Written by: Carissa Siebeneck
The SBA published an important regulatory change in a December corrections notice, so it may have slipped under the radar of your normal SBA rulemaking monitoring. In a correcting amendments notice published on December 27, 2016, the SBA changed the profit distribution rules for joint ventures applicable to 8(a) joint ventures as well as joint ventures (JVs) under the All Small Business Mentor Protégé, Service-Disabled Veteran-Owned (SDVO), Women-Owned, and HUBZone small business programs. We discuss the 8(a) changes below, but they are generally applicable to the other programs.
Under the old rule, the 8(a) Participant(s) had to receive profits from the joint venture commensurate with the amount of work performed by the 8(a) Participant(s), or, in the case of a populated separate legal entity joint venture, commensurate with the share of ownership in the joint venture. The old rule required that the Joint Venture Agreement (JVA) state which of these methods would be used by the JV. Now, under the revised rule (which is already in effect), all profits must be distributed commensurate with the work performed by the 8(a) participant(s). This change is especially important because the SBA requires that the 8(a) participant(s) own at least 51% of the joint venture, while regulations require the 8(a) participant(s) to perform at least 40% of the work performed by the joint venture (performance of work requirement).
In the excerpt below from the Federal Register Notice, the SBA explains why it is making this change and why it is considered a “correction” instead of traditional rulemaking:
SBA’s 8(a) joint venture rule now states that the 8(a) Participant(s) in a joint venture must receive profits from the joint venture commensurate with the work performed by the 8(a) Participant(s). 13 CFR 124.513(c)(4). This change was necessary because under the mentor protégé program, a protégé may perform as little as 40% of the total work performed by the joint venture in aggregate. It would not make sense to require a firm to receive 51% of the profits for doing only 40% of the work. The same language that SBA corrected in the 8(a) regulations is currently in place for joint ventures under all small mentor protégé, Service-Disabled Veteran-Owned, Women-Owned, and HUBZone small business programs. SBA’s intent was for profits to be commensurate with the work performed by each member of the joint venture. These rules currently state that in the case of a separate legal entity, the firm must receive profits commensurate with their ownership interests in the joint venture, which is contrary to SBA’s intent. Consequently, SBA is correcting §§ 125.8(b)(2)(iv), 125.18(b)(2)(iv), 126.616(c)(4) and 127.506(c)(4) to the make the rules consistent with 124.513(c)(4) and across all programs.
81 Fed. Reg. 94941, 94941 (Dec. 27, 2016). While SBA considers this to be a “correction,” it is clearly a substantive change that joint venturers need to consider in drafting their Joint Venture Agreements.
This profit-sharing mandate may prove problematic in implementation, so we recommend that the parties layout out a process for determining the percentage of work performed by each venturer, which should already be in place to monitor compliance with the internal performance of work requirements applicable to the 8(a) joint venturer. It is important to ensure that the profits distribution also takes into account not only the work performed on the contract (as in the performance of work), but also the pre- and post- performance work (which often is not included in performance of work/subcontracting limitation calculations).
While the SBA regulations do not specifically mandate a certain distribution of losses, BHBC usually recommends, in the interest of fairness and consistency, that the venturers allocate losses and other gains, deductions, etc. in the same manner that profits must be distributed.
If you have any questions about how this regulatory change will affect your business, please contact Carissa Siebeneck or Jon DeVore at 202.659.5800.