United States: Important May 30, 2023 Changes To The SBA's Mentor-Protégé And Joint Venture Regulations

On May 30, 2023, the Small Business Administration's ("SBA") Final Rule on Ownership and Control and Contractual Assistance Requirements for the 8(a) Business Development Program (the "Final Rule") became effective. The Final Rule makes several significant changes to SBA's 8(a) Business Development Program, HUBZone program, affiliation rules, and various other SBA regulations. Government contractors who compete for SBA's set-aside contracts should closely review the Final Rule. In this alert, we have summarized the Final Rule's significant changes related to SBA's mentor-protégé and joint venture regulations.

SBA's Joint Venture Regulations

Partners to a joint venture that perform a federal government contract or subcontract are considered affiliated under SBA's regulations unless an exception applies. 13 CFR § 121.103(h). This means that, unless an exception to affiliation applies, SBA will typically aggregate the receipts and/or employees of the joint venture partners when determining the size of the joint venture for all small business programs. If a joint venture does not have an applicable affiliation exception, and the aggregated receipts and/or employees of the joint venture partners collectively exceed the size standard associated with a particular procurement, the joint venture will not be eligible to perform the set-aside contract because it will not be a small business. Therefore, it is very important for contractors to follow closely SBA's regulations related to joint ventures to ensure that their joint venture is not inadvertently disqualified from the competition.

The two primary exceptions to affiliation for joint ventures are applicable when:

1. Two or more business concerns form a joint venture and each of the parties to the joint venture are small under the size standard corresponding to the NAICS code assigned to the contract; or
2. Two firms that are approved by SBA to be a mentor and protégé under SBA's All-Small Mentor-Protégé Program ("ASMPP") (13 CFR § 125.9) joint venture together as a small business for any Federal government prime contract or subcontract, provided that the protégé qualifies as small for the size standard corresponding to the NAICS code assigned to the procurement, and the joint venture agreement includes all of the provisions required by SBA's applicable joint venture regulations. (i.e., § 124.513 (c)-(d) for the 8(a) Business Development Program, § 125.8(b)-(c) for small businesses, § 128.402(c)-(d) for Service-Disabled Veteran-Owned Small Business ("SDVOSB"), § 127.516(c)-(d) for Women-Owned Small Business ("WOSB") Program, etc.)

Significantly, SBA's rules regarding joint venture agreements must be closely followed in order for the parties to avoid disqualification based on noncompliance. Below we address how the Final Rule made several updates to SBA's mentor-protégé and joint venture regulations.

Significant Amendments to SBA's Mentor-Protégé and Joint Venture Regulations

1. Updates to the All-Small Mentor-Protégé Program To Address Parent-Subsidiary Relationships.

SBA's ASMPP regulations at 13 CFR § 125.9 have always prohibited a mentor from having more than three protégés at any one time. SBA applies this limitation to the mentor's entire corporate family. If a parent of the mentor and a subsidiary of the mentor each are parties to separate mentor-protégé agreements, those separate agreements count as two of the three allowed for the entire corporate family at any one time. However, this limit of three protégés for the entire corporate family has created complications when a company that was a mentor in at least two existing mentor-protégé relationships purchases another company that is also a mentor in at least two other existing mentor-protégé relationships, which would cause the parties to exceed the maximum allowed (three) within a corporate family. Recognizing this issue, SBA's Final Rule updates the mentor-protégé regulations with the following language:

13 CFR § 125.9(b)(3)(ii)(B). Therefore, SBA has now confirmed in its regulations that a mentor's corporate family can exceed the maximum three allowed at any one time if that total number of relationships results from an acquisition, and the purchasing mentor commits to honoring the obligations under the seller's mentor-protégé agreement(s). The SBA noted in the Final Rule that this change in its regulations was necessary to protect protégés, which are limited to only two mentor-protégé relationships over their lifetime. 13 CFR § 125.9(e)(6). SBA stated that if existing mentor-protégé relationships were cancelled simply because of an acquisition involving the mentor, the protégé would be the most harmed if that cancelled agreement applied to its lifetime limit. This is a positive change to SBA's regulations.

