Bonding Assistance for Construction Contracts: The Affiliation Problem By Antonio R. Franco and Steven J. Koprince Small businesses will have many opportunities to compete for federal construction and infrastructure work in the coming years. The Obama administration has proposed a large public infrastructure plan, which is expected to include the construction or renovation of schools, roads, bridges and other facilities across the country. In keeping with federal guidelines, much of this work will likely be set aside for small businesses. However, because many sureties have recently adopted more restrictive bonding requirements, small businesses may face a difficult challenge in obtaining the bonds necessary to complete this work. One way for a small business to meet a surety’s bonding requirements is for the small business to receive bonding assistance from a large business. Bonding assistance typically takes the form of an agreement by which the large business agrees to indemnify the bond provided to the small business. A bond indemnification agreement can often allow a small business to obtain a bond it might otherwise be unable to procure. However, a small business considering such an arrangement must be careful not to run afoul of SBA’s affiliation rules. If the bonding assistance causes the SBA to deem the two businesses “affiliates,” the small business may become ineligible to compete for set-aside work. The SBA Office of Hearings and Appeals has held that, as a general rule, bonding assistance alone does not prove that a large and a small business are affiliates. However, in order to pass muster under the affiliation rules, bonding assistance must be consistent with a legitimate business relationship. Three specific factors can help demonstrate that bonding assistance was provided as part of a legitimate business relationship: (1) the large business does not have the exclusive right to provide bonding assistance to the small business; (2) the small business pays the large business a fee for the bond indemnification; and (3) the small business agrees to indemnify and hold harmless the large business from any losses suffered due to the bond indemnification. It is not necessary for all three of these factors to be present for bonding assistance to be acceptable under SBA’s affiliation rules. Nevertheless, a small business would be wise to keep these factors in mind when structuring a bond indemnification agreement with a large business. In addition, a small business considering entering into a bond indemnification agreement with a large business should carefully consider whether any other relationships between itself and the large business could be seen as indicative of affiliation. Although bonding assistance alone is insufficient to prove that two businesses are affiliates, bonding assistance together with evidence of other relationships between two businesses may lead the Office of Hearings and Appeals to determine that the businesses are affiliates. For example, in Size Appeal of David Boland, Inc., SBA No. SIZ-4965 (2008), OHA concluded that a large business and small business were affiliates. OHA based its decision upon a bonding assistance arrangement, together with the longtime association of the two businesses as partners in a joint venture. Given the affiliation rules and OHA precedent, the best course of action for a small business is to obtain bonding assistance from a large business with which the small business has no other significant relationships. Unfortunately, this is not always possible. Many sureties now require that a large business not only indemnify the small business’s bond, but also take an equity stake in the small business itself. Under SBA’s rules, a large business’s equity stake in a small business can be seen as evidence of affiliation. Therefore, if possible, a small business should avoid selling an equity stake to a large business from which it is receiving bonding assistance. If selling an equity stake is the only way to obtain a bond, the small business should ensure that the equity stake taken by the large business is as minimal as possible, and that other indicia of affiliation have been mitigated. Bonding indemnification arrangements between large and small businesses are important in allowing small businesses to obtain construction and infrastructure work, but these agreements must be structured with care. By ensuring that bonding assistance is consistent with a legitimate business relationship and reducing, to the greatest extent possible, other relationships between such concerns, a small business will maximize its chances of avoiding “affiliation” pitfalls on the road to obtaining federal construction work that will be set-aside for small businesses in the future. Antonio Franco is a partner with PilieroMazza PLLC in Washington, DC. He oversees the firm’s Government Contracts/Small Business Group. His practice includes all aspects of federal government contracting and administration. Steven Koprince is an associate with PilieroMazza PLLC, where he practices in the areas of government contracts, construction and regulatory affairs.