Last time on “No Company is an Island,” we addressed the ways that the traditional prime-subcontractor relationship can result in a determination that two teaming partners are affiliated and, as a result, not a small business qualified to receive a set-aside award. Prime-subcontractor affiliation can be insidious as it has a tendency to sneak up on unexpecting teammates. By contrast, affiliation issues between joint ventures, at least facially, are more overt. However, some pitfalls are lurking for the unwary. In this installment of “No Company is an Island,” we will focus on affiliation among joint venturers, or perhaps more importantly, the avoidance of affiliation.
At the outset, it is important to understand that there are two forms of affiliation that joint venturers should be concerned about. First, joint venturers may be considered affiliated for a particular procurement. Indeed, the general rule is that firms submitting offers for a particular procurement as joint venturers are affiliated with each other with regard to that procurement, unless certain exceptions apply. Generally, this means that the combined receipts or number of employees of the members of the joint venture must meet the NAICS threshold applicable to that procurement for the joint venture to qualify as small for that award. We will refer to this type of affiliation as “procurement-specific affiliation.”
Second, joint venturers must also be aware of what we will refer to as “general affiliation.” Specifically, a joint venture relationship can create affiliation between joint venturers that goes beyond the specific procurements that the joint venture pursues. Instead, the members of the joint venture may even become generally affiliated for procurements pursued by the individual members in their own capacity. Needless to say, general affiliation can have a greater impact on the individual joint venturers than the parties anticipated when they decided to form a joint venture.
What rules apply to “procurement-specific affiliation”?
There are, however, exceptions to the general rule that firms submitting an offer for a particular procurement as joint venturers are affiliated for that procurement. First, if each firm that is a member of the joint venture is individually small under the NAICS code applicable to the procurement, the joint venture can submit an offer as a small business for that procurement. For example, assume two companies enter into a joint venture, where one company had average annual receipts for the preceding three years of $10 million, while the other company had average annual receipts for the preceding three years of $15 million. Under the general rule, the receipts of the two joint venturers would be aggregated, and the joint venture would be considered small for any procurement under a NAICS code with a threshold of $25 million or more. Under this exception, however, the joint venture may qualify as small for procurements under NAICS codes with thresholds between $15 and $25 million. This is because both parties to the joint venture individually qualify as small under the applicable NAICS codes. By contrast, the joint venture could not qualify for a procurement under a NAICS code with a $12.5 million threshold as only one of the member entities qualifies as small for such a procurement.
The second exception to a procurement-specific affiliation applies when two firms have an approved agreement under the Small Business Administration’s (SBA’s) mentor/protégé program. The purpose of the mentor-protégé program is “to enhance the capabilities of protégé firms by requiring approved mentors to provide business development assistance to protégé firms and to improve the protégé firms' ability to successfully compete for federal contracts.” 13 C.F.R. § 125.9(a). In the past, the mentor-protégé program was only available to 8(a) protégés and their mentors. A little over a year ago, however, the SBA expanded the mentor-protégé program to all of the SBA’s socio-economic designations—specifically, small businesses, women-owned small businesses (WOSB), service-disabled, veteran-owned small businesses (SDVOSB), and HUBZone small businesses. One of the major benefits of the mentor-protégé program is that the mentor and protégé may joint venture and that joint venture will qualify as small for any procurement that the protégé firm would qualify for individually. Moreover, the joint venture may qualify for any of the socio-economic categories for which the protégé firm qualifies. As a result, a SDVOSB protégé may enter into a joint venture with an SBA-approved mentor that is a large business, and the joint venture will qualify as an SDVOSB for a particular procurement.
The exception to affiliation is one of the major incentives for large businesses to participate in the mentor-protégé program. The participants, however, must ensure that the SBA approves its mentor-protégé agreement prior to submitting an offer as a joint venture. If the proposal comes before the mentor-protégé agreement is approved, the affiliation exception will not apply. Moreover, the joint venture agreement must comply with certain requirements, such as identifying a small business as the managing venturer and an employee of the small business as the project manager responsible for performance of the contract. Again, if the joint venture agreement fails to comply with the regulatory requirements, the joint venture may not be able to take advantage of the affiliation exception.
So, if the joint venture meets an exception to “procurement-specific affiliation,” the parties to the joint venture never have to worry about affiliation, right? Not quite.
The same regulation that provides the first exception to “procurement-specific affiliation” also envisions that the joint venture relationship can be taken too far and ultimately result in “general affiliation.” Specifically, the SBA regulations define a joint venture as “an association of individuals and/or concerns with interests in any degree or proportion consorting to engage in and carry out no more than three specific or limited-purpose business ventures for joint profit over a two year period, for which purpose they combine their efforts, property, money, skill, or knowledge, but not on a continuing or permanent basis for conducting business generally.” 13 C.F.R. § 121.103(h) (emphasis added). To the extent a specific joint venture is awarded more than three contracts in a two-year period, the joint venturers will be “deemed affiliated for all purposes.” Id. This is known as the “3-in-2 Rule.” Once a joint venture violates the 3-in-2 Rule, the joint venturers open themselves up to an analysis that considers whether or not they are generally affiliated, regardless of whether they met a procurement-specific exception to affiliation in the past.
You may be thinking that there is a simple solution to the 3-in-2 Rule—just create a new joint venture between the entities after the prior joint venture receives its third contract. Indeed, that is an option envisioned by the SBA’s regulations. However, that option is not always available, as the regulations state that “[a]t some point, . . . such a longstanding inter-relationship or contractual dependence between the same joint venture partners will lead to a finding of general affiliation between and among them.” 13 C.F.R. § 121.103(h). Obviously, defining the standard as “at some point” does not create the sort of bright-line guidance that makes analyzing the risk of general affiliation particularly easy. In fact, such an analysis is intensely fact specific. That being said, there is a point where joint venturers must separate before the SBA determines that they are inseparable.
Ultimately, keeping an eye on all of the familial, contractual, and administrative ties between the parties to any teaming arrangement, whether a prime-subcontractor or joint venture, is necessary to ensuring that the parties do not fall prey to a determination of affiliation that will cause them to lose an award for which one or all of the teaming partners otherwise may have qualified.
Next time on “No Company is an Island,” we will shift our focus and consider the starting point for many Government Contractors’ efforts to partner—the teaming agreement. Specifically, we will discuss the enforceability of those agreements, and what terms you may want to incorporate or not incorporate, depending on how motivated you are to ensure that the other party is bound by the agreement’s requirements.
To read “No Company is an Island – Part 1: Subcontractor Affiliation,” please click here.
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