Joanna T. Lau and Lau Acquisition Corporation, No. MSB-407 (July 20, 1992) Docket No. MSBE-91-8-12-18 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. 20416 IN THE MATTER OF: ) ) Joanna T. Lau and ) Docket No. MSBE-91-8-12-18 Lau Acquisition Corporation ) d/b/a Lau Technologies ) APPEARANCES For the Petitioner: For the Agency: Jay P. Urwitz, Esq. Michael K. Wyatt, Esq. Hale and Dorr, Attorneys General Counsel 1455 Pennsylvania Avenue, N.W. Gail D. Reinhart, Esq. Washington, DC 20004 Agency Representative Small Business Administration Charles J. Johnson, Esq. 409 Third Street, S.W. Finnegan and Stanzler, P.C. Washington, DC 20416 20 Beacon Street Boston, MA 02108 DIGEST The regulations published at 54 Federal Register 34692, et seq., on August 21, 1989 and codified at 13 CFR Part 124 must be used to evaluate all applications for participation in the Agency's 8(a) program pending as of August 21, 1989 or filed thereafter. 13 CFR 124.1(a)(2)(i). An applicant for participation in the Agency's 8(a) program has the burden of proving, by a preponderance of the evidence, all elements of its eligibility; however, entitlement to a socially disadvantaged status being sought by an individual who is not a member of a designated group must be proved by clear and convincing evidence. Ordinarily, in order to be eligible to participate in the Agency's 8(a) program, an applicant concern must be one which is at least 51 percent unconditionally owned by an individual who is determined by SBA to be socially and economically disadvantaged, and the socially and economically disadvantaged individual upon whom eligibility is based must control the board of directors and the day-to-day operations of the applicant firm. 13 CFR 124.103; 13 CFR 124.104(b). Economically disadvantaged individuals are 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 or a similar line of business who are not socially disadvantaged; and economic disadvantage, or the lack thereof, can be determined only if the applicant concern's business and financial profile is compared with the profiles of businesses that are not owned and controlled by socially disadvantaged individuals. While the Agency's 8(a) program is not intended to assist con- cerns owned and controlled by socially disadvantaged individuals who have accumulated substantial wealth, who have unlimited growth potential or who have not experienced, or have experienced but overcome, impediments to obtaining access to financing, markets and resources, the accumulation of "substantial wealth" and "unlimited growth potential" are relative terms, and compari- son of the "wealth" and "potential" of the individual being considered with that of individuals who are not socially disad- vantaged is a prerequisite if adverse determinations are to be based on conclusions resulting from those findings. When an applicant concern claiming economic disadvantage has adduced substantial evidence to meet its burden of proof, it is unreasonable for the AA/MSB&COD to reach a negative conclusion regarding that firm's economic disadvantage without making a comparison of the firm's access to credit and capital oppor- tunities with the access of other firms in the same or a similar line of business that are not socially disadvantaged. An Agency determination that an applicant is not economically disadvantaged will be found to be contrary to law if the claim was evaluated under a standard other than the one clearly mandated by the regulations; when the regulations explicitly set out a standard of evaluation, the Agency's adoption of a different standard found nowhere in the regulations will be judged to be an arbitrary and capricious act. FINAL DECISION July 20, 1992 Jurisdiction Authority for these proceedings is found in Section 409 of the Business Opportunity Development Reform Act of 1988, Public Law 100-656 (Section 7(j) of the Small Business Act of 1958, as amended; 15 U.S.C. 636(j)), hereinafter referred to as "the Act," and in the regulations codified at 13 CFR Parts 124 and 134, which are referred to hereinafter by section numbers only. Issues In evaluating the Petitioner's claim of economic disadvantage, did the Associate Administrator follow the regulations set forth in 124.106; and, if not, was the Associate Administrator's failure to follow the regulations arbitrary and capricious or contrary to law? Facts The Petitioner applied for admission to the Agency's Section 8(a) program on July 24, 1990, subsequently supplying information to substantiate its eligibility, and, on February 12, 1991, the Associate Administrator 1/ issued his determination of the Petitioner's eligibility, in pertinent part, as follows: 1) It has been determined that you [Joanna T. Lau], the individual upon whom eligibility is based, have not been found to be socially and economically disadvantaged. The Associate Administrator cited four additional factors leading to a determination of ineligibility and invited the Petitioner to submit evidence to refute the findings. On March 18, 1991, the Petitioner submitted additional evidence as suggested and sought a reconsideration of the denial of eligibility in a nine-page letter with 51 pages of exhibits. After consideration of the additional evidence, the AA/MSB&COD again denied the application in a letter addressed to Joanna T. Lau, dated June 28, 1991, which reads, in pertinent part, as follows: After a careful review of the material that you sub- mitted with your request for reconsideration, it has been determined that you have not provided sufficient documentation to overcome four of the five original reasons for decline. The following conditions have not been met: 1) You have not presented sufficient new evidence to allow us to conclude that you are economically disadvantaged. While you have referenced several instances of discrimination and diminished access to credit and capital, the fact remains that you were able to secure financing through Shamut [sic] Bank for the acquisition of the firm, and you have access to a sub- stantial working capital line of credit. The Agency conceded that the three remaining issues were secondary to the major issue of the applicant's economic disadvantage. 2/ The Petition for my review was timely filed by the Petitioner's Counsel on August 12, 1991. Counsel for the Petitioner argues initially that the determin- ation regarding Lau's economically disadvantaged status is arbitrary, capricious and contrary to the law and regulations because the AA/MSB&COD "ignores the standard by which economic disadvantage is to be gauged, [i.e., the requirement in the regulations] that capital and credit opportunities be assessed in comparison 'to others in the same or similar line of business who are not socially disadvantaged.'" Counsel points out that "[t]here is absolutely no evidence of such findings" in the record and argues further: If [the Associate Administrator] had done such an analysis it would have been clear that the credit and capital opportunities available to the Petitioner are: 1) substantially diminished when compared to the huge companies which are her [sic] competitors, and 2) they are, at the least, "likely" to preclude her [sic] from competing in the open market. Indeed, lack of capital is precluding such competition already. With reference to the stated bases for the determination that economically disadvantaged status is lacking, Counsel for the Petitioner argues that the AA/MSB&COD's conclusion that the Petitioner was able to secure limited financing and is thus not economically disadvantaged is not an adequate basis. "Indeed," Counsel asserts, "access to limited financing is necessary to prove that a concern has a potential for success." 3/ Further, Counsel argues, the record includes no evidence of "the level of credit, amount of resources, or number of contracts possessed by the Petitioner's competitors," and, therefore, the Associate Administrator "has not 'clearly enunciated [his] reasoning and [the] bases for that reasoning"' as required by prior decisions of this Office. In the Agency Response, Counsel addresses only two of the "four reasons for the decline" and "agree[s] with Petitioner that the major issue in its appeal is whether Ms. Lau is economically disadvantaged, since three of the four reasons for decline are dependent on the finding that she is not." Counsel contends that the Agency's finding of a lack of economically disadvantaged status is "supported by the record" and the regulations, refer- ring to the regulation at 124.106(a)(ii), "which provide[s] that the 8(a) program 'is not intended to assist concerns owned and controlled by socially disadvantaged individuals...who have overcome impediments to obtaining access to financing, markets and resources."' Counsel cites Lau's ability to obtain financing to purchase the Petitioner, the firm's line of credit for working capital, its backlog of orders, and its "attendant relationships with Federal procuring agencies and prime contractors." Further, she points out that the "Petitioner's total sales for the first 10 months of 1990 were virtually identical to [its predecessor's] total sales during 1988 and 1989" and avers that "this fact supports the conclusion that [the] Petitioner has not been hurt by the change from socially nondisadvantaged to socially disadvantaged ownership." The Agency's Counsel derides the argument of the Petitioner's Counsel "that the