SBA Proposed Rule Outlines New Mentor-Protégé Program for All Small Businesses

HIGHLIGHTS:

• The Small Business Administration (SBA) issued a long-awaited notice of proposed rule-making (NPRM) providing for a new expanded mentor-protégé program that will be available to all small businesses. The proposed rule was released on Feb. 5, 2015; comments are due by April 6, 2015.
• The new program will expand joint venture opportunities throughout all SBA's contracting programs, including the HUBZone, Women-Owned Small Business (WOSB) and Service-Disabled Veteran Owned (SDVO) small business programs, and for small businesses generally.
• The NPRM proposes changes to existing provisions concerning joint venture relationships within the 8(a) program.
• The NPRM also includes specific changes regarding the tribal 8(a) program, including further defining shared administrative services, imposing limitations on management of such 8(a) entities, and clarifying the process for changing a concern's primary NAICS code.
• The NPRM also includes several important provisions expanding HUBZone joint venture abilities; addressing SBA's ability to seek reconsideration of decisions of SBA's Office of Hearings and Appeals; and setting forth the standard of review applied by the Office of Hearings and Appeals in reviewing SBA actions.

The Small Business Administration (SBA) issued a long-awaited notice of proposed rule-making (NPRM) providing for a new mentor-protégé program that will be available to all small businesses. The proposed rule was released on Feb. 5, 2015; comments are due by April 6, 2015.

The 2010 JOBS Act (P.L. 111-240) directed SBA to develop such a program for its status-preferred contracting programs mirroring its current mentor-protégé program which is only available to firms participating in SBA's 8(a) Business Development ("8(a)") program. In the 2013 National Defense Authorization Act (P.L. 112-239; "2013 NDAA"), Congress further expanded the new program to include all small businesses. The NPRM implements these statutory mandates. It also includes several significant changes to 8(a) regulations and the 8(a) mentor-protégé program in particular. For more information about the 2010 Jobs Act and the 2013 NDAA, see Holland & Knight's Government Contracts Blog, "National Defense Authorization Act of 2013 Includes Significant Small Business-Related Provisions," Feb. 1, 2013.

This NPRM follows another important rule-making, issued by SBA on Dec. 29, 2014, that sets forth significant proposed changes to SBA's regulations governing limitations on subcontracting, also mandated by the 2013 NDAA.

Background on SBA's 8(a) Mentor-Protégé Program

SBA has long had a mentor-protégé program for businesses participating in its 8(a) program. That program allows qualified, SBA-approved mentors to provide a variety of assistance to 8(a) program participants (protégés) provided that assistance is set forth in a mentor-protégé agreement approved by SBA and is consistent with SBA's regulations. Unlike all other agency mentor-protégé programs, SBA's 8(a) mentor-program allows mentors and their 8(a) protégés to form joint ventures to pursue and perform 8(a) and small business set-aside contracts. While this is far from the only form of assistance provided by SBA's current 8(a) mentor-protégé program, it has been a particularly popular feature. The new program will expand this joint venture opportunity throughout all SBA's contracting programs, including the HUBZone, Women-Owned Small Business (WOSB) and Service-Disabled Veteran Owned (SDVO) small business programs. A mentor and protégé will be able to joint venture for any contract for which the protégé is eligible. By the terms of the 2013 NDAA this new program will also be open to any small business, including those that do not participate in one of the status-preferred programs.

SBA has consistently expressed concerns about its ability to manage such a large mentor-protégé program. The number of potential small business protégés will be many, many times greater than the universe of 8(a) concerns. SBA already has considerable familiarity with its 8(a) companies since they must apply for and be accepted in the program by SBA. Those 8(a) concerns must make a host of filings, including detailed annual updates, and are subject to inspection and document requests by SBA at virtually any time. Even with these controls in place, the 8(a) mentor-protégé program was the subject of considerable criticism for perceived abuses and concerns that large business mentors were reaping substantially all of the benefits of joint venture contracts in some cases. That criticism led SBA to rewrite substantially the 8(a) mentor-protégé regulations that were finalized in 2011.

Unlike the 8(a) program, the small business set-aside program is a self-certification program and SBA has virtually no visibility into most small businesses. In fact, it may have had no previous contact with many of them. Even with the HUBZone, WOSB and SDVO programs, SBA's insight is still more limited than in the 8(a) program. Allowing prospective mentors greater access to set-aside contracts through joint ventures with these protégés creates significant oversight concerns for SBA. However, by law, SBA is required to establish this expanded mentor-protégé program and the NPRM is in response to this statutory mandate.

