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Top Ten Issues On Certification
Jenkens & Gilchrist A PROFESSIONAL CORPORATION M E M O R A N D U M
To: Clients and Friends From: Cordell M. Parvin Subject: New USDOT DBE Regulations Date: February 26, 1999
TOP TEN ISSUES ON CERTIFICATION FOR DBE CONTRACTORS
1. The concept of affiliation could cause a DBE firm to not meet the small business requirements. Section 26.5 covers the definitions used in the regulations. Significantly, the USDOT has defined "affiliation" using the same terms as in the Small Business Administration (SBA) Regulations. Affiliation comes into play where there is a close relationship between a small business and a large business. That relationship can arise as a result of common management, office sharing and a variety of other situations. There will likely be greater emphasis in the certification process on whether or not there's an affiliation of a DBE with a non-DBE. 2. Size determinations for purposes of determining whether a DBE firm is a small business will be based on the Standard Industrial Classification (SIC) Code designation which best describes the DBE business. The North American Industrial Classification System (NAICS) is currently replacing the SIC Codes. Under either classification system, not all DBEs will be judged by the $16.6 Million annual volume size standard. DBEs have always been required to meet the SBA small business standards. Yet, many states have failed to classify such businesses by the appropriate SIC Code. As a result, in those states DBEs size determinations have been made based on the highest annual volume possible under the SBA regulations. 3. An individual whose net worth exceeds $750,000, excluding the value of their ownership interest in the DBE firm and the equity in his or her primary residence, is conclusively not considered to be economically disadvantaged. Section 26.67 of the new regulations specifically imposes a personal net worth cap of $750,000. This means that, regardless of race, gender or the size of their business, any individual whose personal net worth exceeds $750,000 is not considered economically disadvantaged and is not eligible for the DBE program. Applicants will have to submit a statement of personal net worth and supporting documentation to the recipient with their applications. These statements must be accompanied by appropriate supporting documentation (e.g., tax returns, where relevant). The new regulation does not prescribe the exact supporting documentation that should be provided, it is left to recipients to determine. If the information shows net worth above the cap, the individual would not be eligible for the program. Currently certified firms will be required to submit the information the next time they apply for renewal or recertification. The new regulation explicitly requires that this material be kept confidential. It may be provided to a third party only with the written consent of the individual to whom the information pertains. This provision is specifically intended to pre-empt any contrary application of state or local law (e.g., a state freedom of information act that might be interpreted to require a state transportation agency to provide to a requesting party the personal income tax return of a DBE applicant who had provided the return as supporting documentation for his PNW statement). 4. As before, the ownership by socially and economically disadvantaged individuals must be real, substantial, and continuing. They must enjoy the customary incidents of ownership, and share in the risks and profits commensurate with their ownership interests. The contributions of capital or expertise to acquire ownership interests must be real and substantial. Section 26.69 governs determinations of ownership. Under that Section a firm must be at least 50 percent owned by socially and economically disadvantaged individuals. In the case of a corporation, such individuals must earn at least 51 percent of each class voting stock outstanding and 51 percent of the aggregate of all stock outstanding. In the case of a partnership, 51 percent of each class of partnership interest must be owned by socially and economically disadvantaged individuals. In the case of a limited liability company, at least 51 percent of each call of member interest must be owned by socially and economically disadvantaged individuals. The ownership by socially and economically disadvantaged individuals must be real, substantial, and continuing. They must enjoy the customary incidents of ownership, and share in the risks and profits commensurate with their ownership interests. The contributions of capital or expertise to acquire ownership interests must be real and substantial. Examples of insufficient contributions include a promise to contribute capital, an unsecured note payable to the firm or an owner who is not disadvantaged, or mere participation in the firm's activities as an employee. Debt instruments from financial institutions or other organizations that lend funds in the normal course of their business do not render a firm ineligible. The whole concept of contributions of expertise to obtain ownership has been the subject of varied interpretations for years. In an effort to clarify, the new rule provides the owners expertise must be:
