The Department of Transportation’s (DOT) Disadvantaged Business Enterprise (DBE) Program is in the midst of a major overhaul that would update, streamline, and clarify existing rules, strengthen implementation, and increase reporting requirements. The DOT’s DBE Program allows small businesses owned by socially and economically disadvantaged individuals to tap into billions of dollars’ worth of contracting opportunities issued at the state and local level through federally-funded infrastructure projects. On July 21, 2022, DOT issued a notice of proposed rulemaking (Rule) which presents the biggest potential changes to the DBE Program since 2014. Below are major changes from the Rule that will affect all stakeholders in the DBE Program including certifying agencies, DBE-certified contractors and applicants, and contractors seeking to team with DBE firms. Visit this link to register for an upcoming webinar on the DBE Program and potential impacts of the Rule.
Updated Certification Standards Would Generally Be More Flexible
The Rule seeks to make the eligibility requirements clearer and more flexible so that the certification process becomes quicker and less intrusive on disadvantaged owners.
First, with respect to the requirement that a DBE firm must be a small business under SBA’s size standard applicable to the type of work the DBE firm seeks to perform, the Rule would clarify that a firm’s small business size status should be calculated utilizing the firm’s previous five fiscal years. This change is consistent with pre-existing DOT guidance and the SBA’s calculations, which were changed recently under the Small Business Runway Extension Act of 2018. In addition, DOT also imposes a separate DBE statutory size cap for firms pursuing FTA and FHWA (but not FAA) projects. This separate cap requires that a firm’s average annual gross receipts must be less than $28.48 million (adjusted annually). The Rule would clarify that this DOT-specific calculation of average annual gross receipts uses a three-year period, even though the calculation under SBA’s rules now uses a five-year period. As a result, DBE firms that may perform on FHWA and FTA funded contracts will need to track both their three-year and five-year average gross receipts.
Next, the Rule would make significant changes to the criteria for determining whether a DBE firm’s owner qualifies as economically disadvantaged. The Rule would adjust the Personal Net Worth (PNW) threshold as well as how to calculate PNW. Currently, the threshold sits at $1.32 million, meaning that an individual with a PNW less than $1.32 million is rebuttably presumed to be economically disadvantaged while individuals with a PNW above the threshold are irrefutably determined not to be economically disadvantaged. The Rule would raise the PNW threshold to $1.6 million and would increase that cap every five (5) years, permitting owners with higher net worth to enter and remain in the Program longer. Furthermore, the Rule would alter the calculation of the PNW by proposing to exclude the full balance of retirement accounts. Currently, the present value of retirement accounts must be included. The Rule also proposes to revise the criteria for rebutting a finding of economic disadvantage based on an individual’s ability to accumulate substantial wealth. In this regard, the Rule would eliminate the factors currently listed in the regulations (e.g. whether the individual’s average adjusted gross income exceeds $350,000 over the past three years and his or her total assets exceed $6 million). Instead, the Rule would take a “big picture” approach in which certifiers evaluate whether a “reasonable person” would consider the owner to be economically disadvantaged considering indicators such as ready access to wealth, lavish lifestyle, and income or assets of a type inconsistent with economic disadvantage. This approach is highly subjective, giving significant discretion to certifiers to judge an owner’s financial situation without any objective criteria. DOT appears to recognize as much, as it is seeking comments on this alternative approach in terms of whether the proposed revision is too vague such that it would lead to inconsistent application.
With respect to the ownership requirements, the Rule seeks to replace the concept of “real, substantial, and continuing” capital contributions and ownership with a broader, more flexible requirement that transactions affecting ownership must make “reasonable economic sense.” DOT believes this approach is a more workable standard that can adapt to unforeseen transactions and business structures and is less absolute.
