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Government Contracts Update

A recent decision by the Small Business Administration's (SBA) Office of Hearings and Appeals (OHA) found that a small business that owned only one out of 120 shares of stock in a non-widely held corporation had the power to control the corporation, and thus was affiliated with the corporation in which it held the single interest. This decision should serve as a cautionary tale for small business contractors regarding the implications of their stock ownership in other companies.

Under the SBA's affiliation rules, "[i]f two or more persons (including any individual, concern or other entity) each owns, controls, or has the power to control less than 50 percent of a concern's voting stock, and such minority holdings are equal or approximately equal in size, and the aggregate of these minority holdings is large as compared with any other stock holding, SBA presumes that each such person controls or has the power to control the concern whose size is at issue." 13 C.F.R. § 121.103(c)(2). This is known as the multiple minority shareholder rule, and this presumption can be rebutted by showing that control or the power to control by each minority shareholder does not in fact exist. OHA's recent decision in Size Appeal of Melton Sales & Service, Inc., SBA No. SIZ-5893 (2018), shows the breadth of the multiple minority shareholder rule.

In Melton Sales, the U.S. Army had notified offerors that MTP Drivetrain Service, LLC (MTP) was the apparent successful awardee for a contract for the remanufacture of Route Clearance Vehicle engines that had been set aside for small businesses under NAICS code 333618, Other Engine Equipment Manufacturing, which has a 1,500 employee size standard. Melton Sales & Service, Inc. (Melton Sales) protested the award, arguing that MTP was not small because it was affiliated with several U.S. and foreign entities under common ownership, common management, identity of interest, and totality of the circumstances theories. Specifically, Melton Sales asserted, among other contentions, that MTP was affiliated with Joe Gear Holdings, LLC (Joe Gear) because MTP's principal and managing partner—Joe Niswanger—was also the president and owner of Joe Gear, and Joe Niswanger's son was the chief executive officer of Joe Gear and managed several Joe Gear subsidiaries. Melton Sales further asserted that MTP was affiliated with VIPAR Heavy Duty Inc. (VIPAR) based on Joe Gear's stock ownership in VIPAR. The SBA Area Office found that MTP and Joe Gear (and more than 20 other companies) were affiliated, but that MTP was not affiliated with VIPAR through Joe Gear's stock ownership in VIPAR because Joe Gear owned only one of 120 shares in VIPAR and thus did not have the power to control VIPAR. Melton Sales appealed to OHA.

On appeal, OHA held that the Area Office had erred when analyzing MTP's control over VIPAR under the multiple minority shareholder rule. MTP argued that Joe Gear's single share of stock did not provide it with control over VIPAR. OHA rejected this argument, stating that "individual control is immaterial, as multiple minority shareholders may control a subject concern even if they individually cannot." Instead, "in the absence of clear evidence demonstrating control or the power to control by another party, it is presumed that each minority shareholder has equal control over the subject concern, regardless of the size of the shareholder's interests." OHA found that the record lacked evidence showing that a party other than the 120 shareholders controlled VIPAR and that the Area Office had failed to establish that MTP and Joe Gear had rebutted the presumption of control. OHA thus held: "Therefore, Joe Gear must be presumed to control or have the power to control VIPAR under the multiple minority shareholder rule, and accordingly, MTP is affiliated with VIPAR."

Fortunately for MTP and its affiliates, however, OHA found that the Area Office's error in analyzing Joe Gear's stock ownership in VIPAR under the multiple minority shareholder rule was harmless because, even with the addition of VIPAR's employees, MTP still satisfied the 1,500 employee size standard under NAICS code 333618 for the procurement. Therefore, OHA denied Melton Sales' appeal.

Notwithstanding MTP's eventual "victory" at OHA, Melton Sales should serve as a stark reminder to small businesses that might own stock in non-widely held corporations. Melton Sales demonstrates how OHA is willing to read SBA's multiple minority shareholder rule expansively and will find control or the power to control even when a company owns what most would consider to be a very small portion of a non-widely held corporation. Small business contractors should be cautious with their stock ownership, as they could very well be affiliated with companies over which they do not—and most would not—believe that they have control.

Often a fatal mistake for when small businesses construct a financing or change in ownership transaction with several minority owners, is specifically and explicitly vesting in another, non-affiliated party, control over the concern. As OHA stated in Melton Sales, it is not enough to simply show an owner/investor does not have control; the concern must also "demonstrat[e] control or the power to control by another party." Obviously, this "control or the power to control" by an unaffiliated third party can be uncomfortable for investors and owners, but anything less risks a finding of affiliation and likely the devaluation of the concern.