The individual whose expertise is relied upon must have a significant financial investment in the firm. It will obviously be interesting to see how state DOTs and USDOT determine what expertise is indispensable to the firm's potential success. 5. USDOT has attempted to clarify ownership issues for women owned DBEs. The recipient must always deem as held by a socially and economically disadvantaged individual, for purposes of determining ownership, all interests in a business or other assets obtained as a result of a final property settlement or court order in a divorce or legal separation or through inheritance, or otherwise because of the death of the former owner. Under certain conditions, marital assets which form a basis for ownership of a firm, such assets held jointly or as community property by both spouses used to acquire the ownership interest asserted by one spouse must be deemed to have been acquired by that spouse. Section 23.69 of the new regulation discusses property settlements, inheritances and marital assets. Under that provision, the recipient must always deem as held by a socially and economically disadvantaged individual, for purposes of determining ownership, all interests in a business or other assets obtained as a result of a final property settlement or court order in a divorce or legal separation or through inheritance, or otherwise because of the death of the former owner. On the other hand, recipients must presume as not being held by a socially and economically disadvantaged individual, all interests in a business or other assets obtained by the individual as the result of a gift, or transfer without adequate consideration from any non-disadvantaged individual who is 1) involved in the same firm, 2) involved in the same or similar line of business, and 3) engaged in an ongoing business relationship with the firm or affiliate of the firm. To overcome the presumption, the disadvantaged individual must demonstrate by clear and convincing evidence that the gift or transfer was made for reasons other than obtaining DBE certification and that the disadvantaged individual actually controls the management, policy, and operations of the firm, notwithstanding the continuing participation of a non-disadvantaged individual. With regard to marital assets which form a basis for ownership of a firm, such assets held jointly or as community property by both spouses used to acquire the ownership interest asserted by one spouse must be deemed to have been acquired by that spouse with his or her individual resources, provided that the other spouse irrevocably renounces and transfers all rights in the ownership interest. The recipient is not to count a greater portion of joint or community property assets toward ownership than state law would recognize as belonging to the socially and economically disadvantaged owner of the applicant firm. Copy of the document legally transferring and renouncing the other spouse's rights in the jointly owned or community assets used to acquire an ownership interest in the firm must be included as part of the firm's application for DBE certification. The recipient may consider the following factors in determining the ownership of the firm but it must not regard a contribution of capital as failing to be real and substantial or find the firm ineligible solely because 1) a socially and economically disadvantaged individual acquired his or her ownership interest as the result of a gift, or transfer without adequate consideration other than the types set forth above, 2) there is provision for co-signature of a spouse who is not socially and economically disadvantaged on financing agreements, contracts for purchase or sale of real or personal property, bank signature cards, or other documents; or 3) ownership of the firm in question or its assets is transferred for adequate consideration from a spouse who is not socially and economically disadvantaged to a spouse who is. In that case the recipient must give close scrutiny to the ownership and control of the firm. 6. The rules on control of the DBE firm have not substantively changed. However, the USDOT has added a number of details. Explanations include: 1) the disadvantaged owner must hold the highest officer position; 2) the disadvantaged owner need not have greater experience or expertise than managers or key employees, but they must have an overall understanding of, and managerial and technical competence and experience directly related to, the type of business in which the firm is engaged and the firm's operations; 3) in states where licenses are required the disadvantaged owner must have the license; 4) under certain circumstances a disadvantaged owner need not be paid more than anyone else; and, 5) disadvantaged owners must work must work "full time" for the DBE. Section 26.71 covers the control issue. It includes the same general requirements as before, but adds significant details. As before, the DBE must be an independent business and relationships with non-DBE firms will be closely scrutinized. In the new regulation, USDOT has specified that the disadvantaged owner must hold the highest officer position in the company (e.g., chief executive officer or president) and must control the board of