Ostensible Subcontractor Affiliation: SBA Proposes Exception For “Similarly Situated” Entities

The ostensible subcontractor affiliation rule would be modified to include an exception for “similarly situated” entities serving as subcontractors, if a recent rule change proposed by the SBA goes into effect.

Under the SBA’s proposal, a small business would be exempt from ostensible subcontractor affiliation with another small business for a small business set-aside contract, an 8(a) participant with another 8(a) participant for an 8(a) set-aside contract, and so on.

As SmallGovCon readers are aware, the SBA recently proposed an overhaul of the limitations on subcontracting rules in order to align the SBA’s regulations with changes made by Congress as part of the 2013 National Defense Authorization Act.  The SBA’s proposed rule would establish that a prime contractor may satisfy the applicable limitations on subcontracting either by performing a sufficient percentage of contract itself, or by subcontracting a portion of the work to one or more “similarly situated” entities.  The proposed rule defines a similarly situated entity as a”small business concern subcontractor that is a participant of the same SBA program that qualified the prime contractor as an eligible offeror and awardee of the contract.”

The SBA’s ostensible subcontractor affiliation rule provides that a prime contractor is affiliated with its subcontractor if the subcontractor performs the primary and vital portions of the contract, or if the prime contractor is unusually reliant on the subcontractor.  Ostensible subcontractor affiliation most commonly arises when a small business subcontracts work to a large company, but under the current version of the ostensible subcontractor rule, affiliation can also arise between a small prime and small subcontractor, 8(a) prime and 8(a) subcontractor, and so on.

In its proposed rule, the SBA recognizes that it would be inconsistent and impractical to allow prime contractors to take advantage of the new similarly situated entity rule to meet the limitations on subcontracting, but apply the ostensible subcontractor rule to the same relationships.  Therefore, the SBA proposes to amend the ostensible subcontractor affiliation rule to provide that “an ostensible subcontractor is a subcontractor that is not a similarly situated entity . . ..”  The SBA believes that this amendment to the ostensible subcontractor rule “clearly flows from the NDAA’s treatment of similarly situated subcontractors.”

The SBA’s proposed rule makes a lot of sense, and I applaud the SBA for thinking about how the changes to the limitations on subcontracting would interact with the existing ostensible subcontractor affiliation rule.  The SBA’s proposed rule on the 2013 NDAA certainly was not speedy, but I give the SBA credit for thoroughness and thoughtfulness–and the proposed change to the ostensible subcontractor rule is an example of that.

Two important caveats.

First, this is a proposed rule only–it is not the law.  The SBA will now take comments from the public and publish a final version of the rule.  Only then will the change to the ostensible subcontractor rule (assuming it remains in the final rule) become a matter of law.

Second, assuming the proposal becomes law, it will be very important for small contractors to be mindful that the definition of a similarly situated entity depends on the type of contract at issue.  If, for example, the contract is set-aside for 8(a) companies, an 8(a) firm would only be exempt from affiliation with other 8(a) participants; there would be no exemption from affiliation with non-8(a) small businesses.  In short, under the proposed rule, the exception only applies if the subcontractor would have been eligible to be awarded the prime contract itself.  If not, ostensible subcontractor affiliation will still be possible.

The proposed changes to the SBA’s rules will be among the most important legal developments for small contractors this year.  I will keep you posted on further developments.

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