SBA Proposes Significant Changes to Mentor-Protégé Joint Venture Rules
November 2, 2009
Joseph Hornyak - Northern Virginia
On October 28, 2009, the U.S. Small Business Administration (SBA) issued a lengthy proposed rule to make changes to its 8(a) and size regulations. While the proposed rule purports to codify many of SBA’s existing policies and practices, it also makes significant changes to SBA’s current regulations and implicitly overrules certain decisions of SBA’s Office of Hearings and Appeals (OHA). Among other things, SBA proposes significant changes to its mentor-protégé program and, in particular, the rules applicable to joint ventures between mentors and protégés for both 8(a) and non-8(a) small business set-aside contracts. This alert summarizes the most significant changes in the proposed rule as relevant to mentor-protégé joint ventures.
Number of Offers/Contracts Per Joint Venture
SBA’s current regulations limit a specific joint venture to submitting no more than three offers over a two-year period. Even under the current regulation, this three-offer limitation is easy to circumvent because the same joint venturers can simply create a separate joint venture entity and get a fresh three offers. The proposed rule would change the limit from three offers to three contract awards under one joint venture agreement. The proposed rule would also confirm that the same joint venturers could form additional joint ventures and be awarded three additional contracts for each. The proposed rule, however, makes clear that at some point, too many joint ventures between the same parties could lead to a finding of general affiliation.
“Populated” Versus “Unpopulated” Joint Ventures
A difficult decision joint venturers face when pursuing a government contract is whether to “populate” the joint venture with its own employees or simply use the employees of the individual joint venturers to perform the contract. SBA’s current regulations provide almost no guidance on this important issue. The proposed rule purports to “clarify” SBA’s current policy as follows: “If a joint venture is a separate legal entity, then it must have its own employees. If a joint venture merely exists through a written agreement between two or more individual business entities, then it need not have its own separate employees and employees of each of the individual business entities may perform work for the joint venture.” In other words, if the parties wish their joint venture to take the form of a limited liability company (LLC), the joint venture LLC must hire its own employees to perform the contract (i.e., “populate” the LLC). Although SBA describes this as a “clarification” of its existing policy, in reality, it will change the way many mentor-protégé joint ventures operate.
SBA Approval of 8(a) Joint Venture Agreements
SBA’s current regulations require SBA approval of joint venture agreements for 8(a) contracts prior to award. The proposed rule would permit the parties to a previously-approved joint venture to obtain SBA approval for a second and third 8(a) contact by merely providing SBA an addendum to the original agreement. Under both current regulations and the proposed rule, SBA approval is not required for joint venture agreements for non-8(a) contracts.
Joint Ventures for Non-8(a) Contracts
SBA’s current regulations permit a joint venture between a mentor and a protégé to qualify for both non-8(a) small business set-aside contracts and 8(a) contracts. The current SBA regulations at 13 C.F.R. § 124.513 provide specific requirements for 8(a) joint ventures, including the requirement that: (1) the joint venture agreement be approved by SBA prior to award; (2) the project manager for the contract be an employee of the 8(a) firm; and (3) the 8(a) firm receive at least 51 percent of the joint venture’s profits (but see change discussed in next section).
In Size Appeal of: SES-Tech Global Solutions, the Office of Hearings and Appeals ruled that joint venture agreements for non-8(a) contracts do not need to meet the requirements of § 124.513. OHA held that as long as the protégé firm qualifies as a small business under the applicable size standard, the joint venture members are exempt from affiliation and thus the joint venture itself qualifies as a small business. Thus, conceivably, the large business mentor in such a joint venture could hold a majority interest and employ the project manager, and the joint venture could still qualify for the exemption from affiliation. The proposed rule would reverse SES-Tech. According to the proposed rule: “[a]lthough SBA does not approve the joint venture agreements for procurements outside the 8(a) program, if the size of a joint venture claiming an exception to affiliation is protested, the requirements of § 124.513(c) and (d) must be met in order for the exception to affiliation to apply.” Again, although SBA describes this aspect of the proposed rule as a clarification, in reality, it represents a significant change to the current regulations.
Distribution of Profits
SBA’s current regulations require the 8(a) firm to receive at least 51 percent of the net profits of an 8(a) joint venture. The proposed rule would delete this requirement and replace it with a requirement that the 8(a) firm receive “profits from the joint venture commensurate with the work performed by the 8(a) Participant(s).”
Joint Ventures With Tribally or Alaska Native Corporation (ANC)-Owned Proteges
Under current SBA regulations, tribally-owned and ANC-owned 8(a) firms are permitted to receive sole source contracts above the dollar thresholds applicable to other 8(a) firms ($3.5 and $5.5 million for services and supply contracts, respectively). This exemption has permitted large businesses to form mentor-protégé joint ventures with tribal and ANC-owned concerns and receive large contracts on a sole source basis. Under current SBA regulations, such a joint venture could then subcontract as much as 50 percent of the work back to the mentor, which could effectively permit a large business to receive as much as 70-80 percent of the contract revenue. The proposed rule would provide that, in this scenario, the non-8(a) joint venture member to an 8(a) sole source contract cannot also be a subcontractor to the joint venture.
The “Significant Portion” Requirement
Under current SBA regulations, the protégé in a mentor-protégé joint venture must perform a “significant portion” of the work done by the joint venture. The current regulations do not define “significant portion” as a fixed percentage or otherwise, although SBA has permitted some agencies to use 25 percent as an informal threshold. The proposed rule would state that the 8(a) member of a joint venture for an 8(a) contract must perform at least 40 percent of the work done by the joint venture.
Number of Mentors/Protégés
Under current SBA regulations, a protégé may have only one mentor but, in limited circumstances, a mentor may have multiple protégés, subject to SBA approval. The proposed rule would provide an absolute limit of three protégés per mentor and allow SBA to approve a second mentor for a protégé in limited circumstances.
Mentor-Protégé Joint Ventures for Subcontracts
Under current SBA regulations, a mentor-protégé joint venture can qualify as a small business only for federal prime contracts. The proposed rule would permit mentor-protege joint ventures to qualify as small business for federal subcontracts as well as prime contracts.
Mentor’s Failure to Provide Assistance
To receive SBA approval, a mentor-protégé agreement must specify the developmental assistance that the mentor will be providing to the protégé. According to the narrative explanation accompanying the proposed rule, SBA is concerned that many mentors enter into such relationships solely to obtain contracts and do not provide the promised level of developmental assistance. The proposed rule would permit SBA, in such circumstances, to recommend to a procuring agency that it issue a stop-work order for each federal contract the mentor and protégé are performing as a small business. The stop-work order could be withdrawn if SBA eventually becomes satisfied that the developmental assistance has been or will be provided to the protégé. The rule would also permit SBA to initiate proceedings to debar the mentor from federal contracting if SBA determines that the mentor entered into the mentor/protégé relationship solely to obtain one or more federal contracts.
Other Proposed Changes
The proposed rule would also make many significant changes to the qualification requirements for 8(a) contractors, including gross income, net worth and asset limitations for the individual claiming disadvantaged status. The rule would also allow procuring agencies to receive 8(a) credit for orders placed with 8(a) concerns under multiple award IDIQ contracts even if the underlying contracts were not set-aside exclusively for 8(a) contractors, as long as the competition for the order is restricted to 8(a) concerns and the selected contractor is an 8(a) participant as of the date specified for receipt of task or delivery order proposals.
The proposed rule is not yet final, and SBA has solicited comments by December 28, 2009. Although many aspects of the proposed rule are likely to be controversial, at the very least the rule would clarify many of the ambiguities and unanswered questions in SBA’s existing regulations.
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