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Government Contracts Monitor

New Statute Extends Small Business Size Standard Reference Period to Five (from Three) Years, Enabling More Companies to Qualify as Small

January 17, 2019

By: Hopewell Darneille

In December 2018 – just before Christmas – the Senate approved, and the President signed into law, the so-called “Small Business Runway Extension Act of 2018,” Pub. L. No. 115-324 (the “Act” or “statute”).  This statute extends the three-year reference period for calculating a revenue-based small business’s size status to five years.  This Act was intended – as implied by its name – to extend the period during which most small businesses will qualify and remain small.  The Act thus constituted a nice year-end present to many small businesses, allowing them to continue qualifying and competing as small.  However, other small businesses may be chagrined at having to face continuing competition from larger companies that had been expected to become large, while a few unfortunate companies, who had higher revenues in 2014 and 2015, will find this intended “present” more in the nature of the proverbial “lump of coal” in their holiday stocking, since the longer reference period could result in them being deemed other than small for now.

Complicating the picture is an issue as to when this change is effective.  Most new statutes are deemed effective when issued, unless otherwise explicitly stated.  Here, however, the Small Business Administration (SBA) has complicated the situation by issuing Information Notice No. 6000-180022, dated December 21, 2018, stating that SBA does not deem the Act presently effective, and that effectivity must await implementing rulemaking by SBA.  This means, contrary to the Act’s intent, that SBA’s position is that companies must continue to use the three-year period for size determination purposes, until SBA issues Regulations implementing the new five-year period.  Hopefully, SBA will quickly issue an Interim Rule, implementing this change.  However, the ongoing current Government shutdown, which has closed SBA, means this may take longer than desirable.  Affected companies therefore need to carefully consider their situations and options in connection with any pending bids.

By way of background, and as you may well know, the Small Business Act, as amended, and implementing SBA Size Regulations – and particularly 13 C.F.R. § 121.104(c)(1) – have required that a revenue-based concern’s size status be ascertained based on the concern’s Average Annual Receipts (AAR) over the concern’s three most recently completed fiscal years (see our prior blog article on this topic here).  In response to complaints by companies that either had outgrown, or were in danger of outgrowing, the respective size standards, the House of Representatives voted to amend Section 3(a)(2)(C)(ii)(II) of the Small Business Act, as amended (15 U.S.C. § 632(a)(2)(C)(ii)(II)), to change the three years to five years, to “allow small businesses at every level more time to grow and develop their competitiveness and infrastructure, before entering the open marketplace.”  (See House Rep. No. 115-939, at 2.)  The House explained that “this modest modification of SBA’s size formula is designed to reduce the impact of rapid-growth years which result in spikes in revenue that may prematurely eject a small business out of the small size standard,” and “will protect federal investment in SBA’s small business programs by promoting greater chances of success in the middle market for newly-graduated firms, resulting in enhanced competition against large prime contractors.”  (Id.)

Unfortunately, the proposed Bill focused primarily on the situation of a small business on a gradual increasing revenue trend, and failed to fully consider the adverse impacts on smaller competitors or scenarios where a revenue spike in earlier years, or recent declining revenues, could result in a different situation where a company might qualify as small under a three-year standard, but not under a longer five-year period.  As a result, the Act will not benefit all.  Each company will need to assess its individual situation under the respective NAICS Codes the company is bidding.  In view of this disparate impact, it is already being suggested in some quarters that the Act should be amended to permit use of the more beneficial of either a three-year or five-year period.  Given the current hardening battle lines and party animosity in the new Congress, and the likely small number of adversely affected companies, it is questionable whether this suggested change has much likelihood of success.

Interestingly, the SBA last Spring rejected a separate proposal to extend the three-year base period to five years, in the context of revising SBA’s size standards methodology, perhaps telegraphing SBA’s opposition to the suggested reference period extension efforts.  Specifically, SBA stated its belief that the three-year period sufficiently ameliorates “fluctuations in receipts due to variations in economic conditions,” and balances such “with the overall capabilities of firms that are about to exceed the size standard.”  SBA stated that “[e]xtending the average period to five years would allow a business to greatly exceed the size standard for some years and still be eligible for federal assistance, perhaps at the expense of other smaller businesses.  Such a change is more likely to benefit successful small business graduates by allowing them to prolong their small business status, thereby reducing opportunities for currently defined small businesses.”  (See 84 Fed. Reg. 18466, 18473-74 (4/27/18).)  SBA presumably might therefore be willing to support the proposed alternative scenarios change, to at least minimize the adverse impact on companies that otherwise would qualify as small under the three-year rule.

Initial expectations in most quarters, consistent with general rules of statutory implementation and primacy over inconsistent regulations, were that the new five-year period would become effective immediately.  However, SBA somewhat surprisingly issued the above-discussed Information Notice within just four days of President Trump’s signing the Act into law on December 17, 2018 (and on the eve of the Government shutdown), taking the contrary position and opining that the new five-year period requires SBA rulemaking before becoming effective.  SBA stated that businesses should continue to report their receipts based on a three-year average “[u]ntil SBA changes its Regulations.”  SBA’s stated rationale is that the Act does not include a specific “effective date,” and that “[t]he Small Business Act still requires that new size standards be approved by the Administrator through a rulemaking process.”  The problem with this rationale is that we are not dealing with “new size standards,” but rather, as stated in the House Report, “a modest modification of SBA’s size formula.”  (Emphasis added.)  Importantly, the statutory change is exceedingly narrow and precise, and there is nothing as to which SBA has discretion or as to which invited comments would be meaningful.  Hopefully, SBA will act quickly.  The Information Notice stated that SBA’s Office of Government Contracting and Business Development was already drafting “revisions to SBA’s regulations and SBA’s forms to implement the Runway Extension Act.”  However, that, of course, was before the Government shutdown.  With SBA now shut down, and the growing regulatory backlog across the Government, it may unfortunately be a while before this gets sorted out.  Hopefully, SBA, when it does act, will issue an Interim Rule, implementing the five-year change effective immediately upon issuance, during the consideration of comments and issuance of a Final Rule.

In the meantime, contractors need to calculate their size under the various NAICS Codes using both the three-year (2016, 2017 & 2018) and five-year (2014-2018) reference periods.  If these methodologies produce differing results, contractors should contact legal counsel and carefully consider their options before updating their SAM and DSBS registrations, and submitting any new bids and proposals.  Please recall that SAM is required to be updated to reflect any material changes in a company’s status, and that the information on SAM is deemed to be a certification by the company as to the current accuracy of the posted info.  Please also remember that size certifications in bids and proposals are required to be current and accurate as of the time of initial bid or proposal submission.  The remedies and sanctions for false certifications are severe, and need to be kept closely in mind at all times.

In conclusion, the new Act, once fully implemented and effective, will benefit many small businesses by enabling them to remain small and compete as a small business for a longer period.  However, the continued competition from companies previously expected to lose their small business status, will harm smaller companies who were looking forward to not having to continue competing with such larger companies.  The Act also will create problems for companies that, because of shrinking revenues, were anticipating becoming small in 2019, but now may continue to qualify as other than small for a longer period. 

In addition, SBA’s interpretation as to the delayed effectivity of the change, subjects companies to uncertainty and differing standards in 2019.  Companies on the edge, for whom the differing standards will determine whether the company is small or large, will have to carefully monitor SBA’s implementation and decide how best to proceed in updating the company's size status and bidding on new set-aside opportunities.  Large businesses will also need to carefully consider the impact of this change on their small business subcontracting plan compliance and any small business mentoring or teaming.

 

Hopewell Darneille is responsible for the contents of this Article.

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