Listen up, VOSBs and SDVOSBs! Major changes are in store for the Department of Veterans Affairs’ VOSB/SDVOSB program.
On November 6, 2015, the VA issued a proposed rule, which could drastically change the way the two eligibility requirements for VOSBs and SDVOSBs are interpreted. The VA explained the changes as follows:
This proposed rule would clarify the eligibility requirements for businesses to obtain “verified” status, add and revise definitions, reorder requirements, redefine the definition of “control”, and explain examination procedure and review processes. This proposed rule would additionally implement new changes—references to community property restrictions, “unconditional” ownership, day-to-day requirements, and full-time requirements would be removed or revised and limited in scope; an exception for majority, supermajority, unanimous, or other voting provisions for extraordinary business decisions would be added.
So what, specifically, does that mean? Well, first of all, under the new rule, the VA would no longer require a veteran or service-disabled veteran to “unconditionally” own his or her company. The current regulation, which requires “unconditional” ownership, has caused problems for many VOSBs/SDVOSBs; standard corporate governance provisions such as rights of first refusal, transfer upon incapacity, or transfer upon bankruptcy were often seen as placing “conditions” on ownership and, therefore, nullifying VOSBs/SDVOSB eligibility. In fact, that is exactly what happened in our case, Miles Construction, LLC v. United States.
There, our client’s SDVOSB status was improperly canceled because the VA viewed a “Right of First Refusal” in the company’s governing documents as an impermissible transfer restriction. It took the position that this “restriction” rendered ownership “conditional.” However, when we challenged the agency’s decision, the Court of Federal Claims disagreed. The Court concluded that Rights of First Refusal, such as the one at issue there, fell within the ambit of “normal commercial practices” and did “not affect the veteran’s unconditional ownership.” Thus, our client’s SDVOSB status was restored and it was placed back in the VetBiz database of verified companies. Shortly thereafter, in accordance with the guidance provided by the Court in the Miles case, the VA changed its official policy with respect to transfer restrictions. Now, the VA seeks to amend the regulation (38 C.F.R. § 74.3) itself. The new regulation would be consistent with the Miles decision, and would allow for “commercially reasonable” provisions in corporate governance documents.
As the rule explains:
Section 74.3(b) would be amended to directly address the concerns of VA in balancing commercially reasonable business practices against procurement integrity. Section 74.3(b) as it is currently written is considered by many in the veteran community to be unduly burdensome. VA considered these concerns and addressed them by proposing to limit the scope of unconditional ownership, accepting commercially reasonable conditions and excluding only those that create a significant risk of fraud, waste and abuse. . .
Thus, 38 C.F.R. § 74.3, as amended, would state:
…(b) Unconditional ownership. Ownership must not be subject to prohibited conditions which cause or potentially cause ownership benefits to go to another (other than after death or incapacity).
(1) CVE will analyze conditions on ownership on a case-by-case basis. A condition(s) which is determined to align with commercially reasonable business practices will not be considered a prohibited condition. For purposes of determining commercial reasonability CVE will consider factors, including but not limited to, general use of similar conditions by concerns within the same or similar line of business and uniform applicability of the condition(s)…
The shifting requirements concerning ownership are not the only proposed change. The VA also proposed major changes to 38 C.F.R. § 74.4, the regulation governing “control” of an VOSB/SDVOSB company. Similar to the ownership changes outlined above, the VA proposes to eliminate the “unconditional” control requirement. Instead, the proposed regulation requires that the veteran owner have “control over all decisions of the governing body, with the exception of extraordinary business decisions.” The proposed regulation also recognizes distinctions between types of companies (e.g. Corporation, Limited Liability Corporation, Partnership), which is something brand new. You can see all the proposed changes, which includes the above, and others, here.
The VA has stated that these changes are the agency’s attempt to find “an appropriate balance between preventing fraud in the Veterans First Contracting Program and providing a process that would make it easier for more VOSBs to become verified.” Moreover, these changes would “protect the minority owners of firms thereby encouraging investment and participation in veteran owned businesses.” If these changes are enacted, VOSB/SDVOSBs will have a lot more flexibility in structuring their businesses, and, presumably, it will be a lot easier to figure out where one stands in terms of satisfying eligibility criteria.
Comments to the proposed rule are due by January 5, 2016. We will keep you posted on the status of these developments.
Edward T. DeLisle is Co-Chair of the Federal Contracting Practice Group. Ed frequently advises contractors on federal contracting matters including bid protests, claims and appeals, procurement issues, small business issues and dispute resolution.
Maria L. Panichelli is an Associate in the firm’s Federal Contracting Practice Group. Her practice includes a wide variety of federal contracting and construction matters, as well as all aspects of small business procurement.