A SDVOSB’s Employee Stock Ownership Plan caused the company to be ineligible under the SBA’s SDVOSB rules because the service-disabled veteran did not own 51% of the ESOP class of stock.

A recent SBA Office of Hearings and Appeals decision should serve as a cautionary tale to any SDVOSB contemplating establishing an ESOP–or any other ownership structure consisting of multiple classes of stock.

OHA’s decision in Precise Systems, Inc., SBA No. VET-234 (2014) involved a State Department solicitation for aviation program support services.  The solicitation was set aside for SDVOSBs.

After reviewing competitive proposals, the agency announced that Precise Systems, Inc. was the apparent awardee.  Four unsuccessful competitors then filed protests challenging Precise Systems’ SDVOSB eligibility.  The protesters contended that Precise Systems did not satisfy the SDVOSB ownership requirements under the SBA’s SDVOSB regulations because of the company’s ESOP.

The SBA Director of Government Contracting, which has jurisdiction over SBA SDVOSB protests, determined that John Curtis, a service-disabled veteran, owned more than 51% of Precise Systems’ outstanding shares.  The remaining shares were held by Precise Systems’ ESOP.

The outstanding shares were divided into two categories: Series A and Series B.  All of the shares owned by Mr. Curtis were Series A Common Stock.  The shares owned by the ESOP were Series B Convertible Preferred Stock.  Mr. Curtis did not own any of the Series B stock.

The SBA D/GC noted that under 13 C.F.R. § 125.9, when a SDVOSB is a corporation, service-disabled veterans must own at least 51% of each class of outstanding voting stock.  The D/GC held that Precise Systems did not satisfy this requirement because Mr. Curtis did not own at least 51% of the Class B stock.  The D/GC issued a determination finding Precise Systems to be ineligible for award of the State Department SDVOSB set-aside contract.

Precise Systems filed an appeal with OHA.  Precise Systems made a number of arguments challenging the D/GC’s determination.  Among its arguments, Precise Systems contended that the D/GC’s determination was inconsistent with the regulations governing the VA’s SDVOSB program.  The VA’s separate SDVOSB regulations contain certain exceptions for stock held by an ESOP.  Additionally, Precise Systems argued that it is contrary to good public policy to discourage SDVOSBs from establishing ESOPs.

OHA disagreed with Precise Systems’ reasoning.  With respect to the VA’s SDVOSB program, OHA wrote “[t]he VA program . . . is a separate program from that of SBA, and it specifically exempts ESOPs.”  OHA continued, “SBA’s program contains no such exemption, and there is no legal basis for OHA to read in such an exception.”

OHA also refused to rule in Precise Systems’ favor on the basis of public policy.  OHA wrote that public policy criticism “are beyond the scope of OHA’s review, and instead should be directed to SBA policy officials.”  OHA upheld the D/GC’s ruling.

The Precise Systems case should serve as a warning for any SDVOSB intending to establish an ESOP, or any other structure involving multiple classifications of stock.  Although the SBA’s SDVOSB regulations do not prohibit a SDVOSB from establishing separate classifications of stock, the regulations do require service-disabled veterans to own at least 51% of each class of stock–even when one of those classes of stock has been established for an ESOP.