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Desa Group Inc. v. U.S. Small Business Administration

United States District Court, District of Columbia

May 26, 2016

THE DESA GROUP, INC., Plaintiff,
v.
U.S. SMALL BUSINESS ADMINISTRATION, Defendant.

          MEMORANDUM OPINION GRANTING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT; AND DENYING DEFENDANT’S MOTION FOR SUMMARY JUDGMENT

          RUDOLPH CONTRERAS United States District Judge.

         I. INTRODUCTION

         Plaintiff The Desa Group, Inc. (“TDG”) initiated this action under the Administrative Procedure Act (“APA”), 5 U.S.C. §§ 701 et seq., alleging that Defendant the United States Small Business Administration (“the SBA”) acted arbitrarily and capriciously in terminating TDG from a preferential contracting program for socially and economically disadvantaged small businesses, called the Section 8(a) Business Development Program (“the Section 8(a) program”). To be eligible for the Section 8(a) program, a business must be “unconditionally owned and controlled by one or more socially and economically disadvantaged individuals.” 13 C.F.R. § 124.101. A non-disadvantaged entity or individual may be found to control a business, however, when “[b]usiness relationships exist with non-disadvantaged individuals or entities which cause such dependence that the applicant or Participant cannot exercise independent business judgment without great economic risk.” Id. § 124.106(g)(4). TDG is run by Dionne Fleshman and Ms. Fleshman’s mother, Diane Sumpter, runs a separate company, DESA, Inc., that graduated from the Section 8(a) program in 1997. At times, the two firms have contracted or subcontracted with one another, and their business enterprises appear to be connected in various other ways. The SBA terminated TDG from the Section 8(a) program after the agency concluded that the connections between TDG and DESA indicated that TDG was unduly dependent on DESA.[1]

         TDG does not dispute that there are contacts between the two firms. But the company claims that the SBA acted arbitrarily and capriciously in determining that those connections indicate business relationships that cause TDG to be so dependent on DESA that TDG is unable to exercise its own independent business judgment without great economic risk. See, e.g., Pl.’s Mem. P. & A. Supp. Mot. Summ. J. at 9 (“Pl.’s Mem. Supp.”), ECF No. 14-1. After a thorough review of the record, the Court agrees that the SBA has failed to articulate a rational connection between the evidence in the administrative record and its conclusion that TDG is unduly dependent on DESA. Accordingly, the Court will grant TDG’s motion for summary judgment and will deny the SBA’s cross-motion for summary judgment.

         II. FACTUAL BACKGROUND

         A. Statutory and Regulatory Background

         Section 8(a) of the Small Business Act authorizes the SBA to enter into procurement contracts with the federal government, and then subcontract the SBA’s performance of those contracts to a “socially and economically disadvantaged small business.” 15 U.S.C. § 637(a)(1)(A)-(B). The Section 8(a) program is intended “to assist eligible small disadvantaged business concerns [to] compete in the American economy through business development.” 13 C.F.R. § 124.1. To administer the Section 8(a) program, the SBA has promulgated regulations which set forth, among other things, the program’s eligibility requirements. See generally 13 C.F.R. §§ 124.1 et seq. In order to be eligible for the Section 8(a) program, a business must be “a small business which is unconditionally owned and controlled by one or more socially and economically disadvantaged individuals who are of good character and citizens of and residing in the United States, and which demonstrates potential for success.” Id. § 124.101. The regulations further specify those circumstances in which a business will or will not be considered “controlled” by a socially and economically disadvantaged individual. Of most relevance to this case, a participating business “must be managed on a full-time basis by one or more disadvantaged individuals who possess requisite management capabilities.” Id. § 124.106(a)(1). Despite such management, “[n]on-disadvantaged individuals or entities may be found to control or have the power to control” a business in certain circumstances, including when “[b]usiness relationships exist with non-disadvantaged individuals or entities which cause such dependence that the applicant or Participant cannot exercise independent business judgment without great economic risk.” Id. § 124.106(g)(4).

         A business that is admitted to the program may participate for a term of nine years. See Id. § 124.2. During its participation, the business must “maintain its program eligibility” and “must inform SBA of any changes that would adversely affect its program eligibility.” Id. Moreover, a business may be terminated from the program prior to the expiration of the nine-year term “for good cause.” Id. § 124.303(a). Among the examples of good cause listed in the SBA’s regulations are a business’ failure “for any reason . . . to maintain ownership, full-time day-to-day management, and control by disadvantaged individuals, ” or a business’ failure “to disclose to SBA the extent to which non-disadvantaged persons or firms participate in the management of the Participant business concern.” Id. § 124.303(a)(3), (a)(5).

