Back to Basics: SBA’s OHA Reminds Area Offices How to Apply the Ostensible Subcontractor Rule

We’ve discussed the “ostensible subcontractor rule” quite a few times on the blog (including most recently here and here) because it is one of the most frequent grounds for size protests. It’s also frequently misunderstood. A recent SBA Office of Hearings and Appeals decision, Contego Environmental, LLC, SBA No. SIZ-6054 (May 19, 2020), demonstrates how even SBA Area Offices can misapply the rule and provides useful reminders to contractor looking to avoid violating it.

As a refresher, the SBA may find a prime contractor and its “ostensible” subcontractor affiliated with one another for size purposes where the subcontractor will be performing “primary and vital” contract requirements or if the prime is otherwise unusually reliant on the subcontractor for performance. SBA Area Offices must consider both of these fundamental bases to effectively determine whether the ostensible subcontractor rule applies.

In addition to these considerations, the SBA often relies on a more specific, four-factor test to determine whether a prime contractor is unusually reliant on a subcontractor:

  1. Whether the proposed subcontractor is the incumbent contractor and ineligible to compete for the procurement on its own;
  2. Whether the prime contractor plans to hire the large majority of its workforce from the subcontractor;
  3. Whether the prime contractor’s proposed management previously served with the subcontractor on the incumbent contract; and
  4. Whether the prime contractor lacks relevant experience and must rely upon its more experienced subcontractor to win the contract.

For more on the test, check out this post.

In Contego Environmental, the SDVOSB prime contractor, Indigo Blue Construction, proposed to utilize a large business subcontractor to perform a VA construction project. While this is not all that unusual, especially in the construction world, there were a number of red flags the Area Office noted in Indigo’s proposal.

For one, Indigo consistently referred to itself and its subcontractor collectively throughout its proposal as “Team Indigo Blue.” More problematically, however, the proposal explained that Indigo’s proposed Program Manager, Indigo’s President, would not provide direct, on-site supervision of the required construction work. Instead, it explained that on-site supervision would be provided by several employees of Indigo’s subcontractor. This included at least two key personnel positions, the Project Manager and On-Site Manager, which would be filled by employees of the subcontractor.

Despite these red flags, the Area Office determined that Indigo was not affiliated with its subcontractor under the ostensible subcontractor rule. In reaching its determination, the Area Office relied on the oft-cited four factors and, finding none applied, ceased its analysis.  

On appeal, however, OHA sustained the appeal and remanded back to the Area Office. Importantly, the OHA was concerned about how the Area Office had reached its decision stating that “the Area Office did not discuss, and apparently did not consider, which firm (Indigo or [Subcontractor]) will perform the ‘primary and vital’ contract requirements” and that “[a]s a result, the size determination is incomplete in its analysis of the ostensible subcontractor rule.”

OHA also explained how the Area Office’s error would require it to closely reexamine whether Indigo’s subcontractor would be performing “primary and vital” requirements of the contract. The OHA specifically pointed to Indigo’s plan to fill on-site management roles with subcontractor employees as a matter the Area Office should pay close attention to.

Two key points to derive from this decision:

First, an Area Office should review more than just the four-factor test to determine whether the ostensible subcontractor rule has been violated. Because the four-factor test is applicable only to very specific factual scenarios, Area Offices should also more generally consider the underlying bases for finding ostensible subcontractor affiliation: whether the subcontractor will be performing primary and vital contract requirements and whether the prime will otherwise be unduly reliant on its subcontractor.

Second, prime contractors should be cautious about their proposed management structures. While OHA did not directly rule on this point, it clearly suggested that Indigo’s proposed management structure raised questions about who would perform the contract’s primary and vital requirements, which the Area Office will review closely on remand.

If you have questions or concerns about the ostensible subcontractor rule, or require assistance with an SBA size protest or appeal, Koprince Law is here to help! Email us or give us a call at 785-200-8919.