Joanna T. Lau and Lau Acquisition Corporation, No. MSB-407 (July 20, 1992)
Docket No. MSBE-91-8-12-18


                    UNITED STATES OF AMERICA
                  SMALL BUSINESS ADMINISTRATION
                 OFFICE OF HEARINGS AND APPEALS
                     WASHINGTON, D.C. 20416

IN THE MATTER OF:             )
                              )
Joanna T. Lau and             )    Docket No. MSBE-91-8-12-18
Lau Acquisition Corporation   )
d/b/a Lau Technologies        )

                           APPEARANCES

For the Petitioner:                For the Agency:

Jay P. Urwitz, Esq.                Michael K. Wyatt, Esq.
Hale and Dorr, Attorneys           General Counsel
1455 Pennsylvania Avenue, N.W.     Gail D. Reinhart, Esq.
Washington, DC 20004               Agency Representative
                                   Small Business Administration
Charles J. Johnson, Esq.           409 Third Street, S.W.
Finnegan and Stanzler, P.C.        Washington, DC 20416
20 Beacon Street
Boston, MA 02108

                             DIGEST

The regulations published at 54 Federal Register 34692, et seq.,
on August 21, 1989 and codified at 13 CFR Part 124 must be used
to evaluate all applications for participation in the Agency's
8(a) program pending as of August 21, 1989 or filed thereafter.
13 CFR 124.1(a)(2)(i).

An applicant for participation in the Agency's 8(a) program has
the burden of proving, by a preponderance of the evidence, all
elements of its eligibility; however, entitlement to a socially
disadvantaged status being sought by an individual who is not a
member of a designated group must be proved by clear and
convincing evidence.

Ordinarily, in order to be eligible to participate in the
Agency's 8(a) program, an applicant concern must be one which is
at least 51 percent unconditionally owned by an individual who is
determined by SBA to be socially and economically disadvantaged,
and the socially and economically disadvantaged individual upon
whom eligibility is based must control the board of directors and
the day-to-day operations of the applicant firm. 13 CFR 124.103;
13 CFR 124.104(b).

Economically disadvantaged individuals are socially disadvantaged
individuals whose ability to compete in the free enterprise
system has been impaired due to diminished capital and credit
opportunities, as compared to others in the same or a similar
line of business who are not socially disadvantaged; and economic
disadvantage, or the lack thereof, can be determined only if the
applicant concern's business and financial profile is compared
with the profiles of businesses that are not owned and controlled
by socially disadvantaged individuals.

While the Agency's 8(a) program is not intended to assist con-
cerns owned and controlled by socially disadvantaged individuals
who have accumulated substantial wealth, who have unlimited
growth potential or who have not experienced, or have experienced
but overcome, impediments to obtaining access to financing,
markets and resources, the accumulation of "substantial wealth"
and "unlimited growth potential" are relative terms, and compari-
son of the "wealth" and "potential" of the individual being
considered with that of individuals who are not socially disad-
vantaged is a prerequisite if adverse determinations are to be 
based on conclusions resulting from those findings.

When an applicant concern claiming economic disadvantage has
adduced substantial evidence to meet its burden of proof, it is
unreasonable for the AA/MSB&COD to reach a negative conclusion
regarding that firm's economic disadvantage without making a
comparison of the firm's access to credit and capital oppor-
tunities with the access of other firms in the same or a similar
line of business that are not socially disadvantaged.

An Agency determination that an applicant is not economically
disadvantaged will be found to be contrary to law if the claim
was evaluated under a standard other than the one clearly
mandated by the regulations; when the regulations explicitly set
out a standard of evaluation, the Agency's adoption of a
different standard found nowhere in the regulations will be
judged to be an arbitrary and capricious act.

                         FINAL DECISION

                          July 20, 1992

Jurisdiction

Authority for these proceedings is found in Section 409 of the
Business Opportunity Development Reform Act of 1988, Public Law
100-656 (Section 7(j) of the Small Business Act of 1958, as
amended; 15 U.S.C. 636(j)), hereinafter referred to as "the Act,"
and in the regulations codified at 13 CFR Parts 124 and 134,
which are referred to hereinafter by section numbers only.

