Environmental Energy Associates, Inc., No. MSB-535 (December 14, 1995) Docket No. MSBE-95-9-29-20 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. ______________________________ ) IN THE MATTER OF: ) ) Docket No. MSBE-95-9-29-20 Environmental Energy ) Associates, Inc. ) ______________________________) APPEARANCES For the Petitioner: For the Agency: Balu Kamat John T. Spotila, Esq. Environmental Energy General Counsel Associates, Inc. Audrey H. Liebross, Esq. 560 Columbia Ave. Agency Representative Ridgefield, NJ 07657-1944 Small Business Administration 409 Third Street, SW Washington, DC 20416 DIGEST A provision in the bylaws of an 8(a) applicant firm which requires that two Directors who are "members of a legally recognized minority" are necessary to establish a quorum is not effective to ensure that there is disadvantaged control of the firm's Board of Directors. Disadvantaged control is control by individuals determined by the SBA to be socially and economically disadvantaged. 13 C.F.R. Section 124.104. Owners who are required to manage and control a firm applying for admission into the 8(a) program must be United States citizens and determined by the SBA to be socially and economically disadvantaged. Claiming to be a member of a "legally recognized minority" does not satisfy this requirement. To be in control, the socially and economically disadvantaged individuals must control the Board of Directors of the applicant firm in "actual numbers of voting directors." 13 C.F.R. Section 124.104(b). Nondisadvantaged individuals may be found to control or have the power to control a firm if they control the voting Board of Directors either directly through majority voting membership, or indirectly, if the bylaws allow nondisadvantaged individuals to block any action proposed by the disadvantaged individuals through negative control. An equal number of disadvantaged and nondisadvantaged voting directors could create negative control. FINAL DECISION December 14, 1995 ARKOW, Administrative Law Judge: Petitioner Environmental Energy Associates, Inc. (EEA) challenges a decision of the Respondent U.S. Small Business Administration (SBA) denying it entry into the 8(a) program[1] because the individual upon whom eligibility is based, Mr. Balu Kamat, does not control EEA or its Board of Directors. EEA claims that decision is arbitrary, capricious, and contrary to law because it established that Mr. Kamat controls EEA and its Board of Directors. I disagree. Jurisdiction Jurisdiction on appeal is properly based on 15 U.S.C. Section 637(a)(9) and 13 C.F.R. Parts 124 and 134. The appeal was timely filed under 13 C.F.R. Sections 124.210(b) and 134.11(a)(7). Issue Whether the action of the SBA denying EEA entry into the 8(a) program is arbitrary, capricious, or contrary to law. 15 U.S.C. Section 637(a)(9)(C), 13 C.F.R. Section 124.210(h)(1). Facts On December 21, 1994, EEA applied for admission into the 8(a) program. The basis for the application is that EEA is owned and controlled by Balu Kamat, a socially and economically disadvantaged individual. Mr. Kamat, an American citizen of Indian descent, is presumed to be socially disadvantaged because he is a "Subcontinent Asian American."[2] The SBA denied the application on May 19, 1995. EEA requested the SBA reconsider its decision on June 21, 1995 and submitted additional evidence with its request. On August 14, 1995, the SBA denied EEA's reconsideration request and EEA filed an appeal of that denial on September 29, 1995. The SBA found that EEA was unable to demonstrate that Mr. Balu Kamat, the individual upon whom eligibility is based, controlled EEA and its Board of Directors. Specifically, the SBA stated: You, the individual upon whom eligibility is based, do not control the applicant concern since you do not control its Board of Directors. You provided an amendment to the concern's by-laws which established the number of Directors at four (4). Your son, Mihir Kamat, was elected as a disadvantaged Director. The amendment also provides that three (3) Directors shall establish a quorum and two (2) of the Directors must be "members of a legally recognized minority." Although you have provided documentation to allow us to evaluate your son's personal eligibility as one of the firm's disadvantaged Directors, the statement "members of a legally recognized minority" does not satisfy the Code of Federal Regulations, Sections 124.105 and 124.106 governing the social and economic disadvantage status of an 8(a) applicant. Consequently, the applicant concern has two (2) Board members who are not determined by the SBA to be socially and economically disadvantaged and two (2) who have been determined to be disadvantaged. Since the amendment to the bylaws does not specifically name which three (3) Directors will establish a quorum, nondisadvantaged Directors have the ability to control the Board and can out vote [sic] you two to one. Reconsideration Denial Letter at 1-2. Position of the Parties EEA contends in its appeal that Mr. Kamat controls the firm and its Board of Directors. It reasons that if the current Board should decide a matter with which Mr. Kamat disagrees, as the majority shareholder, he can call a special meeting of the Board of Directors, remove any Director who opposes him, without cause, and appoint Directors who will not oppose him. EEA also contends that its bylaws provide for a quorum with at least two "members of a legally-recognized minority" out of a four-person Board. Thus, EEA claims, the SBA's conclusion is contrary to