After a year of uncertainty, the U.S. Small Business Administration (SBA) has issued its long-awaited final rule implementing the Small Business Runway Extension Act of 2018. The final rule, which becomes effective on January 6, 2020, amends SBA's receipts-based size standard for its procurement programs to adopt a five-year averaging period for calculating annual revenues of firms and their affiliates in all industries that are subject to SBA's receipts-based size standards. In addition, to help firms with declining revenues who might be adversely impacted by five-year period of measurement, SBA's final rule includes a transition period until January 6, 2022, allowing firms to choose either a three-year averaging period or a five-year averaging period for calculating average annual receipts for size standards purposes. For our discussion of the proposed rule issued in July 2019, please read our post here.
As SBA explained, a five-year averaging period should "allow more small firms to benefit from SBA's small business assistance programs by extending their small business status for a longer period." It also may result in more large business contracts being set aside for small businesses under the "Rule of Two" because "[w]ith an expanded pool of small businesses, the Federal Government will have more qualified small businesses to choose from."
SBA acknowledged that the expanded pool of "larger small businesses" caused by the new five-year averaging period may have unintended negative impacts on "smaller small businesses" by stiffening the competition for set-aside awards. However, SBA concluded that any such disadvantages will be mitigated by the likely expansion of small business opportunities. SBA also observed that "smaller small" firms are not always in direct competition against "larger small" firms because of "different missions, capabilities, and resources."
The two-year transition period was a surprise, because it appears to contradict the statutory amendment made by Congress last December, which raised the minimum period of measurement for receipts-based size standards from three years to five years and did not include any transition period in which both lookback periods could apply. SBA claimed it could go beyond the Runway Extension Act because the section of the Small Business Act it amended (15 U.S.C. § 632(a)(2)(C)) does not apply to SBA. SBA claims it issues its size standards subject to an "independent statutory authority" under section 632(a)(2)(A). SBA explained that it has "long interpreted section a(2)(C) as not applying to SBA's size standards issued under section (a)(2)(A). This interpretation of the Small Business Act, which has never been tested in Court, is curious because it effectively removes SBA from the statutory parameters for small business size standards established by Congress in section 632(a)(2)(C).
Earlier this year, Congress included a clarifying amendment in the draft National Defense Authorization Act of 2020 to clarify that SBA was subject to the size standard parameters of section 632(a)(2)(C) when it established its own size standards, but this provision was dropped from the NDAA after the House and Senate met in committee to finalize a joint bill. The result of SBA's claim of unfettered discretion when issuing its own size standards was that it could address concerns and resolve issues far beyond the limits Congress imposed in the Runway Extension Act, including providing for a two-year transition period with dual periods of measurement.
In a disappointment to some contractors, SBA declined to make its final rule retroactive to December 17, 2018 (the date of the Runway Extension Act's enactment) and instead opted for a prospective effective date of January 6, 2020. SBA explained that making the new five-year averaging period retroactive to December 2018 would contradict prior SBA guidance regarding the effectiveness of the Runway Extension Act (which was of questionable legality) and would require corrections to contract awards data in the Federal Procurement Data System-Next Generation (FPDS-NG). Thus, until January 6, 2020, SBA will continue to apply the three-year averaging period. Because a firm's size is determined as of the date the firm certified its size as part of its initial offer (including price), the three-year averaging period continues to apply to offers submitted prior to January 6, 2020. This means that, in reviewing size challenges after January 6, 2020, SBA will still use the three-year averaging period if the challenge relates to a certification submitted prior to the rule's effective date.
Finally, in an interesting twist that may lead to corporate restructuring in advance of a contemplated merger and acquisition activity, SBA clarified that whether a seller or buyer has to include the annual receipts and employees after the closing of a transaction depends on whether the transaction involved the sale of a "segregable division" or the sale of a "separate legal entity." Under SBA's clarifications, the receipts and employees of a segregable division remain with the selling concern for size eligibility purposes after the division has been sold. Likewise, the pre-closing receipts and employees of a segregable division are not treated as the receipts and employees of the acquiring concern for size eligibility purposes after the deal has closed. In contrast, when a separate legal entity is sold, its pre-closing receipts and income pass to the acquiring firm and must be included when it computes its size for post-closing set-aside opportunities. The selling firm no longer includes the employees and revenue of a subsidiary legal entity after it has been sold. SBA explained that "there really is a difference between the sale or acquisition of a segregable division as opposed to the sale or acquisition of a separate legal entity" because "the sale or acquisition of a division is not a question of affiliation" and "simply represents an addition or subtraction to the concern itself." As a result of this clarification, concerns seeking to qualify for set-aside contracts after a strategic transaction may elect to reorganize a segregable division into a subsidiary legal entity in advance of M&A activity so that the seller can avoid including the recently organized subsidiary's receipts and employees when computing its size after closing.
SBA's final rule presents a significant opportunity for contractors to maintain, or in some cases, regain, small business size status for procurement. Contractors should carefully consider how the five-year look back period will apply to them, and determine whether using a three-year or five-year period would be most advantageous in maintaining or regaining small business status. As part of this process, contractors should also consider adopting or enhancing a formal policy for making internal determination of size, documenting the basis for that determination and for communicating to relevant employees the concern's status vis-à-vis each relevant size standard. This is particularly important given the Government's ever-expanding enforcement priorities involving small business programs.