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Small Business Avoids Ostensible Subcontractor Affiliation Despite Hiring 100% Of Incumbent Personnel

by Stephen L. Bacon

When a government service contract transitions from one firm to another, it is common practice for the new contractor to hire employees from the incumbent.  In contracts set aside for small business, this practice can create an affiliation between the two firms under the so-called “ostensible subcontractor” rule if the small business plans to subcontract a large portion of the work to the incumbent.  If it is found to be affiliated with a large business, the small business will be deemed ineligible for award.

In the Size Appeal of NorthWind-CDM Smith Advantage JV, LLC, SBA No. SIZ-6053 (2020), the Small Business Administration’s (“SBA”) Office of Hearings and Appeals (“OHA”) provided guidance to small businesses on how to avoid affiliation under the “ostensible subcontractor” rule.  NorthWind confirms that, if done properly, a small business may team with the incumbent contractor and hire some of its employees without running afoul of the “ostensible subcontractor” rule.  The analysis is complicated by a 2019 Trump Executive Order which rescinds an Obama-era policy that encouraged service contractors to hire qualified incumbent employees.

 

Small Business Teams with an Ineligible Large Incumbent

This case involved a Department of Transportation (“DOT”) procurement for communications and operations research analysis.  The incumbent contract was performed by a large business, DIGITALiBiz, Inc. (“iBiz”).  DOT set aside the new procurement for participants in the SBA’s 8(a) Business Development Program.  After DOT announced that Changeis, Inc. (“Changeis”) was the apparent awardee, NorthWind filed a size protest challenging Changeis’ eligibility. NorthWind argued that Changeis was not small due to its affiliation with iBiz under the “ostensible subcontractor” rule.

In its proposal, Changeis stated it would retain 100% of the incumbent staff and planned to subcontract less than 40% of the work to iBiz.  To perform its share of the work, Changeis planned to hire non-managerial and managerial personnel who worked on the incumbent contract for iBiz and its subcontractors.  Prior to proposal submission, Changeis met with the incumbent employees, assessed their qualifications, made individual employment offers, and obtained letters of commitment from the personnel it intended to hire.

 

Small Business Will Perform the “Primary and Vital” Requirements

Although Changeis’ planned to rely on the incumbent workforce, OHA affirmed a decision by the SBA Area Office which found no affiliation between Changeis and iBiz under the “ostensible subcontractor” rule.  Under the rule, a prime contractor and subcontractor are affiliated if the subcontractor is performing the “primary and vital” requirements of the contract, or when the prime contractor is “unusually reliant” upon the subcontractor. 13 C.F.R. § 121.103(h)(4).  OHA affirmed the Area Office’s finding that Changeis would perform the “primary and vital” requirements and it was not “unusually reliant” on iBiz.

The “primary and vital” requirements are those associated with the principal purpose of the procurement as reflected in the solicitation.  It is not always clear whether certain requirements are “primary and vital” as compared to other requirements.  In those circumstances, where the prime contractor and subcontractor will perform the same types of work, OHA has recognized that the firm that will perform the majority of work is performing the “primary and vital” requirements.

In NorthWind, the Area Office found that the “primary and vital” requirements were to provide a wide range of specialized communications and operations support.  Changeis and iBiz each planned to perform work under the broad umbrella of “communications and operations” support.  Changeis’ proposal and its teaming agreement with iBiz confirmed that Changeis would manage the contract and perform at least 51% of the work.  Accordingly, OHA affirmed the Area Office’s finding that Changeis would perform the contract’s “primary and vital” requirements.

 

Small Business is Not “Unusually Reliant” on the Large Incumbent

OHA also affirmed the Area Office’s determination that Changeis was not “unusually reliant” on iBiz.  OHA looks to “four key factors” to evaluate unusual reliance: (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.  See Size Appeal of DoverStaffing, Inc., SBA No. SIZ-5300 (2011).

The first factor was clearly satisfied in this case because Changeis planned to engage the large incumbent, iBiz, as its subcontractor.  In general, subcontracting work to an ineligible incumbent leads to “heightened scrutiny” of the relationship.  But the presence of that factor alone is not sufficient to find a violation of the “ostensible subcontractor” rule.  Thus, OHA examined the three remaining factors to determine whether Changeis and iBiz were affiliated.

