A recent appeal before the U.S. Small Business Administration’s Office of Hearings and Appeals (OHA) upheld SBA’s denial of an application for a veteran-owned small business because its operating agreement gave too much control to a non-veteran owner and failed to identify a veteran as the highest officer. The decision in Facekay LLC demonstrates the importance of strict adherence to the control requirements laid out by the various SBA programs.
Facekay LLC, SBA No. VSBC-388-A (Sept. 3, 2024) looks at what it means to be “controlled by one or more veterans” as required by 13 C.F.R. § 128.203. For a more in-depth look at veteran-owned small business (VOSB) and service-disabled veteran owned small business (SDVOSB) requirements, check out this post by my colleague. As relevant to this case, a VOSB limited liability company must have one or more qualifying veterans serving as managing members, “with control over all decisions of the limited liability company.” Additionally, the veteran-owner “must hold the highest officer position.” Seems pretty straightforward, right?
Control of an LLC is, in almost all circumstances, going to be established first in the operating agreement. And this is exactly where the SBA is going to be looking to determine how control is allocated between the members of the LLC.
Facekay’s operating agreement reflected that there were two members: a qualifying veteran who owned 51% of the LLC, and a non-veteran who owned 49% of the LLC. The operating agreement also stated that “one or more Qualifying Veterans” must serve as the managing member. It also contained language what stated, “[a]ny member may bind the LLC in all matters in the ordinary course of LLC business.” Further, “[t]his agreement may not be amended except in writing signed by all the members. Any amendments must ensure that veteran members continue to unconditionally and directly own at least 51% of the concern and control all decisions.” The veteran owner was the Chief Operating Officer while the non-veteran owner held the titles of Chief Financial Officer and Chief Executive Officer.
SBA, in its denial of the certification request through the VetCert program, stated that the veteran owner did not have sufficient control over the applicant concern. This was based on two facts. First, the operating agreement stated that it could not be amended except in writing by all the members. For this conclusion, OHA cited to a previous decision that listed “five ‘extraordinary circumstances’ which need not necessarily be controlled exclusively by [veterans].” Snowfensive, LLC, SBA No. VSBC-368-A (2024). The Snowfensive decision listed the following actions as those which the non-qualifying member may have control over: 1) adding new owners; 2) dissolution of the company; 3) sale of the entire company or all assets of the company; 4) a merger of the company; and 5) declaring bankruptcy. Therefore, SBA determined, the veteran owner did not fully control the LLC because it could not amend the operating agreement without the non-veteran owner’s approval. Second, the non-veteran owner was listed as the CEO.
Facekay appealed the SBA’s decision to OHA, claiming that the LLC had appointed the veteran-owner as President, and the company had also appointed the non-veteran owner as President and CEO, and, therefore, the veteran owner held the highest officer position. However, the minutes offered by the LLC didn’t say anything about appointing the veteran-owner as the highest officer. Additionally, 13 C.F.R. § 134.1110 limits OHA’s review to information in the case file unless good cause is shown otherwise. The minutes presented by Facekay were not contained in the case file and the company offered no explanation as to why OHA should take them into consideration.
Finally, nothing was done about the provision that required all members to approve an amendment to the operating agreement—a clear violation of the VOSB control rules. OHA noted that, in “prior decisions, OHA has recognized that a qualifying veteran’s inability to unilaterally amend an operating agreement may, by itself, be grounds to deny certification.” This one may come as a shock to minority owners in SDVOSB businesses. But the right to amend the operating agreement is not a right that a minority owner can have veto power over.
Taking the above into consideration, OHA upheld the SBA’s denial of Facekay’s VOSB application. Neither the operating agreement nor the meeting minutes established that the veteran-owner was in control of the company.
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There are a couple of lessons to learn from this short decision. First, make sure that your operating agreement clearly identifies the qualifying individual as the highest officer—whether in the original operating agreement or by a properly-executed amendment. Second, requiring unanimous approval of any operating agreement amendment is an impermissible restriction on the qualifying individual’s control of the company.
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