Engineering Documentation Systems, Inc., No. 4058 (July 5, 1995) Docket No. SIZ-94-12-12-161 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. 20416 ______________________________ ) SIZE APPEAL OF: ) ) Engineering Documentation ) Systems, Inc. ) ) Docket No. SIZ-94-12-12-161 Appellant ) ) Solicitation No. ) NOO123-94-R-0040 ) Department of the Navy ) Long Beach, California ) ______________________________) DIGEST Where the 95 percent owner and president of a large firm, and the vice-president of the large firm's subsidiary together own 68 percent of the challenged firm's stock, there is an identity of interest through common investment. Where an individual owns a 47 percent share of the stock of a concern and his block of stock is more than twice as large as all other blocks, he is presumed to have the power to control the concern. Where a large firm and the challenged firm have an identity of interest through common investment, the large firm controls the challenged firm, and the large firm shares common management with the challenged firm, the firms are affiliated under the totality of circumstances test. DECISION July 5, 1995 MITNICK, Administrative Judge: [1] Jurisdiction This appeal is decided under the Small Business Act of 1958, 15 U.S.C. 631 et seq., and 13 CFR Part 121. Issue Whether Engineering Documentation Systems, Inc. is affiliated with Exodyne, Inc. and its subsidiaries. Facts On January 25, 1994, the Department of the Navy, Fleet Industrial Supply Center Detachment, issued this solicitation for engineering and technical services. The Contracting Officer set it aside entirely for small business, and classified it under Standard Industrial Classification (SIC) code 8711, with an average annual receipts size standard of $3.5 million. Engineering Documentation Systems, Inc. (EDSI or Appellant) submitted its bid and self-certification as a small business on March 16, 1994. The contract was awarded to EDSI on September 30, 1994. On October 5, 1994, Management Assistance Corporation of America (MACA) protested the award, alleging that EDSI was other than small based on its affiliation with Exodyne, Inc. (Exodyne) and the latter's wholly-owned subsidiaries. The Contracting Officer forwarded the protest to the Small Business Administra- tion, San Francisco Area VI Office of Government Contracting (Area Office) for a size determination. The basic facts are undisputed. EDSI was founded in 1988 by Ralph Rockow (and several others not directly involved in this appeal), and Rockow has been a director since 1988. Rockow, the largest EDSI shareholder, owns 47 percent of its shares. EDSI's Form 355 shows the relative amounts of stock owned by its directors: Ralph Rockow 46.74 percent Greg Corlin, CEO, President and Treasurer 11.06 Sharon Lujon, Secretary, Chairman of the 20.74 Board and Vice-President Barbara Bullis 21.02 _____ 99.56 percent [2] Exodyne extended a $300,000 line of credit to EDSI at its founding. The line of credit expired in March 1993, but EDSI did not fully repay it until eight months later, in November 1993. Rockow and his wife own, respectively, 95 and 5 percent of Exodyne's shares, and he is Exodyne Chairman of the Board, President, and Treasurer. Exodyne in turn owns 100 percent of the capital stock of its four known subsidiaries, Dynamic Sciences, Inc., Exodyne Properties, Inc., Dynamic Educational Systems, Inc., and Exodyne Electric Motors, Inc. Barbara Bullis, the owner of the second largest block of EDSI's shares, 21 percent, is a Dynamic Sciences Vice President. Exodyne and its affiliates have more than 1,000 employees and had annual sales of more than $35 million for Fiscal Year 1993. On December 6, 1994, the Area Office--in reliance on EDSI's SBA Form 355, its tax returns, corporate bylaws, and other related documents--found EDSI to be other than small, because Exodyne's control of EDSI constituted affiliation. The Area Office found that Rockow controlled EDSI because he was the largest shareholder, with a block of shares twice as large as the next shareholder, and he was a director from EDSI's inception. The Area Office found that Rockow's assistance enabled EDSI to obtain its initial government contract, and that EDSI continues to have close financial ties to and to rely upon Rockow and/or Exodyne for financial support, through loan guarantees. The Area Office also found control because Bullis is an EDSI shareholder and Vice President of an Exodyne affiliate. In addition, the Area Office found that Rockow controls Exodyne by virtue of his and his wife's total ownership of all Exodyne's stock; Rockow's and his wife's positions as the company's only directors; and his position as Exodyne Chairman of the Board and President. Finally, the Area Office concluded that EDSI is affiliated with Exodyne by the totality of the circumstances. Appellant received the Area Office's determination on December 8, 1994, and filed an appeal postmarked December 12, 1994. Arguments on Appeal Appellant asserts that the Area Office erred in determining that Rockow has the power to control EDSI, because Rockow is not now nor has he ever been an officer of the corporation or had any operational role; he never has received a salary or compensation for attendance at board meetings; and he has no power to authorize expenditures, solicit bids, or