As frequent SmallGovCon readers know, the Small Business Administration’s ostensible subcontractor rule can be tricky to navigate. The rule requires contractors not to rely too heavily on a subcontractor in the performance of a contract set aside under an SBA socioeconomic program, but what constitutes relying too heavily can be confusing for small business contractors. Without a clear measure of how reliant is too reliant, businesses have to worry that they may be denied an award or even worse, lose one in a post-award protest. In a recent decision, Daniels Building Company, Inc. v. United States, 24-1787, 175 Fed. Cl. 767 (2025), the Court of Federal Claims (COFC) provided potentially helpful insight into what SBA’s Office of Hearings and Appeals (OHA) and the Court of Federal Claims will consider when determining whether a prime contractor is “unusually reliant” on its subcontractor.
The Ostensible Subcontractor Rule
Simply put, this rule requires that any small business awarded a set-aside contract has to be the party actually performing the primary and vital work under the contract and is not overly reliant on a non-similarly situated contractor. 13 C.F.R. § 121.103(h)(3). Read more about the rule here. SBA has another rule establishing limitations on subcontracting which limits what percentage of work can be paid to a non-similar subcontractor. 13 C.F.R. § 125.6. This blog post has some further insight into that particular rule. The overlap between these two rules forms the basis of the ostensible subcontractor rule.
A recent change to the rule, effective May 30, 2023, stated that SBA will not find that the primary and vital requirements are being performed by the subcontractor, or that the prime contractor is unusually reliant on the subcontractor, if the prime contractor can “demonstrate that it, together with any subcontractors that qualify as small businesses, will meet the limitations on subcontracting” found in 13 C.F.R. § 125.6. 13 C.F.R. § 121.103. However, for general construction contracts, the SBA has added to the regulation that “the primary and vital requirements of the contract are the management, supervision and oversight of the project, including coordinating the work of various subcontractors, not the actual construction work performed.” 13 C.F.R. § 121.103(h)(3)(iv). So, the limitations on subcontracting exception does not apply to general construction contracts, like the one at play in this decision.
The rule essentially functions to make sure that set-aside government funds are actually going to the businesses they are set aside for, rather than larger entities that might use the small business as a pass through. While it’s true that subcontractors are essential to the prime’s ability to perform a contract, SBA is wary of a small business contractor being “unduly reliant” on a subcontractor that is not similarly situated (i.e., any business that is not another small business with the same program status, defined in 13 C.F.R. § 125.1). SBA acknowledges the need for contractors to benefit from the experience and past performance of subcontractors—in fact, this is even encouraged by the SBA’s mentor-protégé program (the details of which are governed by 13 C.F.R. § 125.9, and which SmallGovCon readers can find more about here). Nonetheless, if the subcontractor performs “primary and vital requirements” of the contract or the prime is “unusually reliant” on the subcontractor, SBA will treat the prime and subcontractor as affiliated for the purpose of size determination—meaning the prime contractor will be ineligible for the award.
The question remains, how does SBA determine what is “unusually reliant?” The Daniels case provides some insight.
If it Looks Like a Duck, and Quacks Like a Duck…How to Determine Primary and Vital Work
In the Daniels case, the court reviewed an OHA decision finding that an awardee was not unusually reliant on its subcontractor. The prime contractor, Veterans Electrical Group (or VEG) qualified as an SDVOSB and was awarded a contract from the VA. To perform the contract, VEG executed a teaming agreement with Roncelli, Inc., a general contractor, and structured the teaming agreement so that the prime would be compliant with SBA regulations and maintain VEG’s eligibility for the award. Daniels, a disappointed bidder for the award, challenged VEG’s status, arguing they were unduly reliant on Roncelli and thus should be treated as affiliated, thereby rendering them ineligible for the award. The Area Office granted Daniels’ protest, but it was overturned on appeal to OHA. “OHA determined that VEG would be responsible for the overall management of the contract’s performance,” as well as job site oversite and contract performance, and this met the primary and vital requirements for a general construction contract.
The COFC applied a four-factor test to determine whether OHA arrived at the correct decision regarding unusual reliance.
For unusual reliance, SBA case law provides a four-factor test to demonstrate unusual reliance on a subcontractor: (1) “the proposed subcontractor is the incumbent contractor and is ineligible to compete for the procurement;” (2) “the prime contractor plans to hire the large majority of its workforce from the subcontractor;” (3) “the prime contractor’s proposed management previously served with the subcontractor on the incumbent contract;” and (4) “the prime contractor lacks relevant experience and must rely upon its more experienced subcontractor to win the contract.” “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.” 13 C.F.R. § 121.103(a)(5). OHA’s consideration of these four factors, combined with other indicia of unusual reliance, “is consistent with 13 C.F.R. §§ 121.103(a)(5) and (h)(4)” which requires consideration of all aspects of the relationship.
The court clarified that a subcontractor’s assistance to a prime contractor in obtaining a bid “does not demonstrate unusual reliance in and of itself but may be an indicator.” Id. The decision analyzed the VEG/Roncelli relationship through the lens of their teaming agreement, as well as their communications following receipt of the award, and applied the four factors to determine VEG was not unduly reliant on Roncelli. The Court pointed out that VEG was not planning to hire its workforce or management from Roncelli, and that Roncelli was not the incumbent contractor. There was no evidence that VEG relied on Roncelli’s experience to win the contract, and in fact Roncelli was not even mentioned in VEG’s bid.
Bottom Line
In the general construction context, ostensible subcontractor analysis is still based on all factors, not just work percentage. OHA is primarily concerned with suspicious dependence on a subcontractor by a small business awardee. They will look closely for continuity between the prior contractor and the new prime contractor—if it looks like the last contractor has graduated out of the program and is using a new SDVOSB (or similar SBA program participant) to continue receiving that sweet government set aside cash, OHA will hold the new prime contractor ineligible. But if the new prime uses their own employees and management, or the subcontractor is not the incumbent (or is eligible themselves to compete for the award), OHA will not apply the ostensible subcontractor rule. The line between reasonable assistance from a subcontractor and inappropriate reliance can seem hazy, but it really boils down to who is getting the work done and whether government funds are going to the people they were intended to go to.
Editor’s Note: Special thanks to our wonderful legal clerk Will Orlowski for putting together this blog post.
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