Highlights of the Proposed New Mentor-Protégé Program

The new mentor-protégé program (which would be set forth in a new section of the regulations - 13 CFR 125.9) would, in large measure, follow the requirements of the current 8(a) mentor protégé program (13 CFR 124.520). The following are the proposed key elements:

Mentors

To be an eligible mentor an entity would have to demonstrate that: it is in good financial condition; it possesses good character; it is not presently listed on the Excluded Parties List System (EPLS); and it can impart value to the protégé "due to lessons learned and practical experience gained" or "through its knowledge of general business operations and government contracting." To support these showings a mentor would be required to provide tax returns for the past three years or provide SEC filings if it is publicly traded. Approved mentors would be required to recertify as to their good character and favorable financial position on an annual basis.

The proposed rule creates a presumption that a mentor generally will have no more than one protégé at a time. SBA may allow a mentor to add an additional protégé if it can demonstrate doing so "will not adversely affect the development of either protégé firm (e.g., the second firm may not be a competitor of the first firm)." Under no circumstances would SBA allow a mentor to have more than three protégés at one time.

Protégés

A protégé would have to qualify as small under its "primary NAICS code," and SBA would verify that size status by requiring the firm to seek a formal size determination from an SBA area office. Protégés would generally be allowed to have only one mentor at a time, but a second mentor could be added if the relationship would "not compete or otherwise conflict with the assistance" in the first mentor-protégé relationship. The second mentor relationship would have to be in an "unrelated" NAICS code or involve a different set of experience/assistance than is being provided by the first mentor. Additionally, protégés may not be mentors to another firm while in a mentor-protégé relationship themselves.

These proposed provisions raise several issues. First, self-certified small businesses would have to subject themselves to a formal size determination by SBA. An adverse finding would not only eliminate their mentor-protégé prospects but could compromise past and future small business set-aside contracts. That said, particularly given the recent program integrity and anti-fraud provisions imposed by the 2010 JOBS Act, small businesses should be careful that they are properly certifying as small; plus, having a size determination might provide additional cover in the event of a future size challenge. While diligence is in order prior to entering the size determination process with SBA, having an official determination from SBA of small business status should give those businesses greater comfort.

Second, the size determination would be made in connection with the size standard for the firm's "primary NAICS code" generally and not with respect to a particular procurement. SBA's process for determining the primary NAICS is addressed in other aspects of its existing regulations and this proposed rule tweaks those provisions (see below). A prospective protégé would need to ascertain its primary NAICS code and be prepared to provide substantiation based on its contracting experience and historical revenues over the previous three years.

Benefits

Once SBA approves a mentor-protégé agreement, the mentor and protégé would be eligible to submit offers as joint ventures on set-aside procurements for which the protégé is otherwise eligible. [Note: Consistent with current practice in the 8(a) program, the SBA approval must be received before any joint venture proposal can be submitted on a set-aside contract.] A protégé could also sell up to a 40 percent ownership interest to the mentor for the purpose of raising capital. Finally, a mentor and protégé will not be deemed affiliates based on the approved mentor-protégé agreement or assistance provided under it. [Note: Consistent with current practice, the mentor-protégé relationship does not create a blanket exclusion from affiliation, but is limited as noted here and in the NPRM.]

The provision of benefits would cease when the protégé is no longer small for its primary NAICS code. Here again, monitoring the primary NAICS code of the protégé – in addition to the NAICS codes of any specific procurement opportunities – will be essential.

Formal Requirements

The NPRM requires that the mentor-protégé relationship be set forth in a written agreement and approved by SBA. The agreement must set forth the forms of assistance to be provided, must provide that either party could terminate on 30 days' notice, that SBA will review the agreement annually, and may not be for a term of more than three years. The NPRM allows that a second agreement may be entered, either with the same mentor or with a second mentor, also limited to a three-year period.

Within SBA the agreement would have to be approved by the Director/Government Contracting (D/GC). If denied, the parties could seek reconsideration within 45 days. Parties could reapply after a 60-day cooling-off period from the date of SBA's final decision. No Office of Hearings and Appeals (OHA) or other administrative appeal is provided.

