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12 min read

ALOG Corp's SDVO SBC Status Compromised by Stock Purchase Agreement

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The eligibility of ALOG Corporation as a Service-Disabled Veteran-Owned Small Business Concern (SDVO SBC) was challenged in an appeal that centered around a stock purchase agreement that brought the veteran ownership of the company under question. Operations Services, Inc. raised concerns and filed a protest against ALOG Corporation's status as an SDVO SBC.

The backdrop of this case involves the U.S. Air Force releasing a Request for Proposals for Expeditionary/Contingency Medical Material Services, specifically reserving it for SDVO SBCs. Both ALOG Corporation and Operations Services, Inc. submitted their offers for this contract.

Operations Services, Inc. contested ALOG Corporation's eligibility, asserting that they were not controlled by a service-disabled veteran. Subsequently, the protest was forwarded to the Director of Government Contracting for a thorough review.

Investigation by the Director of Government Contracting

On May 18, 2020, the Director of Government Contracting (D/GC) notified ALOG of the protest and requested a response to the allegations along with supporting documents. ALOG responded on June 1, 2020, asserting that it is more than 51% owned by Paul Smith and Stephen Smith, two service-disabled veterans. To support their claim, ALOG provided documents including stock certificates, percentage of voting stock held by service-disabled veterans, Buy-Sell Agreements, Shareholder Agreements, tax returns, and Articles of Incorporation, among others, which showed the distribution of ownership between Paul Smith and Stephen Smith. Together, they owned the majority of ALOG.

ALOG's Stock Purchase Agreement

As part of the appeal process, ALOG presented a Stock Purchase Agreement involving Paul Smith as the seller and Stephen Smith and two other non-service-disabled veterans as the purchasers. The Agreement stated that Paul Smith was the sole shareholder of ALOG, owning an undisclosed number of shares of common stock. The purchasers agreed to acquire a majority of Paul Smith's shares, with Stephen Smith agreeing to purchase a specific number of shares for a designated amount, and the other purchasers acquiring their respective shares at their agreed prices. (The exact numbers were redacted in publicly available court documents.)

The Agreement also outlined restrictions on the sale, transfer, gifting, or encumbrance of the stock, unless otherwise provided in the Agreement. Any recipients of the stock, whether through court orders, divorce settlements, or inheritance, would also be subject to these restrictions.

Specifically, the Agreement described a section titled "Voluntary Sale," which stated that shareholders must first offer their shares (referred to as "Offered Shares") to the Corporation before making them available to third parties. The Corporation had the option to purchase all or a portion of the Offered Shares within a 60-day period. If the Corporation chose not to purchase the Offered Shares within the specified timeframe, the Selling Shareholder was free to transfer them to a third party after a 90-day waiting period. However, any third party acquiring the shares had to comply with the conditions set forth in Sections 14 and 15 of the Agreement. After the 90-day period, the Selling Shareholder would once again be bound by the restrictions outlined in the Agreement.

In addition, Section 6 of the Agreement required mandatory redemption of shares held by Paul Smith and another shareholder whose name has been withheld. It stipulated that these shareholders would sell their shares back to the Corporation, with the agreement becoming effective as of December 31, 2021. The purchase price would be determined according to Section 8 of the Agreement.

Furthermore, Section 14 of the Agreement, titled "Transfer Only to Employees," stated that except for transfers made under Section 4.2, which dealt with sales upon the Shareholder's death, a Shareholder could not transfer any of the shares to a person who is not an employee of the Corporation.

Director of Government Contracting's Determination

In a determination letter dated June 11, 2010, the Director of Government Contracting addressed ALOG's eligibility as a Service-Disabled Veteran-Owned Small Business Concern (SDVO SBC). The Director confirmed that both Paul Smith and Stephen Smith are Service-Disabled Veterans (SDV). During the ownership analysis, the percentage of their ownership in ALOG was determined; however, the exact percentages were redacted in the public record.

ALOG Corporations's Stock Transfer Agreement raised concerns regarding Paul Smith's ownership, as it included provisions that violated the regulations outlined in 13 C.F.R. § 125.11. Section 6 of the agreement obligated the mandatory redemption of shares if either shareholder continued holding them beyond December 31, 2021.

Additionally, the Director's review found that Paul Smith's transfer rights were restricted by Section 14 of the agreement, which prohibited the sale of shares to nonemployees of ALOG. These conditions introduced a forced sale arrangement that violated SBA regulations on unconditional ownership. As an SDV, Paul Smith was required to sell his shares in ALOG by December 31, 2021, but only to ALOG employees. This arrangement provided a benefit to the non-SDV seller and purchaser, further contravening SBA regulations.

The Director determined that Paul Smith's ownership did not meet the requirement of being unconditional. In addition, the Director concluded that Stephen Smith did not possess a sufficient ownership interest to fulfill the "at least 51%" requirement outlined in 13 C.F.R. § 125.12.

