No lease? Maybe you're not so small after all!
We've talked before about the quirks of determining whether a business is a small business for government-contracts purposes. In general, you look to the number of employees a company has, you look at the average revenues of that company, and you use those inputs to determine whether the company is small according to an applicable NAICS code. It's a silly system, and it's subject to NAICS arbitrage. But at least it's usually predictable.
That said, one of the ways things can quickly go sideways is when companies start to partner with other companies. For example, suppose a small business subcontracts with another company that is not a small business, but really the subcontractor will do all the work. In those cases, the government will apply the "ostensible subcontractor" rule and the government will conclude that the prime contractor isn't really small.
Another way this comes into play is with the "nonmanufacturer rule". The basic idea is that some companies make stuff (manufacturers) and some companies resell that stuff (nonmanufacturers). Both can be small businesses! But if the government plans to set aside a contract for manufactured stuff for small businesses, then the stuff has to originate from small manufacturers.[1]
Here's an example of how this works straight from the regulations:
A procuring agency seeks to acquire computer hardware, as well as computer integration and maintenance services. If the procuring agency determines that the principal nature of the procurement is for supplies and classifies the procurement as a supply procurement, the nonmanufacturer rule applies to the computer hardware portion of the requirement. A firm seeking to qualify as a small business nonmanufacturer must supply the computer hardware manufactured by a small business.
Often this is a pretty straightforward analysis.[2] If you sell manufactured stuff under a small-business set aside, then you've either got to be a small business manufacturer yourself or be a nonmanfacturer that delivers stuff made by a small business manufacturer.
But there are nuances! There are supply chains! And, depending on what the government is buying, a company could be considered a manufacturer or a nonmanufacturer.
That will depend on the nature of the "end item" that the government acquires. When a company "transforms" one item into an "end item" that is being procured, the company can be considered a manufacturer of the end item and therefore can compete under a small business set-aside.
For example, suppose the government wants to buy an electric bicycle. If a small business buys non-electric bicycles and, using a combination of ingenuity and electric motor components, turns them into electric bicycles, then the small business is a small manufacturer even if the bicycles came from a large company.
Here's the language from the regulation because it's important to what comes after:
For size purposes, there can be only one manufacturer of the end item being acquired. The manufacturer is the concern which, with its own facilities, performs the primary activities in transforming inorganic or organic substances, including the assembly of parts and components, into the end item being acquired.
Not exactly plain language but, again, a pretty straightforward analysis.
And yet!
Here's a recent case that (spoiler alert) turned on a pretty strange set of facts:
On April 30, 2021, the U.S. Coast Guard issued Request for Requisition (RFR) Solicitation No. 70Z02321RPRT00300 for Indefinite Delivery Indefinite Quantity Fixed-Price with Economic Price Adjustment contract. The purpose of the RFR is “to acquire an estimated 16 River Buoy Tender Variant cutters (WLR) and an estimated 11 Inland Construction Tender Variant (WLIC) cutters, collectively called WCCs under this contract, which are to be fully operational and sustainable over a projected 30-year life cycle.” The WCC Program will replace the capability provided by the Inland Tender Fleet. The Contracting Officer (CO) set aside the procurement entirely for small businesses and assigned North American Industry Classification System (NAICS) Code 336611, Ship Building and Repairing, with a corresponding 1,250 employee size standard. Initial offers were due August 30, 2021, with final proposal revisions due May 31, 2022. Birdon submitted its initial offer on August 30, 2021, and submitted a revised final proposal on May 31, 2022.
On August 30, 2022, the CO notified unsuccessful offerors that Birdon was the apparent successful offeror. On September 6, 2022, Steiner filed a size protest and asserted numerous grounds. Steiner alleged, among other things, that (1) Birdon is other than small for the subject procurement; (2) Birdon is not the manufacturer of the vessels; and (3) Birdon is unduly reliant on Gulf Coast Shipyard as well as affiliated with the shipyard under the ostensible subcontractor rule.
Similarly on September 7, 2022, MBB filed a size protest and asserted, among other things, that (1) Birdon did not comply with the nonmanufacturer rule; and (2) Birdon was other than small for the procurement because of its affiliations with other firms.
