Government contractors seeking to be certified through the Vets First Verification Program under the VA’s Center for Verification and Evaluation have to submit a number of documents. We’ve recently been hearing that CVE is taking a closer look at some of these documents, and this is in line with VA’s recent rule change expanding its list of required documents for verification.
Specifically, CVE will examine franchise agreements and similar documents like distributor agreements. Depending on the language in those agreements, this could lead to a denial of CVE verification. Because of that, we offer a reminder of CVE’s position on these types of agreements, which seems to still be quite strict in spite of regulatory changes implemented last fall.
One important aspect of the SDVOSB rules is that one or more service-disabled veterans must be in unconditional control of the business. “Control by one or more service-disabled veterans means that both the long-term decisions making and the day-to-day management and administration of the business operations must be conducted by one or more service-disabled veterans.” 13 C.F.R. § 125.13(a)
The SBA’s consolidated SDVOSB rules at 13 C.F.R. § 125.13(i), which took effect in October 2018, contain a number of rebuttable presumptions about what can lead to loss of veteran control. The rule states that “[n]on-service-disabled veteran individuals or entities may not control the firm. There is a rebuttable presumption that non-service-disabled veteran individuals or entities control or have the power to control a firm in any of the following circumstances, which are illustrative only and not inclusive.”
In particular, one rebuttable presumption of non-veteran control is where “[b]usiness relationships exist with non-service-disabled veteran individuals or entities which cause such dependence that the applicant or concern cannot exercise independent business judgment without great economic risk.”
In 2016, the CVE issued a fact sheet that discusses when franchise agreements might create control issues for an SDVOSB under these rules. While the fact sheet was issued before the consolidation of SDVOSB rules under SBA, it’s still the best guidance out there from the VA as it appears that CVE will continue to follow it.
In addition, the VA’s verification rules, as of October 1, 2018, now includes franchise agreements in the list of required documents found in the rules at 38 CFR § 74.12. Prior to this date, franchise agreements had not been a required document in the regulation.
The fact sheet says that “[m]ost franchise agreements seek to maintain control of the company in a manner which prevents the Veteran from making decisions concerning day-to-day operations and the overall direction of the company.” In other words, it can be difficult, if not next-to-impossible, to obtain verification as an SDVOSB when operating under a franchise agreement.
The fact sheet provides further examples of provisions that could create control by someone other than a service-disabled veteran:
- Franchisee shall participate in the systemwide marketing and advertising established by the franchisor. Franchisee shall contribute to marketing and advertising fees.
- The franchise owner must devote full business time and attention to the operation of the franchise, cause the franchise to be effectively and efficiently operated, and attend such training sessions as may be reasonably deemed necessary.
- Franchisee may not delegate primary responsibility for the operation of the franchise, the primary place of business, or any additional office or training facility, without franchisor’s written consent.
- The franchise owner may at no time be employed by, perform any service for, or operate any business of any kind other than the franchise business, wherever located, without the prior written consent of the franchisor. If the franchisor consents to the franchisee being employed by, performing any service for, or operating any other business, then the franchisor may require the franchisee to delegate primary responsibility for the operation of the franchise business.
These control concerns could also arise in the case of agreements somewhat akin to franchise agreements, such as some distributor agreements. And similar provisions in any ongoing agreement could cause issues with non-veteran control, such as restrictions on sales strategies or restrictions on sale of an ownership interest. While the fact sheet has been out for a while, CVE still appears to be taking an aggressive approach to franchise agreements and agreements somewhat like them, even under the new consolidated SDVOSB rules.
It would be a good idea for SDVOSBs and aspiring SDVOSBs to review not only franchise agreements, but also similar agreements such as distributor agreements, prior to submission for CVE verification. Provisions like those listed above could still cause significant problems at CVE.