[Federal Register Volume 60, Number 14 (Monday, January 23, 1995)]
[Proposed Rules]
[Pages 4389-4391]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-1505]



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SMALL BUSINESS ADMINISTRATION

13 CFR Part 121


Small Business Size Standards; Ostensible Subcontractor Rule and 
the Affiliation of Business Concerns Under Joint Venture Arrangements

AGENCY: Small Business Administration.

ACTION: Proposed rule.

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SUMMARY: The Small Business Administration (SBA) is proposing a 
revision to its ``ostensible subcontractor'' rule as set forth in its 
affiliation regulation to permit small businesses to enter into 
subcontracts with certain public utilities for the lease and use of 
distribution facilities (telecommunication circuits, petroleum and 
natural gas pipelines, and electric transmission lines) without being 
considered affiliated with the public utility where the small business 
prime contractor adds meaningful value to the contract. This revision 
is being considered to take into account new business arrangements 
which have emerged as a result of deregulation of several public 
utility industries.

DATES: Comments must be submitted on or before March 24, 1995.

ADDRESSES: Send comments to: Gary M. Jackson, Assistant Administrator 
for Size Standards, 409 3rd Street, SW., Mail Code 6880, Washington, DC 
20416.

FOR FURTHER INFORMATION CONTACT:
Gary M. Jackson, Assistant Administrator for Size Standards, (202) 205-
6618.