Once approved, the protégé is required to file an annual report with SBA, including the following:

• all technical and/or management assistance provided by the mentor to the protégé
• all loans to and/or equity investments made by the mentor in the protégé
• all subcontracts awarded to the protégé by the mentor and the value of each subcontract
• all federal contracts awarded to the mentor-protégé relationship as a joint venture, the value of each contract, and the percentage of work performed and percentage of revenue accruing to each party of the joint venture
• a narrative describing the success such assistance has had in addressing the developmental needs of the protégé and addressing any problems encountered
• the mentoring services the protégé receives by category and hours
• certifying whether there have been any changes in the terms of the agreement

SBA would be able to terminate a non-performing mentor, which would render the mentor ineligible to serve as a mentor for two years. SBA can also recommend a stop-work order on any joint venture contracts and finally, SBA can use the mentor's non-performance as a basis for debarment.

Highlights of the Joint Venture Provisions

Once approved by SBA, a mentor and protégé could form joint ventures to pursue set-aside contracts for which the protégé is eligible. SBA has prescribed the terms of any such joint venture relationship that must be set forth in an agreement and approved by SBA prior to the time of award of any set-aside contract to the joint venture. These provisions are largely similar to the current 8(a) joint venture requirements but contain some notable differences (which are also proposed as changes to the 8(a) program regulations). Among other things, the proposed joint venture requirements include the following:

• The protégé must be the managing venturer of the joint venture and a protégé employee must be the project manager of the joint venture.
• The protégé must own at least 51 percent of the joint venture ownership interests and receive a commensurate share of the profit.
• The joint venture must perform the percentage of work on a set-aside contract required by the applicable FAR and SBA limitation on subcontracting rules (i.e., 50 percent for services and manufacturing contracts; and 15-25 percent for construction and specialty trade construction).
• The protégé must perform at least 40 percent of the work performed by the joint venture partners, including the affiliates of the non-small business partner's affiliates through subcontracts at any tier.
• The protégé must perform more than administrative and ministerial tasks.
• The joint venture must establish a special bank account.
• The joint venture agreement must itemize all major equipment, facilities and other resources to be furnished by each party.
• The joint venture agreement must specify the responsibilities of the parties with respect to contract negotiation, source of labor and contract performance.
• The joint venture agreement must provide that each partner will ensure performance of the contract if the other member withdraws or fails to perform.
• The small business member must maintain all accounting and administrative records of the joint venture absent approval by SBA to keep them elsewhere.
• Each party to the joint venture would be required to sign a "certificate of compliance" attesting to compliance with the provisions of the joint venture agreement and that the parties will perform in compliance with the performance of work requirements. The certificate must be provided by the protégé to both SBA and contracting officer prior to performance of any set-aside contract.
• Each joint venture party must allow SBA, including SBA's Office of Inspector General, "to inspect and copy all records and documents." [Note: There is no limitation on the scope of this inspection right.]
• The protégé would be required to file annual reports signed by both joint venture partners explaining how performance of work requirements are met on each set-aside contract, and to report at the conclusion of each contract on the same information. At contract completion both parties would be required to certify compliance to SBA.

The proposed rule also provides that agencies must consider the past performance of each joint venture party when evaluating a proposal from the joint venture. In addition, SBA notes that it may consider suspension and debarment of either joint venture partner for non-compliance with the joint venture agreement, including with the performance of work requirements, failure to submit a certification and failure to provide records as requested.

These added certification and reporting requirements, particularly for mentors, are in response to SBA's concerns that it lacks the ability to take enforcement actions against mentors it perceives as violating program terms or otherwise engaging in behavior SBA finds objectionable.

Proposed Changes to the Current 8(a) Joint Venture Provisions

Of the provisions noted above, the following are among those that differ from the current 8(a) joint venture regulations, which would be amended to adopt these differences:

• the right to inspect the records of both the mentor and protégé
• the requirement that both parties submit a certification of compliance
• the express language regarding the basis for suspension and debarment of either joint venture party

Notably, the proposed rules would drop several current eligibility requirements for 8(a) protégés, including that a protégé be either in the developmental phase of the 8(a) program; have a size that is less than half the corresponding size standard of its primary NAICS code; or never have received an 8(a) contract.

The proposed 8(a) regulations would also clarify that SBA must approve joint venture agreements prior to 8(a) contract awards, but that SBA is not required to approve any addendum addressing performance of a second or third contract to the joint venture for non-8(a) contracts. [Note: SBA's affiliation provisions generally limit joint ventures to three contract awards in a two-year period, although parties may form additional joint ventures subject to SBA's requirements and the same "three-in-two" limitation.]

