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Government Contracts Monitor

Be Careful: You Might Have an Ostensible Subcontractor If . . .

April 11, 2016

By: Lindsay Simmons

When a follow-on contract is set aside for small businesses or an incumbent contractor outgrows the applicable size standard, contractors often get creative. That can be a good thing. There’s nothing inherently wrong with structuring teaming arrangements to support enable proposals from eligible prime contractors. But if your arrangements run afoul of the ostensible subcontractor rule, all your hard work may have been wasted. In its recent decision in Size Appeal of Modus Operandi, Inc., SBA No. SIZ-5716 (2016), the Small Business Administration (SBA) Office of Hearings and Appeals (OHA) provides further guidance concerning key factors that indicate a subcontractor is “ostensible” and, therefore, affiliated with the prime for the procurement in question.

The appeal involved a size determination by the SBA’s Area Office in connection with an Air Force set-aside procurement for the Management, Engineering & Research Concepts — Geophysical (MERC-G) Program. MERC-G is the successor to an earlier procurement (known as SSEAMS) that was not set-aside and on which BAE Systems Technology Solutions & Services, Inc. (BAE) was the prime contractor. The proposed MERC-G awardee, Modus Operandi, Inc. (MOI), had become a subcontractor to BAE on the SSEAMS contract during its last year.

In response to a size protest, however, the Area Office concluded that MOI exceeded the applicable size standard due to affiliation with its proposed subcontractor BAE based on the ostensible subcontractor rule. Specifically, the Area Office emphasized the fact that BAE is the incumbent SSEAMS prime contractor and all of the personnel involved in performing the contract will be current or former BAE employees. On this point, it noted that while 10 of the 20 FTEs proposed staff the MERC-G contract would be MOI employees and 10 would be those of BAE, “all 10 of [MOI’s] employees are incumbent personnel moving from BAE.” The Area Office noted the same dynamic at work with respect to the management team: half would be employed by BAE and the other half was leaving BAE to join MOI for the MERC-G contract. Citing several recent OHA decisions (Size Appeal of Wichita Tribal Enterprises, LLC, SBA No. SIZ-5390 (2012), Size Appeal of SM Resources Corp., Inc., SBA No. SIZ-5338 (2012), and Size Appeal of DoverStaffing, Inc., SBA No. SIZ-5300 (2011)), the Area Office held that because “all of the staff for this contract, including the management team, is being provided by BAE, the large incumbent contractor, [MOI] is unduly reliant on BAE for the performance of this procurement.” It also opined that MOI would contribute nothing more than its small business status to this procurement.

MOI appealed, claiming the size determination was erroneous and should be reversed for a number of reasons. First, MOI disputed the factual findings that it did not propose any of its own personnel, pointing out that it did “propose to use a number of incumbent non-management personnel currently performing work under the SSEAMS contract,” including one MOI employee who had never worked for BAE. In addition, MOI had also proposed other current employees to perform executive management, contract administration, security, and support functions for MERC-G. MOI also argued that it has been in existence for 31 years and that its work on SSEAMS allowed it to obtain experience with the contract requirements. MOI claimed these facts distinguish this case from those relied upon by the Area Office, in each of which (MOI argued) affiliation was based in large part on the fact “the small business prime contractor lacked experience or past performance in the type of work being procured”. Finally, MOI relied on OHA’s recent cases recognizing that hiring key personnel, including the Program Manager, from a subcontractor will not violate the ostensible subcontractor rule if those personnel remain under the supervision and control of the prime contractor. In this regard, MOI claimed that its proposed Program Manager would report to, and would be subordinate to, MOI's management and, while BAE might employ the Deputy Program Manager, he would not be responsible for managing the overall contract but only the BAE subcontract effort.

After reviewing the ostensible subcontractor rule and observing that it is intended to “prevent other than small firms from forming relationships with small firms to evade SBA's size requirements,” the OHA denied the appeal, finding that MOI had not shown clear error in the size determination. Noting that the Area Office based its decision on Size Appeal of DoverStaffing, Inc., the OHA pointed out that several subsequent cases have reaffirmed the reasoning of DoverStaffing and have also identified “four key factors” that have contributed to the findings of unusual reliance: (1) the  proposed subcontractor is the incumbent contractor and is not itself eligible to compete; (2) the prime contractor plans to hire the large majority of its workforce from the subcontractor; (3) the prime contractor's proposed management team  previously served with the subcontractor on the incumbent contract; and (4) the prime contractor lacked relevant experience and was obliged to rely upon its more experienced subcontractor to win the contract. When these factors are met, “the prime contractor is . . . at risk of violating the ostensible subcontractor rule.”

Here, the OHA found the facts fit squarely within the DoverStaffing fact pattern and met all four factors. MOI's subcontractor, BAE, is the incumbent on the predecessor SSEAMS contract for similar services, and is a large business ineligible to submit its own proposal for the MERC-G procurement. Further, MOI proposed to staff its portion of the project almost entirely with personnel hired from BAE, with all non-managerial personnel continuing in the “same role” that they performed on SSEAMS and MOI hiring its manager away from BAE. Finally, BAE (not MOI) has experience in the “Geophysics and Research” technical discipline, the principal subject matter of this procurement. In other words, the OHA agreed with the Area Office determination that the case is highly analogous to the DoverStaffing line of cases.

Indeed, the OHA found unpersuasive all of MOI’s attempts to distinguish this case from DoverStaffing. Even if the facts supported MOI’s claim to have proposed one of its own employees to work on MERC-G (OHA held they did not), the fact that MOI still planned to acquire the vast majority of its proposed workforce (19 of 20) from BAE would still support the Area Office conclusion that the second factor was met. Similarly, according to the OHA, MOI’s plans to use its own personnel to perform executive management, contract administration, security, and support functions for MERC-G does not lessen MOI’s reliance on BAE because there is no indication that these personnel would have a major role on the MERC-G contract. Nor does it matter that MOI will perform “a[t] least a portion of each and every one of the primary and vital activities, and in fact is performing a majority of the work in all but one of such activities.” As the OHA notes, the Area Office did not find that BAE would perform all the primary and vital activities, only that MOI was unduly reliant on BAE. And while hiring key personnel from the subcontractor is not, by itself, sufficient to constitute unusual reliance, an area office nevertheless may consider this factor among others in determining whether unusual reliance exists.

In short, MOI tried numerous arguments in an unsuccessful attempt to avoid a finding of affiliation based on the ostensible subcontractor rule. In order to avoid the same fate, contractors need to be aware of – and design their teaming arrangements on the basis of -- the relevant factors and how SBA applies them.

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