- Posted on: Mar 10 2022
By: Jonathan Brittin [3/10/22]
The U.S. Small Business Administration’s (SBA) Office of Hearings and Appeals (OHA) issued an important decision that the managing venturer must have unequivocal control over the joint venture (JV). Seventh Dimension, LLC, SBA No. VET-6057 (2020) (Emphasis added).
To be eligible to pursue small business contracts, the written agreement establishing the mentor-protégé (MP) JV must comply with the regulations issued by the Small Business Administration (SBA). SBA regulations include a requirement that the JV agreement (JVA) between the mentor and protégé must contain specific provisions for the MP JV to qualify as a small business. See 13 CFR 125.8(b)(2). Among these provisions is a requirement for the JVA to “[d]esignat[e] a small business as the managing venturer of the joint venture.” See 13 C.F.R § 125.8(b)(2)(ii) (emphasis added).
OHA has interpreted this requirement to mean that the small business protege must control the decision-making of the JV. In 2012, OHA determined that the small business did not fully control the decision-making of the JV and lacked the autonomy and authority necessary to be considered the “managing venturer” because the JVA required both members to consent to all “significant actions” and gave the mentor veto power. Matter of HANA-JV, SBA No. VET-227 at 6 (2012) (citing, Matter of Piedmont Contracting & Design, Inc., SBA No. VET-169 (2009) (small business did not exclusively control JV when operating agreement required “unanimous consent of all shareholders for any substantive action.”)). In 2013, OHA ruled that control by small businesses must be unequivocal. SOF Assocs., F JV, SBA No VET-234 at 7 (2013) (Emphasis added). OHA found that the small business was “not really the managing venturer” because the JVA required a supermajority vote to approve “tactical and strategic business issues, without defining what those issues are.” Id.
In Seventh Dimension, LLC, SBA No. VET-6057 (2020), OHA evaluated a JVA, requiring “unanimous consent” for specific actions taken by the JV from a Members Committee that maintained “complete and exclusive control over the management of the Company’s business, including controlling the performance of the Contracts.” Id. at 3. The JVA specified many actions that required unanimous consent from the Members Committee, including;
the final approval and submission of any proposal; entry into any contract with a customer, and any modification of a contract; entry into any subcontract of work in excess of $500,000; approval of the annual budget; hiring an individual to serve as an employee of the company. Id.
On one hand, OHA has held that certain provisions requiring unanimous consent to approve extraordinary actions outside the ordinary course of business do not create affiliation through “negative control,” but only if the provision is narrowly tailored to protect the interest of the minority shareholder (the mentor) and does not disrupt the daily operations of the business. Id. (citing Size Appeal of EA Engineering, Science, and Technology, Inc., SBA No. SIZ-4973 (2008); see also, C.F.R. § 121.103(a)(3). Extraordinary actions outside the ordinary course of business include the issuance of additional stock, amendment of the concern’s charter or bylaws, or entry into a substantially different line of business. Id. (citing EA Engineering Science, at 9-10).
On the other hand, as in the case of Seventh Dimension, LLC, “negative control” exists when a minority shareholder (the mentor) can block or veto “ordinary actions essential to operating the company.” Id. at 4 (citing Size Appeal of Eagle Pharmaceuticals, Inc., SBA No. SIZ-5023 at 10 (2009)). Ordinary actions essential to operating the business include the creation of debt, payment of dividends, hiring and firing of executive officers, and setting compensation. Id. at 15 (citing Size Appeal of Team Waste Gulf Coast, SBA No. SIZ-5864 (2017); Size Appeal of BR Construction, LLC, SBA No. SIZ-5303 (2011)).
Ultimately, OHA held that the large business mentor had “negative control” because the JVA’s unanimous consent requirements gave the mentor veto power over ordinary actions of the day-to-day business operations, such as “the [JV’s] submission of proposals, entry into any contracts, or modifications to such contracts.” Id. (Emphasis added). Consequently, OHA sustained the size protest because the existence of “negative control” resulted in an affiliation finding between the large business mentor and small business protégé. Id.
Seventh Dimension is important for several reasons. First, if the JVA gives the large business mentor too much control over the JV’s decision-making, then SBA will find the JV ineligible due to the existence of “negative control,” which can create an affiliation between the large business mentor and small business protégé. Second, the consequences of an affiliation finding disproportionately impacts small business protégés, which risk losing their small business size status and future contracting opportunities. Third, small business protégés must be careful drafting JVAs to ensure that it always maintains “unequivocal control” over the JV’s decision-making in order to meet the “managing venturer” requirement of 13 C.F.R. § 125.8(b)(2)(ii).
Dunlap Bennett & Ludwig’s team offers a vast array of small business legal counseling services. Our team includes former SBA attorneys and private practice attorneys, who can view our client’s unique issues from all sides of the problem. Visit our Small Business Counseling page to learn more about how we can help advise you. To learn more about Dunlap Bennett & Ludwig and how we assist you, contact us by calling 800-747-9354 or emailing email@example.com.
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