The SBA’s Guide to the Ostensible Contractor Rule

By Grace Mahan

In a recent size appeal decision, Emergent, Inc., SBA No. SIZ-5875, the Small Business Administration (SBA) Office of Hearing and Appeals (OHA) reinforced the criteria it uses to evaluate the “ostensible subcontractor” rule. The rule provides that when a prime contractor is unusually reliant on a subcontractor or when a subcontractor is performing the “primary” requirements of a contract, the two are to be considered affiliated for purposes of the procurement. This can affect the calculation of the size of the contractor for the purpose of the SBA’s small-business rules, potentially rendering the prime contractor “other than small” and ineligible for award.

In Emergent, the SBA OHA clearly lays out the factors used to determine whether the ostensible contractor rule has been violated. The decision illustrates some of the pitfalls that can trap a small business when submitting a proposal, and should be considered by companies that are considering whether to protest an award on the basis of an awardee’s size.

In Emergent, a disappointed bidder contested the small-business designation of a contract awardee, Kapsuun Group, LLC (KG), on the grounds that KG’s relationship to its sister company and to its subcontractors violated the ostensible contractor rule. The SBA issued a size determination and agreed, holding that KG’s proposal violated the rule because it did not “delineate any discrete tasks to KG.”  Further, KG’s proposal did not mention KG in the technical approach portion of its proposal, nor management approach section; the project manager listed by KG was also not an employee of KG, but an executive of one of KG’s proposed subcontractors.  On a subsequent size determination, however, the SBA reversed that determination, and the disappointed bidder appealed to OHA.

In denying the appeal, OHA set forth several criteria to determine whether a small business violates the ostensible contractor rule. Applying these criteria, it found that KG was not unusually reliant on its subcontractors and would in fact perform the primary requirements of the contract.

In determining whether KG would perform the “primary” requirements of the contract, the SBA made clear that, because a procurement’s primary requirements stem from the contract’s principal purpose, they are typically those that account for the majority of the effort or dollar value. The SBA specified that when a contractor and subcontractors are performing the same type of work, the firm performing the majority of the total contract should be deemed as performing the primary contract requirements.  In this case, the record indicated that KG would provide 67 percent of the full-time equivalents (FTEs) that would be performing the primary and vital requirement of the contract – as opposed to 31 percent of the FTEs being provided by KG’s subcontractor.

Next, concerning the charge that KG was unusually reliant upon its subcontractors, the SBA highlighted four key factors that contribute to a finding of “unusual reliance.” (1)  Is the subcontractor an incumbent contractor ineligible to compete for the procurement at issue? (2) Will the contractor hire the majority of its workforce from a subcontractor? (3) Will the contractor’s proposed management serve with a subcontractor on the incumbent contract? And, (4) Is the contractor inexperienced and therefore relying on a subcontractor to win the contract?

Applying these factors, OHA again found that KG was not in violation of the “ostensible subcontractor” rule.  Although KG’s proposed subcontractor was (1) the incumbent on the project, this fact was not itself enough to show that KG would be unusually reliant on its subcontractor.  The record did not indicate (2) that KG would hire its workforce “en masse” from its subcontractor.  Further, KG demonstrated (3) that its proposed project manager would report to KG, and not to KG’s subcontractor.  Finally, (4) KG’s own experience was itself sufficient for KG to win award, irrespective of KG’s subcontractor.

Our firm has extensive experience in the federal procurement process, including helping small businesses comply with federal regulations, as well as helping companies pursue or defend protests. Please contact any of our lawyers if we may be able to assist you with these or other matters.

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