In 2010, Congress significantly increased the risk of owning, teaming with or acquiring a small business government contractor through the so-called “presumed loss rule.” The rule establishes an irrefutable presumption that when a small business misrepresents its size to gain a benefit, such as a contract award or even extra credit under an evaluation factor, the damage to the government is the entire value of that contract. This harsh rule, which could also support treble damages under the False Claims Act, led to a vocal industry response and the creation of a safe harbor for the Small Business Administration “advisory opinions” in the FY 2013 National Defense Authorization Act (NDAA). Indeed, the SBA’s own statistics demonstrate the need for an effective safe harbor. Citing 2010 statistics, the SBA notes that 150 businesses were found to be other than small, but that most were based on errors or misunderstandings and not fraud. 79 Fed. Reg. 35965. As required by the NDAA, on June 25, the SBA issued a proposed rule implementing the safe harbor. See 79 Fed. Reg. 35963. Unfortunately, this four-page rulemaking provides little protection for contractors and leaves many questions unanswered.

The Presumed Loss Rule Creates Significant Risk

The presumed loss rule, in conjunction with the False Claims Act, 31 U.S.C. §§ 3729–3733 (FCA), creates the potential for business-crushing penalties for concerns that mistakenly represent their size status. Typically, damages under the FCA are calculated by determining the difference between the amount paid to the contractor and the value of the goods received and then trebling that delta.1 Under the presumed loss rule, however, damages for willful small business misrepresentations are counter-factually set at 100 percent of contract value. Thus, under the rule, contractors may face millions of dollars in damages even when a contract is performed fully and to the satisfaction of the government customer.

Although the presumed loss rule only applies to “willful” misrepresentations of size, that term provides little protection for contractors because it is not defined in the statute or regulations and is instead left to the trier of fact. Further, the rule is applied broadly and is not just limited to small-business set-aside contracts. It applies to any situation in which small business status is a factor in the government’s decision to award the contract, including “reserves, partial set-asides, price evaluation preferences, source selection factors, and any other mechanisms which are not specifically addressed by the FAR.” Notably, this broad application raises the question of liability for large businesses claiming small business subcontracting credit under small business participation evaluation factors. The FY 2013 NDAA also expanded a similar presumption of loss for small business prime contractors exceeding subcontracting limitations in “the amount expended, in excess of permitted levels, on subcontractors.”

Congress’s Uncertain Safe Harbor Does Little To Help

Due to uncertainty as to how the rule will be applied, the potential for significant liability, and the maze of SBA regulations, both large and small contractors expressed concern that the presumed loss rule was too harsh.

Congress obliged in the most limited fashion. Although the House version of the NDAA provided a broad safe harbor exempting contractors from penalties if they “acted in reliance on a written advisory opinion from a licensed attorney who is not an employee of the defendant” when they certified that they were a small business, the final safe harbor was much more limited. Section 1681 of the FY 2013 NDAA limited the safe harbor protections to contractors acting in “good faith reliance on a written advisory opinion from a Small Business Development Center … or an entity participating in the Procurement Technical Assistance Cooperative Agreement Program ….” This remedy was rendered largely ineffective because it did not set a time period for receipt of an opinion and emphasized that “nothing in this Act shall obligate either entity to provide such a letter ….”

Given little to work with, it is not surprising that the SBA’s June 25 presumed loss rule-making does little to help contractors. Implementing § 1681 at 13 C.F.R. § 121.109, the proposed rule defines a small business advisory opinion as “a written opinion issued by either a Small Business Development Center (SBDC) operation under part 130 of this chapter or a Procurement Technical Assistance Center (PTAC) operation under 10 U.S.C. Chapter 142 which concludes that a firm is entitled to represent itself as a small business concern for purposes of federal government procurement opportunities.” All advisory opinions must be submitted to the SBA Office of General Counsel (OGC) for review and must include the concern’s contact and business information, applicable NAICS codes and size standards, a determination that the concern does not exceed those size standards, along with supporting documentation and a written affirmation from the concern that the information provided to the SBDC or PTAC is, to the best of the concern’s knowledge, “true, accurate, and complete.” The SBA’s OGC will either accept or reject the opinion within ten days of receipt. The regulations also provide that the SBA may refer a concern that is the subject of an advisory opinion for a formal size determination.

The Safe Harbor’s Shortcomings Are Reflected in SBA’s Rulemaking

Although this process seems straightforward enough, the rule demonstrates shortcomings in both Congress’s and the SBA’s approach to creating an effective safe harbor. For example, the rule does not require SBDCs or PTACs to issue advisory opinions or set any timetable for the issuance of those opinions. In fact, the rule will cause significant confusion by giving each individual SBDC or PTAC the choice whether to offer advisory opinions. Moreover, the rule confirms that no additional funding will be offered to offices that offer advisory opinions. Given the additional work involved, it is not clear what incentive individual SBDCs or PTACs will have to issue opinions, thus rendering even this limited safe harbor moot. Even if a small business is able to locate an office that issues advisory opinions, it will not be able to count on receiving the opinion in time to avoid possibly misrepresenting its size for upcoming procurements.

Further, the proposed rule provides no appeal of an adverse SBDC or PTAC decision or a rejection of an advisory letter by the SBA’s OGC. Given that local office decisions are regularly overturned by SBA’s Office of Hearings and Appeals, small businesses plainly need an appellate forum. The rule’s failure to provide an appeal mechanism puts substantial risk on the small business community for possible errors at the SBDC or PTAC level, which a 10-day review by the OGC is unlikely to resolve.

All in all, the SBA’s proposed rulemaking does little to assuage contractor concerns about the limitations on this important safe harbor. As a practical matter, without additional funding, it is unlikely that SBDCs and PTACs will choose to provide these letters. As a result, this effort to limit the consequences of the presumed loss rule is likely to remain a safe harbor in name only.

Rachael K. Plymale