A minority owner with a mere 21.2% stake in a government contractor controlled that contractor for SBA size and affiliation purposes, according to a recent SBA Office of Hearings and Appeals decision.
SBA OHA’s decision in Size Appeal of Civitas Group, LLC, SBA No. SIZ-5424 (2012) is an important reminder that a contractor’s single largest minority shareholder may be deemed to control the company under the SBA size and affiliation rules–even if the contractor’s governing documents do not grant that shareholder actual legal control.
The Civitas Group SBA OHA size appeal decision involved a Department of Justice small business set-aside solicitation for planning, logistics, training and response support services. After reviewing competitive proposals, the DOJ announced that Civitas Group, LLC was the apparent successful offeror. A competitor subsequently filed a SBA size protest, alleging that Civitas was affiliated with various other entities.
Civitas had no majority shareholder. Its single largest shareholder, Albright Stonebridge Group, LLC, owned a 21.2% share. The next largest shareholdings were 12.1%, 10.7%, 10.2%, and 10.1%. Eight other individuals and entities owned the remaining 35.7% of the company.
The SBA Area Office held that Albright controlled Civitas under the “largest minority shareholder rule” (my name for it, not the SBA’s). That rule, codified at 13 C.F.R. 121.103(c)(1), states that individual or entity controls a company when the individual or entity “owns, or has the power to control, 50 percent or more of a concern’s voting stock, or a block of voting stock which is large compared to other outstanding blocks of voting stock.”
The SBA Area Office acknowledged that Civitas’s corporate documents did not necessarily place legal control with Albright. Nevertheless, the SBA Area Office held that the largest minority shareholder rule applies whenever an individual entity owns or controls a block of stock which is large compared to other blocks, regardless of whether the company’s governing documents allow that same shareholder to exercise legal control.
Because Albright was deemed to control Civitas, the SBA Area Office found Civitas affiliated with Albright. The affiliation caused Civitas to exceed the applicable small business size standard for the DOJ contract.
Civitas filed a SBA size appeal with SBA OHA. Civitas’s primary argument was that any two of the four next largest shareholders are large enough to prevent Albright from controlling Civitas. Civitas also pointed out that its governing documents did not allow Albright to exercise legal control of Civitas.
In a brief opinion, SBA OHA rejected Civitas’s arguments. With respect to Civitas’s first contention, SBA OHA held, “[t]his argument lacks merit. The regulation asks whether there is a minority interest that is large relative to the other minority interests, not, as Appellant suggests, whether the remaining stockholders could collaborate to prevent the largest minority shareholder from exercising control.”
SBA OHA also held that legal control of the company was irrelevant to the application of the largest minority shareholder rule. SBA OHA noted that when the SBA adopted the rule, it considered allowing firms to demonstrate that legal control resided with someone other than the largest minority shareholder, “but ultimately chose not to adopt” such a rule. Thus, Civitas’s approach “would be at odds with the agency’s intent in promulgating” the largest minority shareholder rule.
The largest minority shareholder rule can be especially problematic for small government contractors because it is not intuitive. After all, even without reading the SBA size regulations, most contractors intuitively understand that, for example, if the same person owns 100% of two companies, those companies are affiliated. Not so with the largest minority shareholder rule, which applies even when the company’s governing documents do not allow that shareholder to exercise legal control over the company.
For any small government contractor with an ownership structure similar to Civitas’s, the Civitas Group SBA OHA decision is an important reminder to beware of the largest minority shareholder rule–and proactively address any affiliation problems before they result in an adverse SBA size determination.