Opinion ID: 184812
Heading Depth: 2
Heading Rank: 2

Heading: The Small Business Administration's Third Size Determination

Text: 18 DSE challenges the legality of the SBA's Third Size Determination on four separate grounds, broadly alleging that the agency failed to adhere to its own precedent in assessing the number of AMTEC employees. DSE further contends that the district court erred in finding the Third Size Determination not arbitrary and capricious. We review the disputed agency action de novo, and proceed as if the [agency's] decision had been appealed to this court directly. Dr. Pepper/Seven-Up Companies v. F.T.C., 991 F.2d 859, 862 (D.C.Cir.1993). Although the district court's decision on DSE's APA claim is not entitled to any particular deference, the agency's interpretation and application of its own regulations does merit our deference. In assessing the SBA's compliance with the prevailing APA standards, see 5 U.S.C. § 706(2)(A), our mantra is by now familiar. We ask whether the SBA's actions have been arbitrary or capricious, examining whether it has acted consistently with its previous applications of the governing regulations and whether the application of its general regulative doctrines to the specifics of this case has been reasonable. See Troy Corp. v. Browner, 120 F.3d 277, 281 (D.C.Cir.1997); Choctaw Mfg. Co. v. United States, 761 F.2d 609, 616 (11th Cir.1985) (in disappointed bidder action, legality of agency action assessed by asking whether arbitrary and capricious). Finding the SBA's Third Size Determination to constitute a reasonable application of the agency's regulations that accords with its previous decisions, we reject each of DSE's contentions in turn. 19
20 DSE first contends that the SBA Area Office's size determination was arbitrary and capricious in its refusal to give present effect to three acquisitions consummated in the two-month period following AMTEC's self-certification as small. In particular, DSE alleges that the SBA departed from both its own regulations and past precedent when it decided against including the employees of Allied Molded Products, Inc. (Allied Molded), Actown-Electrocoil, Inc. (Actown), and AEIC, Inc. (AEIC) in assessing AMTEC's size. In DSE's view, the chronology of events surrounding these transactions reveal that AMTEC had reached what the SBA terms an agreement in principle to conclude each of the relevant acquisitions as of November 12, 1997. Mindful of our duty to take into account the agency's expertise in making such assessments, we cannot agree. 21 The SBA uses the date of self-certification as the general baseline against which to measure a firm's size. See 13 C.F.R. § 121.404 (Generally, SBA determines the size status of a concern (including its affiliates) as of the date the concern submits a written self-certification that it is small to the procuring agency as part of its initial offer including price.). In addition to two enumerated exceptions to this background principle, neither of which applies here, SBA regulations also provide for giving present effect to certain transactions, treating them as if they had occurred prior to the date of selfcertification. The relevant provision appears as a part of the elaborate standards the SBA uses in determining whether or not associate entities qualify as affiliates for purposes of assessing size. 13 C.F.R. § 121.103 provides that: 22 (a) General Principles of Affiliation. (1) Concerns are affiliates of each other when one concern controls or has the power to control the other, or a third party or parties controls or has the power to control both. 23 (2) SBA considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships, in determining whether affiliation exists.... 24 (d) Affiliation arising under stock options, convertible debentures, and agreements to merge. Since stock options, convertible debentures, and agreements to merge (including agreements in principle) affect the power to control a concern, SBA treats them as though the rights granted have been exercised.... SBA gives present effect to an agreement to merge or sell stock whether such agreement is unconditional, conditional, or finalized but unexecuted. Agreements to open or continue negotiations towards the possibility of a merger or a sale of stock at some later date are not considered agreements in principle and, thus, are not given present effect. 