When I was in fifth grade, I had to go door-to-door selling candy bars to raise money for a class field trip. I worked up the courage to peddle assorted chocolates to most of the neighbors, but avoided houses with those ominous “BEWARE OF DOG” signs. I was selling snacks; I didn’t want to become a snack myself for some large canine.
For service-disabled veteran-owned small business owners, the SBA Office of Hearings and Appeals has recently hung up its own ominous sign: “BEWARE OF LOANS,” at least when they come from non-service-disabled minority owners. In SDVOSB Appeal of Rush-Link One Joint Venture, SBA No. VET-228 (2012), the SBA Office of Hearings and Appeals found that loan arrangements between a service-disabled veteran and the company’s minority owners abrogated the service-disabled veteran owner’s control over the company.
In the Rush-Link One Joint Venture SDVOSB appeal, a service-disabled veteran owned 55% of the company’s stock. In return for providing critical loans to the company, three non-service-disabled veterans, who were minority owners in the company, held secured promissory notes, each secured by one-third of the service-disabled veteran’s interest in the company. The notes stated that the service-disabled veteran could not transfer his interest without the consent of the note holders, and also stated that the service-disabled veteran could not receive dividends or profit distributions until his obligations to the minority owners had been satisfied.
The SBA Area Office concluded that the notes violated 13 C.F.R. § 124.106(g), an 8(a) program rule stating, in relevant part, that a person may be found to exercise control over a company if he or she “provides critical financing” to the company or exercises control “through loan arrangements.” Applying the 8(a) regulation, the SBA Area Office held that the three non-veterans controlled the company through the secured promissory notes—meaning that the service-disabled veteran did not exercise unconditional control.
On appeal, SBA OHA agreed, and upheld the SBA Area Office’s decision. SBA OHA cited another 8(a) program regulation, 13 C.F.R. § 124.3, for the proposition that “ordinary” loans following “normal commercial practices” should not be the basis for finding that a small business owner does not control his or her company. In this case, however, SBA OHA found that the loans in question were “commercially irregular” because “the three note holders are not banks or other commercial lenders, but rather are themselves minority owners and board members” of the company.
Strangely, SBA OHA did not delve into the question of whether it was appropriate for the SBA Area Office to apply 8(a) program regulations to a SDVOSB eligibility protest. One can certainly argue that it makes sense to look to the 8(a) regulations for guidance in determining whether a service-disabled veteran “unconditionally controls” his or her company. However, the Rush-Link One Joint Venture decision seemed to go farther, suggesting that the 8(a) program regulations directly applied to the matter at hand (or at least failing to suggest that the 8(a) regulations were merely persuasive guidance).
In my opinion, SBA OHA should have been more careful to explain that the 8(a) program regulations do not directly apply to the SDVOSB program. In any case, service-disabled veterans are now on notice that, at least when it comes to loans from minority owners, the SBA will apply the 8(a) program rules, and may find that such loan agreements abrogate the service-disabled veteran’s unconditional control. Or, more simply put, BEWARE OF LOANS.