Issues

In evaluating the Petitioner's claim of economic disadvantage,
did the Associate Administrator follow the regulations set forth
in 124.106; and, if not, was the Associate Administrator's
failure to follow the regulations arbitrary and capricious or
contrary to law?

Facts

The Petitioner applied for admission to the Agency's Section 8(a)
program on July 24, 1990, subsequently supplying information to
substantiate its eligibility, and, on February 12, 1991, the
Associate Administrator 1/ issued his determination of the
Petitioner's eligibility, in pertinent part, as follows:

     1) It has been determined that you [Joanna T. Lau], the
     individual upon whom eligibility is based, have not
     been found to be socially and economically
     disadvantaged.

The Associate Administrator cited four additional factors leading
to a determination of ineligibility and invited the Petitioner to
submit evidence to refute the findings.

On March 18, 1991, the Petitioner submitted additional evidence
as suggested and sought a reconsideration of the denial of
eligibility in a nine-page letter with 51 pages of exhibits.
After consideration of the additional evidence, the AA/MSB&COD
again denied the application in a letter addressed to Joanna T.
Lau, dated June 28, 1991, which reads, in pertinent part, as
follows:

     After a careful review of the material that you sub-
     mitted with your request for reconsideration, it has
     been determined that you have not provided sufficient
     documentation to overcome four of the five original
     reasons for decline. The following conditions have not
     been met:

     1) You have not presented sufficient new evidence to
     allow us to conclude that you are economically
     disadvantaged. While you have referenced several
     instances of discrimination and diminished access to
     credit and capital, the fact remains that you were able
     to secure financing through Shamut [sic] Bank for the
     acquisition of the firm, and you have access to a sub-
     stantial working capital line of credit.

The Agency conceded that the three remaining issues were
secondary to the major issue of the applicant's economic
disadvantage. 2/

The Petition for my review was timely filed by the Petitioner's
Counsel on August 12, 1991.

Counsel for the Petitioner argues initially that the determin-
ation regarding Lau's economically disadvantaged status is
arbitrary, capricious and contrary to the law and regulations
because the AA/MSB&COD "ignores the standard by which economic
disadvantage is to be gauged, [i.e., the requirement in the
regulations] that capital and credit opportunities be assessed in
comparison 'to others in the same or similar line of business who
are not socially disadvantaged.'" Counsel points out that
"[t]here is absolutely no evidence of such findings" in the
record and argues further:

     If [the Associate Administrator] had done such an
     analysis it would have been clear that the credit and
     capital opportunities available to the Petitioner are:
     1) substantially diminished when compared to the huge
     companies which are her [sic] competitors, and 2) they
     are, at the least, "likely" to preclude her [sic] from
     competing in the open market. Indeed, lack of capital
     is precluding such competition already.

With reference to the stated bases for the determination that
economically disadvantaged status is lacking, Counsel for the
Petitioner argues that the AA/MSB&COD's conclusion that the
Petitioner was able to secure limited financing and is thus not
economically disadvantaged is not an adequate basis. "Indeed,"
Counsel asserts, "access to limited financing is necessary to
prove that a concern has a potential for success." 3/ Further,
Counsel argues, the record includes no evidence of "the level of
credit, amount of resources, or number of contracts possessed by
the Petitioner's competitors," and, therefore, the Associate
Administrator "has not 'clearly enunciated [his] reasoning and
[the] bases for that reasoning"' as required by prior decisions
of this Office.

In the Agency Response, Counsel addresses only two of the "four
reasons for the decline" and "agree[s] with Petitioner that the
major issue in its appeal is whether Ms. Lau is economically
disadvantaged, since three of the four reasons for decline are
dependent on the finding that she is not." Counsel contends that
the Agency's finding of a lack of economically disadvantaged
status is "supported by the record" and the regulations, refer-
ring to the regulation at 124.106(a)(ii), "which provide[s] that
the 8(a) program 'is not intended to assist concerns owned and
controlled by socially disadvantaged individuals...who have
overcome impediments to obtaining access to financing, markets
and resources."'

Counsel cites Lau's ability to obtain financing to purchase the
Petitioner, the firm's line of credit for working capital, its
backlog of orders, and its "attendant relationships with Federal
procuring agencies and prime contractors." Further, she points
out that the "Petitioner's total sales for the first 10 months of
1990 were virtually identical to [its predecessor's] total sales
during 1988 and 1989" and avers that "this fact supports the
conclusion that [the] Petitioner has not been hurt by the change
from socially nondisadvantaged to socially disadvantaged
ownership."