25 In its Third Size Determination, the SBA found AMTEC to have been affiliated with a series of other companies that, like itself, were owned by North American Fund II, L.P. (Fund II), a venture capital fund. The network of interlocking companies either owned by Fund II or controlled by those who control it is elaborate and rather complex. For purposes of deciding this case, however, we need only point out that as a result of common ownership and control, the SBA deemed all companies owned or managed by Fund II and North American Fund III, L.P. (Fund III) to be affiliates of AMTEC. See Third Size Determination at 4-5. The parties do not contest this finding; instead, their controversy centers around the acquisition of Actown and AEIC by Fund III, and of Allied Molded by AMTEC. Because the question of affiliation is time- and fact-specific, we briefly discuss the chronology of events surrounding each transaction. 26 Fund III and each of Actown and AEIC executed a Letter of Intent on October 23, 1997, in which the parties set forth their intention to enter into an acquisition agreement by the end of that year. The companies had begun negotiations months earlier, after a business search firm contacted Fund III with information regarding Actown and AEIC. After Fund III signed a confidentiality agreement that granted it access to Actown's business information, the companies continued to negotiate a general structure for the deal and a proposed purchase price. The Letter of Intent reflected the agreements that had been reached by October 23rd but, as the SBA Area Office found, did not constitute a binding agreement or an agreement in principle to merge or acquire stock. Id. at 9. The SBA reached this conclusion based on the fact that one key material term, the purchase price of $20 million, is merely 'contemplated' rather than agreed to, and is contingent on a number of variables including Fund III's determination as to [Actown's and AEIC's] financial prospects, existence of dividend payments, results of environmental studies, and adverse changes in the businesses. Id. The Letter of Intent also failed to resolve the liabilities that Fund III would incur upon closing, the impact of the acquisition upon Actown's employees, the negotiation of employment agreements, the method of financing, and the amount of equity and subordinated debt that Fund III would commit. The acquisition was expressly made contingent upon reaching a mutually acceptable agreement on these terms. Finally, as the SBA emphasized, the parties could walk away from the negotiations and terminate the Letter of Intent at any point during the process of due diligence without incurring any liability. Id. Negotiations continued during November, December and January, and the transaction was not consummated until January 13, 1998. 27 Turning to the acquisition of Allied Molded, the parties began negotiations in October of 1997 and signed a Letter of Intent during the week that followed AMTEC's selfcertification. This letter did contain a proposed price, but it was contingent upon various stated assumptions that AMTEC would have to verify. In addition to due diligence and environmental impact studies, the letter also noted that a number of significant issues remained outstanding-- e.g., noncompetition agreements, representations and warranties, conditions and indemnifications--and were to be the subject of further negotiations. Finally, the letter granted AMTEC the right to walk away at any point in time without incurring liability. In its Third Size Determination, the SBA concluded that this letter is sufficiently nonbinding and tentative as to the material terms that it does not constitute an agreement to merge or acquire stock which SBA would give present effect under the regulation. Similarly, it held that the letter did not signify an agreement in principle as final agreement was contingent on the acquiring [company's] due diligence and other variables ..., and was not enforceable. Id. at 10. The parties reached final agreement in December, executing a Purchase and Sale contract on December 30, 1997. 28 With respect to each acquisition, DSE alleges that the SBA's Third Size Determination was arbitrary and capricious in its conclusion that there were neither agreements nor agreements in principle in place as of AMTEC's November 12th small self-certification. Drawing upon a series of previous SBA decisions, DSE alleges that agency practice can be distilled into a two-pronged rule: the SBA gives present effect to an acquisition agreement unless (i) a final agreement rests on conditions that are unusual, incapable of fulfillment, speculative or conjectural; or (ii) the probability that the transaction would ever be consummated is extremely low. We do not believe, however, that the SBA's cases can plausibly be read to state such a rule. DSE's attempted exegesis rests upon a selective misreading of SBA precedent. 