United States: Eye On Affiliation: The Ostensible Subcontractor Rule

Last Updated: December 2 2016
Article by Nicholas T. Solosky

Small business owners must always be mindful of what it means to be "small" in the world of government contracting. After all, losing that small business size status means losing direct access to the lucrative world of set-aside contracts and the SBA's socio-economic programs.

In the past, we've discussed the SBA's rules on affiliation – in short, the rules that determine whether you actually own and control your small business. A finding of affiliation between two companies means that the firms are viewed by the SBA as a single entity for purposes of determining size. Even a very small business can lose its size status if it is affiliated with another company (or multiple companies) that push it over the size threshold.

In addition to paying attention to active connections that could lead to a finding of affiliation, a recent SBA opinion reminds us that small business owners also need to avoid ostensible contractor affiliation (a current hot topic at the SBA and the reason behind many affiliation determinations).

In a nutshell, ostensible contractor affiliation occurs when a small business holds a prime contract – but a subcontractor hired for the job actually ends up controlling the work. Specifically, the SBA targets instances where the subcontractor (and not the small business prime) performs the primary and vital work of the contract. Affiliation can also arise under the ostensible subcontractor rule if the small business is unusually reliant on its subcontractor.

Take, for example, the SBA's recent holding. A small business was awarded an Army contract for waste management services. In its proposal, the small business committed to performing all contract management services, including operations, customer service, and billing. However, it subcontracted out to another business the work of diversion, disposal, and management of solid waste. The SBA determined those waste management services to be the essential requirements of the contract and, therefore, found affiliation under the ostensible contractor rule.

As in all cases of affiliation, the finding had damaging effects, as the original contract awardee now exceeded the size standard of a small business and lost the contract.

This case should lead us to a practical question: How do I avoid becoming affiliated under the ostensible subcontractor rule? Fortunately, there are quite a lot of steps that you can take:

  • Focus on the kinds of work and the percentage of prime contractor performance. In our sample case, it is not too controversial to suggest that waste management services are "primary and vital" to a waste management contract. However, for other contracts, the essential work that should be performed by the small business prime contractor might not be as obvious. In all cases, take the time in advance to think about the primary services being performed and whether the prime contractor is performing a reasonable percentage of that work (in addition to the required percentage of self-performance under the SBA's limitation on subcontracting). If the subcontractor is performing most or all of the heavy lifting, it is a warning that you might have an ostensible subcontractor problem.
  • Preparation, Preparation, Preparation. From the outset, your proposal should give the appearance that the small business prime contractor is in control – even if it is already working with a proposed subcontractor. Adhering to traditional prime and subcontractor roles (rather than approaching from the position of a partnership) can enhance the appearance that the small business is controlling the essential work of the contract.
  • Show Them the Money. One of the hallmarks of ostensible contractor relationships is profit sharing. Any non-traditional method of payment will suggest a lack of control to the SBA. If you hold a prime contract and affiliation is a concern, you should pay your subcontractors like traditional subs.

Like so many issues when it comes to the SBA and affiliation, the ostensible contractor rule exists on a sliding scale. There is no cure-all for avoiding affiliation, and the SBA will look to multiple factors in weighing the " totality of the circumstances."

With that in mind, affiliation should always be at the top of your list. Once a proposal is submitted, it is very difficult to un-tangle the prime and sub relationship. The focus should be on preparing a proposal that places the small business prime firmly in control and includes proactive measures to ensure sufficient performance of the primary and vital work for the contract.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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