United States: SBA Issues Final Rule On ITVAR "Footnote 18" Exception

Joseph Hornyak is a Partner and Denisse Velarde-Cubek is an Associate in Holland & Knight's Northern Virginia office

On January 26, 2016, the Small Business Administration (SBA) published in the Federal Register a final rule modifying the employee-based size standards for 36 industries and sub-industries that are not part of North American Industry Classification System (NAICS) Sector 31–33 (Manufacturing), Sector 42 (Wholesale Trade), or Sector 44–45 (Retail Trade).

SBA notably did not remove the Information Technology Value Added Resellers (ITVAR) "exception" under NAICS 541519 (Other Computer Related Services), as it had proposed to do in the notice of proposed rulemaking published on September 10, 2014.  Instead, SBA amended the ITVAR exception, which appears at Footnote 18 of SBA's Table of Size Standards, by adding the requirement that the supply (i.e., computer hardware and software) component of small business set-aside ITVAR contracts must comply with the nonmanufacturing performance requirements or nonmanufacturer rule.  The final rule maintains the 150-employee alternative size standard under Footnote 18.

As a result of the final rule, an ITVAR contractor that resells the products of large businesses can qualify as a small business under Footnote 18 of NAICS 541519 only if SBA grants a waiver to the nonmanufacturer rule (or where the procurement is below the applicable threshold).

SBA rejected arguments by ITVARs, including members of the "Save Footnote 18" coalition, that obtaining waivers of the nonmanufacturer rule is cumbersome and complicated.  As stated in the final rule, "SBA is concerned that without the compliance with the [nonmanufacturer rule], the ITVAR exception may have allowed small IT resellers to simply serve as 'pass throughs' for large OEMs and other large manufacturers."

The final rule becomes effective February 26, 2016.  However, the final rule does not indicate whether or how it would apply to pre-existing solicitations and contracts.  Many existing Government-Wide Acquisition Vehicles and Multiple-Award Contracts are covered at least in part by Footnote 18, including NASA SEWP V, DHS FirstSource II, NIH ECS III, and Veterans CEC.

In a related development, late last year, Congress enacted and the president signed the 2016 National Defense Authorization Act (Pub L. No. 114-92).  A provision in the NDAA amends the Small Business Act to make clear that the nonmanufacturer rule applies only to contracts that are primarily for supplies, not ones primarily for services.  Beginning in 2011, SBA regulations stated that the nonmanufacturer rule applies only to contracts assigned a manufacturing or supply NAICS code, and not to contracts assigned a services or construction NAICS code, even if the contract included a supplies component.  But, in Rotech Healthcare Inc. v. United States, 118 Fed. Cl. 408 (September 9, 2014), the U.S. Court of Federal Claims ("COFC)" ruled that SBA's regulation conflicted with the underlying statute. Thus, according to the COFC, the nonmanufacturer rule must be followed in all procurements that call for the delivery of any supplies regardless of the NAICS code assigned.  The Government has appealed the COFC's decision in Rotech, but the NDAA effectively negates the interpretation adopted by the COFC.

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