Unified Industries, Incorporated , No. SDBA-131 (March 9, 2000) Docket No. SDBA-99-11-03-29 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. ____________________________________ ) IN THE MATTER OF: ) ) Docket No. SDBA-99-11-03-29 Unified Industries, Incorporated ) ) Decided: March 9, 2000 Petitioner ) ____________________________________) APPEARANCES Craig Anderson, Esq. For Unified Industries, Incorporated Kenneth W. Dodds, Esq. For the Small Business Administration DIGEST An applicant firm whose voting stock is 49.9% owned by a partnership, which in turn is owned and controlled by socially and economically disadvantaged individuals, fails to satisfy the regulatory requirement of direct ownership by disadvantaged individuals. The Administrative Judge lacks authority to remand an SDB application to the AA/SDBCE for reconsideration, based on changes to the applicant firm's ownership occurring after the AA/SDBCE denied the application. INITIAL DECISION BLAZSIK, Administrative Judge: Jurisdiction This appeal petition is decided under the Small Business Act of 1958, 15 U.S.C. Sections 631 et seq.; and 13 C.F.R. Parts 124 and 134 (1999). Issues Whether an applicant firm whose voting stock is 49.9% owned by a partnership, which in turn is owned and controlled by socially and economically disadvantaged individuals, satisfies the regulatory requirement of direct ownership by disadvantaged individuals. Whether the Administrative Judge has authority to remand an SDB application to the AA/SDBCE for reconsideration, based on changes to the applicant firm's ownership occurring after the AA/SDBCE denied the application. Background On June 23, 1999, Unified Industries, Incorporated (Petitioner), applied for certification as a Small Disadvantaged Business (SDB) to the Small Business Administration's (SBA) Acting Associate Administrator for Small Disadvantaged Business Certification and Eligibility (AA/SDBCE). 13 C.F.R. Section 124.1008(a). In the original SDB application, three individuals claimed disadvantaged status: Theodore A. Adams Jr. (Mr. Adams Jr.), Theodore A. Adams, III (Mr. Adams, III), and Herbert E. Long Jr. Petitioner made additional submissions to the AA/SDBCE on June 29th, July 15th, 21st, and 29th, and October 1st. The June 29th submission included additional financial information requested by the BOS, and clarified that Petitioner's eligibility would depend solely on Mr. Adams Jr., and Mr. Adams, III (the Adamses). The July 15th and 21st submissions answered questions on stock ownership and voting. The July 29th submission discussed Petitioner's position that its current ownership arrangement satisfies the requirement of direct ownership by disadvantaged individuals. In September 1999, [1] the BOS and an SBA staff attorney met with Petitioner's General Counsel to discuss the direct ownership requirement with him and inform him how Petitioner could satisfy that requirement. On October 1, 1999, Petitioner submitted additional argument supporting its position that its current ownership arrangement is the "functional equivalent" of direct ownership. Petitioner further stated that, if SBA's "senior legal review level" disagreed with this position, Petitioner "would be willing to discuss progressive steps" to change its ownership structure to satisfy the regulatory requirement. Although Petitioner mentioned several possible alternatives, the October 1st submission made clear that Petitioner had not yet implemented any of them. On October 15, 1999, the AA/SDBCE issued her determination, denying SDB certification. Petitioner filed an Appeal Petition with the Office of Hearings and Appeals (OHA) on November 3, 1999. On November 4, 1999, the Administrative Judge issued a Notice and Deficiency Order, ordering Petitioner to correct specific deficiencies in its Appeal Petition. On November 16, 1999, Petitioner filed an amended Appeal Petition. On January 3, 2000, SBA submitted its Answer and the Administrative Record (AR). SBA requested permission to withhold portions of three documents (Exhibits C, O, and S), asserting the deliberative process privilege and the attorney-client privilege. Petitioner did not object. The Administrative Judge granted the request on January 13, 2000. Facts The Administrative Judge finds the following facts, based on the AR and Petitioner's admissions, are undisputed. Petitioner was incorporated on August 6, 1970. Its primary Standard Industrial Classification code is 8711 (Engineering Services), with a corresponding $20 million average annual receipts size standard. Petitioner's Federal income tax returns for 