SBA Proposes Significant Changes to Its Small Business Regulations

December 7, 2018

By Samuel S. Finnerty

On December 4, 2018, the U.S. Small Business Administration (“SBA”) issued a proposed rule (“Rule”) to implement several provisions of the National Defense Authorization Acts (“NDAA”) of 2016 and 2017 and the Recovery Improvements for Small Entities After Disaster Act of 2015 (“RISE Act”), as well as other clarifying amendments. The Rule will likely garner a lot of attention in the coming weeks, as it proposes a number of sweeping amendments that could have a significant impact on small business government contracting. Indeed, the proposed revisions address key small business issues such as subcontracting plans, the non-manufacturer rule (“NMR”), Information Technology Value Added Reseller (“ITVAR”) procurements, limitations on subcontracting (“LOS”), recertification, size determinations, and the ostensible subcontractor rule. Below, we summarize some of the more notable amendments that will impact small business procurement.

Subcontracting Plans

Consistent with the 2017 NDAA, the Rule states that it shall be a material breach of contract when a contractor or subcontractor fails to comply in good faith with its subcontracting plan requirements, including failing to provide reports and/or cooperate in studies or surveys to determine the extent of compliance. The Rule provides a number of examples of what constitutes a failure to make “good faith” efforts, including, among others, (1) failing to timely submit subcontracting reports and (2) failing to pay small business subcontractors in accordance with the terms of the contract. The Rule also provides that failure to make a good faith effort may be considered in any past performance evaluation of the contractor.

With respect to subcontracting plans, the Rule also requires other than small prime contractors with commercial subcontracting plans to include indirect costs in their subcontracting goals. According to SBA, the burden imposed by this change would be de minimis, as approximately 95% of the firms with commercial subcontracting plans in 2017 already included indirect costs in their subcontracting goals.

Small Business Contracting in Disaster Areas

SBA is proposing to implement certain provisions of the RISE Act to establish contracting preferences for small business concerns (“SBC”) located in disaster areas and to provide agencies with double credit for awards to such concerns. Under the Rule, SBA would use the existing FAR definitions to provide that an agency will receive credit for an “emergency response contract” awarded to a “local firm” that qualifies as an SBC under the applicable size standard for a “major disaster or emergency area.” According to the Rule, a concern is “located in a disaster area,” if, during the last twelve months, it had its main operating office in the area and that office generated at least half of the firm’s gross revenues and employed at least half of the firm’s permanent employees. The Rule provides a number of factors that SBA will consider if the firm does not meet the foregoing criteria in order to determine whether the firm resides or primarily does business in a disaster area.

NMR Size Standard Does Not Apply to ITVAR Procurements

Since 2014, the table of size standards in SBA’s regulations has provided that ITVAR acquisitions under NAICS 541519, footnote 18, have a 150-employee size standard and are subject to the NMR. This, however, has caused some confusion, as the NMR has a 500-employee size standard. And, in a recent size appeal, a firm unsuccessfully argued that the size standard for ITVAR procurements should be the 500-employee NMR standard. To clarify this confusion, the Rule amends the NMR to expressly state that a firm may qualify as an SBC to provide manufactured products or other supply items as a nonmanufacturer if, among other things, it does not exceed 500 employees “(or 150 employees for the Information Technology Value Added Reseller exception to NAICS Code 541519, which is found at § 121.201, footnote 18)”.

Allowing a Set-Aside Within a Set-Aside

In what marks a significant change of policy, the Rule provides contracting officers the authority to set aside orders for a socioeconomic small business program (e.g., 8(a), HUBZone, SDVO, WOSB) under a multiple award contract (“MAC”) awarded as a generic small business set-aside. Notably, although SBA has considered implementing such a rule in the past, it has chosen not to, in part because it was concerned that such a rule would unfairly deprive SBCs of an opportunity to compete for orders issued under their MACs. In the Rule’s preamble, SBA explains that other actions it has taken in recent years have alleviated these concerns. However, SBA is requesting comments on whether it would impact the ability of SBCs to compete for and receive orders.

Size Recertification

SBA is also proposing language to clarify that recertification is required on full-and-open contracts when such contracts are awarded to SBCs. In addition, the Rule adds language to SBA’s 8(a) regulations to require recertification under 8(a) contracts. Similar language can be found in SBA’s SDVO, HUBZone, and WOSB/EDWOSB regulations, but had been missing from its 8(a) regulations.

Moreover, the Rule provides that, if a prime contractor is relying on a similarly situated subcontractor to meet the applicable performance requirements, the similarly situated subcontractor has to recertify, and the prime cannot count the subcontractor towards its performance requirements if the subcontractor recertifies as an entity other than that which it had previously certified. Interestingly, however, the Rule does not impose recertification requirements on the subcontractor, as the duty to recertify generally applies to prime contractors only. As such, it is unclear how this requirement will be administered.

