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Cognitive Professional Services Inc. v. U.S. Small Business Administration

United States District Court, District of Columbia

May 11, 2017

COGNITIVE PROFESSIONAL SERVICES INC., Plaintiff,
v.
U.S. SMALL BUSINESS ADMINISTRATION, Defendant.

          MEMORANDUM OPINION

          KETANJI BROWN JACKSON United States District Judge

         In March of 2014, Plaintiff Cognitive Professional Services (“CPS”) applied to the U.S. Small Business Administration (“SBA”) for admission to the Section 8(a) Business Development program (“Section 8(a) program” or “8(a) BD program”). (See Compl., ECF No. 1, ¶ 11.) SBA denied CPS's Section 8(a) application, citing various grounds, including the agency's conclusion that CPS was neither a small business owned and controlled by an “economically disadvantaged individual[, ]” nor one that had demonstrated “the potential to successfully meet the business development objectives of the 8(a) BD program.” (See Letter from Assoc. Adm'r for Bus. Dev., SBA, to Cassandra Coleman (Nov. 6, 2014) (“Final Denial Letter”), ECF No. 30-2, J.A. at 29, 33 (citing 13 C.F.R. §§ 124.104, 124.107).)[1] The three-count complaint that CPS has filed in this Court maintains that the agency's determination that CPS failed to satisfy the eligibility criteria for admission into the Section 8(a) program was arbitrary and capricious in violation of the Administrative Procedure Act (“APA”), 5 U.S.C. §§ 701-06 (see Compl. ¶¶ 41-43 (Count I)), and was also contrary to certain provisions of the Small Business Act of 1953 (“the Act”), 15 U.S.C. §§ 631-57s (see Compl. ¶¶ 44-45 (Count II)). CPS further contends that the SBA regulation that addresses the potential-for-success factor-13 C.F.R. § 124.107-is “itself invalid” because it does not “reflect the congressional intent of the governing statute.” (Id. ¶¶ 46-47 (Count III).)

         Before this Court at present are the parties' cross-motions for summary judgment. (See Pl.'s Mem. in Supp. of Mot. for Summ. J. (“Pl.'s Mem.”), ECF No. 32-2; Def.'s Mem. of Law in Supp. of Def.'s Cross-Mot. for Summ. J & Opp'n to Pl.'s Mot. (“Def.'s Mem.”), ECF No. 31-1.) CPS argues that it is entitled to judgment as a matter of law because both SBA's regulation governing “potential for success” and the agency's related conclusion that CPS failed to satisfy this criterion are contrary to the text and purpose of the Small Business Act. (See Pl.'s Mem. at 24-26.) CPS also contends that the record evidence did not support SBA's findings regarding CPS's potential for success, and that SBA's determination that CPS was not economically disadvantaged for Section 8(a) program purposes was based on a plainly erroneous interpretation of the agency's own rules. (See Id. at 20-21, 25.) SBA's cross-motion for summary judgment rejects each of these contentions and asserts that the agency must prevail as a matter of law. (See Def.'s Mem. at 13-21.)

         On March 31, 2017, this Court issued an Order in which it DENIED CPS's motion for summary judgment and GRANTED SBA's cross-motion. (See Order of Mar. 31, 2017, ECF No. 37.) This Memorandum Opinion explains the reasons for that Order. In short, and as explained fully below, CPS misreads the Small Business Act and misunderstands the nature of the Section 8(a) program, and as a result, mistakenly maintains that SBA's efforts to ensure that Section 8(a) program applicants have a track record of successful prior business performance are unlawful. To the contrary, the Small Business Act is silent regarding the particular findings that SBA must make when it denies a Section 8(a) program application, and it also does not prescribe the particular manner in which SBA must evaluate a Section 8(a) program applicant's potential for success. Noting this silence, the Court has determined that both SBA's probing potential-for-success regulation and its potential-for-success finding in the instant case are permissible and reasonable in light of the text and purpose of the Small Business Act, and therefore, the Court has concluded that neither agency act is contrary to law. This Court has also found that the record evidence and relevant regulations support SBA's determination that CPS lacked the requisite potential for success and failed to satisfy the economic disadvantage requirement.

