SBA Affiliation Rules: Directors’ Control “Illusory,” Says SBA OHA

A director does not “control” a company under the SBA affiliation rules when that director can be removed at any time by the majority shareholder, according to a recent size appeal decision of the SBA Office of Hearings and Appeals.

In Size Appeal of Environmental Quality Management, Inc., SBA No. SIZ-5429 (2012), SBA OHA arrived at the commonsense conclusion that when a majority shareholder has unfettered discretion to fire a company’s directors, the majority shareholder–not the directors–control the company for purposes of the SBA affiliation rules.

The Environmental Quality Management SBA OHA size appeal decision involved an EPA small business set-aside solicitation for emergency and rapid response services.  After the EPA announced that Environmental Quality Management, Inc. was the apparent awardee, a competitor filed a SBA size protest.  The size protest alleged, in part, that EQM was affiliated with Metalico, Inc. based on common management.

Metalico was a publicly-traded corporation with a six-person board of directors.  Carlos Aguero, Metalico’s founder, was the company’s president, CEO and chairman of the board of directors.  Walter Barandiaran and Paul Garrett were also members of Metalico’s board.

EQM was majority owned by EQM Technologies & Energy, Inc., or EQMTE.  Mr. Aguero, Mr. Barandiaran, and Mr. Garrett also served on EQMTE’s board of directors, with Mr. Barandiaran as chair.  The three directors constituted the majority of the five-person board.

The SBA Area Office determined that the three directors had the ability to control EQMTE because they constituted a majority of the board.  The SBA Area Office then found that the same three directors had the ability to control Metalico, because they could exercise negative control to prevent the board from taking majority action.  Based on this overlapping control, the SBA Area Office issued a size determination finding EQM and Metalico affiliated on the basis of common management, and finding that EQM was not an eligible small business for the EPA procurement.

EQM filed a size appeal with SBA OHA.  EQM argued that under Delaware law, where EQM was organized, a majority shareholder can remove directors at any time with or without cause.  For this reason, EQM contended that any control that the three directors appeared to have over EQM was illusory, because EQM’s majority shareholder, Argentum Capital Partners II, L.P., could remove any or all of the directors if it wished.

SBA OHA agreed with EQP.  SBA OHA noted that under Delaware law and EQM’s bylaws, ACP II had the power to remove directors with or without cause.  SBA OHA wrote, “[a]ccordingly, although it might appear that Messrs. Aguero, Barandiaran, and Garrett collectively control EQMTE’s board, such control is merely illusory.”  SBA OHA held that the SBA Area Office had erred by finding EQM and Metalico affiliated.

In the Environmental Quality Management case, SBA OHA brought a dose of common sense to the SBA affiliation rules.  After all, if a director can be fired anytime he or she takes action with which the majority shareholder disagrees, it is the majority shareholder, not the director, who is truly in control.

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