On September 16, 2022, Birdon filed a consolidated response to all allegations raised in the size protest. Birdon confirmed that it will manufacture the vessels that are the end products of the procurement and perform the primary manufacturing activities. Birdon also asserted that it will manufacture the items in a leased facility. Birdon confirmed that it is not affiliated with Bollinger Shipyards, LLC (Bollinger) under the ostensible subcontractor rule because Birdon will perform the primary and vital requirements of the solicitation and is not unduly reliant on Bollinger. Birdon further contended that there is no affiliation between Birdon and Bollinger under the totality of the circumstances and the size of Birdon and affiliates combined does not exceed the 1,250-employee size standard.
In other words, Birdon competed for a small-business set-aside contract to manufacture some ships.[3] The losing bidders objected that Birdon isn't really a small manufacturer and, instead, the real manufacturer is either Gulf Coast Shipyard or Bollinger Shipyards.
There's really no question that Birdon, standing alone, met the size standards. Despite having 18 affiliates, Birdon met the size standard. Instead, the main question in dispute was whether Birdon would actually be the "manufacturer" of those ships.[4]
Buckle up, folks, because we're about to hit choppy waters.[5]
Remember how I said above that if a company transforms stuff into an end-item that it is a manufacturer? That is true, but there's a catch: the regulations require that the business use "its own facilities". And Birdon doesn't actually own a shipyard. Worse, at the time of contracting, Birdon didn't have a lease for a shipyard:
In determining whether a business concern is a manufacturer, the Area Office must determine that business concern will be “the concern which, with its own facilities, performs the primary activities in transforming inorganic or organic substances, including the assembly of parts and components, into the end item being acquired.” *** I conclude that, in the absence of a requirement in the solicitation, the phrase “its own facilities” in the regulation means that the contractor need only occupy and control the facilities, if not as an owners, then as a lessor or tenant. In the present case, it is undisputed that Birdon does not own a shipyard. The issue then is whether Birdon's Proposal confirms that Birdon will occupy and control those facilities as a lessor or tenant. *** I thus conclude that to determine a challenged concern's proposal met the “its own facilities” requirement, a fully executed lease of the proposed premises for manufacturing need not be in place at the time of the proposal. However, there must be some agreement in writing between the challenged concern and its prospective landlord in place at the time of the proposal for the challenged concern to occupy and control the facilities it will use to manufacture the end item-if not as an owner, then as a tenant.
So, yeah, Birdon ended up losing here. It's not a small manufacturer because it ... didn't have a shipyard... or a landlord... I guess?
Bizarre, right? The undisputed facts in the case were that Birdon was planning to "add 62.3% of total value to the contract" and that Bollinger would "add approximately 16% of total value to the contract". And yet, in the end (you can't make this up!), Birdon was not eligible to be a small manufacturer because Bollinger owned the facilities where Birdon was going to add that value.
The legal logic here is cut and dry, but it feels slippery. Because, well, the Coast Guard was buying ships, not a shipyard. It's quite a leap to conclude that a small-business set aside would turn on the real-property rights of where those ships are assembled. But the regulations say "its own facilities" and lawyers gonna lawyer.
Ah well.
In the end, sure, one obvious lesson for companies bidding for contracts where they plan to claim small-manufacturer status is to make sure that it has a strong property claim to "its own facilities". Never offering legal advice here, but might could want to pin that down pronto!
But another lesson of all of this is that size determinations can be a rich and volatile source of litigation and protest. And, who knows, sometimes you can get some unexpected results!
Them's the breaks!
[1] Or get a waiver.
[2] One nuance that I'm not going to bother with here is that a nonmanufacturer has a size limit of 500 employees regardless of which NAICS code would apply to a manufacturer (or 150 employees in the case of IT Value Added Resellers). So, a small business under a NAICS code might not be a small business under that NAICS code if the nonmanufacturer rule applies. Wild, huh?
[3] If you're curious, like I was, here's what they look like.
[4] There were other issues, but I'm ignoring them for purposes of this post. Sorry lawyers.
[5] Not sorry.