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As a best practice, prime contractors should require a written, affirmative representation of a subcontractor’s small business size status.

SBA Presumed Loss Rule Creates Penalties for Misrepresenting Company Size to Win Contracts

  • 12/13/2013

SBA Presumed Loss Rule Creates Penalties for Misrepresenting Company Size to Win Contracts

The Small Business Administration’s (SBA) final rule implementing the statutory requirements of the Small Business Jobs Act of 2010 became effective on August 27, 2013. The rule establishes the method for calculating damages to the government when a contractor willfully misrepresents its size or status in order to win a contract. The rule, and its use in conjunction with the False Claims Act (FCA), creates the potential for significant penalties.

Certain acts are deemed willful misrepresentations under the rule, including the submission of a bid or proposal on any procurement set aside for small business, or registration on any federal electronic database such as the System for Award Management (SAM) for purposes of being considered for an award as a small business concern.

In addition to forfeiture of all contract payments, violations of the rule can subject contractors or subcontractors to severe penalties including suspension and debarment, civil penalties under the FCA, and/or criminal penalties under the Small Business Act.

Unlike the FCA, which generally considers damages to be the difference between the amount paid by the government and the value received by the government, the new rule assesses damages for willful small business misrepresentations as if the firm in question provided no value whatsoever to the government.

Willful misrepresentation

The rule emphasizes that the question of whether a contractor willfully misrepresented its size or status is a factual determination to be decided by a judge or jury on a case-by-case basis. The SBA identified some circumstances where a contractor might be able to rebut a presumption of willful misrepresentation.

One such example is an unsophisticated firm that, in good faith, misinterprets the SBA’s rules and regulations. Such a firm may be deemed to have not willfully misrepresented its size or status. Likewise, a prudent firm that acts quickly to correct an erroneous representation may be able to defeat or limit liability. Conversely, more sophisticated contractors will most likely not be able to avoid the new liability based on good faith misinterpretation.

Affiliation rules and subcontractors

The regulation requires contractors to have a strong grasp of the SBA’s affiliation rules. Simply checking a firm’s tax returns before making a size representation may not suffice to rebut the presumption of loss. Contractors and potential contractors should make sure they understand the affiliation ramifications of recent corporate actions — changes in ownership, management, mergers, acquisitions, and spin-offs — before making a size or status representation.

Prime contractors will need to consider the rule’s applicability to the size and status representations of their subcontractors, since the rule states that the presumption of loss applies to subcontractors who willfully misrepresent their size or status to receive a subcontract award.

Reading the rule in conjunction with federal acquisition regulation 48 C.F.R. § 19.703(b), which provides that a prime contractor acting in good faith may rely on a subcontractor’s written representation regarding its small business size status, prime contractors should not be held liable for subcontractor size misrepresentations if they rely in good faith on a written representation from their subcontractor.

Both small and large contractors should evaluate their contracting processes to ensure their compliance with the rule as the consequences of noncompliance could be severe. As a best practice, prime contractors should require affirmative representation of small business size status in their subcontracts and document their ongoing review of the subcontractor’s representations in SAM, since the rule requires that entities must recertify their size status annually to continue to be listed as small or disadvantaged in SAM.