The Director found that ALOG met the control requirement stipulated by 13 C.F.R. § 125.13. Paul Smith, serving as CEO/Chairman, oversaw the day-to-day operations involving key employees and government contract bids, while Stephen Smith was responsible for the day-to-day business operations. 

Nevertheless, despite meeting the control requirement, the Director ultimately determined that ALOG does not qualify as an eligible SDVO SBC due to the lack of ownership and control by one or more service-disabled veterans.

Appeal

ALOG appealed to the SBA Office of Hearings and Appeals (OHA) on June 22, 2020, asserting that the D/GC made an error in determining Paul Smith's ownership to be conditional. 

Forced Sale Arrangement or Valid Change in Ownership?

According to ALOG, the Stock Transfer Agreement established a succession plan where ownership would transition from Paul Smith to Stephen Smith. ALOG argued that this arrangement falls under the "change in ownership" provision allowed by 13 C.F.R. § 125.12(f). The business succession plan was initiated by Paul Smith in November 2017 and was set to be completed on December 31, 2021, when he would surrender all his stock. ALOG disagreed with the D/GC's characterization of the Stock Transfer Agreement as a "forced sale arrangement" and contended that it should be recognized as a valid "change in ownership" provision.

To support their argument, ALOG cited precedent from the Court of Federal Claims and the U.S. Supreme Court, specifically referencing Flora v. United States, 357 U.S. 63, 65 (1958). They emphasized the importance of giving effect to the intent of Congress in matters of statutory construction, asserting that Congress intends to aid and protect the interests of small-business concerns. ALOG criticized OHA's strict definition of unconditional ownership established in the Wexford case (In the Matter of Wexford Group Int'l, SBA No. SDV-105, 2006), arguing that it has had negative consequences which they urged the OHA to rectify. 

ALOG argued that the general rule of unconditional ownership in 13 CFR § 125.12 should be interpreted in the context of aiding and protecting small-business concerns. They maintained that the "change of ownership" provision in 13 CFR § 125.12(f) is a legitimate purpose and that enforcing the unconditional ownership rule frustrates their intention to facilitate the transfer of ownership to service-disabled veterans, contradicting the intent of Congress.

Essentially, ALOG argued that the language in the Stock Transfer Agreement should be recognized as a change of ownership provision, and that the specific provision in 13 C.F.R. § 125.12(f) should prevail over the general provision. They argued that the D/GC's decision constituted a clear error of law, as it interprets 13 C.F.R. § 125.12 as an absolute prohibition against counting conditionally owned stock, disregarding the exception for change of ownership agreements in 13 C.F.R. § 125.12(f).

Absurd Consequences Rule

ALOG further contended that SBA's position violates the absurd consequences rule, citing United States v. John C. Grimberg Co., Inc., 702 F.2d 1362, 1390 (1983). They argue that the technical interpretation of unconditional ownership resulted in an absurd consequence "where a Vietnam veteran who has been mentoring a Global War on Terror veteran is stymied in transitioning ownership to the younger veteran by a hyper-technical interpretation of unconditional ownership.”

Operation Services, Inc., Responds

On July 1, 2020, Operation Services, Inc. (OSI) responded to the appeal.

Interpreting “Unconditional Ownership” and “Change of Ownership”

In their response, OSI asserted that ALOG did not meet the ownership requirement under the regulations because a service-disabled veteran did not unconditionally and directly own the company. ALOG countered that there is an exception to the unconditional ownership requirement, as stated in the regulations. However, OSI disputed this argument by pointing out the definition of "unconditional ownership" and stating that there is no reasonable interpretation of the regulations that supports ALOG's position.

OSI cited decisions from the U.S. Supreme Court and Court of Appeals (Lamie v. United States; Shoshone Indian Tribe of the Wind River Reservation v. United States) that emphasize the importance of interpreting statutes based on their clear and unambiguous meaning. OSI presented these cases to strengthen their claim that when a statute is explicit and cohesive, the court's duty is to uphold it as written. In the present case, OSI asserted that the regulations' "unconditional ownership" stipulation carries a clear and unambiguous meaning.

The specific regulation in question, 13 C.F.R. § 125.12(f), allows for a change of ownership for a service-disabled veteran-owned small business (SDVOSB) while still maintaining its status if one or more service-disabled veterans continue to own and control the business. However, OSI argues that this provision does not serve as an exception to the unconditional ownership requirement or the definition of “unconditional ownership.” According to 13 C.F.R. § 125.11, unconditional ownership is ownership that is not subject to any conditions. The regulation provides three exceptions to this definition, but a general change of ownership agreement does not fall under any of those exceptions.