         I. BACKGROUND

         A. Statutory And Regulatory Framework: The Section 8(a) Program

         Congress enacted the Small Business Act of 1953 in order to encourage and develop the “capacity of small business” in America, and thereby promote national “economic well-being” and “security[.]” 15 U.S.C. § 631(a). The Act tasks the Small Business Administration with effectuating the statute's purposes and provisions, see Id. § 633(a); per the statute, SBA administers “a preferential contracting program for socially and economically disadvantaged small businesses, ” which is called the Section 8(a) Business Development program, Desa Grp., Inc. v. U.S. SBA, 190 F.Supp.3d 61, 63 (D.D.C. 2016); see also 15 U.S.C. § 637(a)(1).

         Through the Section 8(a) program-which is specifically designed to combat the pervasive effects of discrimination that have historically prevented small, minority-owned businesses from competing on equal footing in the mainstream business economy, see DynaLantic Corp. v. U.S. Dep't of Def., 885 F.Supp.2d 237, 253-57 (D.D.C. 2012); see also Rothe Dev., Inc. v. Dep't of Def., 107 F.Supp.3d 183, 188 (D.D.C. 2015), aff'd, 836 F.3d 57 (D.C. Cir. 2016), petition for cert. filed, (U.S. April 13, 2017) (No. 16-1239)-eligible participants are provided with “technological, financial, and practical assistance, as well as support through preferential awards of government contracts.” DynaLantic Corp, 885 F.Supp.2d at 243. “[A]dmission to the program is highly desirable” because “the SBA may award a subcontract to an 8(a) program participant on a sole source, i.e., noncompetitive, basis, ” Larry Grant Constr. v. Mills, 956 F.Supp.2d 93, 93-94 (D.D.C. 2013) (citations omitted), and also because “[p]rogram participants are eligible to receive management and technical assistance provided through SBA's private sector service providers, including (i) counseling and training in the operation of small business and business development; (ii) assistance in developing comprehensive business plans; and (iii) assistance obtaining equity and debt financing[, ]” DynaLantic Corp, 885 F.Supp.2d at 245; see also 15 U.S.C. § 636(j)(10)(A); 13 C.F.R. § 124.404. Significantly, however, the remedial assistance that the Section 8(a) program offers is available only to those small and minority-owned businesses that are able to satisfy certain criteria set forth in the Act and in SBA regulations.[2]

         As a general matter, in order to qualify for the Section 8(a) program, an applicant must be “[1] a small business which is [2] unconditionally owned and controlled by one or more [3] socially and economically disadvantaged individuals who are of good character and citizens of and residing in the United States, and which [4] demonstrates potential for success.” 13 C.F.R. § 124.101; see also 15 U.S.C. § 637(a)(4)(A), (a)(4)(B), (a)(5), (a)(6)(A), (a)(7)(A). To determine whether a business is considered “small, ” the agency assigns an industry code to each applicant (there are codes associated with all types economic activity, broken down into “twenty broad sectors”), and then uses a table in the regulations to identify the applicant's corresponding “size standard[.]” Id. § 121.101; see also Id. § 124.102(a)(1); id. § 121.201 (“The size standards . . . are expressed either in number of employees or annual receipts in millions of dollars[.]”). The ownership and control requirements are satisfied when a business is “51 percent unconditionally and directly owned” by one or more socially and economically disadvantaged individuals, id. § 124.105, and when one or more disadvantaged individuals conduct the business's “management and daily business operations[, ]” id. § 124.106. See also 15 U.S.C. § 637(a)(4)(A), (a)(4)(B).[3]

         The final two eligibility requirements-“social and economic disadvantage” and “potential for success”-comprise the bulk of the Court's forthcoming analysis, and thus warrant more detailed explanations.

