Last year, SBA made joint venturing a little easier by relaxing the so-called “three-in-two” rule. But the “two-year” portion of the rule still exists–and in my view, the rule continues to unfairly elevate form over substance.
SBA, it’s time to take the plunge, and get rid of the rest of the three-in-two joint venture rule.
The three-in-two joint venture rule went through a few iterations in its lifetime. But in its most recent form before SBA’s 2020 amendment, the rule said that when a joint venture won its first contract, a two-year window opened. During the two-year window, the joint venture could submit additional offers, until the joint venture received its third award. If the joint venture submitted an offer after the two-year window closed, or after the joint venture received three awards (whichever came first), SBA could find that the joint venture partners were affiliated for all purposes.
In its October 2020 final rule (which took effect on November 16), SBA eliminated the three-contract limit. But the “two year” limit still exists.
The SBA’s 2020 change makes things a little easier for joint venturers, who now know exactly how long they have to submit proposals–two years from the award of the first contract. It’s an improvement on the three-in-two formula: contractors typically cannot predict exactly when a third award might occur, which sometimes left them scrambling to set up a new joint venture if a third award unexpectedly materialized.
But, like the old three-in-two rule, the “two-year” rule applies to a joint venture entity, not to the joint venturers themselves. The two-year restriction is comically easy to circumvent–when the two-year mark arrives, simply set up a new joint venture entity, and voilà: the clock resets to zero.
Consider the following examples:
Companies A and B, which are both small businesses, form a joint venture. The joint venture wins its first contract on May 14, 2021. The joint venture continues submitting proposals for four years, until May 14, 2025. During that time, the joint venture wins six contracts valued at $25 million.
In this example, Companies A and B have violated the two-year rule because they submitted proposals outside the two-year window. The SBA may find the companies generally affiliated–which could cause each company to lose its small business status for an indefinite amount of time.
Now, let’s change the facts just slightly:
Companies C and D, which are both small businesses, form a joint venture. The joint venture wins its first contract on May 14, 2021. The joint venture continues submitting proposals for two years, until May 14, 2023. Companies C and D then form a new joint venture and continue submitting proposals for two more years, until May 14, 2025. During the four-year period, the two joint ventures win six contracts valued at $25 million.
In this example, Companies C and D are not affiliated because their owners apparently spend their free time poring over the Code of Federal Regulations! These regulatory mavens know about the two-year limit, so they wisely form a new joint venture when the initial two-year window closes.
That, in a nutshell, is the utter illogic of the two-year rule: the same two companies, working together as joint venture partners, can win the same contracts, worth the same amount, over the same period of time, and SBA’s affiliation determination will turn on whether the companies happened to know that 13 C.F.R. 121.103(h)(4) required them to form a new unpopulated joint venture entity after two years.
Heck, my examples were charitable: Companies C and D could have won more contracts, worth more money, over a longer period of time, but as long as they remembered to trot off to the Secretary of State’s office every two years and form a new joint venture entity, they likely would have been fine–just like these guys, who won 15 contracts together over a four-year period, but were savvy enough to do it using eight separate joint venture entities!
SBA says its affiliation rules are about shared control, but that’s not how the two-year rule works. Instead, under the two-year rule, SBA effectively weaponizes affiliation and uses it not as the logical outgrowth of common control, but as a form-over-substance “gotcha” to penalize small businesses who don’t know about (or forget about) the arbitrary two-year limit.
SBA’s mission statement says, in part, that SBA exists to “assist and protect the interests of small business concerns.”
How is this purpose served by penalizing companies for bidding work with one joint venture entity after two years, but allowing the same companies to bid the same work after two years by using a second legal entity? And how, exactly, does SBA “assist and protect” small businesses by forcing them to return to a Secretary of State every two years, pay a new filing fee to form a new LLC, adopt a new joint venture agreement, and jump through several other administrative hoops (EIN, DUNS, SAM, etc.) just to keep joint venturing with the same partner?
I will give credit where credit is due: last year’s regulatory change was a marked improvement over the old three-in-two rule. You’re on the right track, SBA. But now it’s time to go the rest of the way. It’s time to eliminate the rest of the illogical and unfair two-year joint venture rule.
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