Despite SBA's overarching goal of having the two mentor-protégé programs mirror one another, SBA has proposed an additional component to the 8(a) regulations addressing blanket purchase agreements, basic ordering agreements and the like. The proposed rule would require the joint venture to submit an addendum to its joint venture agreement for each award under such a vehicle. It also states that each such award would constitute a separate contract award. SBA does not discuss these particular proposed changes directly in its summary, nor does it include these same provisions in the new mentor-protégé joint venture regulation. Further analysis of this proposed change is warranted.

Additional Changes

Changes Related to Tribal, Including ANC and NHO Contracting

1. SBA proposes to define "common administrative service" for purposes of affiliation outside the 8(a) program.

Under the current affiliation regulations, for small business set-asides, tribal concerns (including Alaska Native Corporations (ANCs) and Native Hawaiian Organizations (NHOs) (collectively "entity-owned" concerns) are not affiliated with the tribal parent or other business concerns owned by the same tribe based on common ownership or management or on shared administrative services, so long as adequate payment is made for those services. 13 CFR 121.103(b)(2). [Note: Entity-owned concerns' blanket exception from affiliation for purposes of the 8(a) program, set forth in 13 CFR 124.109, is not affected by this rule.]

The proposed rules would add a definition of "common administrative services" to SBA's affiliation regulations governing entity-owned concerns. The revisions state:

Common administrative services which are subject to the exception to affiliation include, bookkeeping, payroll, recruiting, other human resource support, cleaning services, and other duties which are otherwise unrelated to contract performance or management and can be reasonably pooled or otherwise performed by a holding company or parent entity without interfering with the control of the subject firm.

2. SBA proposes to define "contract administration service" and when such services count as "administrative services" for affiliation purposes.

The proposed rules also define "contract administration services" (i.e., services related to a particular contract) and then distinguish between such services that could be considered "common administrative services" under the exception to affiliation and those that could not. Specifically, SBA states:

Contract administration services that encompass actual and direct day-to-day oversight and control of the performance of a contract/project are not shared common administrative services, and would include tasks or functions such as negotiating directly with the government agency regarding proposal terms, contract terms, scope and modifications, project scheduling, hiring and firing of employees, and overall responsibility for the day-to-day and overall project and contract completion.

As to services that might constitute "administrative services" covered by the affiliation exception, SBA states:

Contract administration services that are administrative in nature may constitute administrative services that can be shared, and would fall within the exception to affiliation. These administrative services include tasks such as record retention not related to a specific contract (e.g., employee time and attendance records), maintenance of databases for awarded contracts, monitoring for regulatory compliance, template development, and assisting accounting with invoice preparation as needed.

3. SBA proposes to clarify the extent to which tribes, ANCs and NHOs can rely on holding companies and the parent for business development support.

Consistent with recent guidance issued by SBA, SBA proposes to amend its regulations to address shared business development services by entity-owned concerns and the extent to which such services fall under the "administrative services" exception to affiliation. SBA has stated that business development services provided to an entity-owned concern by a parent or holding company may fall within the definition of common administrative services." SBA proposes to incorporate this guidance into its regulations. SBA notes in the proposed rules that the nature and timing of the services must be considered to determine whether they may properly be considered within the administrative services exception to affiliation.

4. SBA proposes limitations on day-to-day managers of entity-owned concerns.

SBA has also recently issued guidance setting forth limitations on the management of entity-owned 8(a) and small business concerns. Specifically, SBA has stated that for 8(a) eligibility purposes, an individual may not be responsible for day-to-day management of more than two concerns (regardless of whether those concerns are in the 8(a) program). Language supporting this limitation appears in Section 7(j)(11)(B)(iii)(II) of the Small Business Act (15 U.S.C. 636(j)(11)(B)(iii)(II)), but did not also appear in SBA's 8(a) BD regulations. SBA proposes to add this provision to its regulations.

5. SBA proposes to further define when a tribal entity has a "substantial unfair competitive advantage."

Currently, an entity-owned concern is not eligible for the 8(a) program if the SBA administrator determines that the concern has or is likely to obtain a "substantial unfair competitive advantage within an industry category." 13 CFR 124.109(c)(2)(iii).

Under the proposed rule, SBA seeks to provide clarification as to both the definition of "industry category" and the geographic scope of the industry used to make this determination. The SBA proposes to define industry category based on the six-digit NAICS code that best describes the primary business activity of the concern in defining an industry category. SBA reasons that it is best to apply the same definition of industry as found in other sections of the Small Business Act which rely on the NAICS system.