directors. As before, Individuals who are not socially and economically disadvantaged may be involved in a DBE firm as owners, managers, employees, stockholders, officers, and/or directors, but must not control the firm, or be disproportionately responsible for the operation of the firm. As before, the socially and economically disadvantaged owners of the firm may delegate various areas of the management, policymaking, or daily operations of the firm to non disadvantaged individuals, but such delegations of authority must be revocable, and the socially and economically disadvantaged owners must retain the power to hire and fire any person to whom such authority is delegated. USDOT has made clear that the socially and economically disadvantaged owners must have an overall understanding of, and managerial and technical competence and experience directly related to the firm's business and operations. The socially and economically disadvantaged owners are not required to have experience or expertise in every critical area, or to have greater experience or expertise in a given field than managers or key employees, but they must have the ability to intelligently and critically evaluate information presented to them. USDOT has also specifically stated that expertise limited to office management, administration, or bookkeeping functions unrelated to the principal business activities of the firm is insufficient to demonstrate control. Clearly this provision will be subject to a wide discretion on what is management vs. office management and what constitutes principal business activities of the firm. If state or local law requires the persons to have a particular license or other credential in order to own and/or control a certain type of firm, then the socially and economically disadvantaged persons who own and control a potential DBE firm of that type must possess the required license or credential. If state or local law does not require such a person to have such a license or credential to own and/or control a firm, a recipient may not deny certification solely on the ground that the person lacks the license or credential. However, the recipient can take into account the absence of the license or credential as one factor in determining whether the socially and economically disadvantaged owners actually control the firm. Previously, some recipients chose to deny certification to DBEs if the disadvantaged owner was not the highest paid individual in the firm. Under the new regulation, recipients may consider differences in remuneration in the context of the duties of the persons involved, normal industry practices, the firm's policy and practice concerning reinvestment of income, and any other explanations for the differences proffered by the firm. A recipient may determine that a firm is controlled by its socially and economically disadvantaged owner although that owner's remuneration is lower than that of some other participants in the firm. In a case where a non-disadvantaged individual formerly controlled the firm, and a socially and economically disadvantaged individual now controls it, the recipient may consider a difference between the remuneration of the former and current controller of the firm as a factor in determining who controls the firm, particularly when the non-disadvantaged individual remains involved with the firm and continues to receive greater compensation than the disadvantaged individual. In the past, it was unclear in the regulations whether or not the disadvantaged owner had to be fully employed by the DBE firm. Now, it is clear, that in order to be viewed as controlling a firm, he or she cannot engage in conflicting outside employment or other business interests. It is also clear that absentee ownership of a business and part-time work in a full-time firm are not viewed as constituting control. 7. A disadvantaged owner may control a firm even when a family member participates in the management of the firm. However, if the business is controlled by the family and not by the disadvantaged individual, then it will not get certified. Where ownership has been transferred from a non-disadvantaged family member to a disadvantaged family member, the DBE must prove by clear and convincing evidence that it was not done to take advantage of the program. Family owned and controlled DBEs have raised certification issues where one or more of the family members are not disadvantaged. In the 80s it was not unusual for ownership of a DBE firm to be transferred from a non-disadvantaged individual to a disadvantaged individual to take advantage of the DBE program. In some states, if a husband, brother or son participated in a firm owned by a woman, the firm would not get certified. It was treated as a "family" business. Section 26.71 (k)(1) clarifies that a disadvantaged individual may control a firm even though one or more of the individual's non-disadvantaged immediate family members participate in the firm as a manager, employee, owner, or in another capacity. Recipients must make a judgment about the control the socially and economically disadvantaged owner exercises vis-a-vis other persons involved in the business just as they do in other situations, without regard to whether or not the other persons are immediate family members. However, if the recipient cannot determine that the socially and economically disadvantaged owners--as distinct from the family as a whole—control the firm, then the socially and economically disadvantaged owners have failed to carry their burden of proof concerning control, even though they may participate significantly in the firm's activities. In addition, where a non-disadvantaged individual (whether or not a family member) remains in a firm after transferring ownership and/or control to a disadvantaged individual, the disadvantaged individual must demonstrate by clear and convincing evidence, that:
8. DBE firms will be certified to perform only specific types of work and must either own or lease equipment based on normal industry practices for that type of work. DBEs may use employee leasing companies if it controls the employees. Given that DBEs are generally less capitalized than non-DBEs, the ownership of equipment has been an issue in the certification process. In some states if DBEs did not own their own equipment, they could not be certified. In other states, DBEs leased equipment from one particular prime contractor and did get certified. The new regulation attempts to clarify this issue. Under Section 26.71 (m) the recipient may consider whether the firm owns equipment necessary to perform its work in determining whether a firm is controlled by its disadvantaged owners,. However, the recipient may not determine that a firm is not controlled by socially and economically disadvantaged individuals solely because the firm leases, rather than owns, such equipment, where leasing equipment is a normal industry practice and the lease does not involve a relationship with a prime contractor or other party that compromises the independence of the firm. Section 26.71 (n) The recipient must grant certification to a firm only for specific types of work in which the socially and economically disadvantaged owners have the ability to control the firm. To become certified in an additional type of work, the firm must demonstrate that its socially and economically disadvantaged owners are able to control the firm with respect to that type of work. The recipient may not, in this situation, require that the firm be recertified or submit a new application for certification, but it must verify the disadvantaged owner's control of the firm in the additional type of work. Section 26.71 (q) permits disadvantaged individuals controlling a firm to use an employee leasing company, individuals from controlling their firm if they continue to maintain an employer-employee relationship with the leased employees. This includes being responsible for hiring, firing, training, assigning, and otherwise controlling the on-the-job activities of the employees, as well as ultimate responsibility for wage and tax obligations related to the employees. 9. Section 26.73 distinguishes commercially useful function from certification issues. It further directs recipients to consider "present circumstances" not the past history and to not refuse certification solely because the firm is a new firm. DBE firms must be "for profit" and, except for limited circumstances, DBE firms must be owned by individuals and not by other firms (including DBE firms). During the 80s DBE firms that were found to have not performed a commercially useful function on an individual project were decertified in some states. USDOT and the FHWA provided guidance distinguishing between the commercially useful function portion of the regulations and the certification section. Section 26.73 of the new regulations makes clear that consideration of whether a firm performs a commercially useful function or is a regular dealer pertains solely to counting toward DBE goals the participation of firms that have already been certified as DBEs. However, a recipient may consider, in making certification decisions, whether a firm has exhibited a pattern of conduct indicating its involvement in attempts to evade or subvert the intent or requirements of the DBE program. During the 80s and early 90s many DBEs were denied certification or decertified because of events that occurred years before. This happened to many firms owned by women who had used joint funds to start the firm or whose husband had greater expertise at the inception of the firm. Section 26.73 directs recipients to evaluate the eligibility of a firm on the basis of present circumstances and not refuse to certify a firm based solely on historical information indicating a lack of ownership or control of the firm by disadvantaged individuals at some time in the past. Additionally, a recipient also may not refuse to certify a firm solely on the basis that it is a newly formed firm. Section 26.73(d) specifies that only firms organized for profit may be eligible DBEs. Section 26.73(e) provides that an eligible DBE firm must be owned by disadvantaged individuals and not by another firm--even a DBE firm, except if disadvantaged individuals own and control a firm through a parent or holding company, established for tax, capitalization or other purposes consistent with industry practice, and the parent or holding company in turn owns and controls an operating subsidiary, it may be certified if it otherwise meets all requirements of the regulation. 