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CALIFORNIA DREDGING CO. v. SANDERS

November 3, 1986

California Dredging Co., Et Al., Plaintiffs
v.
James C. Sanders, Et Al., Defendants



The opinion of the court was delivered by: GESELL

 Gesell, District Judge

 In this proceeding the Court is asked to declare invalid a regulation, 13 C.F.R. § 121.2 (1986), issued by the Small Business Administration ("SBA"), defining what constitutes a small business in the dredging industry eligible for favorable governmental procurement consideration under the pertinent provisions of the Small Business Act ("Act"), 15 U.S.C. §§ 631 et seq. (1982 & Supp. III 1985). Plaintiffs, a number of large and small dredging companies, contend that the regulation is arbitrary, capricious and contrary to law. The administrative record was filed and subsequently cross-motions for summary judgment have been briefed and argued. The basic facts describing the dredging industry on which SBA relied are not in dispute but the appropriateness of its small- business standard is sharply challenged.

 The Small Business Act reflects the congressional purpose to promote competition in the economy. *fn1" The Act is designed to encourage competition by enhancing the ability of small businesses to compete against larger concerns, through preferential set-asides on government contracts as well as loans and other assistance. *fn2" The Act defines "a small-business concern" as "one which is independently owned and operated and which is not dominant in its field of operation." It charges SBA with "making a detailed definition" of small businesses, based on the "dollar volume of business" and other criteria. 15 U.S.C. § 632(a). Pursuant to this statutory mandate, SBA has determined that size standards will "vary by industry with particular attention to the structure of the designated industry, Administration policy and the needs of the various Federal programs to which they apply," and has identified a number of specific factors it will consider. *fn3"

 This latest size standard for the dredging industry arose out of a comprehensive SBA review of existing size standards for all industries that commenced in March 1980. See 45 Fed. Reg. 15,442 (1980). After lengthy proceedings SBA decided to retain most of the size standards, adjusting for inflation since 1975 when they were last updated, but including other alterations for some industries. See 49 Fed. Reg. 5,024 (1984).

 SBA withheld decision, however, on the appropriate size standard for the dredging industry because it found "deep polarization within the industry." It noted that of the dredging firms that submitted comments, 28 favored a standard lower than the then-current size standard, which defined as "small" any dredging firm with gross annual revenues of $9.5 million or less, and 12 desired an increase reflecting a full adjustment for inflation. These 40 responses accounted for approximately one quarter of the firms in the industry. SBA ultimately announced that it would retain the $9.5 million size standard pending further review. See id. at 5,025-26; see also 49 Fed. Reg. 47,412-13 (1984). After agency investigation and further comment by interested parties, SBA issued a Proposed Final Rule on December 4, 1984 raising the dredging size standard to $13.5 million, an increase of 40% and one matching the increase in the size standard SBA had found appropriate for several general construction industries which present considerably different questions for analysis. See 49 Fed. Reg. 47,412-13 (1984). Following further comment by interested parties, on November 8, 1985, SBA adopted the regulation challenged here. See 50 Fed. Reg. 46,418 (1985).

 In reviewing the level of concentration in the dredging industry as one of six factors analyzed, *fn5" SBA concluded that viewed on a national level "dredging tends to be dominated by a few large firms to a greater extent than occurs in most other industries in construction." Id. at 9. It noted that ordinarily this would suggest the need for a higher size standard to give more small firms assistance against the industry giants. See id. But when SBA analyzed the industry within the regional markets it had defined, it observed wide variance in the market power of "small" dredging firms. SBA noted that in 1983, 22.4% of federal dredging dollars were for contracts set aside for small firms. Yet the percentage of set-aside dollars varied widely by region. In three regions it was low: Gulf (2.4%), Northeast (7.5%) and Pacific (12.2%). In the Great Lakes region, it was somewhat higher (35.5%). It was considerably higher in the Inland (50.4%) and Southeast (59.6%) regions. See Profile at 7. SBA stated that these differences stem largely from differences in the scale of the work typically performed in each region. *fn6"

 Based on this information and information contained in Table 4 of the Appendix to the Profile, documenting by region the share of each firm operating in the region, SBA concluded that the Gulf Coast and Northeast regions "have patterns of dominance suggesting that a higher size standard would be appropriate" because procurement there has "clearly been dominated by three or four firms and these firms are each large." Id. By contrast, it concluded that the Inland and Great Lakes regions "have patterns of dominance suggesting that a lower size standard would be appropriate," given that dominant firms in that region were already defined as "small." Id. at 10. SBA ultimately determined that the relatively high level of national concentration in the dredging industry should be disregarded for purposes of setting a size standard, because analysis of the experience in different regions produced "indeterminate results." *fn7"

 SBA clearly assumes that the four largest firms in any region must be considered dominant and thus appropriately classified as "large." In suggesting that a higher size standard would be desirable in the Gulf Coast and Northeast regions, it stated that it "would be cautious not to raise the size standard to a level at which any of the four dominant firms in that particular region would qualify as small." *fn10" And by suggesting that the "patterns of dominance" in the Inland and Great Lakes regions call for a lower size standard, id. at 10, SBA necessarily indicated that it considers the leading small firms dominant in those regions. But the Act definitely requires that a small business must be one "which is not dominant in its field of operation." 15 U.S.C. § 632(a). When squarely faced with this dilemma, SBA simply noted without explanation that it "has never considered varying the size standard on a regional basis as a viable alternative to a nationwide size standard." Its failure to do so in this case without rational explanation is arbitrary and an error of law. *fn11"

 The Act does not specify that dominance is to be measured on a national scale and SBA may not limit its inquiry to promulgation of uniform national standards merely for convenience or because this approach may appear appropriate in the vast majority of cases. When most of the firms in an industry are regarded as being confined to a regional market by geographical and financial considerations, the small-business size standard cannot be one that gives a dominant firm in a regional market the preferred status of a small business.

 In sum, SBA has failed to engage in rational rulemaking designed to ensure that the mandate of the Small Business Act is carried out in the dredging industry. Given the purposes of the Act previously reviewed, SBA cannot avoid its responsibility by dismissing considerations of dominance as "indeterminate" and refusing without explanation to consider the realities of competition in the regional markets it has found most truly reflect the competitive environment Congress has charged it to enhance by aiding small business.

 The regulation must be enjoined and the matter remanded to SBA for further consideration in the light of this memorandum. Since the previous $9.5 million size standard is not challenged here, it remains in effect. Other procedural and substantive issues raised by plaintiffs' papers or ...


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