1995, 1996, and 1997 show its average annual receipts for those years were below the applicable size standard. Mr. Adams Jr. directly owned the majority of Petitioner's stock until October 20, 1998. On that day, he and his family executed several stock transactions for estate planning purposes. These transactions transferred most of his stock in Petitioner through his and his wife's living trusts, and into The Theodore A. Adams Jr. Family Limited Partnership (the Partnership). AR, Tabs B and Q. As of October 15, 1999, the Partnership owned 49.9% of Petitioner's stock; Mr. Adams Jr. owned 0.0%; Mr. Adams III owned 1.2%; and various other individuals owned the rest. Id. The SBA Determination On October 15, 1999, the AA/SDBCE issued her determination denying Petitioner SDB certification, because the disadvantaged individuals upon whom Petitioner's claim of eligibility is based do not meet the direct ownership test set forth in the SDB regulations. Specifically, the fact that the Partnership owns the majority of Petitioner's outstanding stock violates the direct ownership test, even if Mr. Adams Jr. controls and owns the Partnership. . The Appeal Petition Petitioner attached to its Appeal Petition an October 21, 1999 letter it had sent to the AA/SDBCE. This letter referred to the October 15th decline letter, and stated Petitioner intended sometime in the future to make various stock transfers to restore direct ownership to the Adamses. On December 13, 1999, Petitioner filed with this Office a copy of a letter addressed to SBA's counsel. This letter stated Petitioner had completed the stock transfers discussed in its October 21st letter, and included evidence of the completed transactions. As to the merits, Petitioner asserts the Adamses' ownership of Petitioner, through the Partnership (which Mr. Adams, Jr. and his wife control), is the functional equivalent of direct ownership of Petitioner by disadvantaged individuals, as required by the SDB regulations. Petitioner also asserts the Partnership includes living trusts, an exception to the direct ownership requirement authorized by the SDB regulation. Therefore, the AA/SDBCE's denial of SDB certification was arbitrary, capricious, and contrary to law. Petitioner also asserts the SBA staff's processing of Petitioner's application was arbitrary, capricious, and contrary to law. Specifically, Petitioner asserts the staff refused to seek "higher level" review of the SBA attorney's conclusions; the staff did not respond to Petitioner's October 1, 1999 offer to modify its ownership arrangement to conform to SBA's position; and the staff failed to respond to Petitioner's October 21, 1999 letter. Finally, as an alternative to a formal appeal, Petitioner requests the Administrative Judge to remand its application to the AA/SDBCE for reconsideration. The SBA Answer SBA opposes both the introduction of Petitioner's October 21, 1999 letter to the AA/SDBCE, and Petitioner's December 13, 1999 letter to SBA counsel. These letters, written after the AA/SDBCE's determination, contain evidence of ownership changes occurring after that date. Petitioner neither has alleged nor shown, that manifest injustice would occur if the Judge were to limit the Appeal to the facts before the AA/SDBCE at the time of her determination. Further, Petitioner neither has sought nor been granted leave to file these documents. SBA asserts the AA/SDBCE's determination is not arbitrary, capricious, or contrary to law, because Petitioner's October 1st submission offered no evidence that Petitioner had changed its ownership structure to meet the direct ownership requirements SBA staff had suggested in the September meeting. Further, Petitioner's "functional equivalence" argument is inapposite here, because the Partnership, not the trusts, owns Petitioner. As for the SBA staff's handling of Petitioner's application, SBA asserts the staff provided --during multiple meetings with Petitioner's counsel, ample opportunity for Petitioner to comply with the direct ownership requirement. SBA did not address Petitioner's request for a remand. On January 14, 2000, Petitioner requested leave to file, and did file, a Response to SBA's Answer. On January 19, 2000, SBA filed a Motion to Strike Petitioner's Response to SBA's Answer. On February 9, 2000, Petitioner filed a Motion for Summary Judgment and a Response to SBA's Motion to Strike. On February 28, 2000, SBA replied and filed a Cross-Motion for Summary Judgment. DISCUSSION Threshold Matters Petitioner filed its Appeal Petition within 45 days after SBA denied its SDB application and, thus, it is timely. 