In a size appeal decision released this past week, the United States Small Business Administration Office of Hearing and Appeals (“SBA-OHA”) took the rare step of overturning its past precedent in the process of affirming a finding of affiliation. In Size Appeal of Tenax Aerospace, LLC, SBA No. SIZ-5701 (2015), the SBA Area Office concluded that Tenax Aerospace was affiliated with a number of entities on the basis of the identity of interest rule (through both common investments and family relationships), 13 C.F.R. 121.103(f). In addition, SBA concluded that Tenax Aerospace was affiliated with Tri-Jet, LLC, because of its minority ownership interest in that company. Tri-Jet had three owners, one of which was Tenax Aerospace, all of whom owned 33% of the company. Even though Tenax Aerospace only held a minority interest in Tri-Jet, SBA concluded that, pursuant to 13 C.F.R. 121.103(c)(2), Tenax Aerospace and Tri-Jet were affiliated based on the presumption that “when a concern is owned by multiple owners with equal minority interests, all of those owners are presumed to control the concern.” Based on these findings of affiliation, Tenax Aerospace was declared “not an eligible small business.”
On appeal to SBA-OHA, Tenax Aerospace argued that it was not affiliated with Tri-Jet, because even though Tenax Aerospace owned a 33% of Tri-Jet, it was merely a passive investor and did not actively manage Tri-Jet. SBA-OHA rejected this argument, noting that SBA-OHA’s case law “does not require a minority owner to have managerial responsibilities for the presumption of control to apply…. Rather, managerial duties prevent the owner from rebutting the presumption.”
Tenax Aerospace also argued it did not control Tri-Jet because, under Tri-Jet’s operating agreement, Tenax Aerospace could not prevent a quorum of the owners (except in cases of extraordinary actions), and therefore could not control Tri-Jet from taking actions favored by a majority of the other owners. In support of this argument, Tenax Aerospace cited the Size of Appeal of Mark Dunning Industries, Inc., SBA No. SIZ-5488 (2013), wherein SBA-OHA held that a quorum requirement in a company’s operating agreement “rebuts the presumption” that a person with a minority ownership interest in the company has the power to control the company, because that minority owner cannot prevent a quorum. In addressing this argument, SBA-OHA first held that the Mark Dunning case was easily distinguishable because, in that case, the minority owners each held 1/9 interests, whereas Tri-Jet’s ownership was more heavily concentrated into 1/3 interests. Then, in a rare move, SBA-OHA took the further step of overruling the holding in Mark Dunning altogether, finding that it was inconsistent with the rationale behind the minority ownership affiliation rule:
Mark Dunning is an outlier that represents an unexplained departure from OHA’s longstanding precedent. It is also inconsistent with the rationale behind the minority ownership rule. As OHA has explained, “The best rationale for the minority shareholder presumption (13 C.F.R. § 121.103(c)(2)) is that all concerns must be controlled by someone or some group at all times. The alternative, to consider none of the minority stockholders as possessing the power to control the concern, would ignore reality and leave the locus of power uncertain and unresolved.” Size Appeal of Technibilt, Ltd., SBA No. SIZ-5304, at 4 (2011) (quoting Size Appeal of Tech. Support Servs., SBA No. SIZ-4794, at 13 (2006).) For this reason, OHA has held that an equal distribution of voting power among three minority stockholders was sufficient to give each the power to control the firm. Size Appeal of Zygo Corp., SBA No. SIZ-2514 (1986). OHA reached this conclusion notwithstanding the fact that “alone, [each minority stockholder] could neither affirmatively establish policy and execute management decisions, nor negatively block action favored by a majority of the stockholders or management.” Id. OHA reaffirmed this approach in Size Appeal of Technibilt, Ltd., SBA No. SIZ-5304 (2011) when it held that an owner’s inability to block a quorum is insufficient to rebut the presumption of a minority owner’s control. Technibilt at 3-4. In Mark Dunning, however, OHA stated, without referring to previous cases, that the presumption of control was rebutted because the minority owner could not block a quorum. Mark Dunning, SBA No. SIZ-5488, at 6. Accordingly, because this aspect of Mark Dunning is inconsistent with OHA’s long line of cases, I conclude that I must overrule its holding that a finding of affiliation under 13 C.F.R. § 121.103(c)(2) may be rebutted by existence of a quorum requirement. I further find the Area Office did not err in declining to follow it.
The Tenax Aerospace case should serve as warning to contractors that even if you only hold a minority ownership interest in another company, and you aren’t the manager of that company, you can still be deemed affiliated with that company based purely on your ownership interest (if your minority interest, and another’s minority interest, are approximately equal in size, and the aggregate of these minority holdings is large as compared with any others’ stock holdings). The fact that you can’t prevent a quorum, or that the other shareholders combined represent a majority of the voting interests, is not sufficient to rebut the presumption of control.