law. The SBA argues in its answer that there are two problems with the way the Board of Directors is constituted. First, if all four Directors are present at a meeting, then the two disadvantaged Directors could not outvote the two nondisadvan- taged Directors. The two nondisadvantaged Directors, however, could exercise negative control over the Board of Directors by blocking proposals of the disadvantaged Directors. Second, a provision in the bylaws provides that a quorum of the Board of Directors "shall be three (3) Directors, at least two of whom shall be members of a legally recognized minority." Appeal Petition at 6. This permits a quorum with "legally recognized minority" members who are not necessarily socially and economically disadvantaged individuals, as required by 13 C.F.R. Section 124.104(b). Discussion The only substantive issue to be resolved in this matter is whether the SBA properly concluded that Mr. Kamat did not control EEA or its Board of Directors. For a firm to be eligible for admission into the 8(a) program it must, among other requirements, be managed and controlled by owners who have been determined by the SBA to be socially and economically disadvantaged. 13 C.F.R. Section 124.104. Such a determination is made through the 8(a) application and evaluation process. See also the definition of "disadvantaged individual" in 13 C.F.R. Section 124.100. This requirement is not necessarily met by individuals who are members of a legally recognized minority. For example, Mrs. Kamat is a Subcontinent Asian but is not a U.S. citizen. Thus, while she is a member of a legally recognized minority she cannot be considered disadvantaged and eligible for the 8(a) program because she is not a citizen. See 13 C.F.R. Section 124.103. Other examples include individuals who are socially but not economically disadvantaged and individuals who have already participated in and exited the 8(a) program. 13 C.F.R. Sections 124.106 & 124.108(c). Accordingly, the provision in the bylaws of EEA, which requires that two Directors who are "members of a legally recognized minority" are necessary to establish a quorum, is not effective to ensure that there is disadvantaged control of the EEA Board of Directors. See Facts, supra. To be in control, the socially and economically disadvantaged individuals must control the Board of Directors of the applicant firm in "actual numbers of voting directors." 13 C.F.R. Section 124.104(b). By way of illustration, Section 124.104(d)(1) suggests that nondisadvantaged individuals may be found to control or have the power to control a firm if they control the voting Board of Directors either directly through majority voting membership, or indirectly, if the bylaws allow nondisadvantaged individuals to block any action proposed by the disadvantaged individuals through negative control. Thus, "an equal number of disadvantaged and nondisadvantaged voting directors could create negative control." Id. The SBA, therefore, was correct when it advised EEA, that because it has two Board members who have been determined to be disadvantaged and two who have not been determined to be disadvantaged, nondisadvantaged individuals exercise negative control over EEA's Board of Directors. The SBA was also correct in advising EEA that appointing nondisadvantaged individuals who are members of a legally recognized minority does not avoid the problem of nondisadvantaged control of the Board of Directors. EEA was correct when it concluded that Mr. Kamat can ultimately control the Board of Directors because he is the majority shareholder and has the power to reconstitute the Board to assure his control is absolute. But, as decided in earlier decisions: [I]t matters not at all what the disadvantaged owner is able to do at some future time to gain control of the applicant firm; "[i]t is the situation that existed at the time [when the application was finally decided] that is pertinent." See Matter of L.C. Associates, Inc., No. 370 (April 9, 1991). Matter of Premier Abatement Technologies Corporation, SBA No. 468 (1994). Accordingly, the SBA was correct in concluding that Mr. Kamat did not control the Board of Directors of EEA as required by 13 C.F.R. Section 124.104(b).[3] Conclusion Respondent's August 14, 1995 determination denying 8(a) program entry to Petitioner, Environmental Energy Associates, Inc. is NOT ARBITRARY, CAPRICIOUS, OR CONTRARY TO LAW. See 15 U.S.C. Section 637(a)(9)(C), 13 C.F.R. Section 124.210(h)(1). This is the final decision of the Small Business Administration and is binding upon all parties, including those within the employ of the Agency. 15 U.S.C. Section 637(a)(9)(D), 13 C.F.R. Sections 124.210(i), 134.32(a)(4). ______________________________ Richard S. Arkow Administrative Law Judge ____________________ [1] Small Business Act of 1958, Section 8(a), 15 U.S.C. Section 637(a) and 13 C.F.R. Part 124. "The 8(a) Program is intended to be used exclusively for business development purposes to help small businesses owned and controlled by socially and economically disadvantaged individuals. . . ." 13 C.F.R. Section 124.1(a). [2] See 13 C.F.R. Section 105(b). [3] Counsel for the SBA suggests that the issue of control of the Board of Directors can be easily resolved to permit a conclusion that Mr. Kamat or other socially and economically disadvantaged individuals control the Board. If so, EEA may reapply for admission into the 8(a) program 12 months after date of this decision if it remedies this problem and otherwise continues to meet 8(a) eligibility criteria.