A Gap in the Law: Uncertainty in How Small Business Joint Ventures Must be Managed
U.S. Small Business Administration (“SBA”) regulations require that mentor-protégé and socioeconomic joint ventures designate the protégé or socioeconomic member as the “managing venturer” of the joint venture. However, the regulations do not define “managing venturer” or state how much control such a “manager” must maintain over the joint venture. In the context of typical small business operating entities (i.e., not joint ventures), SBA’s Office of Hearings and Appeals (“OHA”) has offered detailed guidance on what it means to “control” such entities, but this case law has never been applied to joint ventures. This leaves joint venturing firms without any direction on the subject — beyond the general requirement that they designate a “managing venturer.”
As discussed in more detail below, this is a “gap” in SBA regulations and case law that has led to uncertainty in the governance of small business joint ventures. Given the increasing use of joint ventures by contractors pursuing small business set-aside procurements, this uncertainty is increasingly harmful to the business community.
This article surveys the available OHA case law in order to identify the specific limits of the aforementioned “gap,” and then offers predictions and recommendations for the way that SBA should define the term “managing venturer” in order to minimize business uncertainty and thereby promote small business development through joint venture participation.
It would be an understatement to say that joint venturing is popular right now. Since October 2016, when the SBA All-Small Mentor Protégé Program (“ASMPP”) went live, we have witnessed an explosion in the use of joint ventures to pursue small business set-aside contracts. Previously limited to participants in SBA’s 8(a) Business Development Program (“8(a) Program”), the ASMPP opened up large business mentoring to all types of small businesses, including Service-Disabled Veteran-Owned small businesses (“SDVOSBs”), Women-Owned Small Businesses (“WOSBs”), Historically Underutilized Business Zone small businesses (“HUBZones”), and regular small businesses. One key benefit under the ASMPP is the ability for small business protégés to partner with their large business mentors through an “unpopulated” joint venture, which is a separate, limited-purpose entity that qualifies as a small business for government procurements. And beyond joint ventures through the ASMPP, we’ve also seen an uptick in joint venturing among non-ASMPP small businesses who seek to pool their resources and capabilities in order to enhance their collective competiveness.
Impact on OHA Decisions
As a result of this joint venturing trend, OHA appears to be handling a commensurately higher number of cases involving the size and socioeconomic status of joint ventures. These cases have reinforced bedrock principles such as joint venture agreements needing to include information specific to the procurement being pursued (Asirtek Fed. Servs. LLC, SBA No. VET-269 (2018)); joint ventures being subject to specific ownership and control regulations that differ significantly from the ownership and control regulations applicable to typical, operating small businesses (Commonwealth Home Health Care, Inc., SBA No. CVE-116 (2019)); and mentor-protégé joint ventures remaining eligible for award, even if the mentor withdraws from the mentor-protégé agreement after proposal submission but prior to award (Kentucky Bldg. Maintenance, Inc., et al., SBA No. SIZ-6001 (2019)).
However, a review of recent OHA decisions reveals that OHA has yet to meaningfully address a crucial area — joint venture management.
Joint Venture Management
SBA’s regulations for mentor-protégé joint ventures state that the protégé must be designated as the joint venture’s “managing venturer.” 13 C.F.R § 125.8(b)(2)(ii). Likewise, SBA’s regulations for socioeconomically qualified joint ventures state that the socioeconomically qualified member must be designated as the joint venture’s “managing venturer.” 13 C.F.R § 124.513(c)(2) (8(a) Program); 13 C.F.R § 125.18(b)(2)(ii) (SDVOSBs); 13 C.F.R § 127.506(c)(2) (WOSBs); 13 C.F.R § 126.616(c)(2) (HUBZones).
However, neither SBA regulations nor OHA case law defines “managing venturer.” Does this term mean that the protégé or socioeconomic firm must have control over all decisions of the joint venture? Or control only over decisions relating to contract performance and not corporate governance? Or maybe the term means control over all decisions except those that SBA has previously allowed to be subject to minority veto rights, in the context of regular operating entities? OHA case law, and most recently the SDVOSB regulations, established a list of “extraordinary” actions that a small business’ governing documents could permissibly subject to minority veto (i.e., negative control), without SBA finding that the minority owner who wields such a veto controls the small business. See, e.g., Southern Contracting Solutions III, LLC, SBA No. SIZ-5956 (2018); Team Waste Gulf Coast, LLC, SBA No. SIZ-5864 (2017) (reciting Dooleymack Government Contracting, SBA No. SIZ-5086 (2009)); EA Engineering, Science, and Technology, Inc., SBA No. SIZ-4973 (2008). Examples of such “extraordinary actions” include amending the Bylaws, issuing additional capital stock, entering into any substantially different business, and selling all or substantially all of a firm's assets. The touchstone for the acceptability of minority veto rights is whether the veto right is designed to protect the minority owner's investment, and does not allow the minority owner to block the majority owner’s command of the “ordinary” daily operations of the business. See, e.g., Southern Contracting Solutions III, LLC, supra. However, as stated above, while the foregoing cases are crucial to understanding the limits of minority control over small business federal contractors generally, these cases have never been applied in the context of joint venture management.
