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A few years back, Congress changed how the Small Business Administration would calculate whether a business qualified as small. It had been the average of three years of revenue. The new rule was five years. The question arose: When did the new calculus kick in? This had real consequences for a company called Obsidian. To get the details, the Federal Drive with Tom Temin talked with Smith Pachter McWhorter procurement attorney Zach Prince.

Interview transcript:

Tom Temin
Zach, tell us about this case.

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Zach Prince
Alright, thanks for having me. Tom. Good morning. This case, Obsidian Solutions Group LLC, concerned a small business Obsidian — or at least at one point a small business — that in 2019 bid for a Department of Energy contract that was set aside for small businesses. The size standard was $20.5 million in average annual receipts. Obsidian self certified as small at the time, based on its five year average, for which it was below the threshold. Department of Energy notified Obsidian it was the apparently successful offeror. But DoE had requested confirmation from the Small Business Administration about Obsidian’s size status before awarding the contract. So in 2020, the SBA determined that Obsidian wasn’t small. And that’s because the SBA use a three year average instead of a five year average, to measure Obsidian’s receipts. And based on that determination, DoE did not award to obsidian.

Tom Temin
Well, let me ask you this, though: When did the rule come into effect that switched it from the three year average to the five year average, after Congress ordered this to happen?

Zach Prince
So that’s the core of the dispute. And really why this case was so interesting to me, because we’ve been following this in the government contracts bar very closely since late 2018. Congress passed at the end of 2018, a law called the Runway Extension, the point of this law was to increase the period by which a small business calculates its qualifications as small from three years to five years, to allow businesses that would have graduated out of small business programs to remain in for a longer period. But Congress only amended part of the Small Business Act, they amended Part C, the Small Business Act, rather than Part A. The Small Business Administration, when they put out a rule in 2019, addressing this change in law, said about 50 times that in their view, they’re only bound by Part A of that rule, not by Part C. And so even though they said over and over, we are not required to do it, they said we’re still going to change from three to five years. But we’re going to do it slowly over time. We’re not going to do it retroactively to when the law changed.

Tom Temin
Sure. And just briefly tell us what is in part A, essentially, and what was in part C, the part that actually did get changed legally.

Zach Prince
So part A is assigning certain authorities to the Small Business Administration to establish size standards. Part C is broader. It says, unless specifically authorized by statute, no federal department or agency may prescribe size standards for categorizing small businesses unless they hit the following criteria. So I think most people looked at this statute and said, Okay, Part A is specific to the Small Business Administration. Part C is applicable to everyone, because it talks about no federal department or agency, it doesn’t say, except the Small Business Administration. And that’s how most lawyers that I’ve spoken with had interpreted this. When it came out was Part C was clearly the congressional intent to broadly apply this to every agency. Part A is a special subset of rules for the Small Business Administration.

Tom Temin
Right. So it sounds to me like the Small Business Administration was what they say slow walking this because they just didn’t feel like hurrying up with it.

Zach Prince
Well, that’s what a lot of us thought. The Small Business Administration has been very slow in implementing congressional directives and the National Defense Authorization Acts over the years, and they were slow with this one, too. And I sort of looked at the analysis of the agency and their rulemaking on this issue as pretty fundamentally weak, but I guess shows me because OHHA, the Court of Federal Claims and now the Federal Circuit all agree with the SBA.

Tom Temin
Right. Zach Prince is a procurement attorney with Smith, Pachter McWhorter. So they ruled out that smallness size and therefore Energy canceled the contract with Obsidian. So Obsidian took them to court.

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Zach Prince
That’s right. They first challenged it in the Small Business Administration’s office of Hearing and Appeals or SBA’s OHHA, where they lost. They went to the Court of Federal Claims, arguing again that the SBA misinterpreted the statute, and they lost. And then they went to the circuit, which again, found in favor of the Small Business Administration.

Tom Temin
Right. And SBA never went to Congress and said, “you really need to add this amendment or this change to Part A of the Small Business Act.” Often in other areas, other domains of law, if Congress misses something, they go ahead and do remedial legislation to fix the main legislation. That’s is not unheard of. But it sounds like SBA didn’t really give a hoot on this and just kept with the old rule for a while.

Zach Prince
Well, Congress realized the issue after the fact. And there was an attempted piece of legislation in 2021 that didn’t go anywhere. And then finally, at the very beginning of 2022, Congress acted to explicitly amend Section A to applied Section C requirements to the Small Business Administration; that is, make it a full five years for every agency that puts out size standards. But the problem is Congress didn’t apply it retroactively. In fact, that rule in 2022 only applies starting 2023. So it really didn’t fix the problem.

Tom Temin
At least in Obsidian’s case, if it happened before. By the way, is there formal rulemaking? Or has there been rulemaking that has gone into effect, now making it five years across the board for everybody?

Zach Prince
There has. So that happens in effect as of January 6, 2020. So really, it’s just a year that’s lost for a bunch of companies that would have preferred to have a five year period. But that can be pretty significant for your business, if you lost out on set aside work during that period.

Tom Temin
Okay, so were there any more protests in that period? Or was this the kind of signature case for this?

Zach Prince
This has been the signature case. I’ve heard of other companies that had wanted to protest. There may have been one or two that didn’t go to final decision. But this is the landmark case that we’re going to be pointing to. It might not matter for very many companies at this point. But it does illustrate the Congress, when they’re changing a law that directly impacts a regulatory agency, really ought to be talking to that regulatory agency before they put out the law.

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Tom Temin
Yes, because the usual complaint is that agencies are too vigorous in the application of a law. And as we’ve seen, in the case of EPA, they get trimmed back from what they do in a regulatory sense. In this case, the agency did not move ahead with a new regulation. That seems unusual.

Zach Prince
It is. But to be fair to the agency here, the SBA has taken this position that Section A applies to the SBA, Section C doesn’t, for a very long time. And that was the point the Federal Circuit emphasized whether that’s legally relevant or not, is a different question. But if Congress had just talked to the SBA, they would have known about this very quickly, and they could have fixed this problem at the front end.

Tom Temin
Well, it’s fixed now, I guess, going forward, but in the meantime, ask the agency first, I guess, before you ask Congress.

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