This is a the second article of two taking you back to the basics of affiliation. The first, giving you a general overview of affiliation, can be found here. This follow-on article goes through the different bases for affiliation, as set forth in SBA’s affiliation regulations. Keep in mind though, this is still affiliation “basics” and does not go into a detailed analysis of each type of affiliation, as that would be a novel–not a blog.
1. Common ownership.
Common ownership affiliation arises when two companies have shared ownership. Specifically, it arises when one company owns or controls, or has the power to control, 50% or more of another company’s voting stock, or a block of voting stock which is large compared to other outstanding blocks of voting stock. For example, if one individual owns the majority share in two companies, those companies are affiliated on this basis.
But it is important to note, majority ownership is not always necessary under this rule. For example, if a company has five owners–three with 25% each of the voting stock, one with 15%, and one with 10%–the three 25% owners will each be presumed to control the company because their minority holdings are large, compared with any other stock holding. Additionally, SBA can find that a minority owner controls a company if she or he has “negative control,” or the abiliity to block ordinary actions essential to operating the company–and that entity will be affiliated with other firms the minority owner has control over.
2. Stock options, convertible securities, and agreements to merge.
Affiliation may also arise under stock options, convertible securities, and agreements to merge. Basically, the SBA will treat these types of agreements as though they are already effective, the so-called “present effect” rule. So, for example, when a company agrees to merge with another company, SBA will consider the merger as already having happened. Now, the SBA’s OHA has said it will not apply this present effect rule if the agreement (1) is subject to a condition precedent that is “unusual, incapable of fulfillment, speculative, or conjectural,” or (2) there is a low probability that the transaction would be effectuated, or the rights exercised.
3. Common management.
Affiliation based on common management may arise when two firms share management. Specifically, it arises “where one or more officers, directors, managing members, or partners who control the board of directors and/or management of one concern also control the board of directors or management of one or more other concerns.” According to SBA’s OHA, this “control” does not “require that individual manager(s) exercise total control of a concern, just that they possess critical influence or the ability to exercise substantive control over a concern’s operations.” Keep in mind, this is a different basis that common ownership and does not require majority ownership. For example, if two companies have the same president, those companies may be affiliates, regardless of whether the president is the majority owner of either company.
4. Identity of interest.
Affiliation based on identity of interest arises when two companies “have identical or substantially identical business or economic interests (such as family members, individuals or firms with common investments, or firms that are economically dependent through contractual or other relationships)[,]” and such companies “may be treated as one party with such interests aggregated.” Under this rule, there are three types of identity of interest affiliation: familial relationships, common investments, and economic dependence.
Familial Affiliation is presumed where firms are owned or controlled by spouses, parents, children, and siblings, and those firms conduct business with each other. Common investment affiliation may be presumed where SBA finds that enough common business interests cause the parties to act in unison for their common benefit (but the rules don’t elaborate on how many common interests that is). And economic dependence affiliation is presumed “if the concern in question derived 70% or more of its receipts from another concern over the previous three fiscal years.”
Importantly, this basis for affiliation (including each of its sub-bases) does not automatically lead to affiliation. It leads to a presumption of affiliation which may be rebutted by showing that the companies’ interests are in fact separate.
5. Newly-organized concern.
Affiliation under the newly-organized-concern rule is used by SBA to prevent the use of “spin-off firms” posing as small, independent firms, which are really large firms’ affiliates. It requires four factors: (1) former officers, directors, principal stockholders, managing members, or key employees of one company organize a new company; (2) the new company and old company are in the same or related industry or field of operation; (3) the former officers, etc. serve as officers, directors, principal stockholders, managing members or key employees of the new company; and (4) the old company provides assistance to the new company in the form of contracts, financial assistance, technical assistance, facilities and so on.
6. Joint ventures and ostensible subcontractor.
This affiliation rule explains, subject to exceptions for joint ventures meeting certain SBA requirements, the members of a joint venture are affiliated when the two companies form the joint venture for the purposes of seeking a contract; but, they are affiliated for the purposes of that contract alone. It also provides that a prime contractor may be affiliated with its subcontractor for purposes of the procurement at issue if the subcontractor will perform the primary and vital portions of the work and/or the prime contractor is unusually reliant upon the subcontractor, which is called the “ostensible subcontractor rule.” And a prime contractor and its ostensible subcontractor are treated as joint venturers in determining their size for a particular contract.
7. Franchise and license agreements.
A franchise or license agreement will only result in affiliation based on the restraints in the agreement, or other means, such as common ownership or management. The franchise may place restraints on the franchisee or licensee related to standardized quality, advertising, accounting format and other similar provisions, but excessive restrictions upon the sale of the franchise interest may result in affiliation.
8. Totality of the circumstances.
Great! We made it through the list! If you are a small contractor trying to avoid affiliation and you got through all of those grounds for affiliation without a scratch, you are good, right?
Eh, not quite yet.
SBA’s affiliation regulations add in a fun little catch-all. They say, “In determining whether affiliation exists, SBA will consider the totality of the circumstances, and may find affiliation even though no single factor is sufficient to constitute affiliation.” Under this totality of the circumstances affiliation, SBA will simply decide if it finds two companies’ interactions to be so suggestive of reliance that affiliation can be found. And if so, it won’t matter how many “no” boxes for affiliation your companies’ already checked.
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This is an extremely surface-level swim through the various grounds of affiliation in SBA’s rules. Affiliation is a highly-complex and ever-evolving concept in small business government contracting. So, don’t be afraid to reach out for help in analyzing potential affiliation for your company.
Questions about affiliation? Or need help with another government contracting legal issue? Email us.