         1. Economically Disadvantaged Individuals

         Section 637(a)(6)(A) of Title 15 of the U.S. Code defines “[e]conomically disadvantaged individuals” as “socially disadvantaged individuals whose ability to compete in the free enterprise system has been impaired due to diminished capital and credit opportunities as compared to others in the same business area who are not socially disadvantaged.” 15 U.S.C. § 637(a)(6)(A); accord 13 C.F.R. § 124.104(a). As previously noted, it is undisputed that CPS is led by a socially disadvantaged individual (see supra n. 3); consequently, the economic disadvantage criterion is what is at issue here. In order to determine whether a socially disadvantaged individual has experienced “diminished capital and credit opportunities, ” SBA's regulations provide that the agency will examine the individual's “income for the past three years . . ., personal net worth, and the fair market value of all assets, whether encumbered or not.” 13 C.F.R. § 124.104(c). An individual who exceeds any of the applicable thresholds for personal income, net worth, or total assets “will generally be deemed . . . not economically disadvantaged.” Id.

         With respect to the applicable threshold for an individual's personal income, SBA's regulations provide: “If an individual's adjusted gross income [“AGI”] averaged over the three years preceding submission of the 8(a) application exceeds $250, 000, SBA will presume that such individual is not economically disadvantaged.” Id. § 124.104(c)(3)(i). In order to calculate the aforementioned AGI, the regulation specifies that

[i]ncome received from an applicant or Participant that is an S corporation, LLC or partnership will be excluded from an individual's income where the applicant or Participant provides documentary evidence demonstrating that the income was reinvested in the firm or used to pay taxes arising in the normal course of operations of the firm.

Id. § 124.104(c)(3)(ii). In other words, income that (1) an individual receives from a business that is a Section 8(a) program applicant or Participant that (2) that individual reinvests into the applicant or Participant company, will be excluded from the individual's personal income calculation, so long as the applicant or Participant is an S corporation, LLC, or partnership and provides documentary evidence demonstrating the reinvestment. See id.

         2. Potential For Success

         The Small Business Act also expressly conditions entry into the Section 8(a) program on SBA's determination that, with SBA support, the applicant business will be able to perform contracts awarded through the program and has the potential to succeed in the private sector. The Act states:

No small business concern shall be deemed eligible for any assistance pursuant to this subsection unless the Administration determines that with contract, financial, technical, and management support the small business concern will be able to perform contracts which may be awarded to such concern under paragraph (1)(C) and has reasonable prospects for success in competing in the private sector.

15 U.S.C. § 637(a)(7)(A).

         An SBA regulation further expounds upon the “reasonable prospects for success” requirement, providing that an applicant will be deemed to possess reasonable prospects for success in competing in the private sector if it has been “in business in its primary industry classification for at least two full years immediately prior to the date of its 8(a) BD application[.]” 13 C.F.R. § 124.107. “To satisfy this two-years-in-business rule, the applicant must provide tax returns for the two previous years ‘show[ing] operating revenues' in the industry to which it is applying.” Ardmore Consulting Grp., Inc. v. Contr eras-Sweet, 118 F.Supp.3d 388, 390 (D.D.C. 2015) (alteration in original) (quoting 13 C.F.R. § 124.107(a)). Moreover, per the regulation, an applicant business that cannot satisfy the two-years-in-business rule may nevertheless be deemed to have the potential for success if the applicant meets five enumerated conditions and SBA, in its discretion, decides to grant the applicant a waiver of the two-year rule. See 13 C.F.R. § 124.107(b)(1) (“SBA may waive the two years in business requirement if each of the following five conditions are met[.]”). To be eligible for such a waiver, the applicant business must, inter alia, have “a record of successful performance on contracts from governmental or nongovernmental sources in its primary industry category[.]” 13 C.F.R. § 124.107(b)(1)(iv).[4]

         B. Background Facts

         In March of 2014, CPS-a corporation that provides workforce and organizational improvement solutions-applied for admission into the Section 8(a) program. (See Def.'s Mem. at 6, 7; Pl.'s Mem. at 6.) SBA denied CPS's application approximately six months later, citing a variety of reasons for this decision, including that: (1) Cassandra Coleman, the individual upon whom CPS based its eligibility, was not economically disadvantaged; (2) CPS failed to meet the unconditional ownership requirement; (3) CPS failed to comply with the requirements governing the participation of non-disadvantaged individuals; and (4) CPS had not demonstrated the requisite reasonable prospects for success because it could not satisfy the two-years-in-business rule and did not meet the conditions for a waiver of this requirement. (See Letter from Assoc. Admin., SBA, to Cassandra Coleman (Sept. 17, 2014) (“Initial Denial Letter”), ECF No. 30-2, J.A. at 20-25.)

