Joint Venture 101 Understanding the Treatment of Joint Ventures between Contractors, Part I

Joint Venture 101 Understanding the Treatment of Joint Ventures between Contractors, Part I How joint ventures are defined and treated by the FAR, SBA, and DCAA for their purposes, as well as an in-depth discussion of the circumstances in which joint ventures can compete for government contracts and the requirements joint ventures must meet before receiving contracts. By John Ford and David Lundsten 60 Contract Management December 2011

For many procurements, the formation of a joint venture by two or more contractors is the only feasible means by which the U.S. federal government can obtain the required supplies or services. Similarly, in many instances, forming a joint venture is the only way some contractors can compete for a procurement. This is particularly true of small businesses. What is a Joint Venture? The definition of a joint venture depends on the context in which the term is used. The Federal Acquisition Regulation (FAR) does not contain a universal definition of a joint venture. In fact, the term is used in only four provisions in the FAR. The first mention of a joint venture is in FAR 9.601, where it is stated that Contractor team arrangement means an arrangement in which [t]wo or more companies form a partnership or joint venture to act as a potential prime contractor. 1 As this extract demonstrates, FAR 9.601 views joint ventures as a form of contractor team arrangement. For these purposes, the FAR envisions contractors forming joint ventures to pursue prime contract awards. However, nothing in the FAR prevents companies from forming a joint venture in the hopes of receiving a subcontract. The most extensive FAR discussion of joint ventures occurs in Part 19 and deals with small businesses. Here, the FAR borrows significantly from the Small Business Administration (SBA) rules on affiliation. 2 In this regard, the FAR defines a joint venture as: an association of persons or concerns with interests in any degree or proportion by way of contract, express or implied, consorting to engage in and carry out a single specific business venture for joint profit, for which purpose they combine their efforts, property, money, skill, or knowledge, but not on a continuing or permanent basis for conducting business generally. 3 This was similar to the definition SBA gave until January 11, 2011. At that time, SBA published revised size standard rules to include a new definition of a joint venture. The revised SBA rules now define a joint venture as: an association of individuals and/or concerns with interests in any degree or proportion consorting to engage in and carry out no more than three specific or limited-purpose business ventures for joint profit over a two-year period, for which purpose they combine their efforts, property, money, skill, or knowledge, but not on a continuing or permanent basis for conducting business generally... SBA may also determine that the relationship between a prime contractor and its subcontractor is a joint venture. 4 As for when the relationship between a prime contractor and its subcontractor may be considered a joint venture, the SBA rules state that a contractor and its ostensible subcontractor are treated as joint venturers, and therefore affiliates, for size determination purposes. 5 SBA defines an ostensible subcontractor as a subcontractor that performs primary and vital requirements of a contract, or of an order under a multiple award schedule contract, or a subcontractor upon which the prime contractor is unusually reliant. 6 All aspects of the relationship between the prime and subcontractor are considered in making this determination. It should be noted that there are significant differences between the FAR and SBA definitions as to how to determine if a company, including a joint venture, meets the size standard for a particular procurement. However, because size determinations are the exclusive province of SBA, 7 SBA s rules take precedence over what is in the FAR if there is a conflict between the two. 8 Finally, we cannot overlook the fact that the Defense Contract Audit Agency (DCAA) has its own definition of what a joint venture is. This definition is different from the definitions contained in either the FAR or SBA regulations. The DCAA s Contract Audit Manual (CAM) informs auditors that a joint venture is: [an] enterprise owned and operated by two or more businesses or individuals as a separate entity (not a subsidiary) for the mutual benefit of the members of the group. Joint ventures possess the characteristics of joint control; e.g., joint property, joint liability for losses and expenses, and joint participation in profits. 9 Of course, this definition is not binding on anyone but DCAA auditors because the CAM is not a regulation and is only intended to be internal guidance to DCAA auditors. Unfortunately, the CAM does not mention either the FAR or SBA definitions. Accordingly, the failure of DCAA to base its guidance on what is in the FAR or SBA regulations can have adverse consequences for contractors when dealing with DCAA auditors. Forms of Joint Ventures While all of the definitions discussed above indicate that a joint venture is an enterprise comprised of two or more separate entities, none specify that a joint venture must have any specific form. Thus, theoretically, a joint venture can be in the form of the following: Contract Management December 2011 61