         B. TDG’s Participation in the Section 8(a) Program

         TDG contracts with federal and state agencies, as well as private corporations, to provide “conference support services.” Compl. ¶ 8, ECF No. 1. TDG was certified as a participant in the Section 8(a) program on September 30, 2010, for a nine-year term that was slated to end in September 2019. See A.R. 140; Compl. ¶ 13. TDG was deemed eligible for the program based on the status of the company’s President and CEO, Dionne Fleshman, as a “disadvantaged individual” as defined in the Small Business Act. See A.R. 377. Ms. Fleshman’s mother, Diane Sumpter, runs a separate, but similarly named, company: DESA Inc. (“DESA”). See Id. at 169, 195. Ms. Sumpter and DESA were previously participants in the Section 8(a) program, and DESA graduated from the program in March 1997. See Id. at 169. Shortly before TDG was approved as a Section 8(a) participant, the SBA contacted Ms. Fleshman to ask, among other things, whether “any immediate family members own a business and/or have ever participated in the 8(a) program.” Id. at 193. Ms. Fleshman responded, via email, explaining that her mother, Ms. Sumpter, “owns the company, DESA, Inc., which graduated from the 8(a) program about 13 years ago in 1997.” Id. at 195. Ms. Fleshman further asserted that TDG “has no dependence on DESA, Inc., other than the company being one of my customers, ” and disclosed that during the 2010 calendar year “revenues from DESA, Inc. amount to slightly less than 25% of my company’s revenues, ” but that TDG and DESA “have no common directors, no common officers, no common shareholders and no common employees” and are located at “separate physical locat ions.” Id.

         On October 11, 2012, the SBA’s Office of Program Review (“OPR”) received a complaint on its tip hotline which alleged that Ms. Fleshman did not work full-time for TDG, but worked at both TDG and DESA. See Id. at 169. The complainant further claimed that DESA’s CEO, Ms. Sumpter, was “doing the real managing at [TDG].”[2] Id. After receiving the complaint, Solomon Wheeler, a member of the OPR staff, conducted a review of TDG’s continued eligibility to participate in the Section 8(a) program. As part of that review, Mr. Wheeler sent Ms. Fleshman a November 7, 2012 letter posing a series of questions and directing Ms. Fleshman to provide responses and, in some cases, documentation. See Id. at 316-17. Ms. Fleshman responded to the letter on November 27, 2012. See Id. at 181-85; see also Id. at 186- 315 (reproducing attachments). After reviewing Ms. Fleshman’s responses, and as a result of its investigation, OPR ultimately recommended that the SBA South Carolina District Office (“SCDO”) issue a letter of intent to terminate TDG from the Section 8(a) program. See Id. at 169-75.

         On February 14, 2013, the SCDO sent a letter to Ms. Fleshman informing her that the SBA intended to terminate TDG’s participation in the Section 8(a) program. See generally Id. at 428-40. That letter set forth approximately a dozen grounds that the SCDO claimed established good cause to terminate TDG from the Section 8(a) program. See id.; see also 13 C.F.R. § 124.303(a)(1)-(20) (detailing examples of “good cause”). Because several grounds were abandoned by the SBA in its answer to TDG’s appeal, see A.R. 379 n.2, rejected by the SBA Office of Hearing Appeals (“OHA”) administrative law judge (“ALJ”), or not reached by the ALJ, the Court will detail only on those grounds that remain relevant to this action.[3]

         Citing 31 C.F.R. § 303(a)(3), the SCDO claimed that Ms. Fleshman did not manage TDG full time and, therefore, that TDG had failed “to maintain ownership, full-time day-to-day management, and control by disadvantaged individuals.” Id. at 431. Among other factors, the SCDO claimed that TDG’s invoices showed Ms. Fleshman had been paid “roughly $7, 712 to $10, 000 per month from [DESA], ” which the SCDO posited made it “unfeasible for you to be working full-time to cover TDG’s other contract performance obligations.” Id. The SCDO also argued that many of TDG’s 2012 invoices “show [DESA] as the subcontractor, an indication that [DESA] rather than TDG is managing the contracts, ” and that, prior to relocating, TDG was “housed within [DESA]’s headquarters, ” in a “private office not segregated from [DESA].” Id.

         Citing the same regulation, the SCDO also claimed that “[s]everal facts indicate that Ms. Sumpter has control or has the power to control TDG’s business relationship such that [Ms. Fleshman] cannot exercise independent business judgment without great economic risk.” Id. at 432. The SCDO again pointed to the fact that many of TDG’s invoices showed DESA as the subcontractor, and also noted that Ms. Fleshman had listed Ms. Sumpter as a sub-contractor on TDG’s 2011 payroll listing. Id.; see also Id. at 287. Similarly, the SCDO alleged that TDG had not fully disclosed the extent of Ms. Sumpter’s participation with TDG, circumstances which the agency claimed established good cause under 13 C.F.R. § 124.303(a)(5) for failure “to disclose to SBA the extent to which non-disadvantaged persons or firms participate in the management of the Participant business concern.” Id. at 433. The SCDO stated that it had “met numerous times with TDG, including the firm’s initial 8(a) orientation on 10/26/10, ” and “[i]n every instance Diane Sumpter has been present and was very active in conversations.” Id. at 433-34.