SUPPLEMENTARY INFORMATION: The SBA is proposing to revise its 
``ostensible subcontractor'' rule as set forth in 13 Code of Federal 
Regulations (CFR) part 121.401(1)(4) with regard to affiliation arising 
from certain continuing arrangements. Under this regulation, 
affiliation is generally found to exist when one firm acting as a prime 
contractor enters into a subcontracting arrangement with another firm 
who, in turn, performs the ``primary or vital requirements'' of a 
contract. Under this arrangement, if the prime contractor is reliant 
upon the subcontractor to perform the contract to the extent that the 
subcontractor assumes a controlling role on the contract, then the 
relationship will be regarded by SBA as a joint venture with the two 
firms deemed affiliated under the ``ostensible subcontractor'' rule. 
The size of a joint venture is based on the combined revenues or number 
of employees, depending on the applicable size standard, of both firms. 
For a joint venture to be considered a small business, its size cannot 
exceed the applicable size standard.
    The SBA is considering a modification to this ``ostensible 
subcontractor'' rule by expressly excluding from its coverage 
subcontracting agreements for the lease and use of distribution 
facilities of public utilities for telecommunication circuits, 
petroleum and natural gas pipelines, and electrical transmission lines 
where the prime contractor lessee contributes meaningful value to the 
contract. This modification would allow small businesses to enter into 
certain arrangements with other businesses in the provision of public 
utility services to the government without being considered joint 
venturers and affiliates. The SBA is concerned, however, that such a 
modification could have the unintended effect of allowing a small 
business to act as a mere broker or intermediary on the behalf of a 
large business. This possible consequence, addressed in greater detail 
below, is an issue that the SBA will be examining carefully before 
making a final decision on this proposal. It should be noted that this 
proposed rule would specifically exempt a finding of affiliation based 
solely on subcontracting agreements between firms that lease and use 
the public utility's distribution facilities and the public utility who 
owns and maintains the facilities, but other relationships between the 
firms could still bring about a finding of affiliation.
    The impact of several recent size appeal decisions issued by SBA's 
Office of Hearings and Appeals has led several small businesses to 
request that SBA reassess its regulations on joint ventures as applied 
to firms that lease telecommunications circuits. These decisions found 
resellers of long distance telecommunications services affiliated with 
the owner of the telephone circuits, on the basis that the provider of 
the lines would perform the ``primary and vital requirements'' on a 
government contract by providing, maintaining and repairing 
telecommunications circuits, and that, therefore, the relationship 
between the reseller and long distance provider should be regarded as a 
joint venture arrangement and the firms should be considered affiliated 
under the ``ostensible subcontractor'' rule. As a result of the 
existing regulation and these decisions, federal contracting 
opportunities have been placed in jeopardy for both small businesses 
and small disadvantaged businesses operating through lease arrangements 
for telecommunication lines and circuits. SBA believes that its size 
regulations should be re-evaluated in [[Page 4390]] order to assess 
whether the ``ostensible subcontractor'' rule continues to be 
appropriate in the context of the telecommunications industry as well 
as the other public utility services industries identified above, which 
appear to have similar industry characteristics.
    Over the past decade, deregulation of the public utility industries 
identified above has resulted in the open access of certain 
distribution facilities of public utilities by other firms. This 
development has encouraged the entrance of new firms in these markets 
to provide specialized services. For example, in the long distance 
telephone market a firm (reseller) can purchase bulk access to 
telecommunication circuits and resell telecommunication services to 
smaller volume customers. The economic savings from a volume purchase 
of these circuits by resellers are offered to certain customers who, 
given their relatively small volume of business or need, could not 
obtain similar savings by directly obtaining telephone access through 
the long distance providers. The other two public utility industries 
under consideration in this proposed rule are also experiencing the 
emergence of similar business arrangements where other firms utilize 
the public utility's distribution facilities. In the natural gas 
industry, open access of interstate pipelines has resulted in a 
significant change in the marketing of natural gas. Prior to 
deregulation, 95 percent of natural gas transported through pipelines 
was owned by the pipeline companies. Today, over 95 percent of natural 
gas flowing through interstate pipelines is owned by non-pipeline 
companies. Additionally, open access on a limited basis is now allowed 
for the provision of electric power, and further modifications to 
legislative restrictions on the retail sale of electric services are 
under consideration.
    SBA's preliminary assessment of the public utility industries 
described in this proposed rule is that there may be a legitimate basis 
to permit resellers of telecommunication services, and other firms that 
provide public utility services through the lease and use of 
distribution facilities, to offer their services in the Federal market 
as they do in the commercial market without running afoul of the 
affiliation rules. In many instances, these firms may add value to the 
contract involved and be sound, operating businesses engaged generally 
in the provision of telecommunications and other public utility 
services. Moreover, the extensive capital investment necessary to build 
the distribution facilities associated with providing one of these 
public utility services essentially precludes a firm, other than the 
existing public utility firms, from making such an investment in order 
to perform a specific Federal procurement or in order to serve small 
volume commercial customers. In addition, remaining regulatory 
requirements continue to prohibit or constrain the development of 
capital facilities by new entrants. As indicated above, deregulation 
occurring in these public utility industries has made available to 
other firms the use of distribution facilities of the public utilities 
on a sub-contractual basis. Unlike other industries, the provision of 
public utility services is limited to one or a few public utility 
providers, and new firms that are now able to enter the market do so by 
leasing the distribution facilities of existing public utilities. Firms 
in other service industries usually do not depend on the exclusive 
access to a significant amount of capital facilities of one or a few 
firms within an industry to provide their services.
    As indicated above, SBA is concerned that the effect of the present 
regulations causing affiliation between a prime contractor and an 
``ostensible subcontractor,'' based simply on the leasing of 
distribution facilities, may now be inappropriate with respect to these 
specific public utility industries. For example, even though the 
greatest component of value in government contracts providing 
telecommunications services may be the utility distribution facilities, 
it nevertheless may not be appropriate to regard the subcontractor or 
supplier contributing that component as performing a controlling role 
on the contract where its responsibilities are limited to the provision 
and maintenance of those facilities and the prime contractor provides 
other valuable services. The SBA recognizes that firms that lease and 
use the distribution facilities of these public utilities generally 
perform an important and legitimate economic role in the provision of 
utility services to commercial markets, and the ``ostensible 
subcontractor'' rule may unnecessarily constrain opportunities for 
small business in obtaining Federal contracts for these public utility 
services. On the other hand, SBA does not wish to create by this 
exception a situation in which small business prime contractors qualify 
for small business preferences when they merely are brokers. Thus, the 
exception would apply only if the prime contractor also contributes 
meaningful value to the contract. With respect to the concept of 
meaningful value, SBA has not attempted to quantify what would 
constitute meaningful value for purposes of this rule.
    The SBA is particularly concerned that the effect of the proposed 
modification might lead to abuses in the small business preference 
programs if the modification allows small businesses to act as mere 
brokers or intermediaries on the behalf of large businesses. To explain 
further, a small firm acting as a reseller of long distance telephone 
services might perform several functions, such as consultative 
services, identification and connection of circuits, problem 
resolution, and billing services, in providing long distance 
communication services to its customers. However, these activities may 
be of such limited significance to the contract as a whole when 
compared to the services provided by the long distance telephone 
carrier that the carrier should indeed be properly regarded as a joint 
venturer of the small firm. One of the primary purposes of the 
``ostensible subcontractor'' rule is to ensure that the benefits 
intended for small business in obtaining a government contract are 
enjoyed by that small business and not simply passed through to a large 
business subcontractor. It is not the SBA's intention to depart from 
this long-held policy as a result of a modification of the ``ostensible 
subcontractor'' rule. Comments addressing this aspect of the proposed 
rule would be especially beneficial to SBA's deliberations of this 
issue.
    The SBA seeks public comments on this proposal to modify the 
``ostensible subcontractor'' rule. The SBA is particularly interested 
in obtaining comments which address the following points: (1) The 
nature of the business relationship between a public utility firm and a 
firm that leases the public utility's distribution facilities for 
purposes of reselling public utility services; (2) whether the proposed 
rule could have an unintended adverse effect on SBA's small business 
programs by allowing the brokering of services provided by large 
business; (3) whether a requirement that the prime contractor provide 
meaningful value to the contract adequately protects against abuse, and 
if so, how meaningful value should be determined, whether 
quantitatively or otherwise; (4) whether any modification to the 
``ostensible subcontractor'' rule should be applied to public utility 
industries in addition to those which have been identified in the 
proposed rule; and, (5) alternative approaches to this proposed rule 
that address the issues discussed above. [[Page 4391]] 

