On November 4, 2008, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Rothe Development Corporation v. Department of Defense, No. 2008-1017, 2008 WL 4779586, holding that:

  • Congress lacked a "strong basis in evidence" of discrimination by the Department of Defense ("DOD") against socially and economically disadvantaged individuals and businesses (referred to collectively as "socially disadvantaged businesses" or "SDBs");  
  • Lacking a "strong basis in evidence," the race-conscious remedial measures at 10 U.S.C. § 2323 (setting a goal to award at least 5% of annual contracting dollars to small disadvantaged businesses and authorizing certain set-asides for SDBs) were unconstitutional, violating the Fifth and Fourteenth Amendments to the U.S. Constitution guaranteeing equal protection to all citizens under the law; and  
  • The District Court hearing the case should enter an order declaring that the current 10 U.S.C. § 2323 is facially unconstitutional, and that its further application should be enjoined.  

Since federal procurement includes a hodgepodge of "preferences" for small businesses, minority-owned businesses, women-owned business, veteran-owned businesses, service-disabled-veteran-owned businesses, historically underutilized business zone ("HUBZone") businesses, and other small disadvantaged business concerns, the Rothe decision has the potential for a significant ripple effect. Already the "splash" of the Rothe decision is obvious, with news of the recent decision being picked up by bloggers and newspapers alike. However, its ultimate impact remains to be seen and may be overstated by some recent analyses.

Background and Discussion

The Rothe case concerns the constitutionality of 10 U.S.C. § 2323, which, in relevant part:

  • sets a “goal” that 5% of federal defense contracting dollars for each fiscal year be awarded to certain entities including small business concerns owned and controlled by “socially and economically disadvantaged individuals;”
  •  incorporates the Small Business Act’s presumption that Black Americans, Asian Americans, Hispanic Americans, and Native Americans are socially disadvantaged individuals; and
  • provides that the Department of Defense shall give specific forms of assistance to the listed entities and may, when practicable and necessary to achieve the 5% goal, make advance payments to those entities and award contracts to them at prices up to 10% percent above fair market cost.

Rothe has a long litigative history dating back to the mid-1990s, when (a) Rothe, owned by a Caucasian female, submitted the low bid of $5.57 million for a contract, (b) another company owned by a Korean-American couple and certified as an SDB bid $5.75 million, (c) Rothe's bid was inflated to $6.1 million using the stated price evaluation adjustment, and (d) the adjustment displaced Rothe as the low bidder.

After serial district and appellate court proceedings, the constitutionality of 10 U.S.C. § 2323 was finally addressed in 2007 when the district court granted summary judgment to DOD. Rothe appealed to the Federal Circuit, which ruled as follows:

[W]e must decide whether [10 U.S.C. § 2323], on its face, as reenacted in 2006, violates the right to equal protection (as incorporated against the federal government by the Due Process Clause of the Fifth Amendment). Because we will hold that Congress did not have a “strong basis in evidence” before it in 2006, upon which to conclude that DOD was a passive participant in racial discrimination in relevant markets across the country and that therefore race-conscious remedial measures were necessary, we will reverse the district court’s judgment in part, and will hold that … 10 U.S.C. § 2323 [ ] is unconstitutional on its face.

Because 10 U.S.C. § 2323 incorporates an explicit racial classification – the presumption that members of certain minority groups are "socially disadvantaged" for purposes of obtaining SDB status and the benefits that flow from that status – the Federal Circuit emphasized that the statute must be narrowly tailored to meet governmental objectives, and that the statute is subject to strict scrutiny by the courts.

According to the Federal Circuit, the key flaw with the factual basis for the statute was that the studies relied upon by DOD demonstrating prior discrimination were fundamentally flawed – the studies purporting to measure the disparity between actual and expected contracts for firms owned by socially and economically disadvantaged individuals adopted a faulty benchmark, because they failed to control for firm size and relative capacity.

Potential Impact of the Rothe Decision

While it is obviously difficult to predict exactly how the Rothe decision will play out in the federal contracting world, we think that there are certain observations that can be safely made:

  1. Race-based preferences in federal contracting will continue. While the Federal Circuit struck down this particular statute as unconstitutional, the U.S. Supreme Court has never completely prohibited race-based preferences in federal contracting. In fact, the U.S. Supreme Court most recently addressed the issue in Richmond v. J.A. Croson Co., 488 U.S. 469 (1989) and Adarand Constructors v. Peña, 515 U.S. 200 (1995), indicating that while race-based classifications are subject to strict scrutiny by the courts, if the statute is sufficiently justified with a "strong basis in evidence" and is also narrowly tailored to achieve the government objective, the race-based preference will pass constitutional scrutiny. In light of the fact that the statute in question was enacted in 1998 – years after the Croson and Adarand decisions – Congress clearly does not feel that race-based preferences are something that must or should be avoided. We doubt that it has changed its mind, in light of the fact that 10 U.S.C. § 2323 was reauthorized as recently as 2006.  
  2. Congress will, more than likely, rework 10 U.S.C. § 2323 and support it with a "strong basis in evidence." The Federal Circuit was open to the fact that discrimination might exist and that some statistical and anecdotal evidence might require some sort of remedy, but the Federal Circuit emphasized that there was not a sufficiently robust record on which Congress could have reached a reasoned conclusion. To the extent Congress creates a more robust record, courts will likely defer to Congress.  
  3. The Rothe decision does not call into question all set-asides, simply those based on racial definitions. While some commentators on the Rothe decision speculate that the decision calls into question all small business set-asides, such a conclusion probably overreaches. The Federal Circuit's strict scrutiny analysis was mandated by the express race-based preference in 10 U.S.C. § 2323 and the inadequate factual record developed in support of that preference.  
  4. Definitive guidance from the courts will not be coming any time soon. The Government has 90 days to request review of the Federal Circuit's decision by the U.S. Supreme Court. Even if there is no High Court review, the District Court may take additional time to consider the opinion before issuing a final injunctive order. Given these facts any abandonment of existing SDB contract obligations might well prove to be premature.