Long-time SmallGovCon readers are probably aware of the thorny issues presented by an SBA finding of affiliation. When set aside contracts are dependent on a small business size status, an allegation of affiliation with a large business can be a crisis for a small business contractor. SBA’s affiliation doctrine is large and complex (so much so that we have an entire handbook dedicated to the subject). But there is one catch-all affiliation provision that is perhaps the murkiest area of all, meaning the hardest to predict). If SBA does not find affiliation based on things like common ownership or common management (relatively straightforward concepts), it can nonetheless find affiliation based on “the totality of the circumstances.”
A recent OHA decision found affiliation based on totality of the circumstances, in part based on loans causing economic dependence, heavy reliance on infrastructure of an affiliate, and involvement in banking and operations.
Totality of the circumstances is similar to the old “looks like a duck and quacks like a duck” test. “SBA will consider the totality of the circumstances, and may find affiliation even though no single factor is sufficient to constitute affiliation.” 13 CFR 121.103. SBA is effectively saying that control by one person or company over another exists based on reviewing the relationship between the two companies. In practice, however, it is rarely so obvious. This is a hard-to-predict finding where numerous facts can add up to enough to satisfy a government official. Thankfully (for small business contractors at least), it is not common for OHA to find affiliation based on the totality of the circumstances alone.
A recent OHA decision gives some guidance to this nebulous concept.
Looking at how SBA determined this kind of affiliation can shed some light on what goes into the analysis for OHA. In Petromax Refining Company, LLC, a successful awardee for an aviation-fuel refining contract was protested by the Contracting Officer after she became concerned about the company’s relationship with Sunoco (the well-known oil industry giant). After submitting her protest to the Area Office, Petromax was found affiliated with Sunoco and Bayview Refining Company, LLC (or Bayview, a refining company 100% owned by Sunoco), and SBA determined it was other than small.
The Area Office’s findings stemmed from some serious financial dependence by Petromax on Bayview. Petromax leased the Bayview facility and was the sole operator of that refining facility. Additionally, Bayview provided Petromax with a line of credit to purchase feedstocks (the raw materials used in refining and production) and had the right to deny Petromax’s request to purchase feedstocks from third-party suppliers. This meant that the majority of Petromax’s purchases of raw materials came from Sunoco or its affiliates. What’s more, Petromax had to deposit all of its revenues into a Bayview bank account, which Bayview had access to review.
On appeal, Petromax argued that its lease had been misconstrued, and that all these terms were industry standard and commercially reasonable. Petromax stated that it wasn’t required to exclusively utilize the line of credit, and that while Bayview could review the bank account “to ensure that loaned funds are being utilized as intended,” Bayview couldn’t withdraw or transfer funds. Petromax argued that the lease did not mean Bayview (and thereby Sunoco) could control Petromax.
OHA disagreed. It found that all these factors together, under the totality of the circumstances, meant that Petromax was controlled by Bayview. OHA found that Petromax was reliant on Bayview for financing, as well as infrastructure and equipment for operations. Petromax was required to get permission from Bayview to purchase feedstocks from parties other than Sunoco and could not enter into agreements for storage and handling without confirmation of Bayview’s lien rights in writing.
OHA also determined that, even if Bayview could “only” access the account to review the usage of funds, this necessarily meant that if it did not approve of that fund usage, it had the ability to stop or direct Petromax (i.e., there would be no need to review fund usage if it could not subsequently control those funds upon a dissatisfactory finding). Essentially, Petromax had to get permission from Bayview for routine business decisions that were not related to financing. Bayview had direct control over Petromax’s day-to-day management as well as much of its financing. This led OHA to conclude that Petromax had failed to show the Area Office had made a clear error of fact or law, and therefore OHA would not overturn the finding of affiliation.
It is not surprising that Petromax failed to win its appeal. The level of dependence, both financial and operational, on Sunoco was significant by all measures. Of special importance to OHA was Bayview’s influence over day-to-day operations. The strict financial terms of their contract outweighed industry norms and, all together, were enough to show dependence on Bayview. It therefore stands to reason that contractors should be wary of entering into agreements that allow this level of financial oversight and control by the other party. When in doubt, it is always best to err on the side of caution when it comes to SBA affiliation. As always, keep checking in here at SmallGovCon for more updates regarding affiliation and all things SBA.
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Editor’s Note: Special thanks to our wonderful legal clerk Will Orlowski for putting together this blog post.