10. Prime contractors may be subject to debarment and/or criminal prosecution for using or attempting to use on the basis of false, fraudulent or deceitful statements a firm that does not meet the DBE requirements. While this section in the new regulations does not expressly cover commercially useful function, most of the problems faced by prime contractors since inception of the DBE program have resulted from the federal government coming in after the fact and challenging DBE participation. Prime contractors would be well served by having DBE Compliance Manuals for their managers. Section 26.107 covers enforcement actions which apply to firms participating in the DBE program. Under that Section a firm that does not meet the eligibility criteria that attempts to participate in a USDOT-assisted program as a DBE on the basis of false, fraudulent, or deceitful statements or representations is subject to debarment proceeding under 49 CFR Part 29. Firms that in order to meet DBE contract goals or other DBE program requirements that use or attempt to use on the basis of false, fraudulent or deceitful statements, another firm that does not meet the eligibility criteria is subject likewise to suspension or debarment proceedings. In such a suspenture or debarment proceedings, the concerned operating administration may consider the fact that a proported DBE has been certified by a recipient, but such certification does not preclude the USDOT from determining the proported DBE, or another firm that is used or attempted to use it to meet DBE goals, should be suspended or debarred. USDOT may also take enforcement action under 49 CFR Part 31, Program Fraud and Civil Remedies, or refer the matter to the Department of Justice for prosecution under 18 U.S.C. 1001 or other applicable provisions of law. 11. There is an extremely detailed procedure for uniform certification, certification reviews, certification denials and removal of certification established in Subpart E of the new regulation. Certifications will be extended to three years form the current one year. Section 26.81 establishes that all DOT recipients must participate in Unified Certification Programs (UCP), which must be in an agreement entered into within three years of March 4, 1999. The agreement shall include an implementation schedule ensuring that the UCP is fully operational no later than 18 months following the approval of the agreement by the Secretary. Essentially the UCP is designed to give DBEs "one stop shopping on certification." Section 26.83 specifies the procedures recipients are to follow in making certification decisions. They must:
Under paragraph (e), when a DBE has been certified by another DOT recipient, a recipient has discretion to take any of the following actions:
Paragraph (h) extends the period of certification for a period of at least three years unless and until its certification has been removed through the procedures of Section 26.87. As previously required, paragraph (i) requires DBEs to inform the recipient or UCP in writing of any change in circumstances affecting its ability to meet size, disadvantaged status, ownership, or control requirements of this part or any material change in the information provided in their application form. Under paragraph (j) DBEs must provide an affidavit to the recipient, every year on the anniversary of the date of your certification affirming that there have been no changes in the firm's circumstances affecting its ability to meet size, disadvantaged status, ownership, or control requirements of this part or any material changes in the information provided in its application form, except for changes about which the DBE has notified the recipient under paragraph (i) of this section. The affidavit shall specifically affirm that the DBE firm continues to meet SBA business size criteria and the overall gross receipts cap, documenting this affirmation with supporting documentation of the firm's size and gross receipts. Paragraph (k) requires recipients, to make decisions on applications for certification within 90 days of receiving from the applicant firm all information required under this part. Recipients may extend this time period once, for no more than an additional 60 days, upon written notice to the firm, explaining fully and specifically the reasons for the extension. Unfortunately for DBEs, a recipients failure to make a decision by the applicable deadline under paragraph (k) is deemed a constructive denial of the application, on the basis of which the firm may appeal to DOT under Section 26.89. DBEs would be better served if the recipients failure to timely respond was deemed to be a constructive certification. Section 26.87 establishes the procedures for removing a DBE's certification. It specifically is intended to give DBEs "due process" that had been previously denied them in many jurisdictions. One primary issue was the separation of the decision making process. USDOT made clear that it believes separation of functions is essential. It stated: " there cannot be a fair proceeding if the same party acts as prosecutor and judge." USDOT has also required a record of the hearing, (including a verbatim record of the hearing), because USDOT appellate review is a review of the administrative record. |
