SBA Affiliation Rules: SBA OHA Says Control is the Key

The SBA affiliation regulation, 13 C.F.R. § 121.103, states that all affiliation is premised on the notion of control.  In other words, two companies are affiliated when the same person or entity controls or has the power to control both.

The size appeal decision of the SBA’s Office of Hearings and Appeals in Size Appeal of Manroy, USA, LLC, SBA No. SIZ-5244 (2011), explains that when there is no overlapping control, there is no affiliation, even if one or more of the indicia of affiliation described in the regulation might arguably be present.

Manroy was owned 51% by an individual, John Buckner, and 49% by an entity, Caledonian Heritable, Ltd., or CHL.  The company applied to the HUBZone program, but was denied because the SBA found that it was not a small business.

The SBA’s Area Office determined that Manroy was affiliated with CHL because Mr. Buckner and CHL had two common investments—Manroy, and a piece of real property Manroy used for its offices.  Citing 13 C.F.R. §  121.103(f), the SBA Area Office held that the common investments meant that CHL and Mr. Buckner had an “identity of interest,” under the SBA affiliation rules, resulting in affiliation between CHL and any companies controlled by Mr. Buckner, including Manroy.

SBA OHA disagreed.  As an initial matter, it held that the common investments in question—the company itself, plus a piece of real property used by the company—were insufficient to create an identity of interest under the SBA affiliation rules.  In fact, rather than suggesting that Mr. Buckner and CHL had a broad-based business relationship, which could lead to affiliation, the real property “highlights that Appellant’s business pursuits are the only endeavors that Mr. Buckner and CHL are jointly undertaking.”

Then, SBA OHA got to the real heart of the matter: control.  It wrote:

“More importantly, there is simply no evidence that Appellant and CHL can control one another or that a third party can control both entities.  There is no information in the record that CHL, as minority shareholder, could control appellant.  Nor is there any indication that Mr. Buckner (who does control Appellant) could control CHL.  Thus, the firms cannot be affiliated.”

Catch that last sentence?  I underlined it just in case.  According to SBA OHA (and the regulation itself), two firms cannot be affiliated without overlapping control.  A minority stake, even 49% like CHL’s, does not necessarily amount to control under the SBA affiliation rules  (but draft your bylaws or operating agreement carefully, because veto power or supermajority requirements can cause negative control).

Kudos to SBA OHA for this size appeal decision, which wisely returns the SBA’s focus to the basic definition of affiliation itself—control or the power to control.  Hopefully, Manroy will have some legs as precedent when the SBA reviews future size protests.

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