specify the ownership interests.  This change is yet another example of the Proposed Rule moving to objective standards and requirements for VOSBs.

Accordingly, the Proposed Rule should improve the VA’s VOSB verification program.  The proposed revisions might attract more firms previously intimidated by the costly, uncertain verification maze, while at the same time, providing an adequate check on truly fraudulent actors. And in the coming months, the improved VOSB verification process could be particularly important, depending on the Supreme Court’s disposition of Kingdomware Technologies, Inc. v. United States, No. 14-916—a case that will focus on whether the Veterans First Contracting Program’s set-aside program is mandatory or discretionary.  If the Court were to side with the petitioner, the number of VOSB contracting opportunities under the Veterans First Contracting Program would expand dramatically.

1 The VA’s SDVOSB program should not to be confused with the separate, more commonly utilized SBA SDVOSB program.