SBA to Small Businesses: Be Careful with Ostensible Subcontractors on SBIR Awards

In a recent decision, the Small Business Administration (SBA) Office of Hearings and Appeals (OHA) examined a company that received two Small Business Innovation Research (SBIR) grant awards. The SBA Area Office had determined that the awardee was not an eligible small business due to ostensible subcontractor affiliation and other reasons. This decision is an important reminder for SBIR candidates on how they should structure subcontracting teams, as SBA will examine SBIR awardee eligibility.

In NFRL LLC, SBA No. SIZ-6174 (September 28, 2022), OHA reviewed a size protest decision concerning an a SBIR Phase II awards for a Next Generation Sniper Display and a Long-Range Machine Gun Sight to NFRL. For both awards, NRFL planned to use a company called Lightforce USA as its subcontractor.

Under SBA rules, a SBIR recipient must generally be a company that is more than “50% directly owned and controlled by one or more individuals (who are citizens or permanent resident aliens of the United States)” and a small business under 500 employees. 13 CFR § 121.702. The affiliation rules (also found in 13 CFR § 121.702) are similar to those found for general small business procurements, with some differences.

Typically, only Phase I awardees are eligible for a Phase II award. So, size protests wouldn’t come from a competitor. In this case, the size protest came from the contracting officer. The CO questioned, in part, (1) whether Lightforce may be too involved in award performance as compared to NFRL, (2) overlapping employees between the two companies, and (3) which company employed the Principal Investigator. The Area Office found that NFRL was affiliated with Lightforce “through common ownership, the newly-organized concern rule, and the ostensible subcontractor rule.”

Under the ostensible subcontractor rule, SBA found that:

  • NFRL will be reliant upon Lightforce to perform the primary and vital requirements, including research, breadboard testing, and prototype assembly. The proposals said that Lightforce employees will perform these duties under direction of a current Lightforce employee.
  • Approximately 64-66% of the total base year costs are associated with labor from Lightforce engineers and billed to to the subcontractor, Lightforce.
  • NRFL could not have won the awards “without the employees, past performance, and technical approach” of Lightforce.

A violation of the ostensible subcontracting rule results in both NRFL and Lightforce being treated as joint venturers. Therefore, each of them must independently meet the requirement of majoriy ownership by a US citizen or a permanent resident alien. As Lightforce did not meet this requirement, it was not a valid SBIR awardee.

NFRL appealed to SBA OHA. Interestingly, NFRL did not dispute that it was affiliated with Lightforce under the ostensible subcontractor rule. Rather, it argued that NRFL and Lightforce should not be treated as a joint venture for purposes of SBIR ownership and control requirements because SBA rules say only that “[a] concern and its ostensible subcontractor are treated as joint venturers, and therefore affiliates, for size determination purposes.” 13 C.F.R. § 121.702(c)(7).

Again, one of the SBIR eligibility rules requires ownership or control of greater than 50% by a citizen or permanent resident alien. OHA rejected NFRL’s argument, noting that the rules governing ownership and control of SBIR candidates are part of SBA’s “Small Business Size Regulations” at 13 C.F.R. part 121. As Lightforce is majority owned by an Australian citizen, the awardee did not meet SBIR ownership requirements.

This decision is an important reminder for SBIR prospective awardees. First, the ostensible subcontractor rule and other affiliation rules apply to SBIR awards. The prime contractor must be performing the primary and vital part of the work, and the proposal must reflect the prime contractor’s contribution. Second, ownership and control by a US citizen or permanent resident is crucial, both for a prime awardee and potential subcontractors.

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