The Final Rule also adds language requiring mentors that are a parent or subsidiary of a larger corporate family to identify any other parent or subsidiary concerns that it plans to participate as a mentor in the mentor-protégé arrangement. "The mentor-protégé agreement must: . . . (ii) Identify the specific entity or entities that will provide assistance to or participate in joint ventures with the protégé where the mentor is a parent or subsidiary concern[.]" 13 CFR § 125.9(e)(1)(ii) (emphasis added).

As noted above, a significant benefit of the ASMPP is the exception to affiliation that comes from having an SBA-approved mentor-protégé agreement, which allows the mentor to joint venture with a small business protégé firm without being impacted by SBA's affiliation rules. 13 CFR § 121.103(h)(2)(ii). The affiliation exception results from the SBA's approval of the mentor-protégé agreement. Therefore, mentors who want to use more than one entity within their corporate family to joint venture with the protégé should identify each separate entity in the mentor-protégé agreement to ensure that they all are covered by the affiliation exception. It is highly likely that size protests will be filed in the future challenging the compliance of joint ventures that involve a corporate entity that is not expressly listed in the mentor-protégé agreement.¹

2. Decisions That Non-Managing Partners to a Joint Venture Can Participate In.

SBA's regulations confirm that the managing joint venture partner (i.e., the managing venturer) of a joint venture must independently control all aspects of the day-to-day management and administration of the contractual performance of the joint venture. To obtain the exception to affiliation under SBA's regulations, the joint venture agreement must include language confirming that the managing venturer controls the day-to-day management and administration of the contractual performance and must not include language allowing the other joint venture partner to impede on the managing venturer's management responsibilities.

However, since November 2020, SBA's joint venture regulations for small business set-aside programs have included language allowing the "other partners to the joint venture [to] participate in all corporate governance activities and decisions of the joint venture as is commercially customary." 13 CFR § 125.8(b)(2)(ii)(A). Similar language is included in other joint venture regulations related to the various other socioeconomic programs. See, e.g., 13 CFR § 128.402(c)(2)(i) (re: SDVOSB); 13 CFR § 127.506(c)(2)(i) (re: WOSB).

This competing language allowing non-managing venturers to participate in all corporate governance activities and decisions of the joint venture as is commercially customary, while also requiring the managing venturer to control all decisions about day-to-day management and administration of the contractual performance, has created confusion about how much the non-managing venturer can participate in joint venture decisions. To help alleviate this confusion, the Final Rule has added the following language to the small business joint venture regulations found at 13 CFR § 125.8(b)(2)(ii)(A):

Accordingly, SBA has now confirmed that—in relation to small business joint ventures—determining what contract opportunities the joint venture should seek and initiating litigation on behalf of the joint venture are definitively commercially customary activities for which the non-managing venturer can have some control to participate in and block the managing venturer's decision-making.

While this addition to the small business joint venture regulations adds clarity for that program, the SBA did not add this same clarifying language for socioeconomic joint ventures (e.g., SDVOSB, WOSB, 8(a), HUBZone), which have separate joint venture regulations. While the SBA's Office of Hearings and Appeals ("SBA OHA"), which interprets SBA's regulations, has recently ruled² that the SDVOSB regulations at 13 CFR § 128.402(c)(2)(i) allow for non-managing venturers to participate in decisions about commencing litigation, as of this date, the authors are not aware of any decision that has allowed a non-managing venturer of an SDVOSB joint venture to block decision-making about what contracts the joint venture may seek.

