SBA OHA: 42%-49% Of Revenues Did Not Create Economic Dependence Affiliation

A small business was not affiliated with its largest customer under the SBA’s economic dependence affiliation rule, even though the small business earned as much as 49% of its revenues from the alleged affiliate–and even though the small business’s SEC Annual Report stated that the small business was dependent on its customer.

SBA OHA’s decision indicates that receiving less than 70% of revenues from an alleged affiliate may not, absent other indicia of affiliation, establish affiliation under the economic dependence rule.

SBA OHA’s decision in Size Appeal of Rockwell Medical, Inc., SBA No. SIZ-5559 (2014) involved Rockwell Medical, Inc.’s application to the U.S. Food and Drug Administration for a fee waiver.  The FDA referred the matter to the SBA for a size determination.

The SBA Area Office noted that sales to DaVita, Inc. accounted for 42% of Rockwell’s revenues in 2010, 48% in 2011, and 49% in 2012.  Additionally, Rockwell’s 2012 Annual Report on SEC Form 10-K said of DaVita “[w]e are dependent on this key customer and the loss of its business would have a material adverse effect on our business, financial conditions, and result of operations.”  The SBA Area Office found Rockwell affiliated with DaVita under the economic dependence affiliation rule.

Rockwell filed a size appeal with SBA OHA.  Rockwell argued that its sales to DaVita were not sufficient to constitute economic dependence within the meaning of the affiliation rules.  Rockwell also contended that the statements in its Annual Report were “standard financial statement disclosures” and risk factors that, as a publicly traded company, it was required by law to disclose.

Reviewing its prior decisions, SBA OHA wrote that it has “consistently affirmed determinations of affiliation based on economic dependence in cases where one concern was dependent on the other for the great majority of its revenue.”  SBA OHA pointed out that, under its case law, relying on a single customer for 70% or more of revenues will generally result in economic dependence affiliation.  However, where revenues from a single customer do not amount to the great majority of the small business’s revenues, “there must be some basis for finding economic dependence than the fact that the concern receives a substantial (but not majority) portion  of its revenues from another concern.”   In Rockwell’s case, it received “less than 50% of its revenues from DaVita, a figure nowhere near the 70% established as the standard of economic dependence . . ..”

SBA OHA then wrote that the Form 10-K “does not establish economic dependence by [Rockwell] upon DaVita.”  SBA OHA continued, “[w]hile the 10-K is extremely useful to an Area Office’s investigation of any public company, and in formulating follow-up questions for a challenged firm, when basing grounds for affiliation the Area Office should have stuck to the facts, sales figures, not the opinions of securities lawyers.”  SBA OHA granted Rockwell’s size appeal.

SBA OHA’s decision in the Rockwelll Medical size appeal provides some much-needed clarification about how the economic dependence affiliation rule should be applied when a small business receives a large share–but not 70% or more–of its revenues from a single customer.  Although every size case is somewhat fact dependent, Rockwell Medical may give some comfort to small business owners concerned about potential affiliation with their largest customers.

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