Nevertheless, we can discern some principles from OHA case law that are applicable to joint venture management. First, it is clear that the term “managing venturer” means some degree of control. In Hana-JV, SBA No. VET-227 (2012), OHA held that a joint venture agreement granting both members “veto power over all significant decisions” allowed the Area Office to “reasonably conclude that the [socioeconomic member] lacks the autonomy and authority necessary to be considered the ‘managing venturer.’” Similarly, in Criteroem, LLC, SBA No. VET-246 (2014), where the joint venture agreement provided that “overall management and control of the joint venture shall vest equally in the parties,” the socioeconomic member could not properly serve as the “managing venturer.”
Second, OHA appears to require that a “managing venturer” maintains control, at a minimum, over a joint venture’s contractual performance. In Asirtek Federal Services, LLC, SBA No. VET-269 (2018), although the case was principally decided on other grounds, OHA stated that language giving the minority member control over certain task orders was “potentially problematic” because “if such task orders were of large dollar value, [the managing venturer’s] control over the procurement as a whole might be jeopardized.” Similarly, in Kentucky Bldg. Maintenance, Inc., SBA No. SIZ-6001 (2019), although this case was also decided on other grounds, OHA assessed a vague provision subjecting certain contract hires to “approval,” but because the provision did not clarify whose approval was required, OHA ultimately concluded the provision was too “ambiguous” to “contradict the clear authority” given to the designated “managing venturer.” While the holdings in these cases ultimately diverged, the common thread is that OHA is concerned about a “managing venturer’s” control over contractual matters—in these cases, control over task order performance and hiring decisions, respectively.
Moving Beyond SBA’s Guidance
The foregoing cases are, unfortunately, where SBA’s current guidance ends, which raises questions concerning the inclusion of minority veto rights in joint venture agreements. And it is perhaps not inaccurate to conclude that the inclusion of any minority veto rights is risky — because OHA case law, to date, has not explicitly approved any such veto rights in the context of joint venture agreements. However, when such a case does eventually make its way to OHA, OHA might approve some veto rights.
Indeed, SBA’s regulations for joint venture agreements already prescribe one mandatory veto right. The rules governing mentor-protégé and all socioeconomic joint ventures require:
. . . [T]he establishment and administration of a special bank account in the name of the joint venture. This account must require the signature of all parties to the joint venture or designees for withdrawal purposes. All payments due the joint venture for performance on a contract set aside or reserved for small business will be deposited in the special account; all expenses incurred under the contract will be paid from the account as well;
E.g., 13 C.F.R § 125.8(b)(2)(v). This requirement for the “signature of all parties to the joint venture” is a form of minority veto giving the partner venturer the ability to block the “managing venturer” from spending the resources of the joint venture (or from absconding with such resources). In the normal small business context, bank withdraws would be deemed an “ordinary” business action outside of the reach of a minority investor. See, e.g., Southern Contracting Solutions III, LLC, supra. This dual signature requirement is the only specific grant of veto rights to a partner venturer in the SBA regulations. It raises the question of whether this is the only such right SBA intended to grant, or if other analogous rights should be read into the regulatory requirement for a “managing venturer.”
From Uncertainty to Clarity?
The few OHA cases on the subject, as discussed above, suggest that the “managing venturer” must have control over contract performance, at a minimum. And indeed, this makes sense in light of the purpose of the ASMPP and SBA’s socioeconomic programs, which seek to develop small business capabilities in part through partnerships with and mentorship from larger, more sophisticated firms. These objectives are best achieved if the socioeconomic business (or protégé) leads the contractual effort with support from the mentor or larger venturer.
However, should control over contractual performance be the limit of the “managing venturer” requirement? What interest is served by requiring the protégé or socioeconomic firm to control all other aspects of joint venture governance? Arguably, small firms gain sufficient corporate managerial acumen and experience through maintaining control over their own governance. Requiring these firms to also control the joint venture’s tax status or total budget, for example, could be viewed as merely adding to the burden on small firms’ limited administrative resources rather than providing such firms with unique learning opportunities. On the other hand, one might argue that allowing numerous minority veto provisions would give partner venturers too great a share of the benefits and rights that SBA intends to be enjoyed only by, or at least mostly by, small business protégés and socioeconomically qualified companies.
Until SBA’s regulations or OHA case law answer the foregoing questions, both small and large venturers will continue to debate which veto rights are acceptable, leading in some cases to one or both firms accepting regulatory or business risks in the final outcome. In other cases, such risk dissuades firms from participating in the joint venture altogether, undermining the stated objectives of the ASMPP—to encourage small businesses to partner with more experienced firms.
Therefore, it is vital that SBA clarifies whether the term “managing venturer” means control only over a joint venture’s contract performance—its “ventures”—or control also over the joint venture’s corporate governance and all decision making—or something in between.
This blog was written by Stephen Ramaley at Miles & Stockbridge.
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.