While this addition to the small business joint venture regulations is an improvement that adds clarity to that program, the fact that it is not added to the socioeconomic regulations provides an important reminder about being aware of the separate regulations for the separate programs (and the cases interpreting them) when drafting joint venture agreements. Parties can use strategies to draft their agreements around these concerns. For example, parties can create a joint venture for only one particular contract to avoid the managing venturer using that joint venture to bid on other contracts without the non-managing venturer's approval. Parties can also require written approvals and signatures for amendments to a joint venture agreement, which would prevent a managing member from using that joint venture to compete for other contracts without the non-managing venturer's approval since the agreement must be amended for each separate contract in order to meet the contract-specific requirements, such as itemizing the equipment, facilities, and other resources that will be furnished by each party to perform a contract. However, when making these drafting decisions, it is important for the joint venture partners to be well-versed in SBA's regulations and the case law interpreting them or to obtain assistance from someone who is.

3. Restrictions Preventing 8(a), HUBZone, SDVOSB, and WOSB Concerns From Being A Joint Venture Partner on More Than One Joint Venture That Submits An Offer For A Specific Contract.

The Final Rule also includes language prohibiting 8(a), SDVOSB, HUBZone, and WOSB concerns from participating in more than one joint venture competing for the same contract. The SBA explained that this prohibition was primarily added in order to prevent joint ventures from having access to pricing information from more than one offeror competing for the same award, which can skew pricing.

The primary takeaway for government contractors related to this change is that, 8(a), SDVOSB, HUBZone, and WOSB concerns must be selective when choosing joint venture partners and may not hedge their chances of award by participating in more than one joint venture.

4. Clarifications Regarding HUBZone Joint Venture Requirements.

In the comments to the Final Rule, SBA stated that it has received multiple questions from HUBZone firms and contracting officers expressing confusion about how to determine whether an entity qualifies as a HUBZone joint venture that is eligible to submit an offer for a HUBZone contract because there is no way to designate an entity as a HUBZone joint venture in SBA's Dynamic Small Business Search database.

To clarify the requirements for HUBZone joint ventures, the Final Rule adds the following sentence at 13 CFR § 126.616(a)(1):

The SBA further clarified that this requirement applies to all contracts, including multiple-award contracts. Therefore, a HUBZone joint venture must be registered in SAM, must be designated as a HUBZone joint venture in SAM, and must identify the HUBZone-certified joint venture partner (i.e., the managing venturer) in SAM before competing as a HUBZone joint venture.

5. Confirmation that SBA's Two-Year Rule Applies Only to Contracts; Not Orders.

SBA's regulations provide that a specific joint venture generally may not be awarded contracts beyond a two-year period, starting from the date of the award of the first contract, without the partners to the joint venture being deemed affiliated for the joint venture. 13 CFR § 121.103(h). SBA imposes this Two-Year Rule because it believes that a joint venture should not be an ongoing business, but should instead be an arrangement that is formed for a limited purpose and duration. Accordingly, SBA will find joint venture partners to be affiliated, and will, thus, aggregate their receipts and/or employees in determining the size of the joint venture for all small business programs, where the joint venture submits an offer after two years from the date of the first award to the joint venture.

However, to avoid confusion, the Final Rule has added a sentence to its regulations to confirm that "a joint venture may be issued an order under a previously awarded contract beyond the two-year period." 13 CFR § 121.103(h). SBA has made this update to confirm that the Two-Year Rule applies only to contracts, not to orders. Therefore, a joint venture that wins a multi-year IDIQ contract could still submit multiple offers for orders under that awarded contract but could not compete to be awarded new contracts beyond that two-year period. In order for those same two joint venture partners to be awarded a new contract beyond the two-year period, they can create an entirely new joint venture agreement between the same parties.

6. Revisions to The Ostensible Subcontractor Rule

Under SBA's regulations, an "ostensible subcontractor" situation occurs when a subcontractor that is not a similarly situated entity as the prime contractor (i.e., not an SDVOSB if the prime contractor is an SDVOSB) performs the primary and vital requirements of the subject procurement, or when a prime contractor is unusually reliant on that not similarly situated subcontractor to perform the functions required under the procurement. Several SBA OHA size decisions have addressed the ostensible subcontractor rule, which involves an extremely fact-specific analysis to determine whether the factors are met. Significantly, if parties are deemed to have an ostensible subcontractor relationship, the subcontractor will be considered a joint venture partner to the prime contractor for SBA size determination purposes, which will cause the parties to be affiliated under SBA's regulations for that particular procurement.