In support of their interpretation, OSI cited 15 U.S.C. § 657f, which allows contracting officers to award contracts to concerns owned and controlled by service-disabled veterans. OSI argued that the Small Business Administration's interpretation of "unconditional ownership" is consistent with its approach in other SBA programs and is therefore reasonable.

Objections to the Stock Transfer Agreement

OSI raised objections regarding the Stock Transfer Agreement between ALOG and Paul Smith. They contended that certain provisions within the agreement, particularly Section 6, imposed a forced sale arrangement on Paul Smith's stock ownership. According to this section, if Paul Smith still held shares on December 31, 2021, ALOG was obligated to repurchase those shares from him. Additionally, Section 14 of the agreement prohibited the sale of shares to non-employees of ALOG.

OSI asserted that these conditions infringe upon the concept of "unconditional ownership" as defined in 13 C.F.R. § 125.11. The term "unconditional ownership" refers to ownership that is not subject to arrangements that could potentially shift ownership benefits to another party, except in cases of death or incapacity.

Critically, OSI pointed out that the Agreement explicitly states that if Paul Smith maintains ownership of shares on the specified date, he must sell them back to ALOG, not Stephen Smith. OSI argued that this provision constituted an arrangement that transfers ownership benefits to another party, which contradicts the definition of "unconditional ownership" outlined in 13 C.F.R. § 125.11.

In response to Appellant's counterarguments, OSI asserted that the rules of contractual interpretation do not consider extrinsic evidence, such as the drafter's intent, when the language of the contract itself is clear and unambiguous. OSI claimed that the language of the Agreement unambiguously stated that Paul Smith was required to sell his ALOG shares by December 31, 2021, if he had not done so already, resulting in the transfer of ownership benefits to another party.

Evolution of "Unconditional Control" Definition and the Language of the Stock Transfer Agreement

OSI asserted that the appellant's reliance on the Veterans Contracting Group, Inc. v. United States case was misplaced. ALOG's understanding of the evolution of the definition of "unconditional ownership" and their interpretation of the ruling in Veterans Contracting is flawed, they argue. 

Initially, 13 C.F.R. Part 125 lacked a clear definition for unconditional control. In Wexford, the OHA provided a definition for "unconditional" as possessing unencumbered control and ownership rights. In 2017, the Court of Federal Claims upheld the Wexford definition in Veterans Contracting Group, deeming it reasonable for the SBA to rely on its own interpretation based on previous case history. However, the Court disagreed with the Wexford definition, deeming it overly restrictive. 

Notably, the current definition of "unconditional ownership" found in 13 C.F.R. § 125.11 did not exist when the Veterans Contracting case was decided. On September 28, 2018, the SBA introduced new rules that included a definition for "unconditional ownership," borrowing from its 8(a) BD regulations outlined in part 124.

OSI contends that despite significant events such as the Veterans Contracting decision, the affirmation by the Court of Federal Claims, and the final SBA rule implementation, the Stock Transfer Agreement remained unaltered. OSI believes that the language of the Agreement, as prepared by counsel, contradicts ALOG's current claims and suggests that it was intended to strip Paul Smith of unconditional ownership rather than being a genuine "change in ownership" agreement. Additionally, OSI highlights that sections 6 and 14 of the Agreement violate the existing legal definition of "unconditional ownership."

Request for Dismissal or Denial

Consequently, OSI requests OHA either dismisses ALOG's appeal or, alternatively, denies it under 13 C.F.R. § 134.509(a)(1) because the appeal lacks allegations that, if proven, would warrant overturning or modifying the initial determination. ALOG has failed to raise any exceptions for "change of ownership agreements" concerning the "unconditional ownership" requirement. Appellant's argument that SBA's rules should incorporate such an exception is inappropriate for this Court, as ALJs are bound by validly promulgated agency regulations, and OHA is not the appropriate forum for challenging the regulation's validity.

Response from the Small Business Administration

On July 2, 2020, the SBA issued a response to the appeal, contending that the determination made by the Director of the Office of Government Contracting (D/GC) should be upheld as it was not based on any errors in fact or law. According to the D/GC's findings, ALOG was deemed ineligible for SDVO SBC status due to a conditional ownership arrangement involving Paul Smith and the Stock Transfer Agreement. This arrangement was found to be in violation of 13 C.F.R. § 125.12, which requires unconditional ownership and control by a service-disabled veteran in order to be eligible for SBA status.

The appellant, however, argued that the Stock Transfer Agreement did not violate SBA requirements. They claimed that "unconditional ownership" is not an absolute rule, and that limited exceptions provided by SBA regulations do not apply in their case.

