In the latest Weekly Wright Report:

New SBA Final Rule Clarifies the Ostensible Subcontractor Rule

By: Michael A. Stover, Esq.

On April 27, 2023, the Small Business Administration issued a final rule that among other things made changes to the SBA regulations regarding the “Ostensible Subcontractor Rule.”  The Final Rule is designed to (1) clarify how the OSR applies to general construction contracts and (2) provide guidance on the utilization of the so-called DoverStaffing factors in determining whether a subcontractor is an “ostensible subcontractor.”

The OSR provides that the SBA will treat a small business prime contractor and a subcontractor as joint venturers for size determination purposes if that subcontractor is determined to be an “ostensible subcontractor.” When two companies are considered to be joint venturers, their combined total size is used to determine the applicable size standard. The current regulation defines “ostensible subcontractor” as a subcontractor (1) that is not a similarly situated entity and (2) that performs primary and vital requirements of a contract or order, or upon which the prime contractor is unusually reliant. The Final Rule clarifies that the “primary role of a prime contractor in a general construction project is to oversee and superintend, manage, and schedule the work, including coordinating the work of various subcontractors.” “Those are the functions that are the primary and vital requirements of a general construction contract and ones that a prime contractor must perform.” Accordingly, going forward, the Ostensible Subcontractor Rule will be applied in general construction contracts to the management, supervision, and oversight of the project, including coordinating the work of various subcontractors, and not to the actual construction or specialty trade construction work performed, which the SBA now explicitly recognizes subcontractors often perform. Under the new rule “[t]he prime contractor must retain management of the contract but may delegate a large portion of the actual construction work to its subcontractors.”

With regard to the “unusually reliant on a subcontractor” issue, the new rule provided clarification.  In the DoverStaffing, Inc., case the SBA Office of Hearings and Appeals articulated a four-factor test for determining when a prime contractor may be an ostensible subcontractor:

1. The proposed subcontractor is the incumbent contractor and ineligible to compete for the procurement.
2. The prime contractor plans to hire the large majority of its workforce from the subcontractor.
3. The prime contractor’s proposed management previously served with the subcontractor on the incumbent contract. And
4. The prime contractor lacks relevant experience and must rely upon its more experienced subcontractor to win the contract.

In the Final Rule, the new regulation adds the reliance on incumbent management and the reliance on the subcontractor’s experience from the DoverStaffing factors. However, the SBA added language clarifying that these factors would not be mechanically applied or create any sort of irrebuttable presumption of an ostensible subcontractor. The SBA explained that no single factor is determinative and a prime contractor should be able to use the experience and past performance of its subcontractors to strengthen its offer, even where a subcontractor is the incumbent contractor. The SBA contends that it intends to consider all aspects of the prime contractor’s relationship with the subcontractor and will not limit its inquiry to any enumerated factors. It is only where the subcontractor will perform primary and vital requirements of a contract or order, or where the prime contractor is unusually reliant on the subcontractor, that SBA will find the subcontractor to be an ostensible subcontractor.

The new rule should make it easier for contractors and subcontractor to navigate the ostensible subcontractor waters.  If you have any questions regarding this matter, please contact any member of our Government Contracts Law Group.