Federal Small Business Set-Aside Contracts When Selling or Buying a Business
In a prior Alert (found here), we provided a high-level overview of the Anti-Assignment Act, which requires federal pre-approval for the sale of federal government contracts, often through a “novation agreement” signed by the seller, buyer and the United States Government. This current Alert provides a high-level overview of two issues unique to a “small business concern” or SBC. The first is the impact of an acquisition on the selling contractor’s small business set-aside contracts and pending bids. The second question is whether negotiations can change an SBC’s status even before an acquisition closes.
Various federal contracts are “set-aside” to help satisfy statutory goals for small business contracting for SBCs, which include small businesses, Small Disadvantaged Businesses, veteran-owned and service-disabled veteran-owned small businesses, women-owned small businesses and Historically Underutilized Business Zone (HUBZone) small businesses. Buyers of a SBC need to remember the affiliation rules of the Small Business Administration (SBA) that combine the employees and revenues of affiliated entities for purposes of SBC set-asides. (see here for an overview)
If pre-acquisition due diligence reveals that the seller’s or buyer’s SBC status will be lost after the acquisition, or that the Government may terminate an existing small business set-aside contract, or that the Government may not issue orders under a set-aside contract following a sale, the potential buyer should consider adjusting its purchase price to account for the lost revenues or rethink the acquisition altogether.
What Notice is Required When a Small Business Set-Aside Contract is Transferred?
According to FAR Clause 52.219-28, the contractor under a small business set-aside contract must “rerepresent” its size status in writing and notify the contracting officer of same:
The contractor generally must make the rerepresentation by validating or updating its data in the System for Award Management (SAM) to ensure that its Representations and Certifications section accurately reflects the contractor’s current status. The rerepresentation is done in accordance with the size standard in effect at the time of rerepresentation that corresponds to the North American Industry Classification System (NAICS) code initially assigned to the transferred contract.
Special rules apply to participants in SBA’s 8(a) program, as 8(a) contracts are technically subcontracts to the SBA and 8(a) set-aside contracts must, in general, be performed by the company that obtained the 8(a) contract award or they will be terminated for convenience after a sale, unless a waiver is obtained by the SBA. FAR 19.812(d). Notice to the SBA must be given by the 8(a) contractor immediately upon “entering an agreement (either oral or in writing)” to transfer its ownership interest to any other party. 13 CFR § 124.515(g).
What Happens if the Buyer Rerepresents that the Purchased Business is Still Small with Respect to a Federal Contract?
If a small business set-aside contract is properly transferred under the Anti-Assignment Act, the agency can include the value of options exercised, modifications issued, orders issued or purchases made under blanket purchase agreements on that contract in its small business prime contracting goal achievements.
If the contractor is still small and able to make the rerepresentation, and assuming the acquisition does not affect the competency or responsibility of the contractor under the small business set-aside contract, then the acquisition should not reasonably be expected to impact future orders under that contract.
If the selling business had bids or proposals pending with respect to procurements set-aside for small businesses, the Anti-Assignment Act does not preclude those proposals from being transferred to the buyer. So long as the business remains intact with access to essentially the same personnel and material resources that the selling business possessed, then the contracting office can allow the SBC bid or proposal to be transferred to the buyer, again assuming the buyer’s acquisition does not affect the contractor’s competency or responsibility.
What Happens if the Buyer Rerepresents that the Purchased Business is No Longer Small with Respect to a Federal Contract?
If the small business set-aside contract is properly transferred, the agency can no longer include the value of that contract in its small business prime contracting goals. The rerepresentation will have no effect on terms and conditions of the existing contract. The contractor is still eligible to receive orders under the affected contract. The agency cannot terminate any pending orders or decline to purchase minimum quantities under the contract in response to the rerepresentation.
While agencies have the discretion to decline to exercise future options under a multi-year contract or to order quantities above the minimum amount under a contract, contracting officers frequently will opt for the status quo by continuing to place orders until the end of the contract term, including any option years, and accepting that they no longer are credited for the contract against their small business contracting goals.