A partnership, A corporation, A limited liability corporation, Any combination of these business forms, or None of the above. This is recognized in FAR 4.102 when discussing who can sign a contract on behalf of a joint venture. Specifically, FAR 4.102(d) states: [A] contract with joint ventures may involve any combination of individuals, partnerships, or corporations. The contract shall be signed by each participant in the joint venture in the manner prescribed in paragraphs (a) through (c) above for each type of participant. 10 For these purposes, FAR 4.102(a) through (c) mandates contractor signatures as follows: a. Individuals. A contract with an individual shall be signed by that individual. A contract with an individual doing business as a firm shall be signed by that individual, and the signature shall be followed by the individual s typed, stamped, or printed name and the words, an individual doing business as [insert name of firm]. b. Partnerships. A contract with a partnership shall be signed in the partnership name. Before signing for the government, the contracting officer shall obtain a list of all partners and ensure that the individual(s) signing for the partnership have authority to bind the partnership. c. Corporations. A contract with a corporation shall be signed in the corporate name, followed by the word by and the signature and title of the person authorized to sign. The contracting officer shall ensure that the person signing for the corporation has authority to bind the corporation. 11 The SBA rules have more specific guidance on the form a joint venture may take. The rules state that a joint venture must be in writing and must do business under its own name, and it may (but need not) be in the form of a separate legal entity, and if it is a separate legal entity it may (but need not) be populated (i.e., have its own separate employees). 12 It must be observed that the SBA regulations do not place any restriction on what kind of separate legal entity may be used to create a joint venture. Thus, as long as the separate legal entity is one that is recognized by law in the state where it is created, it should be acceptable as an appropriate legal entity for a joint venture by SBA. Another noteworthy point about the SBA rule is that a separate legal entity joint venture does not have to have its own employees. Finally, neither the FAR nor SBA requires a separate legal entity joint venture to have its own business systems. Accordingly, it would appear that a separate legal entity joint venture can utilize the business systems, such as the accounting systems, of its component entities. The CAM does not differ greatly from the FAR or SBA rules in regard to the form of a joint venture. Again, the CAM provides that: Joint ventures can be either incorporated or unincorporated. The incorporated joint venture involves the issuance of stock and is most common on large construction type contracts. These joint ventures possess the typical characteristics of a corporation. The unincorporated joint venture can be a partnership or teaming arrangement between two or more corporations usually involved in large research and development and/or major weapon systems contracts. Usually in this type of joint venture, the joint venture is the contracting entity and is designated to act as the prime contractor. 13 In regard to incorporated joint ventures, the CAM states that they normally have characteristics common to a corporation, in that they are separate legal entities and act as a contracting party. 14 However, the CAM does not acknowledge that a separate legal entity joint venture may be unpopulated as specified in the SBA rules, and there is the implication that such a joint venture needs to have its own business systems. In contrast to an incorporated joint venture, the CAM provides the following description of an unincorporated joint venture: An unincorporated joint venture usually is either a partnership or a teaming arrangement and most often has: Few or no employees hired and paid by the joint venture, Little or no assets or separate facilities, No separate financial statements, and Little or no [general and administrative], [bid and proposal], or material handling expenses. All contract work is performed by the venturing organizations or other subcontractors. Employees are paid by their respective companies. 15 Despite the foregoing characteristics of an unincorporated joint venture, the CAM asserts that a joint venture, proposed and 62 Contract Management December 2011