AA/MSB&COD's [determination] is arbitrary and capricious because it did not make a numerical comparison between the amount of credit and capital available to [the] Petitioner and that available to certain 'huge companies'...it competes with" and avers that this argument "totally ignores half of the definition contained in [the] regulatory provision [found at 124.106(a)(i), which] requires that an individual show not only that her opportunities to obtain capital and credit have been diminished, but also that 'such diminished opportunities have precluded or [are] likely to preclude such individual from competing in the open market."' (Emphasis in original.) She argues that Ms. Lau and Bowmar/Ali, her predecessor in the business, have competed successfully in the open market since 1952, and that there is no evidence that the degree of the Petitioner's success is likely to diminish. Because the record did not provide enough information to enable me to determine what factors the Associate Administrator had considered in arriving at a determination that the Petitioner was not economically disadvantaged, I remanded the case for further elucidation of the issue with attention to the comparison of the Petitioner's financial condition required by the regulation at 124.106. The Agency's "Decision on Remand," filed on March 13, 1992, recites the results of a comparison performed by the Associate Administrator's staff of the Petitioner's financial condition with that of other companies within SIC code 3812 and of a size similar to Petitioner's. Discussion As with all controversies arising out of disputes between the Agency and applicants for admission to the 8(a) Program, the question of whether this applicant is economically disadvantaged must be decided above all with reference to the applicable statutes and regulations. Of course, the ultimate application of the law must be informed by due regard for inferences that reasonably flow from the language of the law. In evaluating the Applicant's claim of social and economic disadvantage, the Associate Administrator has strayed from the clear, denotative meaning of the regulations. Further, the Associate Administrator followed directives she apparently found implied in the regulations, directives that simply are not there. Because of the former error, the Associate Administrator's finding that Lau is not economically disadvantaged is contrary to law. Because of the latter error, that finding is arbitrary and capricious. "The 8(a) Program is intended...to help small businesses owned and controlled by socially and economically disadvantaged individual[s]." Section 124.1(a)(1). The regulation found at 124.106(a)(2) requires the Agency to determine whether an individual is economically disadvantaged by evaluating three factors, two of which are at issue here: [1] [t]he financial condition of the applicant concern; [2] and the applicant concern's access to credit, capital and markets. An applicant concern's financial condition is to be evaluated by comparing it to that of other concerns "in the same or similar line of business which are not owned and controlled by socially and economically disadvantaged individuals." Section 124.106(2)(i)(C)(5)(ii). In evaluating an applicant concern's access to credit and capital, the Agency must consider a number of factors, including, but not limited to: "Access to long-term financing; access to working capital financing; equipment trade credit; access to raw materials and/or supplier trade credit; and bonding capability." Section 124.106(2)(i)(C)(5)(iii) The regulation found at 124.106(a) defines economically disadvantaged individuals as those: [w]hose ability to compete in the free enterprise sys- tem has been impaired due to diminished capital and credit opportunities as compared to others in the same or similar line of business who are not socially dis- advantaged.... In determining economic disadvantage ...SBA shall compare the applicant concern's business and financial profile with profiles of businesses in the same or similar line of business.... [Emphasis added.] The regulations leave no room for doubt as to the appropriate pool of firms to which the applicant concern must be compared. The phrase "same or similar line of business" is defined in the regulation found at 124.100: Same or similar line of business means all business activities within the same two-digit "Major Group" of the Standard Industrial Classification (SIC) System (set forth in the SIC Manual), as the primary industry classification of the applicant concern. The Petitioner proposed that the Agency compare it to its actual competitors and provided the Agency with a list of those com- petitors. The Agency rejected this approach, substituting as the comparison pool firms that fall within SIC code 3812 and are similar in size to the Petitioner. 