SDVOSB’s Operating Agreement Caused Affiliation

In a recent SBA Office of Hearings and Appeals size decision, a service-disabled veteran-owned small business’s operating agreement caused affiliation under the SBA’s affiliation rules, despite the fact that the majority owner was also labeled as the 51% manager.

SBA OHA’s decision in Size Appeal of Washington Patriot Construction, LLC, SBA No. SIZ-5447 (2013) shows the importance of carefully drafting a small business’s corporate operating agreements or bylaws to prevent affiliation with other companies controlled by the small business’s minority owners.

The Washington Patriot Construction SBA size appeal decision involved an Army Corps of Engineers solicitation for the construction of an access point at Joint Base Lewis-McChord North.  The solicitation designated the procurement as a total set-aside for SDVOSBs.

After evaluating competitive proposals, the Corps announced that Washington Patriot Construction, LLC was the apparent successful offeror.  A disappointed competitor subsequently filed a SBA size protest.  In its size protest, the competitor alleged that Washington Patriot was affiliated with Wade Perrow Construction, or WPC.

According to Washington Patriot’s operating agreement, Mickey Traugutt was the 51% owner of Washington Patriot.  WPC owned the remaining 49%.  The operating agreement also stated that Mr. Traugett was the 51% manager.  Wade Perrow, Elizabeth Perrow, and Dan McKinney were also managers.  The Perrows and Mr. McKinney were all managers of WPC.

The operating agreement provided that all decisions made by the company would be made by the managers.  The operating agreement further stated that “any disagreement between or among Managers over a decision on Company matters, will be resolved by vote of a majority of Managers.”  The Operating Agreement also provided that a manager “may be removed only for acting in bath faith in office . . .”

After reviewing the operating agreement, the SBA Area Office concluded that WPC had the power to control Washington Patriot.  The SBA Area Office reasoned that the Perrows and Mr. McKinney were three-fourths of the company’s managers.  Because a “majority of managers” was necessary to resolve disputes, the three WPC managers could effectively control Washington Patriot.  Based on the overlapping control between WPC and Washington Patriot, the SBA Area Office found the companies affiliated.

Washington Patriot filed a size appeal with SBA OHA, arguing that the SBA Area Office had misconstrued the operating agreement.  SBA OHA disagreed.

SBA OHA pointed out that the operating agreement did not permit managers to be removed except for bad faith.  “Thus, despite his majority ownership of the company, Mr. Traugett cannot simply remove managers that disagree with him,” SBA OHA wrote.

SBA OHA noted that the operating agreement called for disputes to be resolved by a “majority” of managers.  “Notably, the agreement does not state that Mr. Traugett alone will resolve all disputes,” SBA OHA wrote.  “Nor does the agreement state that disagreements will be resolved according to managers’ weighted voting interests.”

SBA OHA determined, “the Area Office correctly concluded that, notwithstanding Mr. Traugett’s 51% ownership and 51% management interests, the operating agreement enables Mr. McKinney and the Perrows to thwart Mr. Traugett’s control over [Washington Patriot] in cases of disagreement.”  SBA OHA upheld the SBA Area Office’s decision finding the companies affiliated.

The Washington Patriot Construction decision shows why it is critical for a small government contractor to carefully draft its operating agreement, bylaws, or other governing documents to avoid affiliation problems.  With a few relatively simple tweaks to its operating agreement, Washington Patriot could have ensured that Mr. Traugett controlled the company.  Instead, Washington Patriot found itself on the wrong end of a SBA size determination–and lost its contract with the Corps.

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