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Ostensible Subcontractor Rule: SBA OHA Confirms “Four Key Factors” To Avoid

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Koprince Law LLC

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In determining whether a prime contractor and subcontractor are affiliated under the ostensible subcontractor rule, the SBA is supposed to consider the totality of the relationship between the parties.  But when it comes to determining whether the ostensible subcontractor rule has been violated, not all components of the prime/subcontractor relationship are created equal.

In a recent decision, the SBA Office of Hearings and Appeals confirmed that there are “four key factors” that are strongly suggestive of ostensible subcontractor affiliation–especially if the subcontractor will perform a large percentage of the overall contract work.

OHA’s decision in Size Appeal of Charitar Realty, SBA No. SIZ-5806 (2017) involved a GSA solicitation for custodial, landscaping and grounds maintenance at two federal courthouses.  The solicitation was issued as an 8(a) set-aside under NAICS code 561720 (Janitorial Services), with a corresponding $18 million size standard.  The solicitation required, among other things, that offerors provide at least three past performance references, completed over the last three years, for similar work.

After evaluating competitive proposals, the SBA announced that Charitar Realty was the apparent successful offeror.  An unsuccessful competitor then filed a size protest.  Although the size protest was found to be untimely, the SBA believed that the protest raised valid concerns.  The Director of the SBA’s Fresno District Office initiated his own size protest against Charitar.

Charitar’s proposal identified itself as the prime contractor and Zero Waste Solutions, Inc. as its subcontractor.  ZWS was the incumbent contractor, but had graduated from the 8(a) Program and was not eligible for the follow-on contract.

The proposal stated that “the allocation of financial risk, responsibility, and profit sharing will be 51% [Charitar] and 49% [ZWS].”  The proposal included three past performance references: two for ZWS and one for Charitar.  The project performed by Charitar was much smaller in scope and value.

The proposed Project Manager was a current employee of ZWS, who had agreed to move to Charitar’s payroll if Charitar won the prime contract.  Additionally, the SBA Area Office found that Charitar’s “entire workforce” would be hired from ZWS.

The SBA Area Office determined that Charitar was unusually reliant upon ZWS.  The SBA Area Offices deemed the firms affiliated under the ostensible subcontractor rule.  The affiliation caused Charitar to be ineligible for award.

Charitar appealed to OHA.  Charitar argued that the SBA Area Office had erred by finding a violation of the ostensible subcontractor rule.

OHA began its opinion by reiterating that the ostensible subcontractor rule “provides that when a subcontractor is performing the primary and vital requirements of the contract, or when the prime contractor is unusually reliant upon the subcontractor, the two firms are affiliated for purposes of the procurement at issue.”  The rule is intended ” to prevent [large] firms from forming relationships with small firms to evade SBA’s size requirements.”

To determine whether a relationship violates the ostensible subcontractor rule, the SBA Area Office “must examine all aspects of the relationship, including the terms of the proposal and any agreements between the firms.”  However, OHA’s prior case law has “identified ‘four key factors’ that have contributed to the findings of unusual reliance.”  OHA explained that those four factors are:

(1) the proposed subcontractor is the incumbent contractor and is ineligible to compete for the procurement; (2) the prime contractor plans to hire the large majority of its workforce from the subcontractor; (3) the prime contractor’s proposed management previously served with the subcontractor on the incumbent contract; and (4) the prime contractor lacks relevant experience and must rely upon its more experienced subcontractor to win the contract.

When these four factors are present, “violation of the ostensible subcontractor rule is more likely to be found if the proposed subcontractor will perform 40% or more of the contract.”

In this case, all four of the “key factors” were present.  ZWS was “ineligible to submit its own proposal” under the solicitation.  Charitar “will staff its portion of the contract almost entirely with personnel hired from ZWS.”  Charitar proposed “a ZWS employee to manage the contract” as Charitar’s Project Manager.  And although Charitar had some experience in the industry, Charitar produced no evidence that it had “ever performed” a contract of the size defined as “Similar Work” in the solicitation.  Finally, ZWS was proposed to perform 49% of the work, “a larger proportion than the 40%” that heightens the risk of ostensible subcontractor affiliation.

OHA affirmed the SBA Area Office’s size determination.

Ostensible subcontractor affiliation is intensely fact-specific, and the SBA will examine the totality of the relationship between the parties.  But as the Charitar Realty case demonstrates, the risk of ostensible subcontractor affiliation increases significantly where the “four key factors” identified in the case are present–particularly where the subcontractor will perform more than 40% of the work.

Because ostensible subcontractor affiliation is so fact-specific, it’s difficult to be 100% sure that any specific relationship will pass muster.  That said, avoiding the four key factors will likely go a long way toward showing the SBA that there has been no ostensible subcontractor violation.


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