4/ The regulations concerning a determination of economic disadvantage make no reference to size, only to the line of business. The definition of "same or similar line of business" does not include a size limitation. The group of businesses to be included in the pool is to be derived from the SIC Manual. 5/ The SIC Manual does not attach a size standard to the SIC codes. The Associate Administrator argues that the pool of companies selected for the comparison is an appropriate pool because it was assembled based on size and SIC code. This may be intuitively satisfying. From a business point of view, it may even be more apt than the pool mandated by the regulations. But therein lies the fatal flaw in the Associate Administrator's analysis. The comparison she performed falls hopelessly short of the mark because it bears no resemblance to the comparison that the regulations explicitly state should be made and which I directed the Agency to make, namely, a comparison of the Petitioner's financial condition to that of other firms in the same or similar line of business. Despite the explicit directive contained in the regulations, the Associate Administrator compared the Petitioner's financial condition (as measured by several standard indicators) to that of firms within SIC code 3812 whose sizes were similar to the Petitioner's. 6/ I need not be convinced that the Associate Administrator's fail- ure to use the correct pool of companies, viz., all of Major Group 38, did in fact cause an outcome different from that which would have resulted had the correct pool been used. Rather, it is sufficient that I be convinced that a different outcome might have resulted. In the face of the Agency's manifest failure to adhere to the regulations, I am compelled to find that the Agency acted contrary to law. In light of the explicit directive of the regulations, the Agency's use of an analysis different from that mandated by the regulations is arbitrary and capricious. It is beyond peradventure that an agency is bound to follow its own regulations. 7/ Conclusion Because the Associate Administrator, failing to comply with my remand order and disregarding the clear mandate of the regula- tions, compared the applicant firm to a pool of businesses other than, and not at all equivalent to, the pool clearly mandated by the regulations found at 124.106(a) and 124.100, her deter mination that the Petitioner is not economically disadvantaged is ARBITRARY, CAPRICIOUS, AND CONTRARY TO LAW. This constitutes the final decision of the Small Business Admin- istration, and it is binding upon the Petitioner, the Agency and those within the employ of the Agency. See 124.210(i). _____________________________ Benjamin G Usher Administrative Law Judge __________________________ 1/ The Agency's Associate Administrator for Minority Small Business and Capital Ownership Development may be referred to herein as the Associate Administrator or the AA/MSB&COD, and either term will denote the Acting Associate Administrator, if applicable. 2/ In the Agency Response to the Petition, filed on September 27, 1991, Counsel for the Agency "confesses error" with respect to that part of the denial based upon Lau's inability to establish a quorum of the firm's board of directors inasmuch as "that reason is based on Petitioner's old (August 8, 1990) quorum rule, rather than on the revised rule adopted on March 1, 1991 and submitted to the Agency as part of the reconsideration request...." 3/ Counsel cites Neuma Corp. v. Abdnor, 713 F. Supp. 1 (D.D.C. 1989) to support that proposition. 4/ In the AGENCY'S DECISION ON REMAND, in a section entitled "LAU TECHNOLOGIES, BUSINESS FINANCIAL CONDITION," the Agency lists as an "Assumption:" 1. Financial analysis for May 27, 1990 was compared to SIC code 3812 (Search, Detection, Navigation, Guidance, Aero- nautical, and Nautical Systems, Instruments, and Equipment) Attached [sic]. 5/ The Standard Industrial Classification Manual, 1987 Edition; Executive Office of the President, Office of Management and Budget. 6/ Major Group 38 is considerably different inasmuch as it encompasses 16 businesses in addition to those listed under SIC code 3812. Businesses categorized under Major Group 38 manufacture diverse goods from watches to prosthetic devices to photographic equipment. 7/ In enunciating this long-settled principle, the Supreme Court wrote: [r]egulations validly prescribed by a government administrator are binding upon him as well as the citizen.... Service v. Dulles, 354 U.S. 363, 372, 77 S.Ct. 1152, 1160, 1 L.Ed.2d 1403, 1410 (1957).