SBA Office of Hearings and Appeals Reaffirms “Unconditional Ownership” Requirement in the SBA SDVOSB Program

A recent case reinforces that, just because the corporate governing documents of an SDVOSB  satisfy the unconditional ownership requirements for VA’s  SDVOSB set aside program, does not mean that the unconditional ownership requirements under SBA regulations will be met. Last month, the SBA Office of Hearings and Appeals issued a decision, Veterans Contracting Group, Inc., SBA No. VET-265 (2017), which reaffirmed the SBA SDVOSB Program’s requirement that an SDVOSB be 51-percent unconditionally and directly owned by one or more service-disabled veterans (“SDV”). More specifically, OHA upheld an SBA determination that a concern named Veterans Contracting Group, Inc. (“VCS”) did not meet SDVOSB eligibility requirements due to certain provisions in a shareholders agreement among VCS’ owners which placed impermissible conditions on the SDV’s ownership interest in VCS. These provisions stated that, upon a shareholder’s death or incompetency, all of his or her shares must be purchased by VCS at the “Certificate Value” which is the value of the company as determined by the company’s accountant in his or her reasonable discretion. Thus, when the SDV dies, he is not able to dispose of his stock as he chooses. Rather, his estate must sell it to VCS and at VCS’ predetermined price. 

 

At least since an earlier OHA decision issued in 2006, “unconditional ownership” has been interpreted to mean that SDVs must (a) own the company “immediately and fully,” (b) have the ability to convey or transfer their ownership interest “whenever and to whomever they choose” and (c) “upon departure, resignation, retirement or death, still own their stock and do with it as they choose.”  Wexford Group, Int’l, Inc., SBA No. SDV-105 (2006). Following the Wexford standard, OHA upheld SBA’s determination with respect to the above-discussed provisions in the shareholders agreement. Such provisions placed impermissible conditions on the SDV’s ownership of the concern because he cannot dispose of the shares as he wishes in the event of his death or incapacity and has no control over the price of the shares. Likewise, the SDV’s shares cannot, upon his death, be left as part of his estate to anyone he chooses or passed to anyone of his or his trustee’s choice if he is determined to be incompetent. 

 

On the other hand, the shareholders agreement contained a similar provision stating that if a shareholder becomes insolvent, he shall have been deemed to offer his shares to the Company at “Certificate Value.”  Although the SBA originally determined that this provision was also an impermissible condition on the SDV’s ownership interest under SBA regulations, OHA disagreed, explaining that bankruptcy or insolvency proceedings would necessarily impose legal restraints on the disposition of a shareholder’s property that would override the shareholders agreement. This possibility of insolvency exists for all business, so that a provision in the shareholders agreement designed to deal with such a possibility does not render the SDV’s ownership interest conditional. 

 

OHA’s decision in Veterans Contracting Group, Inc. does not break any new ground. However, the decision brings into sharp relief the differences in the “unconditional ownership requirements” between the SBA’s SDVOSB program and the U.S. Department of Veterans Affairs’ (“VA”) SDVOSB program. On appeal, VCS relied on a past U.S. Court of Federal Claims (“COFC”) decision, Miles Construction, LLC v. United States, 108 Fed. Cl. 792 (2013), which held that an operating agreement which gave the surviving members of an SDVOSB a right of first refusal to the membership interest of another member that had died or become incapacitated was not a basis for finding that the SDV’s ownership rights had an impermissible condition for purposes of the VA’s SDVOSB program. However, OHA explained that Miles did not apply to the SBA SDVOSB program because it was a separate program from the VA SDVOSB program, and the SBA’s regulations governing impermissible conditions on SDVOSB ownership interests were different from that of the VA’s. In particular, the applicable VA regulation governing unconditional ownership state that pledges or other encumbrances of stock which follow “normal commercial practices” are not conditions upon the SDV’s ownership interest. The COFC found that such rights of first refusal constitute a “normal commercial practice” within the meaning of the VA’s SDVOSB program regulations. However, the SBA regulations and the Wexford standard do not contain such a “normal commercial practices” exception to the unconditional ownership requirement.    

 

A concern which is a VA-verified SDVOSB would be wise to review its corporate formation documents with counsel and if necessary, consider any changes to insure eligibility for non-VA SDVOSB set asides.