The SBA Affiliation Rules, Trustees, and Negative Control: A Cautionary Tale

Small government contractors ask me, with some frequency, whether placing a company’s stock in a trust will protect the company from affiliation under the SBA affiliation rules.

I typically answer this question with one of my own: “who will control the trust?”  I tell them that if the same people who currently control the company will continue to control it once the stock is placed in trust, the mere act of placing the company’s stock in the trust is unlikely to shield the company from affiliation with other companies controlled by those same people.

A recent size appeal decision of the SBA Office of Hearings and Appeals confirms that the ordinary SBA affiliation rules typically still apply when a company’s ownership is placed in trust.  In fact, in this size appeal decision, the company in question lost out on a contract because one of the trustees had so-called “negative control” over the company–essentially, the ability to veto the decisions of the other trustee.

SBA OHA’s decision in Size Appeal of Chu & Gassman, Inc., SBA No. SIZ-5344 (2012) involved a VA procurement for architect/engineering services.  After Chu & Gassman was identified as the apparent successful offeror, a competitor filed a SBA size protest, alleging that Chu & Gassman was affiliated under the SBA affiliation rules with two other businesses: Chu & Gassman Consulting Engineers, PC and Sunrise Management Services, Inc.

The SBA Area Office found that Mr. Gassman controlled Chu & Gassman, because he was the 51% owner and president.  Mr. Chu was the 49% owner.  In contrast, Mr. Chu was the 51% owner and president of Engineers, whereas Mr. Gassman was the 49% owner.  Sunrise Management Services was controlled by an Employee Stock Ownership Plan trust, which was managed and directed by Mr. Chu and Mr. Gassman as trustees.  Mr. Chu and Mr. Gassman also served as the company’s two directors.

The Area Office found that Chu & Gassman was affiliated with both Engineers and Sunrise under the SBA affiliation rules.  On appeal, SBA OHA reversed the finding with respect to Engineers.  (SBA OHA used particularly feisty language, scolding the Area Office for failing to follow its directions in an earlier decision involving the same companies.  I will write a separate post later this week discussing this matter in greater detail).

However, SBA OHA agreed with the Area Office that Chu & Gassman was affiliated with Sunrise.  It noted that “Mr. Gassman is one of two Trustees controlling the ESOP Trust which holds all of the Sunrise stock, and he is also a director of Sunrise.”  SBA OHA continued, “these facts . . . establish[] a clear cut case of negative control of Sunrise by Mr. Gassman”  under the SBA affiliation rules.  SBA OHA explained that negative control arises when an individual can block others from taking affirmative action on behalf of the company, and stated that “[t]he fact that Mr. Gassman has a fiduciary duty as a Trustee in no way diminishes his power to exercise negative control over Sunrise.”  SBA OHA concluded that the two companies were “clearly affiliated.”

The Chu & Gassman SBA size appeal decision confirms that simply placing stock ownership in trust is not sufficient to avoid affiliation under the SBA affiliation rules.  Shared control is the underlying concept of all forms of affiliation, and if the same individuals have the power to control two companies–whether that control is affirmative or negative–those companies will likely be considered affiliates.

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