Back in 2020, we discussed an SBA Office of Hearings and Appeals (OHA) decision stating that the managing venturer must control every aspect of the joint venture. This position, which we questioned in that article, has changed since that time, and we explored the changes to the regulatory language in question not long thereafter. But this regulatory language was still vague. Since that time, there has been much case law development. The Court of Federal Claims (COFC) held in 2022, “[a] minority owner’s control over “extraordinary” actions, such as actions intended to protect the investment of minority shareholders, will not result in a finding of negative control” and applied this idea to a populated joint venture. Swift & Staley, Inc. v. United States, No. 21-1279, 2022 WL 1231428 (Fed. Cl. Mar. 31, 2022), aff’d, No. 2022-1601, 2022 WL 17576348 (Fed. Cir. Dec. 12, 2022). It now appears, fairly established at this point, that non-managing venturers can have a say in what can best be described as “extraordinary actions.” These are the sorts of decisions that can completely change the trajectory of the joint venture. But contractors must still be very careful in giving the non-managing venturer a say in the joint venture’s decisions. As one firm learned the hard way in a recent COFC case, a joint venture with too many actions controllable by the non-managing venturer may end up ineligible for set-asides. Here, we explore this decision.
In 2023, the COFC heard an appeal of the SBA’s determination that LS3, LLC, (LS3), a mentor-protégé joint venture comprised of LUKAYVA—the protégé and SDVOSB—and its mentor, Systems Application & Technologies, Inc. (SA-TECH), was not an eligible SDVOSB joint venture. LS3, LLC v. United States, No. 23-1392, 2023 WL 8638647 (Fed. Cl. Dec. 14, 2023). LS3 was awarded a contract for engineering support services for the Navy, and a competitor filed a combined size and status protest with the SBA, alleging that LS3 both was not small under the regulations and further lacked eligibility for SDVOSB contracts. SBA OHA found that LS3 was not eligible for SDVOSB eligibility, and then dismissed the size protests as moot since LS3 was already found ineligible. The appeal to the COFC thus specifically concerned the allegation that LS3 lacked SDVOSB eligibility.
OHA based its decision on four simple considerations: (1) LS3’s operating agreement established a management committee; (2) the Management Committee held decisional power over LS3’s actions; (3) management committee actions required a majority vote of the members of the committee; and (4) SA-TECH and LUKAYVA had equal representation on the committee, providing SA-TECH with the ability to block any management committee actions. The COFC stated that the question on appeal then was whether “OHA’s action was arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law and, if so, whether the error is prejudicial.”
LS3 essentially argued that OHA was wrong because it found that LUKAYVA did not have unequivocal control over LS3. However, this overstated OHA’s position. COFC observed that “OHA took issue with the type of negative control SA-TECH could assert via the Management Committee and the breadth of activities it could control.” As the SDVOSB member of the joint venture, “LUKAYVA needs to be in the driver’s seat when it comes to day-to-day management and administration of the business operations.”
While LS3 argued that OHA was saying SA-TECH could have zero negative control, the COFC observed this was not the case. “OHA’s decision is specific to SA-TECH’s ability to assert negative control in the day-to-day management and administration of the contractual performance by virtue of its fifty percent representation on the Management Committee. That is, OHA’s decision is limited to who can control the breadth of LS3’s day-to-day management and administration of contract performance.” This was the problem with LS3’s agreement. It didn’t just let SA-TECH have a deciding say in those “extraordinary actions.” It gave SA-TECH and LUKAYVA 50% of the vote each. And because a majority of the vote was required for any action, essentially, SA-TECH could block any vote of LUKAYVA, be it on an extraordinary action OR a day-to-day matter. As a result, the operating agreement created a situation that went well past any extraordinary action exception to the requirement that the managing venturer control the joint venture. SA-TECH had essentially complete power to block all decisions by LUKAYVA.
As such, contractors need to keep in mind that, while this extraordinary action exception is useful, it is not unlimited. You must be very careful to ensure non-managing venturers for socioeconomic joint ventures and mentor-protégé joint ventures only have say on extraordinary actions. But that raises the question: What is and is not extraordinary?
Extraordinary Actions v. Day-To-Day Actions
13 C.F.R. 125.8(b)(2)(ii)(A) states:
“The managing venturer is responsible for controlling the day-to-day management and administration of the contractual performance of the joint venture, but other partners to the joint venture may participate in all corporate governance activities and decisions of the joint venture as is commercially customary. The joint venture agreement may not give to a non-managing venturer negative control over activities of the joint venture, unless those provisions would otherwise be commercially customary for a joint venture agreement for a government contract outside of SBA’s programs.”
What is meant, however, by “commercially customary” regarding extraordinary actions? There is no hard rule it appears. The case law is what must be looked at. There appear to be some generally agreed ideas. “Adding new members and dissolving the concern has been found to be an extraordinary action.” Strategic All. Sols. LLC, SBA No. VET-277, 2022 (Sept. 22, 2022). The same SBA decision held “[s]elling or otherwise disposing of the firm’s assets, admitting new members, amending the JVOA in any manner that materially alters the rights of existing members, or filing for bankruptcy all constitute extraordinary actions that may require the minority shareholder’s input, but do not create negative control.” Id.
The same decision also helpfully points out some examples of day-to-day actions. “Conversely, OHA has characterized a number of actions as essential to the daily operation of the company, and therefore granting a minority owner the power to block such actions does in fact constitute negative control. A minority member who has control over the budget, has the power to hire and fire officers, and sets employee compensation, has control over the daily operations of a concern.” Id. This helps give at least some sense of what is and is not an extraordinary action. This post also discusses a recent joint venture agreement that provided do much daily control to the non-managing venturer.
However, keep in mind with all this that this area of law is still rapidly developing, and some of this may change. One thing that can be safely said: Take drafting your joint venture agreement and joint venture operating agreement very seriously. Little mistakes can cause serious consequences. The language you choose is crucial. We always recommend at least having an attorney look over your joint venture agreement before you prepare to bid on that first contract.
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