Joint Ventures: Is “Unequivocal Control” Required?

Fans of the blog know that we’re wild about joint ventures: they allow small business contractors to use their size status while, at the same time, leveraging their joint venture partner’s experience and capabilities.

But joint ventures—particularly joint ventures under one of the SBA’s socioeconomic programs—can be tricky to create. For joint ventures between a small and a large company, the venturers first need an approved mentor-protégé agreement. And regardless, for the joint venture to qualify under a socioeconomic designation, that joint venture must have a compliant agreement.

But that’s still not enough to create a compliant joint venture. As a recent SBA Office of Hearings and Appeals decision explains, the small business venturer must unequivocally control the joint venture.

Control over a joint venture has long been a confusing subject for joint venturers. On the one hand, the SBA’s socioeconomic regulations require the person on whom the company’s eligibility is based to control the company. For SDVOSBs, as an example, this means that the service-disabled veteran owner must control all aspects of the company, save for five “extraordinary circumstances” that are specifically designated in the SBA’s regulations. 13 C.F.R. §§ 125.11, 125.13. On the other hand, the SBA’s joint venture regulations do not explicitly require that same level of control over the joint venture by the SDVOSB venturer; instead, they require the SDVOSB venturer to act as the managing venturer, and to designate a project manager “responsible for performance of the contract” awarded to the joint venture. 13 C.F.R. § 125.18(b)(2)(ii).

In Seventh Dimension, LLC, SBA VET-6057 (June 11, 2020), the SBA OHA had occasion to consider the level of control that an SDVOSB must exert over an SDVOSB joint venture. At issue was the eligibility of Aquila Alliance LLC—a mentor-protégé SDVOSB joint venture between Advanced Computer Learning Corporation (ACLC), as the SDVOSB venturer, and General Dynamics Information Technology (GDIT), as the non-managing venturer—under a procurement set aside for SDVOSBs by the U.S. Army Special Operations Command.

On its face, the joint venture checked the appropriate boxes for eligibility: ACLC was an eligible SDVOSB and had an approved-mentor-protégé agreement with GDIT. Moreover, the parties appeared to have a compliant joint venture agreement under the SBA’s SDVOSB joint venture regulations. Importantly, ACLC was designated as Aquila’s managing venturer and an ACLC employee was named its project manager.

Aquila’s joint venture agreement, however, also provided for a Member’s Committee. Representation on the Member’s Committee was tilted in favor of ACLC—having two committee members to GDIT’s one. The Committee, moreover, was authorized to “exercise complete and exclusive control over the management of the Company’s business, including controlling the performance of the Contracts[.]”

Notwithstanding the Member’s Committee’s control over the joint venture, the joint venture agreement identified several items that required unanimous approval of the venturers. Included in these requirements were the approval to bid on projects (and final approval for any bid); entering into any contract with the government; entering into subcontracts valued at $500,000 or more; incurring debt (other than trade payables or leases); incurring expenses valued at more than 5% of budget; and settling litigation.

After Seventh Dimension filed an eligibility protest, the SBA Area Office found that Aquila was an eligible SDVOSB joint venture. Seventh Dimension then appealed, arguing, in part, that ACLC does not control Aquila and, as a result, Aquila is not an eligible SDVOSB.

The OHA agreed with Seventh Dimension’s arguments, finding that ACLC’s inability to control Aquila meant that the joint venture was not eligible as an SDVOSB.

Citing the requirement that an employee of the SDVOSB be the joint venture’s project manager, the OHA wrote that “this means the [SDVOSB] must control the decision-making of the joint venture.” This control, the OHA wrote, “must be unequivocal.”

Such unequivocal control did not exist under the Aquila joint venture agreement, given the unanimity requirements. These requirements well-exceeded the “extraordinary circumstances” outlined in the SDVOSB regulations, including submitting proposals and entering into contracts—ordinary actions that go to the very purpose of the joint venture. Given these unanimity requirements, and considering other aspects of GDIT’s negative control over the functions of the joint venture, the OHA concluded that GDIT controls the ordinary functions of the joint venture. In other words, ACLC was not able to manage the joint venture and, therefore, Aquila’s joint venture agreement did not comply with the SBA’s regulations. OHA concluded that Aquila was not an eligible SDVOSB.

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In my mind, the OHA’s determination that an SDVOSB venturer must “unequivocally control” the joint venture is problematic, as it conflates the requirements for the underlying SDVOSB’s eligibility with the joint venture’s eligibility. Although the SDVOSB regulations require the service-disabled veteran owner to exercise unequivocal control over the SDVOSB under 13 C.F.R. § 125.13, the SDVOSB joint venture regulations don’t require this same level of control. Instead, to be an eligible SDVOSB joint venture, the company has to have a joint venture agreement that meets the regulatory requirements—including that the SDVOSB serve as managing venturer and that one of its employees serve as project manager, “responsible for performing the contract.” 13 C.F.R. § 125.18(b)(2)(ii). “Exercising unequivocal control over the joint venture” is simply not one of the requirements stated in the SDVOSB joint venture regulations.

The SDVOSB joint venture regulations differ from the underlying SDVOSB regulations in other important ways. First, the SDVOSB joint venture regulations specifically allow the non-managing venturer to exercise negative control not permitted to minority members of the SDVOSB entity itself, by requiring that both venturers co-sign any checks paid out of the joint venture’s bank account. 13 C.F.R. § 125.18(b)(2)(v). In other words, the SDVOSB regulations tacitly allow the non-managing venturer the ability to withhold its consent to paying for the joint venture’s indebtedness—a clear act of negative control. In an SDVOSB, however, requiring a minority member’s countersignature before a check can be issued would be an improper usurpation of the service-disabled veteran’s inherent control.

Second, the nature of the joint venture profit split demonstrates that an SDVOSB need not have unequivocal control. The SDVOSB regulations generally require that the service-disabled veteran owner receive the highest compensation from the SDVOSB; if a non-service-disabled veteran instead receives the highest compensation, the presumption is that that person controls the company. 13 C.F.R. § 125.13(i)(2). In an SDVOSB joint venture, however, the non-SDVOSB venturer can receive the highest compensation—because profits are split commensurate with the parties’ work, and because the non-SDVOSB venturer can perform up to 60% of the joint venture’s work, the non-SDVOSB venturer might receive an outsized share of the profits. 13 C.F.R. § 125.18(b)(2)(iv), (b)(3). Again, the SDVOSB regulations contemplate that the non-managing venturer might have some level of control over the joint venture.

Practically speaking, a relaxed control requirement makes sense in the context of a joint venture. Under the SBA’s regulations, a joint venture is, in many respects, a legal fiction: it is a separate unpopulated legal entity, under which two or more entities “combine their efforts, property, money, skill, or knowledge” in order to perform under a specific contract. 13 C.F.R. § 121.103(h). It is nothing more than the sum of its parts—including those parts contributed by the non-managing venturer. To say that the non-managing venturer cannot exercise any control over how the joint venture operates ignores the relationship of the parties. Moreover, it threatens to undermine the joint venture regime itself, as I can’t imagine many entities would be willing to participate in a joint venture if they are precluded from having a say over whether that joint venture will even submit an opportunity under a specific contract and, if so, how that contract will be performed.

We simply don’t read the joint venture regulations as requiring unequivocal control. But, at least for now, it’s clear the OHA considers the managing venturer’s ability to “unequivocally control” the joint venture as a prerequisite to eligibility.

If you have any questions about joint ventures, please email us or give us a call at 785-200-8919.