SBA also proposes to clarify that the geographic scope of the industry category is on a national scale – not a local one. SBA's reasoning is that as NAICS codes and their related size standards are developed on a national basis, it makes sense to use the same scale here. Accordingly, SBA proposes that a concern will not be subject to the affiliation exemption where found to have, or likely have, a substantial unfair competitive advantage in a specific NAICS code with a specific size standard on a national scale.

6. SBA addresses economic disadvantage and Native Hawaiian Organizations.

The proposed rule here clarifies that an NHO-owned concern's eligibility for 8(a) participation is separate and distinct from individual members' eligibility. While an individual Hawaiian Native may have used their own business to participate in the 8(a) program, their eligibility could help qualify the NHO as economically disadvantaged as well.

Further, the proposed rule does not propose specific changes with regard to how the SBA determines an NHO is economically disadvantaged. Rather, SBA is requesting comments as to whether there should be a different approach. Currently, NHOs are required to be economically disadvantaged to establish eligibility to participate in the 8(a) program, but there is little guidance on how that determination is made beyond looking to the economic disadvantage of a majority of its members. SBA suggests that an alternative method in making the determination would be to utilize the same method in making the determination for tribes. The issue appears to be how to define the community of the NHO in a similar way to the population of the tribe. SBA will consider comments received on or before April 6, 2015, in developing a final rule.

Other 8(a) and Small Business Proposed Changes – NAICS Codes and Set-Asides

The designation of a firm's "primary NAICS code" is becoming increasingly important in SBA's programs. 8(a) concerns have long had to demonstrate they are "small" for their primary industry. In the 2011 amendments to its 8(a) regulations, SBA added provisions addressing the industry designations of entity-owned concerns, including by expanding the regulation stating that an entity-owned applicant to the 8(a) program cannot join the program using the same primary business classification or "NAICS" code as another participant (or recent participant) that is owned by the same entity. As discussed above, the primary NAICS code of potential protégés in the new mentor-protégé program is a significant eligibility consideration.

Under the 2011 revisions to SBA's regulations, SBA formalized a process by which a business concern could request that SBA formally change its primary NAICS code designation based on the firm's revenue allocation over the past three years. While not explicitly permitted by the regulations, in practice, SBA has also been initiating primary NAICS code changes for concerns. SBA proposes to formalize its ability to engage in this process. SBA also proposes to clarify that the concern's primary NAICS code will be the code in which the participant has the greatest amount of revenue over a three-year period, but it need not represent a majority (i.e., more than 50 percent) of the concern's revenues. Prior to formally changing the participant's NAICS code, the proposed regulations require SBA to first notify the concern and allow for an opportunity to provide information as to why such a change would be inappropriate.

The NPRM also includes proposed regulations specific to 8(a) set-aside contracts. Specifically, the rule allows an agency to set-aside specific task or delivery orders for 8(a) competition even if the multiple award contract from which the order originates was not an 8(a) set-aside contract.

Proposed Changes Related to Other Status-Preferred Programs – HUBZone Joint Ventures

Current HUBZone rules only permit HUBZones to joint venture with other qualified HUBzone companies. The proposed rule would allow HUBZone companies to joint venture with other non-HUBZone small businesses in order to make the program consistent with the others. Additionally, the proposed rule adds regulatory language to clarify that the burden to prove HUBZone eligibility lies with the applicant and to state that SBA will make its determination as to HUBZone certification within 90 days of receipt of a complete application.

Proposed Changes Related to SBA Office of Hearing and Appeals Procedures

The proposed rule includes revisions to the OHA rules of procedure that govern all appeals. OHA precedent prevented SBA from requesting reconsideration of an OHA decision if it did not appear as a party in the original appeal. This change allows SBA to seek reconsideration of an OHA decision even if it did not intervene and was not a party in interest in the proceedings prior to the issuance of the decision.

Another change to the OHA rules is specific to the standard of review for appeals brought related to the 8(a) program. Currently, the standard requires OHA to determine whether an SBA determination was reasonable or whether it was arbitrary, capricious, or contrary to law. Under the proposed change, if OHA determines that SBA's decision considered all relevant factors, did not make a clear error of judgment, and that SBA's "path of reasoning may reasonably be discerned," then the SBA determination will stand on appeal. In other words, if the OHA can figure out why a poorly written decision concerning an 8(a) matter was decided, OHA will uphold it. 
   

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.