Rulings from the SBA’s Office of Hearings and Appeals Reveal Insight on the Ostensible Subcontractor Rule

Small business prime contractors doing work for the federal government, whether through competitive set-asides or contracts to be awarded through full and open competition, have a number of lines that must be carefully walked. In particular, small business concerns (SBCs) must be wary of the relationships that may give rise to a finding by the Small Business Administration (SBA) of affiliation. When the SBA makes a finding that two or more concerns are affiliated, it is ruling that there are connections between the contractors that make them, in effect, one concern even if they are legally distinct entities. The SBA then will combine the revenues of the two concerns, often resulting in a total that exceeds the size standard for a particular contract and makes the small business seeking that contract ineligible. With proper and careful guidance, contractors can avoid findings of affiliation, but SBCs should always be aware of the basis for a finding of affiliation.

One way the SBA finds affiliation that is of particular interest to construction contractors is the ostensible subcontractor rule. The ostensible subcontractor rule is implicated when a prime contractor is attempting to put together a bid or proposal responsive to the government’s needs by relying unduly, out of necessity and industry practice, on a structure of subcontractors and supplies to perform the key purpose of a contract.

The rule allows SBA to find affiliation in a large variety of ways. Recent cases by the SBA’s Office of Hearings and Appeals (“OHA”) present excellent insight into what relationships between concerns fall within the rule and lead to a finding of affiliation.

In a recent case, OHA ruled that a small business, Red River Computer Co., was affiliated with a large business, Cisco Systems Inc., which the small business planned to use as a key subcontractor on a federal contract. The contract involved maintenance of Cisco brand hardware and software. The small business proposed that Cisco would perform most of the services required by the contract while the small business would provide ancillary services, including management, training, and support and would maintain its status as a small business entity. OHA found that Cisco, and not the small business, would be performing the primary and vital requirements of the contract and the small business was unduly reliant upon Cisco.

Iron Sword Enterprises, LLC gives another indication of where small business prime contractors can run afoul of the ostensible subcontractor rule. Iron Sword proposed to subcontract work to a joint venture consisting of two large contractors. The contract called for an on-site project manager and Iron Sword planned to use an employee of the joint venture as the project manager. Iron Sword itself would only provide supervision and oversight over the project. OHA found that the crucial management of the contract resided in the joint venture and not the small business prime contractor and, accordingly, that the two companies were affiliated.

In yet another recent case, a small business contractor pursued a contract for trash collection and disposal services for the Army. The small business had little or no experience in the industry and decided to subcontract all of the trash and recyclable collection to Waste Management, a large company. OHA ruled that the primary and vital requirements of the contract were the collection and transportation of the trash and recyclable materials. Though the small business ostensibly would manage the contract, it would not use its own resources to actually perform the vital requirements of the contract, making it unduly reliant on its subcontractor. Therefore, OHA found that the two companies were affiliated.

Despite the apparent harshness of the ostensible subcontractor rule and the fact that there is no clear line of what equals being “unduly reliant,” small business contractors can properly pursue and win awards of complicated federal contracts, even if the contract calls for extensive subcontracting. As these cases demonstrate, when choosing to pursue a particular contract, a small business must try to determine what the primary and vital requirements of the contract are. Most often, the solicitation will not specifically make such a statement. Then in its proposal, the small business must demonstrate that it will perform those requirements. In addition, where significant subcontracting is expected, as in construction, the small business must retain actual control and management over the contract. With proper vetting of potential contracts and structuring of a proposal, a small business contractor can secure federal contracts and use larger businesses to assist in performance without being unduly reliant upon those larger companies.

Evangelin Lee Nichols and Stephen J. Kelleher are attorneys at Smith, Currie & Hancock LLP, Washington, D.C.