29 Upon examination, none of the cases cited by DSE resemble the case at bar. In nearly all, the presence of a binding agreement or an agreement in principle was fully evident. The only question was whether the SBA would give present effect to that pre-existing agreement when the transaction it described would not be consummated until some point in the future. See, e.g., Size Appeal of Consol. Indus., Inc., No. 4235 (SBA OHA 1997) (giving present effect to option agreement under which large entity could purchase all of Consolidated's stock at a set price); Syro Steel, No. 3800 (SBA OHA 1993) (where Articles of Incorporation, Agreement of Merger, Agreement and Plan of Merger had all been executed, and S-4 registration statement filed with the SEC seeking regulatory approval of merger, held that binding agreement had been reached at time of self-certification); Dependable Courier Servs., No. 2110 (SBA OHA 1985) (giving present effect to a takeover when the companies had executed a Stock Purchase Agreement granting negative control over the target to the acquiring company and leaving formal completion subject only to minor contingencies); Mark Wienert, SBA No. 865 (1976) (as Board of Directors had each ratified Principles of Agreement, leaving only minor and routine conditions precedent to closing, present effect deemed appropriate). Here, by contrast, we are asked to review the propriety of the SBA's determination that no agreement in principle existed as to either acquisition by the date of self-certification. Conceptually, this question precedes any inquiry into whether such an agreement, if found, should be given present effect. 30 Given the fluidity of contemplated and evolving corporate transactions, which relegates any post hoc examination to a search for indicia of an agreement, we consider SBA expertise to be at its apex when determining whether an agreement in principle exists. We will not readily substitute our judgment for that of the agency, see Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43, 103 S.Ct. 2856, 77 L.Ed.2d 443 (1983), but will defer to its experience provided that the agency has offered a reasoned explanation for its decision, and that the result is in accord with material facts contained in the administrative record. The SBA's Third Size Determination easily satisfies this standard. With respect to the acquisitions of Allied Molded, Actown, and AEIC, the SBA explained that the companies had not reached an agreement in principle because the respective letters of intent failed to resolve important terms of conditions of the proposed transactions. Since this conclusion is consistent with SBA regulations, see 13 C.F.R. § 121.103(d) (Agreements to open or continue negotiations toward the possibility of a merger or a sale of stock at some later date are not considered 'agreements in principle' and, thus, are not given present effect.), as well as prior SBA precedent, see Size Appeal of Geosyntec Consultants, No. 4277 (SBA OHA 1997) (refusing to give present effect to binding agreement reached four days after self-certification where target company had rejected a previous comprehensive bid but parties continued negotiating toward an accord), we will not disturb it.
31 DSE's remaining challenges to the SBA's Third Size Determination are easily disposed of. First, DSE alleges that the SBA acted unlawfully in utilizing a full-time equivalency formula 3 to count the number of temporary workers used by AMTEC and its affiliates. The government conceded at oral argument that the SBA has always rejected the use of equivalency figures as inconsistent with its regulations requiring that a count include all individuals employed on a fulltime, part-time, temporary, or other basis, 13 C.F.R. § 121.106(a), and that [p]art-time and temporary employees are counted the same as full-time employees. 13 C.F.R. § 121.106(b)(2). See, e.g., Atlantic Plastic & Chemical Co., No. 1290 (SBA SAB 1979), aff'd on recons., No. 1299 (1979) (rejecting attempt to measure part-time employees by use of full-time equivalency formula) 4 ; Golden West Refining Co., No. 2132 (SBA OHA 1985) (A review of the OHA's and Size Appeals Board's [ ] decisions concerning 'number of employees' shows that: the concern cannot count employees on an equivalency basis but must count as employees all full-time, part-time and temporary employees....). It is a settled tenet of administrative law that an agency cannot depart from a long-standing policy without providing sufficient explanation of its rationale for altering course. See Simmons v. ICC, 829 F.2d 150, 156 (D.C.Cir.1987); Telecommunications Research & Action Ctr. v. FCC, 800 F.2d 1181, 1184 (D.C.Cir.1986). However, it is equally well settled that the principle of harmless error applies to judicial review of agency action. See 5 U.S.C. § 706 (In making the foregoing determinations [of whether agency action is arbitrary and capricious] ... due account shall be taken of the rule of prejudicial error.); Doolin Sec. Sav. Bank, FSB v. Office of Thrift Supervision, 139 F.3d 203, 212 (D.C.Cir.1998). 