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established as a separate business entity, should have its own set of books and supporting documentation sufficient for an audit trail. 16 This guidance can result in problems for contractors and contracting officers, which was directly addressed in the bid protest case McKissack & Delcan JV II, B-401973.2; B-401973.4 (January 12, 2010). This case was a protest arising from a request for proposals issued by the Federal Transportation Administration (FTA). The joint venture identified the direct labor rates for required personnel, listing alongside each labor rate the joint venture partner from which the employee would be assigned Delcan Corporation or The McKissack Group and calculated a total direct labor cost for each partner. The joint venture provided a labor overhead rate for each joint venture partner that was applied to each of the joint venture partner s total direct labor costs. After auditing the joint venture s proposal, DCAA stated in the Government Accountability Office (GAO) decision: The proposal submitted to the government does not show that the joint venture is an independent entity. An independent joint venture for government contracting purposes would have employees committed from each company and the indirect rate structure would be unique to the joint venture. In addition, the indirect rate structure proposed is Delcan s; the proposal should contain an indirect rate structure specific to McKissack & Delcan Joint Venture II. Utilizing the DCAA audit report, the contracting officer determined that the joint venture s proposal was unacceptable. The joint venture then protested to GAO. In responding to the protest, FTA submitted a memorandum from the branch manager of DCAA s Reston, Virginia, branch office that stated in the GAO decision: [T]he contractor s proposal did not comply with [Cost Accounting Standards (CAS)] 401 because the contractor s proposal did not contain a unique rate structure, which an independent and professional operated organization would have in the regular course of business... The CAS/FAR noncompliance issue is not the number of indirect rates, [but rather that] MD-JV does not have its own indirect rate structure for allocating costs to government contracts. In ruling on this protest, GAO first observed that FTA s rejection of the joint venture s proposal due to evaluated problems in its accounting system concerns a matter of a prospective contractor s responsibility, not technical acceptability. GAO will not question a negative determination of responsibility unless the determination lacks any reasonable basis. In this respect, while a contracting officer has significant discretion in this area, GAO noted that a negative responsibility determination will not be found to be reasonable where it is based primarily on unreasonable or unsupported conclusions. Moreover, an agency s reliance upon the advice of DCAA does not insulate the agency from responsibility for error on the part of DCAA. In this case, GAO observed that, except for the foregoing conclusory 64 Contract Management December 2011

statements, neither FTA nor DCAA provided any analysis or legal authority as to why the joint venture indirect rate structure violated CAS 401. Moreover, GAO stated that it had found no other authority that prohibited the joint venture s proposed dual overhead rate structure. Accordingly, GAO held that the FTA had not provided a reasonable basis for its conclusion that the joint venture did not have an adequate accounting system. 17 FAR Treatment of Joint Ventures As mentioned above, joint ventures are considered to be a form of teaming arrangement pursuant to the FAR. 18 As noted in FAR 9.602, team arrangements can be beneficial to both the government and the companies involved. Looking at this from a contractor s perspective, the reason for forming most joint ventures is to enhance the participants chances of receiving an award. 19 Therefore, in determining whether to form a joint venture, the starting point is the solicitation. Each potential participant must examine its own capabilities in light of the requirements of the solicitation. This examination should not be limited to the technical capabilities, but also to the financial and management capabilities required for the potential contract. Another issue that should be examined is the past performance record of potential participants. Because of the emphasis placed on past performance today, being able to enhance your past performance rating may be a significant factor in deciding whether to form a joint venture. In addition, be sure to consider the marketing abilities of potential participants. This would be a major consideration in regard to indefinite delivery contracts under which orders can be placed by differing activities. Last but certainly not least, it is essential that potential joint venture participants be able to work together. If the parties to a joint venture cannot work together, contract performance can be jeopardized. Moreover, if there are disputes between the joint venture participants, the cost of litigation to resolve those disputes likely will not be recoverable on government contracts. 20 Because joint ventures can be beneficial to the government, the FAR states that the government will recognize the validity of joint ventures, provided that the arrangements are identified and company relationships are fully disclosed in an offer or, for arrangements entered into after submission of an offer, before the arrangement becomes effective. 21 The FAR does not say how this identification and disclosure are to be made. However, it would seem that it would be prudent to include a copy of the joint venture agreement with the proposal to which it applies. Although not specifically addressed toward joint ventures, there are two issues that may not receive appropriate attention when forming a joint venture. First is the issue of receiving a taxpayer identification number (TIN). FAR 4.902 observes that 31 U.S.C. 7701(c) requires each contractor doing business with a government agency to furnish its TIN to that agency. Additionally, 31 U.S.C. 3325(d) requires the government to include, with each certified voucher prepared by the government payment office Contract Management December 2011 65