The argument was rebutted by SBA, asserting that there was no evidence in the Protest File indicating that a service-disabled veteran would have owned and controlled the firm after the change in ownership that occurred on December 31, 2021. The appellant had asked the Office of Hearings and Appeals (OHA) and SBA to infer that Stephen Smith would have retained ownership of the firm and thus maintained eligibility based on a clause in the Agreement. However, SBA pointed out that the Agreement, as it stood, did not support this inference. SBA maintained that the sections in the Agreement aligned with the type of conditional ownership that SBA regulations prohibited, where ownership benefits may potentially have gone to another party.

Ultimately, SBA maintained that the D/GC correctly concluded that the appellant was not an eligible SDVO SBC. Therefore, they requested OHA to affirm this determination on appeal.

Analysis and Conclusion

The appellant's failure to demonstrate any clear error in the determination by the Director of the General Counsel (D/GC) led to the appeal being denied.

OHA's Definition of Unconditional Ownership and the Wexford Standard

In order to qualify as an eligible SDVO SBC (Service-Disabled Veteran-Owned Small Business Concern), the regulations state that a concern must be owned, unconditionally and directly, by one or more service-disabled veterans, with a minimum ownership stake of 51%.

Unconditional ownership, as defined by the regulations, means that there should be no conditions or agreements that transfer ownership benefits to another party, except in cases of death or incapacity. Pledging or using stock or ownership interest as collateral, including seller-financed transactions, does not affect the unconditional nature of ownership as long as the terms adhere to standard commercial practices and the owner retains control, provided there are no violations of the terms.

Furthermore, the regulations specify that a concern may change its ownership or business structure as long as one or more service-disabled veterans continue to own and control the concern after the change.

Before the Small Business Administration established its own definition of unconditional ownership, the Office of Hearings and Appeals had its own working definition. According to OHA, unconditional ownership means that there should be no limitations or restrictions on the control and ownership of a concern by service-disabled veterans. This includes immediate and full ownership without waiting for future events. Additionally, service-disabled veterans should have the right to convey or transfer their ownership interest or stock to anyone they choose, even in the event of departure, resignation, retirement, or death.

OHA's Wexford standard is used to determine whether a concern is unconditionally owned by a service-disabled veteran. This definition was upheld by the court in the case Veterans Contracting Group, Inc. v. United States. Subsequently, the SBA defined unconditional ownership in 13 C.F.R. § 125.11, with exceptions for death, incapacity, and pledges of stock. Essentially, unconditional ownership means that there should be no restrictions on the service-disabled veteran's ownership or ability to dispose of shares, except for the circumstances specified in the regulation.

Forced Sale Arrangement in the Stock Transfer Agreement

In the case at hand, the Stock Transfer Agreement stated that Paul Smith was obligated to sell all of his shares to the Corporation by December 31, 2021. This arrangement restricted the ability of the service-disabled veteran (SDV) to transfer shares to non-employees of the Appellant. The SBA had determined that there was no evidence to suggest that the SDV or Stephen Smith would retain ownership and control of the firm after the change in ownership. Furthermore, the forced sale arrangement outlined in the Stock Transfer Agreement was deemed to be in violation of 13 C.F.R. § 125.12.

According to the Agreement, shareholders of the Appellant corporation were not permitted to sell, mortgage, or transfer stock without adhering to the specified regulations. The Appellant corporation held the right of first refusal for any sale of shares made by shareholders, and shares could not be transferred to individuals who were not employees of the Appellant corporation. If Paul Smith had remained a shareholder by December 31, 2021, he would have been required to sell all of his shares to the Appellant corporation. Paul Smith's ownership of the shares was subject to various restrictions and had an expiration date.

Lack of Exception for Unconditional Ownership

The Appellant's argument, which relied on canons of statutory construction, has no basis in the text and is without merit. There is no indication in the text or placement of 13 C.F.R. § 125.12(f) that it serves as an exception to the requirement for unconditional ownership. While § 125.12(f) allows for a change in ownership without losing eligibility, it does not grant unrestricted permission for ownership change through any means. The regulation specifically outlines exceptions for ownership transfer in cases of death, incapacity, and stock pledges, but does not mention any other exceptions to unconditional ownership.

Director of Government Contracting Decision Upheld

The decision made by the Director of Government Contracting (D/GC) was justified and aligned with the record and the Agreement's clear language. The Agreement, which includes a forced sale arrangement, imposes restrictions on Paul Smith's ownership of Appellant. These limitations also impact Appellant's ownership by service-disabled veterans (SDVs). Taking these factors into consideration, the D/GC correctly determined that Paul Smith did not possess unconditional ownership of his share in Appellant, thus resulting in Appellant not being unconditionally owned by SDVs. The D/GC's determination does not exhibit clear error.

Final Ruling

As a result, the appeal is denied, and the D/GC's status determination is affirmed. This decision represents the final ruling of the Small Business Administration.


Looking to start or get help with your Service Disabled Veteran-Owned Small Business? Visit our dedicated page on SDVOSB SBA Verification for more information or to request your free consultation.

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