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GAO Agrees with the SBA: For Now, Base Small Business Size on 3-Year Average Revenue

by | Sep 28, 2019 | Government Contracts

A recent GAO decision resolves for the time being a critical small business issue: whether the 3-year revenue average for determining small business status was still valid. GAO denied a protest that argued the 3-year period had been revised by a new law that extended the 3-year period to 5 years effective immediately. Although the GAO decision describes the current state of the law, there remain a number of additional, unresolved issues for Congress and the SBA to resolve.

The GAO Decision. Two small businesses protested to GAO the terms of a GSA solicitation that required small business status to be based on the 3-year revenue average. The protestors believed that a firm’s small business status should be based on a firm’s 5-year revenue average in accordance with a law Congress passed in 2018, “The Small Business Runway Extension Act of 2018” (“Extension Act”) that was to be effective immediately upon presidential signature.

To resolve the protest, GAO asked the SBA for its views. According to the SBA, the Extension Act did not change SBA’s current 3-year look-back regulation because Congress had not amended the part of the SBA’s statute dealing with SBA size standards. That part authorizes SBA to set size standards for SBA programs via Federal Register rule making that had not yet been done. According to the SBA, the Extension Act amended the wrong part of the SBA law: it amended the part of the SBA law that allows non-SBA agencies to issue their own size standards for their own agency programs. The SBA concluded by stating current policy: because a firm’s small business size status is determined as of the date when it certifies its size in a proposal, the SBA will apply the 3–year calculation period to any firm that self-certified its size prior to the effective date of a final Federal Register rule.

GAO denied the protest. Because GAO typically defers to an agency’s interpretation of its own regulations, GAO agreed with the SBA’s interpretation: “we grant deference to SBA’s interpretation of the Small Business Act, particularly with regard to its role in the establishment, amendment, and interpretation of small business size standards.”  Techanax, LLC; Rigil Corp., B-408685.22, Aug. 16, 2019.

Although the GAO decision states the current law, it is likely that the 5-year period will be the law at some point in the future. But that is not the only unresolved small business issue. Some background might give helpful guidance on what other changes might be on the horizon. 

Congressional Response

As mentioned above, last year the President signed  the Extension Act that, according to Congressional intent, changed the time period used to measure revenue for qualifying as a small business to 5 years from 3 years. The two-sentence Extension Act, however, did not expressly state an effective date.

In early 2019, the SBA expressed its disagreement with several aspects of Congress’s interpretation of the SBA’s statute and with the Extension Act. The SBA claimed that, as it later argued to GAO, Congress amended the wrong part of the SBA statute. The SBA also refused to have the Extension Act apply immediately because it believed the 3-year revenue regulation could be changed only if Congress amended the correct part of the SBA statute and after the SBA had used Federal Register rule making. 

In Spring 2019, Congress responded. The House of Representatives considered, passed,  and sent on to the Senate where it is currently pending,  H.R. 2345, Clarifying the Small Business Runway Extension Act (“Clarifying Act.”).  According to the Clarifying Act, Congress intended the Extension Act to take effect immediately upon signing by the President on December 17, 2018.

The Clarifying Act adds two other, interesting provisions. One would allow a firm to use either the 3-year or the 5-year average, whichever one made the firm a small business. That provision would mitigate one of the perhaps unintended consequences of the Extension Act: the 5-year lookback could eliminate some small businesses. For example, a firm that had experienced within the past 5 years a dip in revenue might benefit from that dip by returning to small business status through retention of the 3-year rule; but those firms might revert to a large business if only the 5-year standard were used.   

The second interesting provision pushes back against the SBA’s claim that Congress changed the wrong part of the SBA law, the argument the SBA successfully used in the GAO decision. Specifically, the SBA had argued that the Extension Act amended the requirements for non-SBA agencies to issue their own size standards, not the SBA’s size standards. According to the House’s Report on the Clarifying Act, legal experts advised the House Committee on Small Business that the Extension Act correctly changed the SBA statute because the “non-SBA” provision dealt with “federal agencies” and the SBA obviously is a federal agency.   

Thus, in the bill before the Senate, Congress is now trying to make sure the 5-year period gets implemented effective last year and that this longer period does not cost firms their small business status.

SBA Action

After the Extension Act controversy began in early 2019, the SBA become involved and, on June 23, 2019, issued a proposed rule to implement the Extension Act’s change to the 5-year standard.

In addition, any change would not be effective until its publication as a final rule: “This proposed rule only would affect the application of SBA’s size standard rules after the effective date of a final rule. Thus, until the effective date of a final rule, SBA will continue to apply the 3-year averaging period in the present § 121.104 for calculating annual average receipts for all SBA’s receipts-based size standards.” Small Business Size Standards: Calculation of Annual Average Receipts, 84 FR 29399-01.

The proposed rule does not resolve the issues involving the possibility of the 5-year rule reducing the number of small businesses. Instead, it appears to ask for comments on the issue. The SBA commentary discusses the benefits to the larger small businesses and the disadvantages to smaller small businesses: “by enabling mid-size businesses to regain small business status and by lengthening the small business status of advanced and successful larger small businesses, the longer averaging period may disadvantage smaller small businesses in more need of Federal assistance than their more advanced and larger counterparts in competing for Federal opportunities.” Id.

Comments on the proposed rule closed on August 23, 2019. As of this publication date, the SBA has not adopted a final rule.

In conclusion, we anticipate the resolution of these small business issues within the next few months. We will continue to keep you informed of these changes.

Berenzweig Leonard is teaming up with Red Team Consulting for a monthly newsletter featuring reports on recent contract decisions,  recent upcoming contracts, key protest decisions, events, Words of Wisdom, and more. This post was published in the September 2019 newsletter. To sign up for our govcon newsletters, please click here. 

Terry O’Connor is a Partner at Berenzweig Leonard. Terry and Stephanie Wilson  lead the firm’s Government Contracts practice. Terry can be reached at [email protected].