The Agency's Counsel derides the argument of the Petitioner's
Counsel "that the AA/MSB&COD's [determination] is arbitrary and
capricious because it did not make a numerical comparison between
the amount of credit and capital available to [the] Petitioner
and that available to certain 'huge companies'...it competes
with" and avers that this argument "totally ignores half of the
definition contained in [the] regulatory provision [found at
124.106(a)(i), which] requires that an individual show not only
that her opportunities to obtain capital and credit have been
diminished, but also that 'such diminished opportunities have
precluded or [are] likely to preclude such individual from
competing in the open market."' (Emphasis in original.) She
argues that Ms. Lau and Bowmar/Ali, her predecessor in the
business, have competed successfully in the open market since
1952, and that there is no evidence that the degree of the
Petitioner's success is likely to diminish.

Because the record did not provide enough information to enable
me to determine what factors the Associate Administrator had
considered in arriving at a determination that the Petitioner was
not economically disadvantaged, I remanded the case for further
elucidation of the issue with attention to the comparison of the
Petitioner's financial condition required by the regulation at
124.106.

The Agency's "Decision on Remand," filed on March 13, 1992,
recites the results of a comparison performed by the Associate
Administrator's staff of the Petitioner's financial condition
with that of other companies within SIC code 3812 and of a size
similar to Petitioner's.

Discussion

As with all controversies arising out of disputes between the
Agency and applicants for admission to the 8(a) Program, the
question of whether this applicant is economically disadvantaged
must be decided above all with reference to the applicable
statutes and regulations. Of course, the ultimate application of
the law must be informed by due regard for inferences that
reasonably flow from the language of the law.

In evaluating the Applicant's claim of social and economic
disadvantage, the Associate Administrator has strayed from the
clear, denotative meaning of the regulations. Further, the
Associate Administrator followed directives she apparently found
implied in the regulations, directives that simply are not there.
Because of the former error, the Associate Administrator's
finding that Lau is not economically disadvantaged is contrary to
law. Because of the latter error, that finding is arbitrary and
capricious.

"The 8(a) Program is intended...to help small businesses owned
and controlled by socially and economically disadvantaged
individual[s]." Section 124.1(a)(1).

The regulation found at 124.106(a)(2) requires the Agency to
determine whether an individual is economically disadvantaged by
evaluating three factors, two of which are at issue here:

     [1] [t]he financial condition of the applicant concern;

     [2] and the applicant concern's access to credit,
     capital and markets.

An applicant concern's financial condition is to be evaluated by
comparing it to that of other concerns "in the same or similar
line of business which are not owned and controlled by socially
and economically disadvantaged individuals." Section
124.106(2)(i)(C)(5)(ii). In evaluating an applicant concern's
access to credit and capital, the Agency must consider a number
of factors, including, but not limited to: "Access to long-term
financing; access to working capital financing; equipment trade
credit; access to raw materials and/or supplier trade credit; and
bonding capability." Section 124.106(2)(i)(C)(5)(iii)

The regulation found at 124.106(a) defines economically
disadvantaged individuals as those:
     
     [w]hose ability to compete in the free enterprise sys-
     tem has been impaired due to diminished capital and
     credit opportunities as compared to others in the same
     or similar line of business who are not socially dis-
     advantaged.... In determining economic disadvantage
     ...SBA shall compare the applicant concern's business
     and financial profile with profiles of businesses in
     the same or similar line of business.... [Emphasis
     added.]

The regulations leave no room for doubt as to the appropriate
pool of firms to which the applicant concern must be compared.
The phrase "same or similar line of business" is defined in the
regulation found at 124.100:
     
     Same or similar line of business means all business
     activities within the same two-digit "Major Group" of
     the Standard Industrial Classification (SIC) System
     (set forth in the SIC Manual), as the primary industry
     classification of the applicant concern.