         In response to SBA's denial of its application, CPS timely filed a reconsideration request, in which it provided additional information addressing SBA's stated concerns. (See Reconsideration Request, ECF Nos. 30-4 to 30-6, J.A. at 44-327.) SBA reviewed CPS's request for reconsideration, but concluded that CPS had provided insufficient evidence to warrant rescinding the denial. (See Final Denial Letter, J.A. at 29.) In its final denial letter, dated November 6, 2014, SBA reaffirmed all of its original reasons for denying CPS's application (see id., J.A. at 29-34); two of these reasons are discussed at length below.[5]

         1. SBA's Findings Regarding CPS's Prospects For Success

         In its final denial letter, SBA concluded that CPS had failed to meet a number of criteria which, under 13 C.F.R. § 124.107, are necessary to demonstrate reasonable prospects for success. (See id., J.A. at 32-34.) First, SBA concluded that CPS had “not generated revenues in its primary industry for two consecutive years[, ]” and therefore failed to satisfy the two-years-in-business requirement. (Id., J.A. at 32.)

         SBA also found that CPS had not satisfied two out of the five criteria for a waiver of the two-years-in-business requirement. (See id., J.A. at 33.) Specifically, SBA noted that CPS had failed to demonstrate “a record of successful performance on contracts from governmental or nongovernmental sources in its primary Industry category[, ]” as required by 13 C.F.R. § 124.107(b)(1)(iv). (Id.) SBA acknowledged that CPS had recently changed its primary industry code, but the lack of evidence of completed contracts in CPS's (current) primary industry meant that SBA was unable to “verify a track record of performance on contracts from governmental or nongovernmental sources in [CPS's] primary industry.” (Id.) SBA further concluded that CPS did not have “adequate capital to sustain its operations and carry out its business plan as a Participant”-another requirement for a waiver of the two-years-in-business rule, see 13 C.F.R. § 124.107(b)(1)(iii)- because CPS had “only generated a small portion of its sales from” the industry code under which it sought certification and had “generated most of its revenues” from its former industry code. (Id., J.A. at 33.)

         2. SBA's Findings Regarding Economic Disadvantage

         SBA also determined that CPS had failed to satisfy the economic disadvantage requirement because Coleman had averaged an adjusted gross income in excess of $250, 000 over the previous three years. (See id., J.A. at 30.) SBA specifically noted that Coleman had listed her AGI on her IRS 1040 Forms as follows: $260, 107 (2013), $1, 084, 957 (2012), and $67, 833 (2011). (See id.) SBA took the average of these three figures to arrive at a three-year AGI of over $400, 000, which exceeded the applicable $250, 000 threshold and thus triggered a presumption that Coleman was not economically disadvantaged. (See id.) See also 13 C.F.R. § 124.104(c)(3)(i).

         SBA further explained its reasons for rejecting the alternative calculation that CPS had proffered in its reconsideration request. (See Final Denial Letter, J.A. at 30.) CPS argued that SBA should have excluded from its calculation of Coleman's 2012 AGI approximately $922, 000 that Coleman received as income from an organization called Harvest Professional Services Company (“Harvest”). (See Reconsideration Request, J.A. at 49-50; see also Final Denial Letter, J.A. at 30.) Coleman had purportedly invested this $922, 000 from Harvest into CPS, and CPS argued that, per 13 C.F.R. § 124.104(c)(3)(ii)- which is quoted above-SBA should have excluded this income from Coleman's AGI. (See Reconsideration Request, J.A. at 49-50; see also Pl.'s Mem. at 7-8.) SBA responded that “[s]ince Harvest Professional Services Company is not the applicant or Participant, income from this company cannot be excluded” under that regulation, and “there are no provisions in the regulations for excluding the Income from Harvest Professional Services Company[, ]” as CPS had requested. (Final Denial Letter, J.A. at 30; see also Id. (noting that CPS's “request to exclude this income was reviewed by Senior Legal Counsel, who concurred that this income could not be excluded and that your adjusted average three year income was excessive”).)

         C. ...


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