As to the second factor, OHA found that the record did not establish that Changeis will hire the large majority of its workforce from iBiz. Although Changeis intended to hire 100% of the incumbent staff, many of those employees worked for iBiz’s subcontractors.  Moreover, the new contract required more labor hours than the incumbent contract.  As a result, Changeis would need to hire dozens of new employees to perform the expanded scope of work.

OHA further noted that “hiring the incumbent workforce alone is not problematic so long as the personnel to be hired from incumbent are reviewed individually rather than a unilateral transfer of employees or hiring en masse.”  Size Appeal of Inquiries, Inc., SBA No. SIZ-6008, at 23 (2019).  Because Changeis’ executives reviewed the qualifications of the incumbent employees, made individual offers of employment, and obtained letters of commitment from those personnel, OHA found there was no basis to conclude that Changeis engaged in impermissible en masse hiring of iBiz’s employees.

OHA recognized that the third factor “does appear to be met” because Changeis proposed managerial personnel who worked for iBiz on the incumbent contract.  Nevertheless, OHA determined that this was mitigated by the fact that the managerial personnel will be hired by Changeis upon award and will be controlled and supervised by Changeis during performance.

OHA affirmed the Area Office’s finding that the fourth factor was not met because Changeis had relevant experience. Changeis provided three of the five past performance references included in the proposal and had eleven other prime contracts considered relevant.  Despite this experience, NorthWind claimed that Changeis did not have specific experience with large dollar value contracts.  OHA rejected this claim as speculative and, in any event, found that NorthWind failed to explain why prior experience with one very large contract was necessary to perform numerous smaller task orders contemplated under the contract with DOT.  Based on its review of the four DoverStaffing factors, OHA affirmed the Area Office’s finding that Changeis and iBiz were not affiliated.

 

Executive Order 13495 and the “Ostensible Subcontractor” Rule

In its decision, OHA agreed with the Area Office that Changeis’ hiring of non-managerial employees from iBiz was consistent with Executive Order 13,495, Nondisplacement of Qualified Workers Under Service Contracts.  Executive Order 13,495 was issued in 2009 by President Obama.  Under FAR 52.222-17, which implemented Executive Order 13,495, successor contractors were required to offer a right of first refusal of employment to qualified incumbent non-managerial employees.

Last year, President Trump issued Executive Order 13,897 to revoke Executive Order 13,495.  NorthWind argued that it was improper for the Area Office to rely on Executive Order 13,495 because it is no longer in effect.  OHA rejected NorthWind’s contention because Executive Order 13,495 remained in effect as of the date to determine Changeis’ size for the procurement.

In light of the policy reflected in Executive Order 13,495, OHA has previously stated that the hiring of non-managerial employees from the incumbent cannot be considered strong evidence of unusual reliance.  For example, in Size Appeal of Spiral Solutions and Techs., Inc., SBA No. SIZ-5279, at 28 (2011), OHA explained that “insofar as OHA may have previously suggested that the hiring of incumbent non-management personnel is indicative of undue reliance under the ostensible subcontractor rule, such an interpretation plainly is no longer sensible in light of Executive Order 13,495.”

It will be interesting to see whether OHA’s analysis under the ostensible subcontractor rule changes based on the revocation of Executive Order 13,495.  In Executive Order 13,897, President Trump directed agencies to promptly rescind regulations implementing Executive Order 13,495, such as FAR 52.222-17.  In future procurements that do not include FAR 52.222-17, it is possible that OHA could revert to the view expressed in some prior cases that hiring incumbent employees may be indicative of undue reliance.  See, e.g. Size Appeal of The Analysis Group, LLC, SBA No. SIZ-4814, at 6 (2006).  This would be problematic for many contractors who have relied on OHA’s consistent recognition in recent years that the practice of hiring incumbent employees is very common, particularly on service contracts, and not indicative of undue reliance as a result of the Obama-era policy.

 

Conclusion

There are many important size eligibility considerations for small businesses to think about when they are planning to team with a large incumbent for a set-aside opportunity.  Although the ostensible subcontractor inquiry is very fact-specific and will depend on the unique circumstances of each procurement, the NorthWind appeal offers some guidance as to how small businesses can avoid affiliation in this situation.  If you have questions about the ostensible subcontractor rule, please contact Stephen L. Bacon at sbacon@rjo.com.

 


Disclaimer: The materials provided are offered for informational and educational purposes only and are not offered as and do not constitute legal advice or legal opinions.  The transmission or receipt of information or communications with Rogers Joseph O’Donnell does not constitute or create an attorney-client relationship between us and any recipient.

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