DOT also seeks to add flexibility to the requirement that the disadvantaged owner must control the firm. For instance, the regulations have strict limitations on the extent that non-disadvantaged individuals, particularly non-disadvantaged family members, may participate in management of a DBE firm. The Rule would shift the focus from the actions of the non-disadvantaged participants in the firm to those of the disadvantaged owner, seeking to ensure that the disadvantaged owner controls the firm through managerial oversight, revocable delegation of authority, and critical and independent decision-making. This change would be beneficial to family-run firms, where certifiers often question whether the disadvantaged owner actually controls the firm simply because family members participate in some level of operations and management.
Another critical change is that the Rule proposes to explicitly allow non-disadvantaged owners to have the power to block extraordinary measures that would affect their ownership rights. Currently, DOT’s regulations state that the disadvantaged owner must be in control of all decision-making of the DBE firm which leaves in question whether non-disadvantaged owners may have any veto rights. The proposed change would align better with customary commercial practices where minority owners are able to block certain extraordinary corporate actions to protect their ownership interest.
Changes to Certification Procedures
The Rule proposes to streamline its procedures and encourage certifiers to afford DBE applicants an opportunity to correct deficiencies prior to certification denial.
The Rule would make clear that certifiers may notify the applicant about ineligibility concerns and allow the firm to correct the deficiencies prior to rendering a decision on the application. This practice, which some certifiers already implement, permits firms to fix issues of which they may not have been aware, without immediately having their applications rejected and being forced to wait a year to reapply.
Once DBE firms are certified in their home states (i.e. where their principal place of business is located), they make seek interstate certification in other states. DOT’s regulations currently permit an interstate certifier to either accept the home state’s certification or to perform its own limited analysis to determine whether certification is appropriate. DOT has found that interstate certifiers more often than not fail to follow requirements in undertaking their own limited analysis which has led to many successful appeals by DBE firms of interstate certification denials. As a result, the Rule proposes to require reciprocity, i.e. to require an interstate certifier to accept certifications from a firm that has already been certified as a DBE. This should be a welcome change as it would ease the burden on DBE firms and certifiers alike by eliminating the need to investigate the firm’s eligibility when it has already gone through that process in its home state, and thus significantly shortening the timeframe for receiving interstate certification.
To strengthen program integrity, the Rule would provide that if DOT upholds a firm’s decertification on appeal, that firm would automatically be decertified in all states, without any appeal rights to challenge the automatic decertification since the firm already had the opportunity to challenge its decertification. This would give each appeal substantial weight since it would impact the DBE firm’s certifications across all states.
Changes to Counting Credit for DBE Firms, Prompt Payment Enforcement, and Requirements to Make Good Faith Efforts to Use DBE Firms
The current DBE regulations lay out specific requirements for how a recipient or prime contractor may take credit for work performed by its DBE contractors. The Rule proposes various changes in this regard. For instance, under the current rules, drop-shipper DBEs generally can only take credit for the fees or commissions they charge for their services. Under the Rule, these drop-shipping DBE firms may receive credit for 40% of the cost of materials they supply, including transportation costs, rather than just the fees they charge—so long as they meet the Rule’s definition for a DBE distributor. This will encourage more participation of DBE drop-shippers in the DBE program and use of them by prime contractors. However, the Rule also proposes to limit the total allowable credit for a prime contractor’s expenditures with DBE suppliers (manufacturers, regular dealers, distributors, and transaction facilitators) to no more than 50 percent of the contract goals, with exceptions permitted on a contract-by-contract basis. This means prime contractors would have to rely on DBE firms to perform work other than providing supplies in order to meet their goals.
The DBE Program requires prime contractors to pay subcontractors for satisfactory performance no later than thirty days from the prime contractor’s receipt of payment from the recipient. However, investigation into this requirement has found that recipients often fail to proactively monitor prompt payment compliance, instead waiting for subcontractors to complain before taking action. To implement provisions in the Bipartisan Infrastructure Law which mandated that DOT take steps to ensure prompt payment of DBE contractors, the Rule would require recipients to implement a program for affirmative monitoring of prompt payments to subcontractors, as well as a means for enforcement and potential penalties for noncompliance. The Rule also would make clear that the prompt payment obligation flows down to lower-tier DBE subcontractors. These changes should help DBE firms receive payment more quickly, without needing to resort to complaining to recipients.