The Petitioner proposed that the Agency compare it to its actual
competitors and provided the Agency with a list of those com-
petitors. The Agency rejected this approach, substituting as the
comparison pool firms that fall within SIC code 3812 and are
similar in size to the Petitioner. 4/ The regulations concerning
a determination of economic disadvantage make no reference to
size, only to the line of business. The definition of "same or
similar line of business" does not include a size limitation. The
group of businesses to be included in the pool is to be derived
from the SIC Manual. 5/ The SIC Manual does not attach a size
standard to the SIC codes.

The Associate Administrator argues that the pool of companies
selected for the comparison is an appropriate pool because it was
assembled based on size and SIC code. This may be intuitively
satisfying. From a business point of view, it may even be more
apt than the pool mandated by the regulations. But therein lies
the fatal flaw in the Associate Administrator's analysis. The
comparison she performed falls hopelessly short of the mark
because it bears no resemblance to the comparison that the
regulations explicitly state should be made and which I directed
the Agency to make, namely, a comparison of the Petitioner's
financial condition to that of other firms in the same or similar
line of business. Despite the explicit directive contained in the
regulations, the Associate Administrator compared the
Petitioner's financial condition (as measured by several standard
indicators) to that of firms within SIC code 3812 whose sizes
were similar to the Petitioner's. 6/

I need not be convinced that the Associate Administrator's fail-
ure to use the correct pool of companies, viz., all of Major
Group 38, did in fact cause an outcome different from that which
would have resulted had the correct pool been used. Rather, it is
sufficient that I be convinced that a different outcome might
have resulted. In the face of the Agency's manifest failure to
adhere to the regulations, I am compelled to find that the Agency
acted contrary to law.

In light of the explicit directive of the regulations, the
Agency's use of an analysis different from that mandated by the
regulations is arbitrary and capricious. It is beyond
peradventure that an agency is bound to follow its own
regulations. 7/

Conclusion

Because the Associate Administrator, failing to comply with my
remand order and disregarding the clear mandate of the regula-
tions, compared the applicant firm to a pool of businesses other
than, and not at all equivalent to, the pool clearly mandated by
the regulations found at 124.106(a) and 124.100, her deter
mination that the Petitioner is not economically disadvantaged is
ARBITRARY, CAPRICIOUS, AND CONTRARY TO LAW.

This constitutes the final decision of the Small Business Admin-
istration, and it is binding upon the Petitioner, the Agency and
those within the employ of the Agency. See 124.210(i).

                              _____________________________
                              Benjamin G Usher
                              Administrative Law Judge

__________________________

1/ The Agency's Associate Administrator for Minority Small
Business and Capital Ownership Development may be referred to
herein as the Associate Administrator or the AA/MSB&COD, and
either term will denote the Acting Associate Administrator, if
applicable.

2/ In the Agency Response to the Petition, filed on September 27,
1991, Counsel for the Agency "confesses error" with respect to
that part of the denial based upon Lau's inability to establish a
quorum of the firm's board of directors inasmuch as "that reason
is based on Petitioner's old (August 8, 1990) quorum rule, rather
than on the revised rule adopted on March 1, 1991 and submitted
to the Agency as part of the reconsideration request...."

3/ Counsel cites Neuma Corp. v. Abdnor, 713 F. Supp. 1 (D.D.C.
1989) to support that proposition.

4/ In the AGENCY'S DECISION ON REMAND, in a section entitled "LAU
TECHNOLOGIES, BUSINESS FINANCIAL CONDITION," the Agency lists as
an "Assumption:"

     1. Financial analysis for May 27, 1990 was compared to SIC
     code 3812 (Search, Detection, Navigation, Guidance, Aero-
     nautical, and Nautical Systems, Instruments, and Equipment)
     Attached [sic].

5/ The Standard Industrial Classification Manual, 1987 Edition;
Executive Office of the President, Office of Management and
Budget.

6/ Major Group 38 is considerably different inasmuch as it
encompasses 16 businesses in addition to those listed under SIC
code 3812. Businesses categorized under Major Group 38
manufacture diverse goods from watches to prosthetic devices to
photographic equipment.

7/ In enunciating this long-settled principle, the Supreme Court
wrote:

     [r]egulations validly prescribed by a government
     administrator are binding upon him as well as the
     citizen.... Service v. Dulles, 354 U.S. 363, 372, 77 S.Ct.
     1152, 1160, 1 L.Ed.2d 1403, 1410 (1957).