New Avenue for SBA Protests: Ostensible Subcontractor Status Protests

SBA has issued a final rule, effective December 30, that will now provide an avenue to protest situations where the prime contractor on a SDVOSB, HUBZone, or WOSB set-aside contract is subcontracting most or all of the work to a non-similarly situated—but still small business—concern. It will also allow SBA to review eligibility for 8(a) Program contracts on this ground as well.

Interestingly, this was not something that could be protested at SBA under the previous SBA size protest regulations or the FAR. Prior to the new rule, an offeror for a socioeconomic set-aside contract could protest an awardee’s SDVOSB, HUBZone, or WOSB status. And it could protest an awardee’s size on the basis of a violation of the ostensible subcontractor rule. But an offeror could not protest an awardee’s status on the basis of ostensible subcontractor affiliation with a non-similarly situated small business—until now.

SBA defines an ostensible subcontractor as a subcontractor that “performs primary and vital requirements of a contract, or of an order,” or as “a subcontractor upon which the prime contractor is unusually reliant.” When SBA finds that a prime contractor has an ostensible subcontractor, it “will treat the small business prime contractor and its subcontractor as joint venturers[,]” and aggregate the companies for size purposes. If the aggregate receipts or employees makes the awardee other than small, the awardee will be found ineligible for award based on this affiliation.

But if such affiliation does not result in size ineligibility for the contract’s NAICS code, there was no way to protest status ineligibility on the basis of ostensible subcontractor affiliation. And there was really no way for SBA to review this aspect of 8(a) Program contract eligibility either. In proposing the new rule, SBA explained:

SBA has become aware of service contract set-asides for the SDVO, HUBZone, 8(a) or WOSB programs where the prime contractor subcontracts most or all of the actual performance to a small business that is small for the applicable NAICS code but not eligible to compete for award of the prime contract and thus not a similarly situated entity[.]

But as SBA acknowledged:

There is no existing regulatory mechanism for an unsuccessful offeror, the SBA, or a contracting officer to protest a socioeconomic set-aside or sole-source award to a prime contractor that is unduly reliant on a small, but not similarly situated entity, subcontractor.

SBA determined that the inability to regulate such circumstances was not in concert with SBA’s policy of treating ostensible subcontractors and their prime contractors as joint ventures. In SBA’s words:

The performance of a set-aside or sole source service contract by a small business concern that is not eligible to compete for the prime contract is contrary to the intent and purpose of the statutory authorities for socioeconomic category set-aside and sole source procurements.

Thus, SBA has proposed a new rule to address this issue and to ensure that contractors performing “set-aside contracts in a manner more consistent with a joint venture than a prime/sub relationship” will be held accountable to SBA’s requirements for socioeconomic joint ventures. The new rule will allow SBA to make a determination on whether the SDVOSB, HUBZone, or WOSB is over-reliant on the non-similarly situated subcontractor during an SBA status protest determination.

It will be codified in the SDVOSB, HUBZone, and WOSB regulations regarding contract eligibility. The rules for each type of set-aside will basically state the same thing:

Where a subcontractor that is not similarly situated performs primary and vital requirements of a set-aside or sole-source service contract or order, or where a prime contractor is unduly reliant on a small business that is not similarly situated to perform the set-aside or sole source service contract or order, the prime contractor is not eligible for award of an [SDVOSB, HUBZone, or WOSB/EDWOSB] contract.

SBA will add similar language to the SDVOSB, HUBZone, and WOSB protest grounds, providing a new avenue for “cases where the prime contractor appears unduly reliant on a small, non-similarly situated entity subcontractor or where the small nonsimilarly situated entity is performing the primary and vital requirements of the contract[.]”

As for 8(a) Program contract eligibility (which still cannot be protested under SBA’s regulations), the new rule will simply add language to the contract eligibility regulations allowing SBA to review whether the Participant “will meet the limitations on subcontracting provisions[.]”

SBA will make all of these determinations under the existing ostensible subcontractor rule and OHA decisions. And where SBA determines that the non-similarly situated subcontractor is an ostensible subcontractor, it will treat the relationship as a joint venture that is not in compliance with SBA’s requirements to receive and perform socioeconomic program set-aside or sole-source award contracts as a joint venture.

For an example of how this new rule changes things, lets say we have two companies: Rick Innovations, LLC, an SDVOSB; and Morty Safety, LLC, a small business. Rick is awarded a VA contract 100% set aside for SDVOSBs, and Morty is his only subcontractor on the project. Rick is unduly reliant on Morty for the contract’s performance and Morty will actually be the company performing the primary and vital requirements of the contract.

Now, let’s say an unsuccessful offeror protests the size and status of Rick under the previous SBA regulations. If SBA finds ostensible subcontractor affiliation but the two firms’ aggregated size is under the applicable contract size standard and finds that Rick is an eligible SDVOSB—Rick will be found eligible for the VA contract. This is the case even though Morty, a non-SDVOSB, will be performing most of the contract; but under the old rule there is nothing more SBA can do.

Under the new rule, however, SBA would consider Rick and Morty a joint venture. And the joint venture would be found non-compliant with SBA’s strict rules for a SDVOSB joint venture between an SDVOSB and a small business (the ostensible subcontractor relationship means that Rick would not meet the limitation on subcontracting requirements). Rick would therefore be ineligible for the VA contract.

Thus, this new rule will close what many consider to be a significant loophole in the current regulations—though SBA acknowledged that the new rule has faced some opposition. But regardless, SBA feels the new rule will better serve the intent and policy of the socioeconomic programs. SBA explained:

While SBA encourages benefits that accrue to the small business community as a whole, Congress’s clear intent in authorizing separate and distinct Government contracting programs was to bolster specific socioeconomic groups’ ability to successfully compete for and perform on Government contracts. SBA would be subverting Congress’s intent if it focused on rules that benefit the overall small business community at the expense of the groups identified by Congress as meriting focus.

As for SDVOSB, HUBZone companies, 8(a) Program Participants, and WOSB prime contractors proposing the use of small business subcontractors, so long as you demonstrate adherence to the applicable limitation on subcontracting requirements–which was already required–the new rule and new protest avenue might be nothing to worry about. The rules explain this “safe harbor” as follows:

SBA will find that a prime [SDVOSB/ HUBZone/8(a) Program/WOSB or EDWOSB] contractor is performing the primary and vital requirements of a contract or order and is not unduly reliant on one or more non-similarly situated subcontracts where the prime contractor can demonstrate that it, together with any similarly situated entity, will meet the limitations on subcontracting provisions set forth in § 125.6.

For most SDVOSBs, HUBZone companies, 8(a) Program Participants, and WOSBs, the new rule should provide a benefit. Not only will it prevent ineligible firms from taking advantage of a loophole to receive contracts they could not otherwise get, but it will also open up subcontracting opportunities for these socioeconomic program participants that may have previously gone to small businesses outside these programs.

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