Compliance With Regulatory Flexibility Act; Executive Orders 12612, 
12778, and 12866; and the Paperwork Reduction Act.

    This rule has been reviewed under Executive Order 12866. SBA 
certifies that this proposed rule, if adopted, would not have a 
significant economic impact on a substantial number of small entities 
within the meaning of the Regulatory Flexibility Act, 15 U.S.C., et 
seq. The SBA has made this determination based on the fact that a 
limited number of Federal contracts would likely be awarded to small 
businesses as a direct result of this action. Thus, even though this 
proposed rule, if adopted as final, would make eligible previously 
ineligible firms for SBA procurement preference programs, SBA does not 
expect the number of affected firms to be significant.
For purposes of Executive Order 12612, SBA certifies that this proposed 
rule would not have Federalism implications warranting the preparation 
of a Federalism assessment. For purposes of Executive Order 12778, SBA 
certifies that this proposed rule is drafted, to the extent 
practicable, in accordance with the standards set forth in section 2 of 
that Order. For purposes of the Regulatory Flexibility Act, the SBA 
certifies that this proposed rule would not have a significant economic 
effect on a substantial number of small entities for the same reason 
indicated above. For purposes of the Paperwork Reduction Act, the SBA 
certifies that this proposed rule would not impose any new reporting or 
recordkeeping requirements.

List of Subjects in 13 CFR Part 121

    Government procurement, Government property, Grant programs--
business, Loan programs--business, Small businesses.

    Accordingly, part 121 of 13 CFR is amended as follows:

PART 121--[AMENDED]

    1. The authority citation of part 121 continues to read as follows:

    Authority: 15 U.S.C. 632(a), 634(b)(6), 637(a), and 644(c); and 
Pub. L. 102-486, 106 Stat. 2776, 3133.

    2. Sec. 121.401(1)(4) is revised to read as follows:


Sec. 121.401  Affiliation.

* * * * *
    (l) * * *
    (4) An ostensible subcontractor which performs or is to perform 
primary or vital requirements of a contract may have such a 
controlling role that it must be considered a joint venturer 
affiliated on the contract with the prime contractor. In determining 
whether subcontracting rises to the level of affiliation as a joint 
venture, SBA considers whether the prime contractor has unusual 
reliance on the subcontractor. This provision does not apply to 
subcontracts entered into with public utility concerns providing 
open access to distribution facilities if such subcontracts are 
limited to the lease and use of telecommunication circuits, 
petroleum pipelines, natural gas pipelines, or electric transmission 
lines, and if the prime contractor contributes meaningful value to 
the contract.
* * * * *
    Dated: December 2, 1994.
Philip Lader,
Administrator.
[FR Doc. 95-1505 Filed 1-20-95; 8:45 am]
BILLING CODE 8025-01-M