13 C.F.R. Sections 134.202(a), 134.204(e)(3). The Administrative Judge EXCLUDES Petitioner's October 21 and December 13, 1999 letters. The regulations explicitly limit the Administrative Judge's review of an SDB determination to the facts before the AA/SDBCE at the time of her determination and to the arguments on appeal. 13 C.F.R. Section 124.1008(f)(3)(ii). The Administrative Judge will admit new evidence only if she determines manifest injustice would occur if she does not do so (id.); that is, if her failure to admit the evidence would be plainly wrong, and would result in substantial prejudice to Petitioner. In the Matter of Alloy Specialties, Inc., No. SDBA- 108 at 5 (1999). These letters do not meet this standard, because Petitioner's appeal neither pleads nor proves manifest injustice. Further, they are irrelevant to the issue here: whether the AA/SDBCE's determination, on the basis of the record before her at the time, was arbitrary, capricious, or contrary to law. Here, Petitioner's evidence involves remedial action it took only after receiving the AA/SDBCE's determination. Similarly, the Administrative Judge DENIES Petitioner's request for leave to file its Response to SBA's Answer and GRANTS SBA's Motion to Strike. As before, the Administrative Judge finds Petitioner's Response consists of statements relating to events which occurred after the AA/SDBCE's October 15th determination, and extensive repetition of the Appeal Petition. 13 C.F.R. Section 134.218(b). Merits of the Appeal A firm applying for SDB certification must demonstrate to the AA/SDBCE that those individuals claiming disadvantaged status own and control the firm. 13 C.F.R. Section 124.1008(c)(2). In determining whether a firm meets this requirement, the AA/SDBCE applies the same criteria used for the 8(a) program. 13 C.F.R. Section 124.1002(a); In the Matter of Trisha Koch & Associates, No. SDBA-113 at 4 (1999). The AA/SDBCE must examine the relevant data and articulate a satisfactory explanation for its action, including a "rational connection between the facts found and the choice made." In the Matter of IRECOR, Inc., No. SDBA-104 at 5 (1999). On appeal, the Administrative Judge reviews the AA/SDBCE's determination, applying the following standard of review: whether the record demonstrates her determination was "arbitrary, capricious, or contrary to law." 13 C.F.R. Section 124.1008(f)(3)(ii). The sole issue on appeal here is whether Petitioner qualifies under the Small Business Act requirement that "socially and economically disadvantaged individuals" must own at least 51% of the firm. 15 U.S.C. Sections 637(a)(4)(A)(i)(I); 637(d)(3)(C)(i) (emphasis added). [2] The implementing regulations require that, "at least 51 percent of each class of voting stock outstanding . . . must be unconditionally owned by one or more individuals determined by SBA to be socially and economically disadvantaged." 13 C.F.R. Section 124.105(d) (emphasis added). Further, ownership by socially and economically disadvantaged individuals "must be direct ownership." 13 C.F.R. Section 124.105(a) (emphasis added). A firm owned principally "by another business entity . . . that is in turn owned and controlled by one or more disadvantaged individuals does not meet this requirement." Id. [3] OHA has held that an SDB applicant wholly owned by a holding company which is, in turn, 90% owned by the disadvantaged individual, does not satisfy the direct ownership requirement. In the Matter of Century Technologies, Inc., No. SDBA-123 at 6 (2000). There, the disadvantaged individual had directly owned the majority interest in the applicant firm for many years before establishing a holding company, a business entity, and transferring to it his stock in the applicant firm. Because of the similar facts here, the Administrative Judge concludes Century Technologies must control. In order for Petitioner to qualify as a firm owned by socially and economically disadvantaged individuals, Mr. Adams Jr. and Mr. Adams III, the two individuals claiming disadvantage, must own individually and directly at least 51% of its voting stock. It is undisputed that, at the time of the AA/SDBCE's determination, the Partnership, owned 49.9% of Petitioner's stock; whereas the two individuals claiming social and economic disadvantage owned only 1.2%. Therefore, the Administrative Judge concludes the AA/SDBCE correctly found Petitioner failed to satisfy the regulatory requirement of direct ownership by disadvantaged individuals. [4] The Administrative Judge also rejects, as contrary to the explicit regulatory language, Petitioner's "functional equivalence" argument: the Adamses actually own and control Petitioner because they own and control the Partnership, which in turn owns 49.9% of Petitioner. The regulation explicitly requires that a firm owned principally by another business entity, which in turn is owned by disadvantaged individuals, fails to meet the requirement of direct ownership by disadvantaged individuals. 