Every small business owner needs to be aware of the Small Business Administration’s (SBA) ostensible subcontractor rule.
In a nutshell, ostensible contractor affiliation occurs when a small business holds a prime contract – but a subcontractor hired for the job actually ends up controlling the work. The SBA targets instances where the subcontractor (and not the small business prime) performs the “primary and vital” work of the contract. Affiliation can also arise under the ostensible subcontractor rule if the small business is “unusually reliant” on its subcontractor.
The typical ostensible subcontractor rule violation involves a small business (prime contractor) and a large business (subcontractor). For example, if the small business lacks the needed resources or expertise, it can find itself leaning on its large subcontractor to run the project to too great of an extent. Anytime the large sub takes over a primary role on the project, there is danger of ostensible contractor affiliation.
However, in a recent decision, the SBA’s Office of Hearings and Appeals (OHA) drew out an important distinction in the law. While the small prime/large sub relationship is more common, the ostensible subcontractor rule remains firmly in play even as between two small businesses.
The OHA decision arises out of a size protest filed in connection with a health services contract offered by the Florida Army National Guard. After the SBA Area Office found the contract awardee small for purposes of the contract, the protester appealed and argued that the Area Office improperly failed to consider whether the awardee was affiliated with its proposed subcontractor under the ostensible subcontractor rule.
The Area Office based its decision on the size of the proposed contractor/subcontractor team. Specifically, the Area Office reasoned that – because both firms were small for the purposes of the procurement – even if they formed a joint venture, affiliation by the ostensible subcontractor rule would not be found. According to the Area Office, the SBA’s regulations intend for joint ventures to be treated as small as long as each of the joint venture members is small, without regard to the ostensible subcontractor rule.
On appeal, OHA disagreed with the Area Office. OHA pointed out that the ostensible subcontractor rule does not include any exceptions for joint ventures where both members are small. To the contrary, the rule requires SBA to evaluate whether the firms are ostensible subcontractors; if they are, they will be considered joint venturers and affiliated for the purposes of a size determination.
OHA found that it could not accept Area Office’s conclusion that there had been no violation of the ostensible subcontractor rule because it never performed the required analysis. Accordingly, OHA granted the appeal and ordered the Area Office to make a new size determination, including an examination of whether the participating firms were affiliated under the ostensible subcontractor rule.
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