Do you have an “ostensible subcontractor” problem?

Size matters. Companies that exceed applicable SBA size standards are ineligible for award of small business set-aside contracts. The SBA uses rules of affiliation to make sure companies do not take unfair advantage of the benefits of small business contracting programs. When measuring whether a company comes within the applicable size standard, the SBA counts not just the company’s own revenue/employees, but also the revenue/employees of the company’s “affiliates.” It is important to understand how affiliation can occur because if companies are found to be “affiliated” lost business opportunities could result. It can be costly (both in time and money) to fight a size protest, even if a company is ultimately vindicated.

There are a number of rules that the SBA looks at to determine whether a contractor is “affiliated” for size purposes, but some are relied on more than others by competitors to protest awards. One of the most litigated areas contractors should be aware of is the “ostensible subcontractor rule.” Under the ostensible subcontractor rule, 13 C.F.R. § 121.103 (h)(4), a prime contractor and its subcontractor will be considered “affiliated” when:

  1. The prime contractor is a small business and deemed “unusually reliant” upon a large business subcontractor, or
  2. The subcontractor performs the “primary and vital” requirements of the prime contract.

The ostensible subcontractor rule is designed to prevent large firms from colluding with small business to circumvent SBA size regulations. Whether there is a violation of this rule is highly fact intensive. Important considerations include the subcontractor’s level of control and influence over the prime contractor’s proposal, whether the key personnel in the proposal are employed by the prime contractor or subcontractor, and whether the subcontractor in question was the incumbent prime contractor and is no longer eligible to submit a prime offer. In the end, the SBA will look to the totality of the circumstances.

There a number of ways to protect against the ostensible contractor rule. A popular method is to draft a teaming agreement that clearly identifies the responsibilities and key functions of the prime contractor. As part of this process, consideration of the “primary and vital” requirements defined in a Request for Proposal is important. The SBA’s recent decision in the Size Appeal of NEIE Medical Waste Services, LLC, SIZ-5547 (Apr. 3, 2014) confirms the importance of  the division of “primary and vial” requirement. Often, the more specific the scope of work is in a teaming agreement, the more likely a company will be able to defeat ostensible subcontractor allegations. With proper planning, companies entering into a teaming agreement can reap the benefits of small business contracts with less risk of being found affiliated.