13 C.F.R. Section 124.105(a). In issuing this regulation, SBA noted the direct ownership requirement is statutory, but stated the regulation was necessary for clarification. 62 Fed. Reg. 43583, 43586 (August 14, 1997) (preamble to proposed rule). In summary, the AA/SDBCE's determination, that Petitioner is not at least 51% directly owned by disadvantaged individuals, was based on explicit statutory and regulatory requirements, and is fully supported by the record. Accordingly, the Administrative Judge concludes the AA/SDBCE's determination was not arbitrary, capricious or contrary to law. [5] Other Issues The Administrative Judge rejects Petitioner's assertions that the processing of Petitioner's SDB application by SBA staff, including SBA counsel, was arbitrary, capricious, and contrary to law. First, Petitioner is not entitled to a "higher level" legal review before the AA/SDBCE denies an application, because the regulations do not authorize it. See 13 C.F.R. Section 124.1008. Second, the regulations do not require the AA/SDBCE to stay the processing of an application indefinitely. Id. In fact, Petitioner's October 1, 1999 letter constitutes an admission that Petitioner had not even begun to remedy the specific deficiencies the staff previously had identified. Instead, it contained only arguments and an offer to make future changes. In addition, the SBA's Answer mentions the numerous meetings SBA staff had with Petitioner to assist it during the application process, which Petitioner did not deny. Thus, Administrative Judge concludes the AA/SDBCE, after SBA staff personally met with Petitioner to offer assistance, reasonably issued her written determination without responding to Petitioner's tardy "offer". Moreover, because Petitioner's October 21, 1999 letter followed the AA/SDBCE's determination, it is irrelevant to this appeal. Finally, the Administrative Judge rejects Petitioner's request to remand its application to the AA/SDBCE for reconsideration. The Administrative Judge finds no authority, and Petitioner has cited none, for a remand based on changes to the applicant firm's ownership occurring after the AA/SDBCE denied the application. [6] CONCLUSION Based on the Administrative Judge's conclusion that the SBA's determination was not arbitrary, capricious, or contrary to law, she AFFIRMS the determination, and DENIES the Appeal Petition. This is the initial decision of the SBA. Absent a request for review, this decision will become the SBA's final decision 30 days after the date of this decision. 13 C.F.R. Sections 134.227(b), 134.228(a) (1999). __________________________________ GLORIA E. BLAZSIK Administrative Judge _________________________ [1] The actual date is not of record. [2] The exceptions are inapplicable here: for firms owned by economically disadvantaged Indian tribes, tribally-owned entities, or Native Hawaiian organizations. 15 U.S.C. Section 637(a)(4)(A)(i). [3] While, "ownership by a trust, such as a living trust, may be treated as the functional equivalent of ownership by a disadvantaged individual" in certain cases (id.) that exception is inapplicable here. Although living trusts did own some of Petitioner's stock previously, on October 20, 1998, they owned none of it on the October 15, 1999 determination date. Tab Q. [4] The Administrative Judge notes, even if disadvantaged individuals owned all of Petitioner's stock not held by the Partnership, Petitioner still did not meet the 51% direct ownership requirement, because the Partnership owns 49.9%. IRECOR, supra at 6. [5] The AA/SDBCE's stated reason for declining Petitioner's application was that disadvantaged individuals do not meet the direct ownership criteria. Thus, while she erred in finding the Partnership owned the majority of Petitioner's stock, this error did not affect her ultimate conclusion. Accordingly, the error was harmless, and did not prejudice Petitioner's substantive rights. Century Technologies, supra at 6; 28 U.S.C. Section 2111. [6] In light of the outcome, the Administrative Judge need not consider Petitioner's February 9, 2000 Motion for Summary Judgment or the SBA's Motion for Cross-Summary Judgment. Posted: March, 2000