As PilieroMazza previously highlighted, contractors wishing to pursue set-aside work through small business joint ventures (JVs) must comply with the Small Business Administration’s (SBA) JV regulations, which require certain JVs to have detailed and specific JV agreements (JVAs). A recent case from SBA’s Office of Hearing and Appeals (OHA) highlights just how important it is that small business JVs also comply with applicable state laws. Contractors should be aware that failing to comply with state laws can cause a small business JV to be ineligible for a contract award.
The Case for State Law Compliance
In the Size Appeal of SysCom, Inc., SBA No. SIZ-6195 (Mar. 7, 2023), OHA reversed an SBA Area Office decision finding SNI United, LLC (SNI)—a JV between an 8(a) participant and a small business—eligible for award of an 8(a) contract because SNI did not comply with the state laws of Michigan, SNI’s state of organization and because its bylaws allowed its non-8(a) member to exert negative control over SNI.
Pursuant to SBA regulations, a joint venture between an 8(a) participant and its large business mentor (or one or more small businesses) may compete for an 8(a) set-aside contract, provided the JV complies with SBA’s JV regulations, which require, among other things, that the entity’s JVA designate an 8(a) participant as its “managing venturer,” responsible for “controlling the day-to-day management and administration of the contractual performance of the joint venture.” In SysCom, OHA found that although SNI’s JVA designated an 8(a) participant as its managing venturer, that was not sufficient, under Michigan law, to establish that SNI was managed by an 8(a) company. OHA explained that “Michigan law stipulates that unless a particular Manager or Managing Member is identified in an [limited liability company’s (LLC’s)] operating agreement or articles of organization, all members are deemed to be managers of the LLC.” In that case, SNI informed SBA that it did not have an operating agreement, and according to SNI’s Articles of Organization, its 8(a) member was not designated as the manager or managing member of SNI. Notably, OHA recognized the contradiction between SNI’s JVA and Michigan law, but concluded that Michigan law “must take precedence.” Consequently, OHA concluded that SNI was not managed by an 8(a) participant, as required under SBA regulations, and was not eligible for award.
In addition, OHA found that SNI’s bylaws gave its non-8(a) member the power to control the JV, in violation of SBA regulations. SNI’s bylaws required a “majority” of the Board of Directors to establish a quorum or take action. Because SNI’s Board of Directors was comprised of two individuals, one appointed by its 8(a) member and one appointed by its non-8(a) member, this meant that both SNI members had to be present at Board meetings to establish a quorum. OHA explained that this allows the non-8(a) member to exert negative control over SNI by, for example, declining to attend Board meetings, thereby preventing the quorum needed for Board action. OHA recognized that SNI was formed “without the benefit of legal assistance,” but found the facts compelled “the conclusion that SNI’s business structures do not meet SBA joint venture requirements[.]”
In a size protest, the company whose size is under consideration has the burden of establishing its small business size status. As the case above highlights, for a small business JV, this means strictly complying with SBA’s JV regulations and applicable state laws, which may require, for example, that the JV carefully memorialize its management structure in its organizational documents. A JV can check all the regulatory boxes required under SBA regulations and still fail to qualify as a small business if it is not careful to ensure state law compliance.
If you need assistance drafting a joint venture agreement or operating agreement or would like to discuss how to navigate SBA and state law requirements, please contact the author of this blog, Sam Finnerty, or another member of PilieroMazza’s Government Contracts Group. Special thanks to Kelly Kirchgasser for her assistance in drafting this blog.