and submitted to a disbursing official, the TIN of the contractor receiving payment under the voucher. There is no exception to these requirements for joint ventures. Thus, if a joint venture is to be a contractor (i.e., the contract will be issued to the joint venture), then the joint venture must obtain a TIN. 22 Whether the joint venture will be taxed is yet another issue that must be researched. 23 Closely related to the necessity for obtaining a TIN is the issue of registration in the Central Contractor Registry (CCR). For these purposes, FAR 9.1102 generally requires contractors to be registered in the CCR as a prerequisite to award of a contract. Thus, if a contract will be issued to a joint venture, that joint venture must be registered in the CCR before it can receive a contract unless an exception listed in FAR 4.1102 applies. 24 SBA Treatment of Joint Ventures The principal issues relating to joint ventures from SBA s perspective are size (based on affiliation) and the amount of contract work that will be done by a small business prime contractor under a setaside contract. Affiliation is significant because SBA has established size standards 25 that are to be applied when determining a contractor s status as a small business. These size standards vary depending on the North American Industry Classification System (NAICS) code applicable to a procurement. In determining the size status of a concern, SBA generally examines the revenue or number of employees of the contractor and all its affiliates. 26 SBA regulations state that, with certain limited exceptions, concerns submitting offers on a particular procurement as joint venturers are affiliated with each other with regard to the performance of that contract. 27 However, a joint venture may submit an offer as a small business for a procurement without regard to affiliation so long as each participant in the joint venture is small under the size standard corresponding to the NAICS code assigned to the contract, 28 provided that: The procurement qualifies as a bundled 29 requirement, at any dollar value; or The procurement is other than a bundled requirement and: For a procurement having a receipts-based size standard, the dollar value of the procurement, including options, exceeds half the size standard corresponding to the NAICS code assigned to the contract; or For a procurement having an employee-based size standard, the dollar value of the procurement, including options, exceeds $10 million. Another issue that is significant to joint ventures relates to the limitations on subcontracting when a contract is awarded to a small business concern on a set-aside or sole-source basis. In general, 13 C.F.R. 125.6 provides that: In the case of a contract for services (except construction), the [small business] concern will perform at least 50 percent of the cost of the contract incurred for personnel with its own employees. In the case of a contract for supplies or products (other than procurement from a nonmanufacturer in such supplies or products), the [small business] concern will perform at least 50 percent of the cost of manufacturing the supplies or products (not including the costs of materials). 30 If the concern is a joint venture, the socalled 50-percent rule applies to the joint venture, not the individual members of the joint venture. However, if the joint venture is an unpopulated joint venture comprised of an 8(a) participant and its mentor, in accordance with 13 C.F.R. 125.513, then the 8(a) participant is required to perform at least 40 percent of the work done by the joint venture. 66 Contract Management December 2011

One final point of interest to small business concerns that needs to be addressed concerning joint ventures is how to treat revenue generated by the joint venture or the number of employees employed by the joint venture. For these purposes, 13 C.F.R. 121.103(h)(5) states that a concern must include in its receipts its proportionate share of joint venture receipts, and in its total number of employees its proportionate share of joint venture employees. While most issues relating to joint ventures between small business concerns will be of interest only to small business concerns, there is one issue that has relevance to large businesses. That issue is the role a joint venture that qualifies as a small business may play in regard to a large business meeting its small business subcontracting goals. In accordance with the FAR, a large business receiving a contract that exceeds $650,000 ($1.5 million for construction) must prepare a small business subcontracting plan acceptable to the contracting officer. 