September, 2014

Court of Federal Claims Invalidates SBA Rulemaking and Broadens the Reach of the Non-Manufacturer Rule

6 min

A recent decision from the U.S. Court of Federal Claims substantially broadens the reach of the Small Business Administration's (SBA) Non-Manufacturer Rule (NMR) to all federal procurements that require the provision of manufactured supplies, regardless of whether the procurement also has a services component. In Rotech Healthcare, Inc., v United States, Case No. 14-502C (September 19, 2014) (Damich, J.), the Court effectively invalidated SBA regulations that seek to limit the application of the NMR only to procurements that have been assigned a manufacturing North American Industry Classification System (NAICS) code, or to the supply component of a manufacturing or supply contract that also has a services component.

If the Court's Rotech decision stands, many combination supply/services procurements that previously escaped the reach of the NMR (due to an agency's designation of the procurement as "services" instead of "supply") will now be subject to the rule's constraints. This ruling will reduce the number of small business set-aside procurements in cases where there are no domestic small business manufacturers available (because no offeror could comply with the NMR). At the same time, the ruling will substantially increase opportunities for small business manufacturers as long as the procurement itself remains set aside for small businesses. Conversely, this ruling may eliminate small business set-aside contracts for resellers providing services along with products of a large business manufacturer.

The Non-Manufacturer Rule

The NMR allows a firm to qualify as a small business concern under a solicitation for the provision of manufactured products or other supplies as a "nonmanufacturer" as long as it meets certain requirements. One of these requirements is that the small business nonmanufacturer must provide only end items that were manufactured by another small business in the United States. 13 C.F.R. § 406(b); 15 U.S.C. § 637(a)(17)(B). This requirement is implemented through FAR 52.219-6, Notice of Total Small Business Set-Aside, which requires offerors in all small business set-asides to agree to furnish "only end items manufactured or produced by small businesses in the United States, or its outlying areas." FAR 52.219-6(d). Construction and services contracts, however, are expressly exempted from this requirement. Id.

The SBA's current regulations allow agencies (and small business offerors) to avoid the constraints of the NMR when the procurement is for both supplies and services:

(3) The nonmanufacturer rule applies only to procurements that have been assigned a manufacturing or supply NAICS code. The nonmanufacturer rule does not apply to contracts that have been assigned a service, construction, or specialty trade construction NAICS code.

(4) The nonmanufacturer rule applies only to the supply component of a requirement classified as a manufacturing or supply contract. If a requirement is classified as a service contract, but also has a supply component, the nonmanufacturer rule does not apply to the supply component of the requirement. 13 C.F.R. § 406(b).

Thus, under these rules, if an agency designates a procurement as a "services" contract, it is the SBA's position that the NMR should not apply. Therefore, a small business services contractor would be permitted to supply end items manufactured by a large business or foreign business because the NMR does not apply to "services" contracts.

The Rotech Decision

The Rotech decision concluded that these regulations were contrary to the Small Business Act, which unambiguously states that the NMR applies "for any procurement contract for the supply of a product," not just procurements that the agency designates as a supply or manufacturing procurement. 15 U.S.C. § 637(a)(17)(A) (emphasis added).

The Court's decision is notable because it directly refutes the SBA's attempted rulemaking and interpretation of the Small Business Act. The Court's decision notes that a prior Court of Federal Claims case (Rotech v. United States, 71 Fed. Cl. 393 (2006) (Bush, J.)), already examined the statutory text and held that the word "any" unambiguously means that the NMR applies to all supply contracts, not just those that an agency decides to classify as a supply contract. Subsequent to this ruling, however, the SBA promulgated the above-quoted regulations to address the question previously unanswered in the SBA's regulations—that is, whether and to what extent the NMR rule applies to procurements that have both a supply and services component.

Following the Supreme Court's holding in Nat'l Cable & Telecomms. Ass'n v. Brand X Internet Servs., 545 U.S. 967 (2005), which relied on Chevron, U.S.A. Inc. v. NRDC, 467 U.S. 837 (1984), the latest Rotech decision concluded that the Court of Federal Claim's prior judicial construction of 15 U.S.C. § 637(a)(17)(A) trumps the SBA's rulemaking. The Court explained that the prior judicial decision in this case (Rotech v. United States, 71 Fed. Cl. 393 (2006)) indeed held that the language of the statute was unambiguous ("any" means any and all). As a result, the SBA's subsequent interpretation of the statute and corresponding rulemaking was not entitled to any Chevron deference.

According to Rotech, the SBA's regulations attempting to limit the application of the NMR in procurements with both services and supplies are invalid and contrary to law.

What You Need to Know

As a result of the Rotech decision, the validity and future of 13 C.F.R. § 406(b)(3) and (4) is doubtful. "Any" procurement for supplies, even if it includes a services component, is now arguably subject to the NMR.

  • At a minimum, all contractors (small and large) should look carefully at combination supply/services solicitations and assess the impact of the NMR on the field of eligible prime small business offerors, as well as available domestic small business manufacturers. Agency decisions to set aside certain supply/services solicitations for small businesses may be protested if no small business can comply with the NMR.
  • This ruling will likely impact the number of supply/services solicitations capable of being set aside for small businesses since it will now require offerors to satisfy the constraints of the NMR (e.g., likely impact on the agency's Rule of Two analysis).
  • Small business services contractors should look carefully at combination supply/services solicitations and determine whether they can comply with the NMR for the supply component; in particular, whether they can supply end items manufactured by another small business in the United States. Failure to demonstrate compliance with the NMR in a proposal may be grounds for disqualification (and therefore, the subject of a potential protest by a competitor).
  • There may be pressure on the SBA to issue waivers of the NMR, but that requires a determination that there are no small business manufacturers or processors available to participate in the federal marketplace for that class of products. 13 C.F.R. § 121.1202.

If you have any questions regarding this alert, please contact the authors.