SBA's Final Rule amends the ostensible subcontractor rule to add more clarity to this highly fact-specific analysis. Most significantly, the Final Rule amended the ostensible subcontractor rule to clarify how it applies to construction contracts that often involve one general contractor managing the work and multiple subcontractors actually performing the majority of the work by adding the following two paragraphs:

13 CFR § 121.103(h)(3)(iii)-(iv).

Notably, while SBA's comments to the Final Rule confirmed that the above language was added to specifically address construction and specialty trade contracts, the amended language also applies equally to a contract or order set-aside or reserved for small business for services that are not construction. Therefore, any prime contractor performing a services contract that is not construction or performing a construction or specialty trade contract, can avoid the impacts of the ostensible subcontractor rule simply by meeting the limitations on subcontractor rule, which is found at 13 CFR § 125.6. For general construction contracts, the limitation on subcontracting rule generally requires the small business prime contractor not to pay more than 85% of the amount paid by the government to it to firms that are not similarly situated, excluding cost of materials as they are not considered subcontracted for purposes of this rule. For services contracts (except construction), the small business prime contractor must not pay more than 50% of the amount paid by the government to firms that are not similarly situated. Therefore, by dividing clear workshare and confirming that workshare in the proposal and/or subcontract, several contractors can now completely avoid a potential ostensible subcontractor rule finding, which is a welcome change to SBA's regulations.

7. Populated Joint Ventures.

For several years, SBA has prohibited separate legal entity joint ventures (i.e., separate corporations or limited liability companies) from being populated with individuals who are intended to perform contracts awarded to the joint venture. SBA has required separate legal entity joint ventures to be "unpopulated" because SBA intends for joint ventures to be created as limited purpose entities, not ongoing business entities. SBA believes that populating the separate legal entity with employees who are intended to perform the contract for that entity creates more permanence than if the separate parties to the joint venture perform the work themselves, with the joint venture essentially being a pass-through entity.

The Final Rule, however, has updated SBA's regulations to clarify the application of SBA's rules related to populated joint ventures with the following paragraphs:

13 CFR § 121.103(h)(1)(i)-(iii).

Therefore, based on these amendments, a separate legal entity can be populated with employees to perform a contract only if all parties to the joint venture are "similarly situated," which means that every party to the joint venture has the same status (i.e., all are SDVOSB, WOSB, etc.). However, even in those situations where the joint venture members are similarly situated, if the joint venture is populated with employees, the SBA will consider those joint venture partners affiliated for purposes of that joint venture and SBA will aggregate the revenues or employees of all partners to the joint venture when determining the size of a populated joint venture. Consequently, this rule for populated joint ventures, which finds the joint venture partners affiliated, is significantly different than the affiliation exception for unpopulated joint ventures that allows the joint venture composed of two or more business concerns to submit an offer as a small business so long as each concern is small under the size standard corresponding to the NAICS code assigned to the contract. See 13 CFR § 121.103(h)(1)(i) (discussed above). Even with these clarifications included in the Final Rule, there are still very few benefits to having a populated joint venture and the large majority of joint venture partners would be better positioned with an unpopulated joint venture.

Conclusion

The Final Rule has made several significant changes to SBA's size regulations, including those related to mentor-protégé agreements and joint ventures, which should be closely reviewed by all government contractors. The changes made by the Final Rule apply to all solicitations issued on or after May 30, 2023.

Footnotes

1. The list of active mentor-protégé agreements, including the parties to them, are available on the SBA's website at https://www.sba.gov/document/support-active-mentor-protege-agreements.

2. Size Appeal of Strategic Alliance Solutions, VET-278, 2023 WL 580566 (Jan. 12, 2023).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.