As readers of SmallGovCon know, SBA interprets its small business joint venture rules vary strictly. A small business joint venture must follow all of SBA’s requirements down to the letter, or risk being found noncompliant. In a recent case, SBA’s Office of Hearings and Appeals (OHA) examined how a joint venture was managed under the state law of Michigan and found that the joint venture was noncompliant with small business rules.
In Size Appeal of: Syscom, Inc., SBA No. SIZ-6195, 2023 (2023), SBA’s Office of Hearings and Appeals (OHA) considered a size protest arising from an Air Force procurement for Integrated Solid Waste Management set aside for 8(a) Participants under a size standard of $41.5 million. SNI United, LLC (SNI) was the apparent awardee, and SysCom, Inc. (SysCom or Appellant) challenged SNI’s size.
SNI was a joint venture (JV) composed of an 8(a) participant, 1-855-US-TRASH, LLC (US Trash), and a small business, Six Nations, Inc. (Six Nations). SysCom alleged that the joint venture was noncompliant because, among other reasons, US Trash didn’t control day-to-day management and managers from Six Nations controlled the JV.
An initial size determination said that SNI was a small business, but after an appeal OHA sent it back to the Area Office to take another look, stating that “although SNI represented to the Area Office that it is a joint venture between two business concerns, majority-owned and controlled by US Trash, its Managing Venturer, these assertions appear inconsistent with Michigan state law as well as with other evidence in the record, much of which SNI itself submitted to the Area Office.”
Interestingly, the Area Office said, on remand, that it “cannot decide the enforceability or scope of this provision or the other peculiarities of [SNI’s] organization and their effect on its control. Any inquiry into ‘whether SNI’s business and ownership structures meet SBA joint venture requirements’ is premature . . . .” The Area Office also noted it has no “expertise in interpreting or applying Michigan state law”, nor does it have “the luxury of time nor other assistance and resources to undertake such an effort”.
The Michigan statue in question states:
Unless the articles of organization state that the business of the limited liability company is to be managed by 1 or more managers, the business of the limited liability company shall be managed by the members, subject to any provision in an operating agreement restricting or enlarging the management rights and duties of any member or group of members. If management is vested in the members, both of the following apply:
(a) The members are considered managers for purposes of applying this act, including section 406 regarding the agency authority of managers, unless the context clearly requires otherwise.
(b) The members have, and are subject to, all duties and liabilities of managers and to all limitations on liability and indemnification rights of managers.
On appeal, OHA reiterated that an 8(a) joint venture must 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”. 13 C.F.R. § 124.513(c)(2). But OHA noted a particularity of Michigan law that caused a problem for the joint venture.
Michigan law stipulates that, unless a particular Manager or Managing Member is identified in an LLC’s operating agreement or articles of organization, all members are deemed to be managers of the LLC. SNI informed the Area Office that it does not have an operating agreement, and according to SNI’s Articles of Organization, US Trash is not designated as the Manager or Managing Member of SNI. Given this record, then, the Area Office properly found a “clear contradiction” between SNI’s JVA and Michigan law, and correctly concluded that Michigan law must take precedence. It follows that US Trash is not the Managing Venturer of SNI, in contravention of 13 C.F.R. § 124.513(c)(2).
But there was also a problem with the JV’s Board of Directors, consisting of only two people, one from each joint venture member. Under this setup, “Ms. McMahan (one of SNI’s two Directors) can exert negative control over SNI by, for example, declining to attend Board meetings, thereby blocking a quorum. . . .” SNI argued that that “Ms. McMahan’s control over SNI is illusory, because Mr. Hamad, as SNI’s majority shareholder, may unilaterally remove her from the Board.” But the bylaws stated: “no Director shall be removed if the number of votes recorded against his removal would be sufficient, if cumulatively voted at an election of the entire Board of Directors to elect one or more Directors.” Under this language, “it does not appear that Mr. Hamad, with only 51% ownership, has a sufficiently large ownership interest in SNI to unilaterally remove Ms. McMahan from SNI’s Board.”
This decision makes it clear that having a written joint venture agreement and operating agreement is a must. And that written document must clearly set forth who is the managing venturer and manager of the joint venture and possibly designate the managing member as well. While this decision focused on Michigan law, other states may have similar rules. As we’ve said before, be careful setting up your joint venture.
Questions about this post? Or need help with a government contracting legal issue? Email us.OHA: Ill-Defined Joint Venture Agreement and State Law Requirements Means JV was Invalid first appeared on SmallGovCon - Government Contracts Law Blog.