The DOT also believes the current rule, as it relates to design-build contracts, unnecessarily limits the participation of DBEs because it requires contractors to commit to specific DBE subcontractors prior to contract award, when the ability to define the project’s needs and identify a particular DBE firm may be difficult to do. The Rule instead would require prime contractors on design build contracts to submit DBE Performance Plans (DPPs) with their proposals, rather than committing to specific DBEs or submitting good faith efforts at the time of the proposal. This is akin to Small Business Subcontracting Plans required by other-than-small businesses for federal government prime contracts. To increase compliance, the Rule would also require ongoing monitoring and oversight of the contractor to evaluate its good faith efforts to comply with the DPP. This change is intended to result in greater opportunities for DBEs to participate in design build contracts.
Administrative Changes That Would Decrease the Burden on DBE Firms and Certifying Agencies
The DBE Program requires applicants to regularly submit documentation via notarized statements, sworn affidavits, and unsworn declarations. DOT found that COVID-19 made it difficult and unsafe to get forms notarized in person. Therefore, the Rule would eliminate the requirement for sworn affidavits and notarization. It would instead require the use of unsworn declarations under penalty of perjury. Removing this administrative burden is a positive change many DBE firms would welcome. Similarly, during the pandemic, DOT permitted certifying agencies to conduct site visits of DBE applicants virtually. The Rule would permanently allow, but not require, certifiers to conduct site visits virtually, recognizing that certifiers could learn requisite information about the firm’s operations and management through virtual methods while significantly easing the administrative burden on certifiers and DBE firms of having to arrange for in-person visits.
Increased Monitoring and Reporting Requirements
The Rule seeks to strengthen recipient oversight of prime contractors and subcontractors to ensure firms are meeting DBE goals, specifically highlighting the importance of the “running tally” requirement for recipients. Recipients must keep a running tally of payments actually made to DBE firms, including a means of comparing those payments to commitments made by the recipient. The Rule would expand this, requiring recipients to track actual prime contractor payments to DBEs relative to the commitments they made at the time of proposal submission. DOT’s increased emphasis on ensuring that federal funds provided to states are appropriately given to DBE firms is consistent with a government-wide crackdown on fraud and abuse in socioeconomic programs.
Finally, the Rule proposes to require certifiers to amend their DBE directories to permit DBE firms to provide additional information about their capabilities that they can choose to make public. This may include a capability statement, state licenses held, pre-qualifications, personnel and firm qualifications, bonding coverage, recently completed projects, equipment capability, and a link to the firm’s website, though DOT requests comment on what categories of information would be useful to have publicly available. DOT sees this as a cost-effective and time-saving alternative for DBEs to market their qualifications while providing a one-stop baseline tool for prime contractors as they seek out potential DBE subcontractors.
These are just some of the significant changes found in DOT’s Rule. The recent explosion in funding, as promised by the Bipartisan Infrastructure Law, appears to be influencing DOT’s proposed changes. Particularly, these changes appear more inclusive of small businesses, which can be considered a positive for many. It is imperative that DBE firms, and those prime or subcontractors trying to tap into this funding, understand these potential changes. If you’re interested in submitting public comments on the Rule, you must do so prior to October 31st.
If you would like assistance understanding the impact of the Rule for your business, or in submitting comments to DOT, please contact Jackie Unger, the author of this client alert, or another member of PilieroMazza’s Government Contracts Group. Please visit this link to register for an upcoming webinar on the DBE Program and the Rule’s potential impacts.
Special thanks to Daniel Figuenick for his assistance with this client alert.