32 Under the APA, we will not set aside agency action unless the party asserting error [can] demonstrate prejudice from the error, Air Canada v. Department of Transp., 148 F.3d 1142, 1156 (D.C.Cir.1998), a burden that DSE has conspicuously failed to meet. In the Third Size Determination, the SBA determined that AMTEC and its affiliates had a total of 1413.19 employees for the twelve months preceding AMTEC's self-certification as small. See Third Size Determination at 12. Of these, only 44.54 were classified as temporary employees. See id. In the evidentiary hearings before the district court, AMTEC introduced additional testimony from its Deloitte & Touche accountant that counted temporary employees based on the actual number of individuals used--the same head count method used to measure the number of full-time and part-time employees. According to the accountant's testimony, AMTEC and its affiliates had 1428.30 employees during the relevant time period. See 6/15/98 Tr. at 10-13; DSE II at 26. In other words, an actual head count assigned fifteen additional employees to AMTEC, but left it well short of the 1500 allowed for this procurement under SIC Code 3483. Although this information was never presented to the SBA, DSE did have the opportunity to cross-examine AMTEC's witness, and to introduce any evidence to the contrary. DSE failed to provide us with any reason to believe that it could ever show this revised count to be erroneous. Accordingly, we find the agency's error to have been harmless. 5 Cf. State of North Carolina v. FERC, 112 F.3d 1175, 1191 (D.C.Cir.1997) (although FERC utilized erroneous data, error was harmless as petitioner could not show that revised data would alter the Commission's projection). 33 DSE next contends that the SBA was arbitrary and capricious in its failure to investigate whether the general partners of North American Company, Ltd.--a limited partnership--had other commercial interests that should have been considered affiliates of AMTEC. The record belies this assertion. As required by its regulations, see 13 C.F.R. § 121.103(a)(1), (4), the SBA examined all of the holdings of North American Company's managing general partner, the individual who controlled its activities. See Third Size Determination at 4-8. Quantrad Sensor, Inc., SBA No. 4255 (SBA OHA 1997), cited by DSE for the proposition that the SBA should have gone on to examine the holdings of the other partners as well, does not provide to the contrary. In Quantrad, the OHA held that the SBA could request information from a general partnership's general partners, not that it was under an obligation to do so. In fact, in Size Appeal of Interactive Resources, Inc., No. 3168 (SBA OHA 1989), relied upon by the Area Office in Quantrad, the OHA explicitly held that: 34 In a limited partnership, each partner's liability is limited, except that of the General Partner. A General Partner in a limited partnership has all the rights and powers of a General Partner in a General Partnership. Thus, a General Partner in a limited partnership is also presumptively in control of the limited partnership for purposes of the affiliation regulation. 35 (Emphasis added). Having examined the holdings of North American Company's general partner, the SBA was under no obligation to make any further inquiries. 36 Finally, DSE alleges that the SBA should have determined whether a joint venture between North American Company and another business, Allied Capital Commercial Corporation, received financial assistance from the SBA. We disagree. While 13 C.F.R. § 121.103(f)(1) provides that [p]arties to a joint venture are affiliates if any one of them seeks SBA financial assistance for use in connection with the joint venture, there was no evidence that any SBA funds had been used in connection with the North American-Allied Capital project. In testimony before the district court, which occurred prior to the Third Size Determination and at which the SBA was represented, the controlling partner of North American Company testified that the joint venture in question had no relationship whatsoever with the SBA. Given the SBA's general reliance upon the parties' voluntary disclosure of relevant information, see 13 C.F.R. § 121.405(a)-(b), policed by severe criminal penalties for knowingly misrepresenting the small business size status of a concern ... [or] for knowingly making false statements or misrepresentations to SBA, 13 C.F.R. § 121.108, we do not see how it had any obligation to investigate further. 37 Accordingly, we conclude that the SBA's Third Size Determination was not arbitrary and capricious. We also affirm the district court's interlocutory order dissolving the preliminary injunction against performance on AMTEC's contract with the Army. 6 See DSE II at 27. As our discussion well illustrates, the court properly concluded that DSE had little to no likelihood of prevailing on the merits of its claim. 38