Forming a SBA Joint Venture? Beware of State Laws in Government Procurement

calendar iconMay 2, 2023

Oh No, We Messed Up! Beware of State Laws in Government Procurement

Susan Moser | Partner, Government Contractor Industry Leader
John Ford | Senior Consultant, Government Contracting Industry Practice

A recent decision by the Small Business Administration’s (SBA) Office of Hearings and Appeals (OHA) shows why government contractors contemplating forming a joint venture should get competent advice from a knowledgeable government contracting consultant or attorney before doing so.

Size Appeal of Syscom, Inc.

In Size Appeal of Syscom, Inc. SBA No. SIZ-6195 (March 7,2023), OHA was asked to determine whether an 8(a) joint venture was small. Here, two companies, an 8(a) participant, 1-855-US-TRASH, LLC (US Trash), and a small business, Six Nations, Inc. (Six Nations), formed a joint venture (JV) SNI United, LLC (SNI), which was subject to the laws of Michigan. Although SBA rules do not require a JV to be in any particular form, SNI was a limited liability company (LLC). Thus, it was unnecessary for the two companies to form a separate legal entity. Significantly, the two companies drafted the corporate documents related to the joint venture themselves, without assistance of legal counsel, based on forms they found online. As it turned out, this was a huge mistake.

As an LLC, SNI was not required to have a board of directors. However, because SNI’s members drafted the corporate documents for the JV based on forms found online, the JV created bylaws and adopted a board of directors to manage it. Further, SNI had no operating agreement, but instead had Bylaws, Articles of Organization and a Joint Venture Agreement (JVA). Although the JVA named US Trash as the managing member of the JV, as required by SBA rules, Michigan law states that unless a particular Manager or Managing Member is identified in an LLC’s operating agreement or articles of organization, all members are deemed to be managers of the LLC.

SNI did not have an operating agreement and, according to SNI’s Articles of Organization, US Trash is not designated as the Manager or Managing Member of SNI. Thus, there was a contradiction between the JVA and Michigan law. OHA determined that Michigan law must take precedence over the JVA and held that US Trash was not the managing member of SNI, as required by 13 CFR § 124.513(c)(2). Therefore, SNI was not eligible to receive an award as an 8(a) concern.

Ramifications of the Decision

Interestingly, this decision did not state that the JVA did not comply with SBA rules. Further, there was no mention of whether the JVA had been approved by the SBA. Assuming the JVA was entered into in accordance with SBA rules, that fact did not save SNI because the corporate documents SNI found online conflicted with Michigan law. More importantly, those corporate documents did not reflect the actual intent of the parties.

OHA also went on to find that SNI was not an eligible 8(a) JV because, in accordance with the SNI Bylaws, Six Nations could exercise negative control over the JV. That was because the Board of Directors consisted of two members, one from each JV participant. Because the Board could not take action unless a majority of the Board was present, Six Nations could block action merely by not attending a Board meeting.

While the foregoing shows why it is not a good idea to engage in self-help when addressing legal matters, JV agreements are not the only area where state law comes into play regarding government procurement. One of the major areas where state law plays a significant role is in subcontracting. Generally, the Federal Acquisition Regulation (FAR) does not apply to prime contractors when they are seeking to award a subcontract. Instead, subcontracts are primarily considered to be commercial transactions subject to state law. In this regard, it is not uncommon for subcontracts to identify the state law that is applicable to the subcontract.

However, this can present potential problems when it comes to application of FAR clauses incorporated in subcontracts. We do not think it is advisable to have such clauses subjected to interpretation by the courts of the fifty states, plus U.S. territories and possessions, using domestic law principles. Instead, we think it advisable to insert a clause in subcontracts stating that the interpretation of FAR clauses will be governed by the decisions of the boards of contract appeals, the Court of Federal Claims and the Court of Appeals for the Federal Circuit.

We highlight this case as a good example of the importance of getting competent professional advice. Unfortunately, many small or start-up entities do not understand that spending money on the front end for advice will pay dividends down the road, thereby avoiding lost opportunities when advice is not sought.

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