How not to structure a joint venture
A Federal court throws cold water on JV management by committee. Plus, why JVs are limited to two years.
Joint ventures are the fastest-growing segment of small-business contractors. Could hundreds of them be invalid after a Federal court ruling?
I wrote last month about how JVs have increased their contract dollars by 300% since SBA introduced the All-Small Mentor-Protégé program:
Recognizing that opportunity, more and more joint ventures are being formed every day. There are now 29,600 small-business joint ventures registered in SAM.gov. That means there are more joint ventures than there are small businesses in any of the SBA certification programs:
But, because of a Court of Federal Claims case this month, hundreds of those joint ventures might be improperly formed. SBA created the concept of a small-business joint venture under direction from Congress—more on that in a moment. For now, just understand that, in creating the concept, SBA set strict criteria on how a small-business joint venture can qualify for preferences under the socioeconomic small business programs—8(a), service-disabled veteran-owned, HUBZone, and women-owned—and under the SBA mentor-protégé program.
There are 12 criteria in all. While moderating a panel on mentor-protégé at AGC Seattle, Aaron Rugg called these the “dirty dozen,” and I am going to borrow that phrase for the rest of my career. Among the dirty dozen are requirements for reporting to SBA, controlling the contractual performance of the joint venture, and the profit share. There are slight differences—mostly in the reporting requirements—between joint-venture requirements for SBA’s multiple programs.
The case before the Court of Federal Claims involved two mentor-protégé joint ventures going after a Navy engineering contract. The Navy had set aside the contract for small businesses. The small-business joint venture that the Navy selected was between WEIS, the mentor, and its protégé, NEI. The other joint venture, Acacia7, initially protested the size of NEI. NEI was able to show that, on its own, it was a small business. But the protester Acacia7 then argued that NEI’s joint venture with WEIS did not meet SBA’s joint-venture rules and therefore could not qualify to receive the set-aside award.
Of the dirty dozen, the particular rule in question was #2, which is easily the longest of the 12—so long it’s not worth quoting the whole thing here; just click the link for 13 CFR 125.8(b)(2)(ii). In short, for the mentor-protégé program, Rule #2 requires that the small business—not the mentor—be responsible for the joint venture’s day-to-day management. There are exceptions for corporate governance activities and decisions that are “commercially customary,” a term that SBA does not define.
NEI’s joint venture had a structure that SBA does not cover in its rules, and that’s what got the firm in trouble. The joint venture had a position for Responsible Manager, which was held by NEI. That’s OK. But the joint venture also had a Program Manager, held by WEIS. And it had an Executive Committee. The Executive Committee was a two-person entity, with one member from NEI and one member from WEIS. The joint venture’s corporate documents gave the Executive Committee authority to delegate responsibilities to the Responsible Manager and to decide “general policy matters” for the joint venture.
An SBA judge ruled that this structure violated Rule #2. The Claims Court upheld the judge’s ruling, finding that the “decision comports with 13 C.F.R. § 125.8(b)(2)(ii) and has a rational basis.” The problem with the joint venture’s structure was that NEI shared authority with WEIS’s Program Manager and NEI’s manager was “subordinate” to the Executive Committee, wrote the SBA judge.
In comments in the first SBA decision in this case, SBA lawyers stated that Rule #2 was intended “to require the managing joint venture partner to independently control all aspects of day-to-day management and administration of contract performance.” Basically, SBA never envisioned this executive-committee structure when creating small-business joint ventures.
And this isn’t the first time that joint ventures have tried the committee structure. It appears to be quite common. In another case, SBA’s Office of Hearing and Appeals ruled a joint venture ineligible for a veteran-owned set-aside because of a so-called management committee.
There may be ways to use a management-committee or executive-committee structure. I found another case where the committee was 2-1, with the qualifying business having majority control. And, in a recent veteran-owned small business case, SBA OHA expanded the investor protections for non-joint-venture small businesses. That expansion presumably would extend to joint-venture members as well.
That said, small businesses in joint ventures—or those considering them—need to be careful about using this committee concept. SBA already has stated that the small business is expected to “independently” control the day-to-day aspects of the joint venture. If it’s a committee that’s doing that, you may be in trouble under the dirty dozen.
Why JVs are limited to two years
While many GovCon lawyers are following GAO’s battle against AI-generated bid protests, I’ve been transfixed by the back-and-forth over SBA’s two-year joint-venture rule. SBA limits joint ventures to bidding on contracts for two years, with the time period starting on the date of the joint venture’s first contract award or novation. The current debate is whether that’s necessary. Should SBA instead allow joint ventures to bid indefinitely?
I think the question really should be whether the SBA limit is required by law. Under the Supreme Court’s Loper Bright ruling, agencies have to hew closely to the text of the statute. Often, the agencies have to figure out not just what Congress said in a law, but what Congress meant.
There is an old law about joint ventures that SBA has to take into account. Public Law 100-656, the Business Opportunity Development Reform Act of 1988, created joint ventures for tribal 8(a) firms. Importantly, the law limited the joint ventures to receiving two contracts.
More recently, in 2013, Congress authorized SBA to create mentor-protégé programs for non-8(a) firms. The law provided that the new programs “shall be identical” to SBA’s then-existing 8(a) mentor-protégé program. At that point in time, SBA’s 8(a) mentor-protégé program limited joint ventures to three contracts over two years.
Finally—and this might be the most persuasive reason—joint ventures are a well-worn concept outside of small-business contracting. This 1956 paper in the Cornell Law Review defines a joint venture as an association “for the duration of that particular transaction or series of transactions or for a limited time.” The paper quotes a 1925 case on the “limited duration of a joint adventure.” Yes, “adventure”—wouldn’t that be a memorable way for SBA to brand the program?
The point is that SBA does not make up the joint-venture rules in a vacuum. They need to meet Congress’s expectations, and they need to recognize the long existence of joint ventures generally. Congress expects that joint ventures will be limited, and more or less as they looked in 2013. And joint ventures in the traditional sense are of limited duration. That doesn’t necessarily mean that the concept needs to be static—SBA moved away from the three-contracts-over-two-years rule because task orders became so common. It wasn’t practical to limit companies to three contracts while still arguing that, under the Rule of Two, an order is a contract. But it also doesn’t mean that SBA can disregard the Congressional intent in changing the rules.
With 20 years of Federal legal experience, Sam Le counsels small businesses through government contracting matters, including bid protests, contract compliance, small business certifications, and procurement disputes. His website is www.samlelaw.com.
Great info, Sam. As a newcomer to GovCon, having this information is incredibly valuable.