SBA Affiliation Rules: “Inter-Affiliate Transactions” Exception Is Narrow

Under the SBA’s affiliation rules, the so-called “inter-affiliate transactions” exception applies only where the companies in question would be eligible to file a consolidated tax return.

In a recent size appeal decision, the SBA Office of Hearings and Appeals held that the inter-affiliate transactions exception does not apply when affiliated companies are ineligible to file a consolidated tax return–a result that seems to authorize “double counting” of affiliated companies’ revenues in the context of SBA size determinations.

If you are a regular reader of SmallGovCon (and I certainly hope that you are),  you will recall yesterday’s post about OHA’s size appeal decision in Size Appeals of G&C Fab-Con, LLC, SBA No. SIZ-5649 (2015).  That post focused on the interaction–or lack thereof–between the VA CVE’s SDVOSB verification and the SBA’s size determination process.  But the G&C Fab-Con decision is also important because of OHA’s interpretation of how the revenues of affiliated companies are counted in the size determination process.

The G&C Fab-Con size appeal involved three VA RFPs for construction projects at national cemeteries.  All three RFPs were set aside for SDVOSBs under NAICS codes designated with $33.5 million receipts-based size standards.

In September and October 2014, the VA announced that G&C Fab-Con, LLC was the apparent awardee under all three RFPs.  Unsuccessful competitors filed SBA size protests, challenging G&C’s eligibility for the awards.

The SBA Area Office found that Dr. James Carter Griffith owned 51% of G&C and served as its Managing Member.  The remaining 49% was owned by three members of the Creter family.  The Creters also served as officers of G&C, holding the positions of Vice President of Construction, Vice President of Operations, Quality Assurance/Quality Control Manager, Senior Project Manager, Secretary, and Treasurer.  The Creters controlled other businesses, collectively referred to as the “Creter companies” in OHA’s redacted decision.  One of the Creter companies, known as “Company 1” in the redacted decision, had done business with G&C.

The SBA Area Office determined that G&C was affiliated with the Creter companies under the “common management” affiliation rule.  The Area Office emphasized that the Creters held key positions with G&C and therefore “have critical influence or the ability to substantively control” G&C.  The Area Office concluded that G&C’s average annual receipts, when combined with those of the Creter companies, exceeded the $33.5 million size standard.

G&C filed a size appeal with OHA.  Among its arguments, G&C contended that transactions between itself and Company 1 should be excluded under the SBA’s “inter-affiliate transactions” rule under 13 C.F.R. § 121.104(a).  That rule provides that “total receipts” for SBA size purposes does not include “proceeds from transactions between a concern and its domestic or foreign affiliates.”  In previous decisions, OHA has written that the purpose of the inter-affiliate transactions rule is to prevent “double counting of income” during the size determination process.

Based on the plain language of the regulation, one might assume that the inter-affiliate transactions exception would apply to transactions between G&C and Company 1.  But OHA took a different view.  After examining the SBA’s regulatory history–that is, the comments made by SBA when it issued the regulation–OHA concluded that the “the inter-affiliate transaction exclusion applies only if the concerns in question have a parent-subsidiary relationship and are eligible to file a consolidated tax return.”

OHA concluded that the SBA Area Office had correctly declined to apply the inter-affiliate transactions rule to the transactions between G&C and Company 1.  OHA denied G&C’s size appeal.

I have a great deal of respect for OHA, and rarely find myself disagreeing with the legal merits of an OHA decision.  Here, though, I think OHA got it wrong.  The plain language of the regulation excludes transactions between “affiliates,” and “affiliates” is broadly defined in 13 C.F.R. § 121.103 to include companies with many types of overlapping control–including common management.  In my view, the inter-affiliate transaction rule was clear; there was no need for OHA to turn to the regulatory history to arrive at a different (and much narrower) meaning of the term “affiliates.”  OHA itself has previously written that regulatory history should only be consulted when a regulation is facially ambiguous, not to create an ambiguity that was not evident from the regulation’s text.

Regardless of the legal merits, I am concerned that the decision essentially authorizes the SBA to double count receipts of affiliated companies, except when those companies are affiliated due to a formal parent/subsidiary relationship.  For example, assume that “Company A” earns $10 million from a government prime contract, and subcontracts $4 million of that amount to “Company B.”  If the two companies are affiliated, the affiliates should be found to have collectively earned $10 million; Company B’s $4 million is the same money that Company A was paid by the government and only should be counted once.  But under OHA’s decision, if Company B is not a subsidiary of Company A, but instead is affiliated with Company A for some other reason, the affiliates will be assessed with $14 million in collective revenues–effectively double-counting the amounts subcontracted to Company B.

I do not think it is wise public policy to double-count the revenues of affiliated companies, which I believe will lead to artificially inflated “receipts.”  Additionally, I do not believe that there is a good public policy distinction to be made between parent/subsidiary affiliates and other types of affiliates that would exclude such double-counting in the former instance, but not the latter.

Perhaps OHA will reconsider its approach, but if not, I hope that the SBA’s regulators will strongly consider amending the regulation to clarify that it applies to all affiliate relationships.  In the meantime, small businesses should beware of transacting business with actual or potential affiliates, except in the case of a formal parent/subsidiary relationship.

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