Businesses controlled by brothers were presumed affiliated under the SBA’s affiliation rules.

In a recent size determination, the SBA Office of Hearings and Appeals held that a contractor was affiliated with companies controlled by its largest owners’ brother, even though the companies had only minimal business dealings.  OHA’s decision highlights the “familial relationships” affiliation rule, which can often trip up even sophisticated contractors–but the decision, which was based on a March 2016 size determination request, did not take into account changes to that regulation that went into effect a few months later.

OHA’s decision in Size Appeal of Quigg Bros., Inc., SBA No. SIZ-5786 (2016) arose from a HUBZone Program application submitted by Quigg Bros., Inc..  On March 30, 2016, the HUBZone Program office asked that the SBA Area Office conduct a size determination on Quigg Bros. to determine whether the company was a small business in its primary NAICS code, 237310 (Highway, Street, and Bridge Construction).

The SBA Area Office determined that Quigg Bros. was owned by six related individuals. The two largest shareholders were John Quigg and Patrick Quigg.  The SBA Area Office determined that all six of the owners, including John Quigg and Patrick Quigg, controlled Quigg Bros.

The SBA Area Office then proceeded to examine potential affiliation with various other entities.  As is relevant to this post, William Quigg–the brother of John Quigg and Patrick Quigg–controlled three companies: Root Construction Inc. (RC), Barrier West, Inc. (BW), and Cottonwood, Inc.  These companies were identified as “related parties” in Quigg Bros.’ financial statements.  When the SBA asked for an explanation, Quigg Bros. stated that “[b]ecause we have loaned money to these entities our CPAs feel they are related.” However, Quigg Bros. pointed out, William Quigg was not an owner or officer of Quigg Bros., nor were John Quigg or Patrick Quigg involved as owners or officers of RC, BW, or Cottonwood.

The SBA Area Office issued a size determination finding Quigg Bros. to be affiliated with various other entities, including RC, BW and Cottonwood.  The SBA Area Office stated that companies controlled by close family members are presumed to be affiliated.  Although the presumption of affiliation may be rebutted, the SBA Area Office apparently found that the loans between Quigg Bros. and the other three companies (as well as other business dealings between the brothers) precluded Quigg Bros. from rebutting the presumption.  As a result of its affiliations, Quigg Bros. was found ineligible for admission to the HUBZone Program.

Quigg Bros. filed a size appeal with OHA.  Quigg Bros. highlighted the fact that none of its owners had any ownership interest in RC, BW or Cottonwood.  Quigg Bros. also pointed out that William Quigg was not an owner or officer of Quigg Bros.  Additionally, Quigg Bros. stated, the business dealings between the companies were minimal, and the companies did not share any officers, employees, facilities, or equipment.

OHA wrote that “SBA regulations create a rebuttable presumption that close family members have identical interests and must be treated as one person.”  The challenged firm “may rebut this presumption by demonstrating a clear line of fracture between family members.”

In this case, “the Area Office correctly presumed that William Quigg shares an identity of interest with his brothers, and afforded [Quigg Bros.] several opportunities to rebut this presumption.”  However, “the record reflects various business dealings between the brothers and their respective companies, including both contracts and loans, as well as joint investments” in two other companies.  These circumstances “undermine [Quigg Bros.’] claim of clear fracture, as OHA has recognized that ‘where there is financial assistance, loans, or significant subcontracting between the firms,’ and ‘whether the family members participate in multiple businesses together’ are among the criteria to be considered in determining whether clear fracture exists.”

OHA also found that the SBA Area Office did not err by failing to undertake a company-by-company analysis to determine whether Quigg Bros. was affiliated with each of the individual companies controlled by William Quigg. Citing prior decisions, OHA wrote that “if a challenged firm does not rebut the presumption of identity of interest between family members, all of the family members’ investments are aggregated.” OHA upheld the SBA Area Office’s size determination, and denied the size appeal.

In Quigg Brothers, the size determination request came in March 2016, so OHA applied the SBA’s then-existing rules on family relationships.  It’s worth noting, however, that the SBA adjusted those rules in a rulemaking effective on June 30, 2016.  The SBA’s affiliation rule now 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. 

The plain text of the new rule suggests that–unlike in Quigg Bros. and prior OHA cases–the primary focus of the regulation may be on the businesses, not the family members.  In other words, the company-by-company analysis OHA rejected in Quigg Bros. might be required moving forward.  Additionally, unlike in prior cases, the new regulation suggests that the presumption doesn’t arise in the first place unless there is a close family relationship and the companies in question conduct business with one another.

Make no mistake: family relationships are still a viable basis of affiliation under the SBA’s revised regulations.  But it remains to be seen how the new regulation will affect OHA’s analysis in future cases.