SBA Affiliation Rules: 4.16% Minority Owner “Controlled” Company

An owner of a mere 4.16% minority interest nonetheless “controlled” a company within the meaning of the SBA’s affiliation rules because the company’s ownership was split among approximately 20 companies, each with an equal ownership interest.

In a recent size appeal decision, the SBA Office of Hearings and Appeals confirmed that, where a company has no 50% or greater owner, a minority owner may be presumed to control the company–even where that ownership is as little as 4.16%.

OHA’s decision in Size Appeal of Government Contracting Resources, Inc., SBA No. SIZ-5706 (2016) involved a NAVFAC solicitation for base operating support services.  The solicitation was issued as a SDVOSB set-aside under NAICS code 561210 (Facilities Support Services), with a corresponding $38.5 million size standard.

After evaluating competitive proposals, NAVFAC announced that Government Contracting Resources, Inc. was the apparent successful offeror.  Two unsuccessful competitors then filed SBA size protests.

The SBA Area Office determined that GCR and “approximately 20 other companies” each owned equal minority interests in Valley Indemnity, Ltd.  The SBA Area Office also noted that GCR’s President and CEO served on Valley’s Board of Directors.

The SBA Area Office then applied the “minority ownership presumption” under the SBA’s affiliation rules.  That regulation, 13 C.F.R. 121.103(c)(2), states:

If two or more persons (including any individual, concern or other entity) each owns, controls, or has the power to control less than 50 percent of a concern’s voting stock, and such minority holdings are equal or approximately equal in size, and the aggregate of these minority holdings is large as compared with any other stock holding, SBA presumes that each such person controls or has the power to control the concern whose size is at issue. This presumption may be rebutted by a showing that such control or power to control does not in fact exist.

The SBA Area Office determined that GCR had not rebutted the presumption that it controlled Valley.  Applying the minority ownership presumption, the SBA Area Office found that GCR was affiliated with Valley.  The affiliation, in turn, caused GCR to exceed the $38.5 million size standard under the NAVFAC solicitation.  The SBA Area Office issued a size determination finding GCR to be ineligible for award.

GCR filed a size appeal with OHA.  GCR argued, in part, that its 4.16% minority stake did not give it control over Valley.  GCR noted that, under Valley’s corporate documents, a quorum for a shareholder vote required a majority of shares.  GCR contended that its ownership stake was too small to “create a quorum, prevent a quorum, cause any vote to pass, block any vote,” or cast a tie-breaking vote.  In fact, GCR stated, its 4.16% stake was too small even to convene a shareholder meeting.

OHA wrote that, under 13 C.F.R. 121.103(c)(2), “when a concern is owned by multiple owners with equal minority interests, all of those owners are presumed to control the concern.”  The presumption is rebuttable, but “the mere fact that a minority shareholder cannot individually control a concern is not sufficient to overcome the presumption.”  Rather, a minority shareholder may rebut the presumption “by showing that a party other than the minority shareholder has the power to control.”

In this case, OHA held, the presumption of control was not rebutted merely because GCR’s 4.16% interest was insufficient to create a quorum, cause the company to take action, or block corporate action.  “This argument,” OHA wrote, “amounts to an assertion that [GCR] cannot individually control Valley,” a contention that OHA has rejected in prior size appeals.  In fact, “the very purpose of the [minority shareholder rule] is to address situations in which no single person or entity has actual affirmative or negative power to control a concern.”

OHA continued, “[n]otably, if [GCR’s] interests are too small to control Valley, the same could be said for each of Valley’s other owners, with the result being that no party would control Valley.”  The SBA “will not accept an argument that a firm is not controlled by any party.”  Rather, “all concerns must be controlled by someone or some group at all times.”  The alternative, “to consider none of the minority stockholders as possessing the power to control the concern,” would “ignore reality and leave the locus of power uncertain and unresolved.”

OHA concluded that the SBA Area Office had properly applied the minority shareholder presumption, and denied GCR’s size appeal.

In discussing the SBA’s affiliation rules on SmallGovCon, I’ve often mentioned that some of the rules are intuitive (e.g., if an individual own 100% of two companies, they are affiliated), whereas others are not.  And of course, it’s the “not intuitive” affiliation rules that sometimes trip up even sophisticated contractors.

In my view, the minority shareholder presumption falls squarely into the “not intuitive” camp.  A company like GCR cannot be faulted for assuming that its 4.16% minority ownership interest did not establish control or affiliation.  Unfortunately for GCR, that assumption proved to be incorrect.  For others who might be in a similar boat, the Government Contracting Resources case offers an opportunity to consider whether an affiliation problem exists–and if so, take steps to address it before the issue arises in the context of a size protest.

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