         On the basis of these and other grounds detailed in its letter, the SCDO informed Ms. Fleshman that it “intends to terminate The Desa Group, Inc., with good cause from the 8(a) Business Development Program, ” and that Ms. Fleshman had “30 days from the day of receipt of th[e] Letter of Intent to Terminate to submit a written response.” Id. at 439.

         On March 19, 2013, Ms. Fleshman responded with a lengthy letter, refuting the SCDO’s contentions. In particular, she claimed that the SCDO had mischaracterized the relationship between TDG and DESA when the agency relied on the invoices listing revenues from DESA as grounds to conclude that Ms. Fleshman was not dedicating her full-time employment to TDG. Id. at 105. She explained that DESA “is one of TDG’s clients, ” and therefore, “[a]s head of TDG, I am working on a full-time basis delivering services to all of my clients and fulfilling my contractual obligations.” Id. at 105-06. Moreover, she argued that far from listing “many” invoices showing DESA as a subcontractor, Ms. Fleshman asserted that there existed only a “single project where [DESA] is a subcontractor of TDG, ” and for which DESA “only performs about 16% of the work as a subcontractor.” Id. at 106, 108. With respect to the firm’s location, Ms. Fleshman noted that TDG had relocated and had not been housed in the same location as DESA “since before it was admitted to the 8(a) Program, ” and that, even while it was located at the same address, TDG’s office was “segregated from [DESA].” Id. at 106-07. Finally, Ms. Fleshman maintained that Ms. Sumpter was listed not as an employee but as “a 1099 independent contractor for the delivery of marketing services.” Id. at 108.

         Over a year later-on July 31, 2014-the SBA’s Office of Business Development responded to Ms. Fleshman’s letter and concluded that, “[b]ased on a thorough review of the information submitted in response to the proposed termination action, . . . the reasons cited for termination have not been overcome.” Id. at 387. The SBA responded to and rejected each of TDG’s contentions, and informed TDG that the company would be terminated from the Section 8(a) program unless it filed an appeal within 45 days with the SBA’s Office of Hearings and Appeals (“OHA”). Id. at 388-409.

         TDG did file an appeal, and the ALJ issued his decision on February 5, 2015. As pertinent to this action, the ALJ rejected SBA’s claim that Ms. Sumpter controls, or has the ability to control, TDG. See Id. at 381-83. As the ALJ explained, “[i]n many instances, the Termination Letter identified a real or perceived business connection between [TDG] and DESA, [and] then made a conclusory statement that the connection was indicative of shared management, improper reliance, or lack of full-time dedication to [TDG], ” but had “rarely attempted to explain how the evidence supported the conclusion.” Id. at 382. Specific to the SBA’s contentions regarding TDG’s earnings from DESA, the ALJ found that the SBA’s conclusion that “Ms. Fleshman is an employee of DESA” was “contrary to the evidence” because “Ms. Fleshman is not employed directly by DESA, ” and the invoices merely show payments made to TDG “pursuant to its subcontract with DESA, ” which were not “Ms. Fleshman’s personal income.” Id. at 383.

         At the same time, however, in the final three paragraphs of his opinion, the ALJ noted that control by a non-disadvantaged individual may be found where “‘business relationships exist . . . which cause such dependence that the applicant or participant cannot exercise independent business judgment without great economic risk.’” Id. at 383 (quoting 13 C.F.R. § 124.106(g)(4)). The ALJ concluded that, while the “examples cited in [SBA’s] Termination Letter may not be persuasive evidence of actual control by Ms. Sumpter, . . . they are evidence of significant interconnectedness between the two companies.” Id. The ALJ then cited several factors which he found demonstrated such interconnectedness, including: (1) that “[b]oth companies act or have acted as subcontractors for the other company”; (2) that TDG “maintains an office in DESA Inc.’s headquarters in order to more effectively manage its contractual obligations to the elder company”; (3) that TDG’s “own headquarters is in a building owned by Ms. Sumpter”; (4) that TDG “holds meetings in DESA’s building, and Ms. Sumpter is a vocal participant in those meetings”; (5) that, regardless of whether Ms. Sumpter was acting as TDG’s “marketing contractor or as its manager, ” it was “clear that Ms. Sumpter plays a critical role in [TDG’s] success”; (6) that “DESA was responsible for almost 40% of [TDG’s] revenues in 2010”; and (7) that DESA was paying TDG “between $7, 000 and $10, 000 per month from 2010 ...


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