Many of the SBA’s small business programs have restrictions on what are commonly referred to as “extraordinary circumstances” or “extraordinary actions.” It’s a topic that we have discussed many times before, including this blog post discussing a case at SBA’s Office of Hearings and Appeals, reviewing extraordinary circumstances in the context of control and operating agreements. SBA often discusses extraordinary circumstances in the context of joint venture control, where the managing venturer must control decisions except for those considered to be extraordinary. But there is a different meaning in the context of an entity seeking certification under an SBA socioeconomic program, where the qualifying individual must have control over all actions and circumstances except for those determined to be extraordinary. This post will focus on the latter situation. And, as any knowledgeable small business federal government contractor can attest to, knowing what actions are and are not extraordinary, is very important to maintain eligibility for the SBA’s programs.
Unfortunately, as many small business federal government contractors can also likely attest to, it is not as simple as looking at a regulation to know whether a certain action or circumstance is extraordinary or not. After all, across the SBA’s programs, including the WOSB, SDVOSB, and 8(a) programs, it is not exactly black and white. Thankfully, SBA seems to have acknowledged that fact, as evidenced by the upcoming final rule that, as part of many revisions, directly updates this issue.
Knowing what actions are and are not considered extraordinary is extraordinarily important. (Ha! see what I did there?) Why? Well, it all comes down to control. When looking at the SBA’s programs, the qualifying individual, meaning the person upon whom eligibility for any given SBA program is based, must have control over the business. This is a basic building block of all SBA programs which is stated in 13 C.F.R. § 124.106 for 8(a) Program participants, 13 C.F.R. § 127.202 for WOSBs, and 13 C.F.R. § 128.203 for SDVOSBs. The HUBZone program is based on location and employees, not the qualifying individual, so it works differently.
Well, SBA will now clear up some of the uncertainty with its new rule, effective January 16, 2025.
The old version of 13 C.F.R. § 121.103(a)(3) states:
[c]ontrol may be affirmative or negative. Negative control includes, but is not limited to, instances where a minority shareholder has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.
With the upcoming change, 13 C.F.R. § 121.103(a)(3) will include a list of what is considered extraordinary circumstances:
Control may be affirmative or negative. Negative control includes, but is not limited to, instances where a minority shareholder has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders. However, SBA will not find that a minority shareholder has negative control where such minority shareholder has the authority to block action by the board of directors or shareholders regarding the following extraordinary circumstances:
(i) Adding a new equity stakeholder or increasing the investment amount of an equity stakeholder;
(ii) Dissolution of the company;
(iii) Sale of the company or all assets of the company;
(iv) The merger of the company;
(v) The company declaring bankruptcy;
(vi) Amendment of the company’s corporate governance documents to remove the shareholder’s authority to block any of (a)(3)(i) through (v); and
(vii) Any other extraordinary action that is crafted solely to protect the investment of the minority shareholders, and not to impede the majority’s ability to control the concern’s operations or to conduct the concern’s business as it chooses.
The addition of (c)(i)-(vii) helps to clear up some questions that have been lingering about what a minority shareholder is permitted to do, and what SBA considers negative control. SBA will be updating the WOSB and 8(a) program rules, and clarifying the SDVOSB rule, along these same lines, in sections 124.106(h), 127.202(h) and 128.203(j)(6).
Similar to the small business rule, here is what the new 8(a) rule will say at 13 C.F.R. § 124.106(h):
(h) Exception for extraordinary circumstances. SBA will not find that a lack of control exists where a socially and economically disadvantaged individual does not have the unilateral power and authority to make decisions regarding the following extraordinary circumstances:
(1) Adding a new equity stakeholder or increasing the investment amount of an equity stakeholder;
(2) Dissolution of the company;
(3) Sale of the company or all assets of the company;
(4) The merger of the company;
(5) The company declaring bankruptcy;
(6) Amendment of the company’s corporate governance documents to remove the shareholder’s authority to block any of paragraphs (h)(1) through (5) of this section;
(7) Any other extraordinary action that is crafted solely to protect the investment of the minority shareholders, and not to impede the majority’s ability to control the concern’s operations or to conduct the concern’s business as it chooses.
Thankfully, these actions appear to be in line with what earlier OHA decisions have held. In its commentary, SBA agreed with a comment asking “that SBA adopt language stated in OHA size appeal cases that super majority provisions crafted to protect the investment of the minority shareholders, and not to impede the majority’s ability to control the concern’s operations or to conduct the concern’s business as it chooses should be permitted.” This appears to bring in the various decisions over the years that have defined extraordinary actions.
I know that I, for one, appreciate the new transparency as it gives small business federal government contractors a clear line to follow in a topic that was, at best, a bit foggy.
These changes will go into effect on January 16, 2025.
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