Posted on 12/18/2011 9:37 AM

DEPENDENCY ON LARGE KILLS SMALL STATUS

Recently, a small business appealed the decision of the Small Business Administration (SBA) Area Office that it was economically dependent upon its largest customer, was thereby affiliated with the large business and was therefore ineligible for award of a contract set aside for small businesses.   The Area Office relied on a prior decision which concluded "that when one firm relies on a second firm for 70% or more of its revenue, the first firm is economically dependent upon the second firm." 

The pertinent regulation defines affiliates to include situations where one controls or has the power to control the other and it does not matter whether that control is exercised provided the power to control exists.  SBA precedent holds that even in the absence of other ties between the companies, the dependence by one firm on another for the large majority if its revenue is sufficient to uphold a finding of affiliation between the firms.  However, there must be a longstanding relationship between the firms; economic dependence cannot be assumed from one contract of short duration.

In analyzing affiliation, the litmus test is whether one concern has the power to control another.  It's the power to control that counts.  It does not matter whether control is exercised.  In the recent size appeal of TPG Consulting, LLC, the SBA's Office of Hearings and Appeals (OHA) concluded that the record supported the conclusion that TPG was economically dependent upon Toyota as its main souce of revenue and that Toyota could therefore control TPG. 

The lesson from the decision is that economic dependence, which can kill small business status, may be found in the context of a vendor/customer relationship.  Also, if the 70% total revenue threshold is exceeded in only one of the prior three years, it is sufficient to disqualify a small business under the affiliation rule.  TPG argued it was not heavily dependent upon Toyota for its revenues.  Nevertheless, any percentage greater than 70% equates to economic dependence as a matter of law.

Once heavy economic dependence is shown, OHA has not found the presumption of affiliation has been rebutted.

One of the more interesting aspects of the TPG case is the OHA really did not go into an analysis of the ability to control.  It was enough that dependency created the possibility of control.  We would like to have seen a discussion of just how and why this seemingly unrebuttable presumption justifies such a severe penalty to a small business.

bill@spriggsconsultingservices.com

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