In at least one case, however, GSA has proactively advised that if a prime contractor on a small business Governmentwide Acquisition Contract or GWAC becomes other than a SBC as a result of a merger or acquisition, with or without a novation agreement, the responsible contracting officer must take prompt action to ensure the contract holder is removed from the GWAC, ideally through a mutually agreed no cost contract cancellation, but, failing that, by a termination for convenience by the Government as authorized under the GWAC terms. See GSA Alliant Small Business GWAC Ordering Guide, Appendix XII, pp. 50-51.
Accordingly, if the small business set-aside contract is critical to the value proposition for the buyer’s acquisition, before agreeing to purchase the business the buyer should have an open discussion with the seller and (where possible) the contracting officer with respect to the likelihood of future orders under the contract.
As noted above, if the selling business had pending bids or proposals with respect to procurements set aside for small business, the Anti-Assignment Act does not preclude those proposals from being transferred to the buyer. Under 13 CFR § 121.404(a), the SBA determines the size status as of the date a contractor submits a written self-certification that it is small to the procuring activity as part of its initial offer (or other formal response to a solicitation), which includes price. Thus, it is possible that a SBC could submit a bid for a small business set-aside contract and that the contracting officer could accept the bid and award the contract prior to being notified that the SBC had been acquired. Of course, following such notification, the agency would no longer get credit for that contract against its small business contracting goals.
Under the “Present Effect Rule” a SBC May Lose Its Preferential Status Based on a Letter of Intent
Companies engaging in a possible merger or acquisition involving federal set-aside contracts must also keep in mind the “present effect rule,” which can change a SBC’s size status when a detailed letter of intent is signed, even though a deal is not closed until much later.
Ownership and control are the factors that govern whether a business is a SBC. The SBA considers “agreements to merge (including agreements in principle) to have a present effect on the power to control a concern.” Such agreements are treated as though the rights granted in them were exercised upon signature. 13 C.F.R. § 121.103(d). The same rule states that agreements to open or continue merger or sale negotiations at some later date are not agreements in principle and thus are not given present effect. And “[a]greements that are subject to conditions precedent which are incapable of fulfillment, speculative, conjectural, or unenforceable under state or Federal law, or where the probability of the transaction . . . occurring is shown to be extremely remote” also are not agreements in principle and thus are not given present effect. 13 C.F.R. §121.103(c)(2)(ii)
The SBA has avoided drawing bright lines in this area, and the Court of Federal Claims has upheld the SBA’s decision to give “present effect” to letters of intent (which often are unenforceable under state law) if “there is supporting evidence to show that serious negotiations between the parties have occurred.” WRS Infrastructure & Envtl., Inc. v. United States, 85 Fed. Cl. 442 (2009). In WRS, the parties signed a letter of intent stating that the parties had conducted substantial due diligence and concluded that the buyer intended to purchase all of the seller’s outstanding stock at a specific price by a certain target closing date. The affiliation was deemed to occur on the date the LOI was signed, even though the LOI stated it was a non-binding agreement. “[A] firm becomes affiliated with another when it reaches an agreement in principle to acquire the other by the state of self-certification, even if the merger or acquisition has yet to be executed.” Id. (quoting Size Appeal of Geosyntec Consultant, SBA No. 4277 (1997)). Size Appeal of Heard Construction, Inc., SBA No. SIZ-5461 (Apr. 3, 2013).
By contrast, the SBA’s Office of Hearings and Appeals gave no present effect to a “non-binding indicative offer” that included a range of prices and conditioned the offer on further due diligence from the seller that included extensive additional information including all contracts, audit reports, rosters of employees and contractors, balance sheets and a documentation of the seller’s assets. The “indicative offer” anticipated a “confirmatory offer” would be made after due diligence. These factors demonstrated that there was no “agreement in principle” that would affect the SBC’s size status. Size Appeal of the W.I.N.N. Group, Inc., SBA No. SIZ-5360 (June 6, 2012).
Business buyers hoping to take advantage of existing or future small business set-aside contracts must perform appropriate due diligence to ensure that the acquisition will not render the combined business ineligible to compete for future small business set-aside contracts or receive future orders on existing contracts because of the loss of SBC status. And the same buyers must ensure their letters of intent or similar proposal letters are not drafted in a manner that would result in affiliation between the buyer and the target.
If you have any questions about federal small business set-aside contracts when selling or buying a business or if you would like to learn more about the issues covered in this Alert, please contact your Smith Anderson lawyer.