Limitations on Subcontracting

The Rule proposes a number of revisions pertaining to LOS compliance. First, the Rule clarifies when an independent contractor can be counted as an employee for size and LOS purposes. According to SBA, it would not be equitable to consider an individual an employee for one purpose but not for the other. In this regard, SBA acknowledged that the current LOS regulation has created some confusion as to how to properly treat independent contractors. As it stands, the LOS regulation provides that “[w]ork performed by an independent contractor shall be considered a subcontract, and may count toward meeting the applicable LOS where the independent contractor qualifies as a similarly situated entity.” However, for size purposes, an individual contractor paid through a 1099 may be properly treated as an employee. As such, in order to clarify its intent, the Rule revises SBA’s LOS regulation to provide that (1), where a contract is assigned a NAICS code with an employee-based size standard, an independent contractor may be deemed an employee of the firm under the terms of the Size Policy Statement and (2), where a contract is assigned a NAICS code with a receipts-based size standard, an independent contractor could not be considered an employee but, rather, would always be deemed a subcontractor. Thus, for a contract that is assigned a NAICS code having an employee-based size standard, if an individual were considered an employee for size purposes, he/she would also be considered an employee for LOS purposes.

SBA is also proposing to add language to the LOS regulation to clarify that contracting officers may request information from contractors regarding LOS compliance and that LOS compliance is not required for every contract. In addition, SBA is requesting comments on whether all small business prime contractors performing set-aside or sole source contracts should be required to demonstrate compliance with the LOS to the contracting officer, and if so, how it should be demonstrated.

Lastly, in a welcome development, SBA is proposing to create several exclusions from calculating LOS compliance where there are no small business providers, such as spending on media buys, transportation/disposal for environmental remediation firms, and cloud computing. With respect to cloud computing, SBA is asking for comments on whether it should be treated as a supply under the NMR, such that waivers could be obtained. SBA is also requesting comments on whether the foregoing types of costs should be excluded from the calculation for purposes of measuring LOS compliance. Indeed, SBA does not want these exceptions to be abused. For example, it does not want agencies taking small business credit where the principal purpose of the acquisition is to obtain services from an other than SBC—i.e., a situation where perhaps the contract should not be set aside.

Ostensible Subcontractor

SBA is proposing to amend its regulations to allow an unsuccessful offeror, SBA, or a contracting officer to protest a socioeconomic set-aside or sole source award to a prime contractor that is unduly reliant on a small, but not similarly situated subcontractor (i.e., ostensible subcontractor affiliation). By way of background, an ostensible subcontractor is a subcontractor that is not a similarly situated entity (e.g., not a small business, SDVOSB, HUBZone, or 8(a)) and performs primary and vital requirements of a contract or a subcontractor upon which the prime contractor is unusually reliant. In such cases, assuming that an exception to joint venture affiliation does not apply, SBA will treat the small business prime contractor and its ostensible subcontractor as joint venturers and, therefore, affiliates. And, if the “joint venture” is other than small, the prime contractor is ineligible for award due to this affiliation.

Notably, however, under SBA’s recently enacted joint venture regulations, a joint venture receives an exception from affiliation if both venturers are small under the applicable NAICS code. This means, for example, that if an SDVOSB contract is awarded to an SDVOSB company and that company subcontracts most or all of the actual performance to a business that is small for the applicable NAICS code, but not an SDVOSB (e.g., a generic small business, HUBZone, 8(a), or WOSB), there is currently no way to protest the awardee on the basis of ostensible subcontractor affiliation. Indeed, since both the prime and the subcontractor are small businesses, even if they are deemed a “joint venture,” they are exempt from a finding of affiliation.

To address this type of outcome, under the proposed rule, an interested party would now be able to protest the status of such an awardee, and SBA would evaluate the relationship between the prime and its subcontractor under the ostensible subcontractor rule. To that end, if SBA found that the subcontractor was an ostensible subcontractor, it would treat the arrangement between the contractors as a joint venture that is not subject to an exemption from affiliation. This is a significant change, as it creates a basis for a status protest where one did not previously exist.

Kit Assemblers

SBA is also proposing to remove the kit assembler exception to the NMR. Instead, SBA will apply the multiple item rule to kit assembler acquisitions. Under this rule, if the majority of the items in a kit are made by a small business, no waiver of the NMR is required, but if the majority of the items are not made by a small business, a waiver of the NMR must be obtained.

Size Determinations

SBA is also proposing to amend 13 C.F.R. § 121.404(a) to make it clear that size is generally determined at the time of initial offer or response including price—and not when other formal responses are received after the initial offer, such as final proposal revisions. SBA is also proposing to add a paragraph to the foregoing regulation to articulate an exception to this general rule. Namely, when an agency awards a MAC that does not require offers for the contract to include price, size will be determined on the date of initial offer for the contract, which may not include price.

Other Changes

The Rule also addresses a few other topics such as posting notice of substantial bundling, subcontracting compliance reviews, procurement center representative reviews, and set-asides where one offer is received.

Consistent with the procedures outlined in the Administrative Procedure Act, SBA has invited and will be accepting comments to the Rule, provided they are received on of before February 4, 2019. Instructions on where and how to submit comments can be found here.

If you would like to know more about the Rule and its potential impact on your company or industry, please contact PilieroMazza, and one of our government contracts attorneys will be happy to assist you.

About the Author: Sam Finnerty is an associate with PilieroMazza in the Government Contracts Group. He may be reached at sfinnerty@pilieromazza.com.
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