bind the company to contractual relationships. Rather, EDSI is governed by a three- member board of directors, a majority of which must approve all board actions, so that a single director never may force the company to act or refuse to act on initiatives supported by the other board members. [3] Appellant asserts further that a shareholder cannot actually exercise control over EDSI, unless he or she can elect two of the three board members, which Rockow lacks sufficient shares or any agreement with other shareholders to do. Even if Rockow used "cumulative voting", a right accorded shareholders in the corporation's bylaws, he still could unilaterally appoint only one director. [4] Appellant asserts that, at the time EDSI submitted its self- certification, EDSI had no financial relationship with Exodyne. Finally, Appellant asserts that Bullis, a Dynamic Sciences Vice President, is not a key employee; she merely administers employee benefit plans. MACA asserts in response to the appeal that EDSI is affiliated with Exodyne and its affiliates because Rockow helped found the company; his 47 percent share of stocks is the largest single block, more than twice as large as the next largest block, which gives him negative control of EDSI; he is an EDSI director; and he provided important financial support from EDSI's inception until recently. MACA also asserts that Exodyne provided the financing on favorable terms because, although the line of credit expired on March 31, 1993, EDSI did not fully repay it until November 1993. MACA asserts in further support of Exodyne-EDSI affiliation, that Rockow consistently voted Bullis' shares of EDSI from 1992-1994, effectively giving Exodyne control of 67 percent of EDSI; and that Bullis is Vice-President of an Exodyne subsidiary. MACA asserts common management as another basis for EDSI- Exodyne affiliation, since Rockow is an Exodyne officer, director and shareholder and an EDSI director and shareholder; and Bullis is an Exodyne key employee and an EDSI shareholder. Finally, MACA asserts that EDSI and Exodyne are affiliated under the "newly organized concern" rule, and "totality of the circumstances." Discussion Appellant's appeal was timely as to this solicitation, because it was filed within five days of its receipt of the Area Office's determination. 13 C.F.R. Section 121.1705(a)(2). In determining whether affiliation exists, all appropriate factors including, among others, common ownership, common management, and contractual relationships, must be considered. Affiliation also may occur where one firm or individual directly or indirectly controls or has the power to control both firms. 13 C.F.R. Section 121.401(a)(2). The record first demonstrates an identity of interest, based on common investment, amounting to affiliation between Rockow, Exodyne President and 95 percent owner, who also is an EDSI director and 47 percent EDSI owner; and Bullis, EDSI 21 percent shareholder and Dynamic Sciences Vice President. 13 C.F.R. Section 121.401(d). In addition, it is undisputed that Rockow controls Exodyne and its subsidiaries. Moreover, Rockow is presumed to control EDSI. The applicable regulation, 13 C.F.R. Section 401(e)(2), permits a presumption of control through stock ownership where a person owns less than 50 percent of a firm's stock, if that block of stock is large as compared to other outstanding blocks of stock. Because Rockow owns 47 percent of EDSI's voting stock--more than twice as large as the next largest block, Bullis' 21 percent (according to EDSI's Form 355)--the presumption applies. See Size Appeal of Intercontinental Manufacturing Co., No. 3879 (1994). Appellant fails to rebut, and the record bolsters, the above presumption. Rockow was one of the founders of EDSI, and his 47 percent of shares is more than twice as much as Bullis' 21 percent. Moreover, Appellant's appeal concedes that a shareholder could exert control only if he/she could select two of the three members of the board of directors. Under these facts, Rockow's and Bullis' combined votes, amounting to 68 percent of the shares, clearly could elect Rockow and another director. Alternatively, if cumulative voting were applied, Rockow's 845,000 and Bullis' 380,000 total 1,225,000 shares, well over the 904,000 shares Appellant claims are necessary to elect two of the three EDSI directors. The facts here are distinguishable from Size Appeal of Tri- Fuels, No. 3563 (1992), relied upon by Appellant, where the largest shareholder would have had more difficulty in controlling a five-seven person Board of Directors than the three-person Board here. The possibility of such combined voting is considerable in view of Bullis' position as Vice President of an Exodyne subsidiary, and the likelihood that Rockow could influence her vote. Hence, both Rockow's and Bullis' common investment in EDSI and Bullis' employment by an Exodyne subsidiary create a perception that Rockow and she have an identity of interest and should be treated as one party. See, for example, Size Appeal of Les Violins, Inc., No. 4021 (1995). However, even if Rockow could not affirmatively control EDSI by forcing his own initiatives through, he can exert negative control by blocking other directors' initiatives. See, for example, Size Appeal of Binghamton Simulator Company, Inc., No. 3881 (1994). Thus, if