Novation Disaster: SBIR Phase III Award Stripped by GAO

Contractors interested in acquiring participants in the SBA’s Small Business Innovation Research (SBIR) program beware: successfully novating SBIR contracts has been made significantly harder by a recent GAO decision.

Worse still, SBIR novation mistakes can jeopardize future awards under the SBIR contract vehicles. Tread lightly.

For those who are unfamiliar, SBIR is a program overseen by the SBA that is designed to provide research and development opportunities for small businesses in the federal sphere. Federal agencies with research budgets that exceed $100 million are required to participate in the SBIR program. These participating agencies will identify specific research and development projects that are of interest, and small businesses will compete for SBIR awards.

The SBIR program is unique because its awards utilize a three-phase procurement structure. During Phase I, the awarded contractor demonstrates the feasibility, technical merit, and commercial prospects of the proposed technology. If the technology investigated in Phase I shows promise, the awarding agency may make a Phase II award. During Phase II, the awardee firm continues to develop the technology further and move toward prototyping. Finally, SBIR contractors may be awarded a Phase III award to commercialize the technology developed during the earlier Phases. Importantly, only Phase I awardees are eligible to receive Phase II awards; Phase III awards require prior Phase I and Phase II awards.

GAO’s recent decision in ASRC Federal Data Network Technologies, LLC, B-418028 et al. (Dec. 26, 2019) involved a Phase III SBIR award for integration of various medical information systems. The project was requested by the Defense Health Agency.

Understanding the protest arguments requires a little bit of background.

In September 2014, a Phase III basic ordering agreement was awarded to DDL Omni Engineering LLC. The basic ordering agreement was a continuation of earlier work DDL Omni had performed under its SBIR Phase I and Phase II awards.

Roughly four years later, DDL Omni was acquired by American Systems Corporation. American Systems subsequently executed a novation agreement with the government that recognized American Systems as the successor in interest under various DDL Omni contracts. Among the novated contracts was DDL Omni’s SBIR Phase III basic ordering agreement and its associated orders; however, the novation did not include the underlying Phase I and Phase II awards made to DDL Omni. The novation process was completed in spring 2019.

In September 2019, DHA issued a new basic ordering agreement to American Systems for health systems integration. The purpose of the new agreement was to “build on efforts that derive from, extend, or complete efforts that were generated under previous SBIR Phase I and II work.” Concurrently, DHA issued a new order for specific health services integration. Importantly, the new basic ordering agreement and order were issued to American Systems based on the SBIR Phase I and Phase II work performed by DDL Omni. These Phase I and Phase II awards to DDL Omni were not among the contracts novated to American Systems.

American System’s order and underlying basic ordering agreement awards were protested by ASRC Federal Data Network Technologies, LLC. According to ASRC, American Systems was not eligible for an SBIR Phase III award because American Systems did not hold the underlying Phase I and Phase II SBIR contract awards at the time of the Phase III.

ASRC’s argument leverages instructions set forth within the SBIR Policy Directive, which is published by the SBA to provide additional guidance on SBIR program administration. As relevant to ASRC’s protest, the SBIR Policy Directive provides direct guidance on the applicability of novation. Specifically, the Directive expressly acknowledges that SBIR awardees may include successors in interest that have SBIR contracts novated to them. The Directive caveats this authority, however, with the following example: “in order to receive a Phase III award, the Awardee must have either received a prior Phase I or Phase II award or been novated a Phase I or Phase II award[.]” SBIR Policy Directive § 6(a)(5).

In resolving ASRCs protest, GAO began by interpreting the plain language of the applicable regulations. In this case, GAO evaluated the language of the SBIR Program Policy Directive, and concluded that “plain language of the SBIR Policy Directive requires that in order to be eligible to receive a phase III award, a company has to have either performed, been novated, or been identified as a successor in interest to, a phase I or II award.”

GAO’s decision relied heavily on the example provided within the SBIR Policy Directive that predicated Phase III awards to successors in interest to be based on novated Phase I or Phase II awards. According to GAO, since the Phase III award to American Systems relied on Phase I and Phase II awards that were completed by DDL Omni and not novated to American Systems, the Phase III award was improper. GAO sustained ASRC’s protest.

Interestingly, the SBA did weigh in during the protest briefing period and advocated in favor of American Systems remaining its Phase III eligibility. According to the SBA, “a firm that owns all rights or interests in the work performed under an SBIR award, may be considered a successor-in-interest and receive a subsequent SBIR award without a prior novation, assuming the awardee meets all other eligibility requirements.”

Unfortunately, the SBA was not able to find the footing for its position as clearly in the SBIR Policy Directive. As such, GAO rejected the SBA’s interpretation of the SBIR Policy Directive—despite the SBA being responsible for publishing the Directive in the first place.

GAO’s decision is an example of the difficulties present when acquiring small businesses. American System’s acquisition of DDL Omni and subsequent novation of DDL Omni’s Phase III award was not enough preserve American System’s right to receive new Phase III awards. Decisions like this one can make it more challenging for small businesses to be acquired, as the risks to successors in interest are simply too high to warrant taking the chance. This can stifle small business innovation—the very thing the SBIR program is designed to promote.

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