SBA Didn’t Properly Justify 8(a) Termination, Says Court

SBA’s regulations provide that an 8(a) program participant that no longer is owned or controlled by socially and economically disadvantaged person can be terminated from the 8(a) program. But the decision to terminate is not one to be made lightly: SBA must make sure that it not only has evidence in support of its termination decision, it must also explain how that evidence demonstrates its conclusions.

This requirement was at issue in a recent court decision that found an SBA 8(a) program termination decision to be based on “numerous erroneous assumptions” and “unsupported conclusions, not substantial evidence.”

The 8(a) program serves an important policy objective: to assist socially and economically disadvantaged small businesses to compete for (and perform) government contracts as a means of business development. To qualify for the 8(a) program, a company must be “a small business which is unconditionally owned and controlled by one or more socially and economically disadvantaged individuals who are of good character and citizens of and residing in the United States, and which demonstrates potential for success.” 13 C.F.R. 124.101.

With respect to control, the SBA’s regulations require that a business be managed full-time by at least one capable disadvantaged individual. But certain business relationships may jeopardize that control: the regulations caution that non-disadvantaged persons may be found to control (or have the power to control) the 8(a) company when business relationships with such non-disadvantaged persons “cause such dependence that the [8(a) Program] applicant or Participant cannot exercise independent business judgment without great economic risk.” Id. § 124.106(g)(4).

In The Desa Group, Inc. v. U.S. Small Business Administration, Civ. No. 15-0411 (RC) (May 26, 2016), the United States District Court for the District of Columbia analyzed the issue of control, when it considered The Desa Group’s (“TDG”) argument that SBA had arbitrarily terminated it from the 8(a) program. The SBA had based its termination on a finding that TDG was supposedly controlled by DESA, Inc., a former 8(a) participant controlled by the mother of TDG’s 8(a) participant owner, Dionne Fleshman.

As part of its application for the 8(a) program, TDG disclosed its relation to DESA, noting that DESA was run by Ms. Fleshman’s mother, but asserted that TDG was not dependent on DESA other than the fact that DESA was a TDG customer. SBA approved TDG’s 8(a) application on September 30, 2010.

A little more than two years later, SBA received information that cast doubt on these statements. A tipster informed SBA that Ms. Fleshman actually worked at both TDG and DESA, and that her mother (DESA’s owner) actually managed TDG. The SBA initiated an investigation of the allegations. Following its investigation, SBA advised TDG that it intended to terminate its participation in the 8(a) program.

After receiving its notice of termination, TDG appealed to the SBA’s Office for Hearings and Appeals. OHA rejected SBA’s claim that Ms. Fleshman’s mother actually controlled TDG. Even still,  OHA found “significant interconnectedness” between TDG and DESA that demonstrated DESA’s control. Specifically, OHA noted that TDG and DESA acted as subcontractors for each other; that TDG maintained an office in DESA’s headquarters; that the building where TDG housed its own headquarters was owned by Ms. Fleshman’s mother, who “plays a critical role” in TDG’s success; that DESA was responsible for nearly 40% of TDG’s revenues in 2010; and that DESA was paying TDG between $7,000 and $10,000 per month from 2010 to 2012. As a result, OHA determined that TDG could not exercise independent business judgment apart from DESA without great economic risk. As a result, DESA controlled TDG. TDG’s appeal was denied.

Usually, 8(a) termination appeals end at OHA. But TDG wasn’t done fighting. TDG sued the SBA in federal court, arguing that SBA’s termination decision was arbitrary and capricious. The U.S. District Court for the District of Columbia, after considering the parties’ evidence and arguments, agreed with TDG.

The Court noted that several of the SBA’s reasons for termination appeared unsupported by evidence, and that much of the evidence that was offered by SBA in support of its decision was disputed. Additionally, the Court concluded that neither SBA nor OHA had explained how TDG’s connections with DESA demonstrated such a high level of dependence that TDG could not exercise independent business judgment without great economic risk.

As an example, the Court agreed with SBA that, as a general matter, the level of revenue that TDG received from DESA “might support a finding of dependence that prohibited TDG from exercising its own independent business judgment without great economic risk[.]” But the Court faulted SBA for not explaining how the facts supported its conclusion:

[T]he mere fact that DESA pays for TDG’s services does not necessarily indicate that it is able to assert control over how TDG runs its business or the business judgment TDG or Ms. Fleschman make in doing so.

The “implicit, unexplained assumption” in the SBA’s argument was that any contractual relationship between the companies indicated that Ms. Fleshman has ceded control over TDG to DESA. This was simply a bridge too far.

The Court concluded:

The agency has identified several contacts or connections between TDG and DESA. But under the regulation the SBA has invoked here, mere contacts or business relationships alone are insufficient to show control; the agency must establish that those relationships cause such dependence that TDG cannot exercise independent business judgment without great economic risk. The SBA has done no more than conclusorily state that the contracts here equate to the level of dependence necessary to show that Ms. Sumpter or DESA controls TDG.

The Court thus found that SBA had not met its burden to terminate TDG from the 8(a) program. It therefore remanded the issue back to SBA for additional investigation or explanation.

The Desa Group demonstrates that 8(a) termination decisions cannot be made lightly. In order to properly terminate an 8(a) program participant, SBA must back its decision with evidence, explanation, and analysis. Mere conclusory statements don’t do the trick.

And The Desa Group is also a good reminder that an 8(a) Program participant need not simply accept an SBA final termination decision–instead, like TDG, a terminated 8(a) program participant may fight SBA in federal court after exhausting its internal SBA remedies.