31 As a part of that plan, and in accordance with FAR 52.219-19, the contractor must establish goals for the percentage and dollar amount of subcontracts to be awarded to each of six categories of small business concerns. For these purposes, the FAR states that a joint venture may qualify as a small business concern. 32 Thus, small businesses should not overlook the possibility of receiving subcontract awards through the formation of joint ventures and large businesses should not ignore this opportunity to find small business concerns that enable the large businesses to meet their subcontracting goals. However, it should be noted that because the exceptions to the affiliation rule described above do not apply to subcontractors, the members of a joint venture are likely to be considered affiliates under such arrangements. While the foregoing applies to most joint ventures that involve small businesses, SBA has promulgated specific rules that apply to joint ventures involving HUBZone small business concerns; service-disabledveteran owned small business concerns; 8(a) participants, including joint ventures between an 8(a) participant and its mentor; and women-owned small business concerns. These rules will be discussed in the second part of this article in the January 2012 issue of Contract Management. CM About the Authors JOHN FORD is a senior consultant with Cherry Bekaert & Holland and a member of the firm s Government Contractor Services Group. He can be reached at jford@cbh.com. DAVID LUNDSTEN is a partner with Cherry Bekaert & Holland and a member of the firm s Government Contractor Services Group. He can be reached at dlundsten@cbh.com. Send comments about this article to cm@ncmahq.org. Endnotes 1. FAR 9.601. 2. In determining the size of a concern, SBA considers the receipts or employees of a concern and all its affiliates. Thus, determining whether firms are affiliated with each other is a key issue in computing the size of a concern. 3. FAR 19.101(7)(i). 4. 13 C.F.R. 121.103(h). 5. 13 C.F.R. 121.103(h)(4). 6. Ibid. 7. Dynalantic Corp., B-402326 (March 15, 2010) ( SBA, not our office, has conclusive authority to determine the size status of an offeror for federal procurement purposes, including whether the offeror is a manufacturer under the small business size standards. See 15 U.S.C. 632(a)(2). ); Accord, White Hawk Group, Inc., Todd Construction, LP, and Whitehawk/Todd, a Joint Venture v. U.S., COFC No. 09-374C (February 25, 2010). 8. MCS Portable Restroom Service, B-299291 (March 28, 2007). 9. CAM 7-1802(b)1. 10. FAR 4.102(d). 11. FAR 4.102(a) (c). 12. 13 C.F.R. 121.103(h). 13. CAM 7-1802(b)1. 14. CAM 7-1803(a). 15. CAM 7-1803(b). 16. CAM 7-1808.1(a). 17. In a related protest arising from the same solicitation but involving a joint venture that qualified as a small business, GAO noted that if a small business was denied a cost reimbursement contract because it had an inadequate accounting system, the agency was required to refer that matter to SBA for a Certificate of Competency determination. See, PMO Partnership Joint Venture, B-401973.3; B-401973.5 (January 14, 2010). 18. FAR 9.601. 19. In this regard, forming a joint venture can reduce the cost and risk of proposal preparation and contract performance. 20. FAR 31.205-47(f)(5)(I) makes litigation costs between joint venture participants expressly unallowable. 21. FAR 9.603. 22. See also, FAR 52.204-5 and FAR 52.204-7 and their prescriptive language. 23. As discussed above, joint ventures do not have to be in any particular form. Thus, the fact that a joint venture is not a separate legal entity or does not have any employees or assets other than a contract does not necessarily mean that it is exempt from paying taxes. Therefore, it is advisable to have a joint venture agreement examined by a competent tax attorney or accountant as well as a competent business attorney to ensure that the agreement does not inadvertently cause the joint venture to be subject to taxation. 24. Generally, see 13 C.F.R. 121.101. These size standards are based either on the average revenue the contractor has received during its last three completed fiscal years (13 C.F.R. 121.104) or the average number of employees the contractor has had during each pay period for the previous 12 months (13 C.F.R. 121.106). 25. 13 C.F.R. 121.103. 26. 13 C.F.R. 121.103(h)(2). 27. As will be discussed later, special rules apply in this regard to joint ventures comprised of an 8(a) participant and a mentor under SBA s Mentor Protégé program. 28. For these purposes, bundling refers to the consolidation of two or more procurement requirements for goods or services previously provided or performed under separate, small contracts into a solicitation of offers for a single contract that is likely to be unsuitable for award to a small business concern. Further, the phrase separate, smaller contracts refers to contracts that have previously been performed by one or more small business concerns or was suitable for award to one or more small business concerns. 29. See, generally, FAR 52.219-14. 30. See 13 C.F.R. 126.200 for a discussion of what a concern must do to become a qualified HUB- Zone small business concern. 31. As per FAR 19.702. 32. FAR 19.001. Contract Management December 2011 67