SBA Clarifies Family Relationship & Economic Dependence Affiliation Rules

The SBA has changed its affiliation regulations to clarify when a presumption of affiliation exists due to family relationships or economic dependence.

In its major final rulemaking published today, the SBA clears up some longstanding confusion regarding affiliation based on a so-called “identity of interest.”

The SBA’s current “identity of interest” affiliation rule states that businesses controlled by family members may be deemed affiliated–but does not explain how close the family relationship must be in order for the rule to apply.  The SBA’s final rule eliminates this confusion.  It states:

Firms owned or controlled by married couples, parties to a civil union, parents, children, and siblings are presumed to be affiliated with each other if they conduct business with each other, such as subcontracts or joint ventures or share or provide loans, resources, equipment, locations or employees with one another. This presumption may be overcome by showing a clear line of fracture between the concerns. Other types of familial relationships are not grounds for affiliation on family relationships.

By limiting the application of the rule to certain types of close family relationships, the SBA essentially codifies SBA Office of Hearings and Appeals case law, which has long interpreted the rule to apply only to close family relationships.  It’s a good thing to have the types of relationships at issue spelled out in the regulation, rather than buried in a series of administrative decisions.

More interesting to me is the fact that the final rule suggests that the presumption of affiliation doesn’t apply unless the firms in question “conduct business with each other.”  I wonder whether this regulation essentially overturns OHA’s recent decision in W&T Travel Services, LLC.  In that case, OHA held that two firms were affiliated because the family members in question were jointly involved in a third business–even though the two firms in question had no meaningful business relationships.  I will be curious to see how OHA addresses this component of the final rule when cases begin to arise under it.

The SBA’s final rule also codifies OHA case law regarding so-called “economic dependence” affiliation.  As my colleague Matt Schoonover recently wrote, OHA has long held that a small business ordinarily will be deemed affiliated with another entity where the small business receives 70% or more of its revenues from that entity.  The final rule provides:

(2) SBA may presume an identity of interest based upon economic dependence if the concern in question derived 70% or more of its receipts from another concern over the previous three fiscal years.

(i) This presumption may be rebutted by a showing that despite the contractual relations with another concern, the concern at issue is not solely dependent on that other concern, such as where the concern has been in business for a short amount of time and has only been able to secure a limited number of contracts.

As with the rule on family relationships, the codification of the “70% rule” will help small businesses better understand their affiliation risks, without having to delve into OHA’s case law.  In that regard, it’s a positive change.