New, consolidated SDVOSB eligibility regulations kicked in on October 1. The new regulations replace the old VA and SBA rules, which provided separate eligibility standards for SDVOSBs.
Veterans have long been confused by the fact that the Government operated two separate SDVOSB programs, each with its own standards. The consolidated rule will eliminate that confusion, and that’s a very good thing. There are also several other pieces of the new SDVOSB eligibility rule that veterans should like–but also some that aren’t so great, or that require further clarification as to how they’ll be applied.
My colleague Matt Schoonover provided a broader overview of the new regulations earlier last week. Now it’s time for me to get on my soapbox. Without further ado, here’s my list of the good, bad, and the downright ugly from the new SDVOSB regulations.
The SBA’s old SDVOSB regulations could be maddeningly vague, particularly when it came to the question of what the SBA meant by “unconditional control.” In fact, in a handful of cases, the SBA’s Administrative Judges used the 8(a) Program regulations as a reference point for interpreting SDVOSB requirements. Whether one likes or dislikes the new regulations, they at least provide veterans with much more clarity than the SBA’s old SDVOSB regulations, making compliance easier.
Bye-Bye “Draconian and Perverse.”
The new rules seem to do away with perhaps the most egregious interpretation of “unconditional” that I’ve seen. In late 2017 and early 2018, the SBA took the position that a veteran did not “unconditionally” own his company because the company’s bylaws said that the veteran’s ownership would transfer to the 49% owner in the event of the veteran’s death or incapacity.
A federal judge famously called the SBA’s position “draconian and perverse,” but nonetheless within the SBA’s broad powers. The new regulation excludes “death or incapacity” from the definition of “unconditional ownership,” appearing to effectively overturn SBA’s prior precedent. But the new regulation is much less clear about whether ordinary rights of first refusal–such as those that simply say that each owner must offer his or her shares to the others before selling to third parties–is permissible. (More on that below).
Forget About Community Property.
Married veterans living in so-called “community property” states have long been forced to ask their spouses to legally disclaim their legal ownership rights in SDVOSBs. The new regulations provide that “[o]wnership will be determined without regard to community property laws,” eliminating this burdensome requirement.
No Full-Time Devotion.
Veterans–particularly those running start-ups–have been frustrated with the VA’s old requirement that the veteran holding the highest officer position work “full time” for the SDVOSB. The new regulations dial back on this requirement.
The regulations specify that there is a rebuttable presumption that a person who does not work for the company during normal working hours does not control the company. But, as the SBA says in the commentary accompanying the new regulations, “[a]s a rebuttable presumption, this is not a full-time devotion requirement and can be rebutted by providing evidence of control.”
A Physical Test in an Online World.
As telecommuting and location-independent work skyrocket in the Internet age, the new regulations take a giant step backward. They say that “there is a rebuttable presumption that a service-disabled veteran does not control the firm if that individual is not located within a reasonable commute to [the] firm’s headquarters and/or job-sites locations, regardless of the firm’s industry.”
Not only does this unnecessary test discourage reasonable telecommuting–by disabled individuals, no less, some of whom have physical limitations making commuting difficult–it is also maddeningly unclear in its use of the term “and/or.” Many government contractors work regionally, nationally or even internationally, with jobsites spread hundreds of miles apart.
If, for example, a company is headquartered in Kansas City but has jobsites in Virginia and California, then what? Is the veteran okay if he or she lives close to the Kansas City headquarters, even though the jobsites are nowhere nearby? Would a California residence suffice, if this is the primary jobsite, even though the Missouri headquarters is far away? Or perhaps the SBA expects veterans to have ready access to teleportation technology, making for an easy commute to all three locations?
The regulations say that, in the case of a veteran with a permanent and severe disability, the spouse or permanent caregiver of the veteran can run the company’s management and daily business operations. Now, don’t get me wrong–I support the notion that veterans with permanent and severe disabilities ought to be able to appoint someone else to run the company’s daily operations. But why should that person be the veteran’s own spouse or permanent caregiver?
A spouse or caregiver may not have the industry or business know-how necessary to run the company successfully, much less effectively control all aspects of its daily operations. And the reverse is true, too: I’d hate to think of a veteran choosing a personal caregiver based on an individual’s business savvy, instead of that person’s ability as a caregiver. Additionally, while the new regulations don’t impose a full-time devotion requirement, they do generally require that the individual running daily operations be working during normal business hours. But shouldn’t an appointed caregiver be, um, caregiving during some of those hours?
If it were up to me, I’d allow the veteran to appoint a non-caregiver business manager, and ditch the requirement that the person appointed be the spouse or caregiver.
The Downright Ugly
Primary NAICS Code.
The new regulations appear to say that a company cannot qualify as an SDVOSB unless it is small in its primary NAICS code. The regulations define an SDVOSB as a type of “small business concern,” and defines “small business concern” as “a concern that, with its affiliates, meets the size standard corresponding to the NAICS code for its primary industry . . ..” If this is the intent, it would be a big change to prior SBA regulations, and could dramatically and unfairly limit the ability of a particular company to qualify for SDVOSB contracts.
For example, consider a solicitation set aside for SDVOSBs under NAICS code 236220 (Commercial and Institutional Building Construction), with a corresponding $36.5 million size standard. As I read it, if a company had $30 million in average annual receipts, it could bid on the solicitation if its primary NAICS code was 236220, or some other NAICS code with a size standard exceeding $30 million. But if the same company had a primary NAICS code like 238140 (Masonry Contractors), with a $15 million size standard, it would be ineligible.
I hope I’m wrong about how this will be applied, because it sounds very unfair–and could lead to some real gamesmanship when it comes to companies self-certifying their primary NAICS codes in SAM.
Rights of First Refusal.
As I mentioned above, the new SBA regulations seem to allow rights of first refusal in the case of the veteran’s death or incapacity. That’s a step in the right direction. But what about an ordinary right of first refusal, simply stating that if one owner (including the veteran) wishes to sell, he or she must offer the interest to the other owners first?
Such provisions are commonplace in corporate documents, and have been permitted by the VA since mid-2013. Many companies in the VetBiz database undoubtedly have such restrictions in their bylaws and operating agreements. It’s unclear whether those companies remain eligible SDVOSBs under the new regulations.
The new regulations do specify that “adding a new equity stakeholder” is an “extraordinary” item over which a non-veteran may exercise veto power. That’s good, as far as it goes, but not all of these transactions involve a new stakeholder.
For example, let’s say that a company has a veteran owner with 51% and two non-veteran owners, each with 24.5%. As I read it, each of the non-veterans would be unable to prevent the veteran from transferring his or her entire share to the other non-veteran, because no “new equity stakeholder” would be added.
More troubling, the new regulations discuss the “extraordinary” exceptions in the portion of the regulations dealing with unconditional control; the SBA has historically found that right of first refusal provisions violate the requirement for unconditional ownership. Hopefully, this uncertainty will be resolved in favor of allowing reasonable right of first refusal provisions, but if not, I’m worried that many currently-verified SDVOSBs could be deemed ineligible.
The Road Ahead
There is a lot to like in the SBA’s consolidated SDVOSB regulations, but some real areas of concern, as well. As these rules get applied and interpreted in practice, my colleagues and I will keep you posted–and I hope that the SBA will be willing to quickly make tweaks to its new rules if any interpretations prove unfair.