Rockow opposed an initiative, the other two directors, Lujon and Corlin, lack sufficient shares to override his vote. They could do so only if Bullis voted with them, which appears highly unlikely in light of her position vis a vis Exodyne. [5] The cases Appellant cites, Size Appeal of Automated Design, Inc., No. 3927A (1994); and Size Appeal of Superior Cable Corp., No. 3366 (1990) are distinguishable from the facts here. In both these cases, the persons in question owned only a small minority of shares (respectively 16.3 and 17.2 percent), while others owned the great majority of the shares. Hence, these shareholders could not affirmatively or negatively control the companies involved. The presumption of Rockow's control of EDSI is further strengthened by Exodyne's five-year line of credit to EDSI and the latter's continued use of it. First, Appellant did not repay this line of credit although it claimed to be financially self- sufficient from March 1993. Second, Appellant concedes it did not use the credit of two of its other owners, because it still had Exodyne's line of credit. Third, Appellant's argument that the terms were not favorable is contradicted by the its delay of full repayment of Exodyne's line of credit until November 1993, eight months after it expired (and only four months before its self-certification). Fourth, Appellant's statement that it was financially self-sufficient from March 1993 is inconsistent with its continued use of the line of credit and its delay in repayment. All of the above factors demonstrate EDSI's continued link with and financial dependence on Exodyne, amounting to control. [6] The record here also demonstrates, although to a lesser degree, affiliation based on EDSI-Exodyne common management. 13 C.F.R. Section 121.401(h). Rockow, with his wife, totally controls Exodyne, and is a long-time director of EDSI. Bullis, who owns the second largest block of EDSI shares, is Vice President of an Exodyne subsidiary. Finally, the cumulative effect of all of the above, Exodyne- EDSI identity of interest through common investment, Exodyne's ability to control EDSI, and Exodyne-EDSI common management, constitute affiliation under the totality of circumstances test. See, for example, Size Appeal of Bunkoff General Contractors, Inc., No. 3804 (1993). [7] Inasmuch as EDSI and Exodyne and its affiliates are affiliated, the average annual receipts of these entities must be aggregated to determine EDSI's size. See 13 C.F.R. Section 121.401(a). Since the combined receipts exceed the applicable size standard, EDSI is a large business and ineligible for this solicitation. [8] Conclusion The determination of the Regional Office is AFFIRMED, and the appeal is DENIED. This constitutes the final decision of the Small Business Administration. See 13 C.F.R. Section 121.1720(b). ______________________________ Mona K. Mitnick Administrative Judge ____________________ [1] This case previously was assigned to Administrative Judge Gloria Blazsik. As the Acting Assistant Administrator for Hearings and Appeals, I have designated myself as Administrative Judge, and am now presiding in this matter for the Office of Hearings and Appeals, in accordance with 13 C.F.R. Section 134.18(a). [2] According to Appellant, an EDSI employee, John Henry, owns the remaining .44 percent of the stock. [3] Appellant asserts that, shortly after the Area Office issued its size determination, Rockow sold all his shares in and resigned as a director of EDSI; he subsequently was recerti-fied as a small business. However, Appellant produced no evidence to substantiate its claim. In any event, any such sale is irrelevant to this appeal, since the crucial time for determining Appellant's size was the date it self-certified. 13 C.F.R. Section 121.904. [4] "Cumulative voting" enables a shareholder to cast all his or her votes for a single director or to divide the votes among two or more directors. [5] Appellant's argument that Bullis, as Vice-President of Dynamic Sciences, is not a key employee, is unpersuasive. Appellant's own Form 355 lists Exodyne as an affiliate and lists Bullis as an officer of an Exodyne affiliate. Further, Appellant failed to present contrary evidence to the Regional Office and, therefore, has failed to carry its burden of proof in establishing by a preponderance of the evidence that Bullis was not a key employee. See 13 C.F.R. Section 121.1707. (Appellant's appeal erroneously states that the standard is substantial evidence, which it claims it met.) [6] The case relied on by Appellant, Multi-Services Assistance, Inc., No. 3605 (1992), is distinguishable because it involves a line of credit established after self [7] MACA's assertion that EDSI is affiliated with Exodyne under the newly-organized concern test, 13 C.F.R. 121.401(j), is without merit. EDSI, which was founded in 1988, is not a newly organized concern. See, for example, Size Appeal of Govern Services, No. 3496 (1991); and Size Appeal of Service Resources, Inc., No. 3332 (1990). [8] Although the findings are not necessary to the outcome, the Area Office's erred in finding that Rockow was responsible for EDSI's first contract and that EDSI and Exodyne still have close financial ties, through loan guarantees. MACA merely makes these bare assertions, but presents no supporting evidence.