Letters of Intent and the SBA: Potential for Affiliation By Alan D. Titus For years, business entities have relied on letters of intent (LOIs) as the first step in the acquisition process. Traditionally, LOIs contain substantive provisions regarding deal points, but also indicate that the terms set forth are nonbinding (with certain exceptions) until final deal documents have been negotiated and executed by all parties. Under most states’ laws a nonbinding LOI cannot be enforced by the parties. A recent decision by SBA’s Office of Hearings and Appeals (OHA) may have a profound effect on how LOIs are used in the government contracting arena. OHA held that the two parties to a nonbinding LOI were affiliated at the time one of the companies submitted a proposal on a small business set-aside contract even though the proposal was submitted before the acquisition was finalized but after the LOI was executed. The deal was consummated prior to award of the contract and a size protest was filed. Under 13 C.F.R. § 121.103(d)(1) stock options, convertible securities and agreements to merge (including agreements in principle) are given present effect for affiliation purposes. Often referred to as the “present effect rule,” this regulation creates affiliation between the small business and the other party to such agreements. There are several exceptions to the present effect rule such as 13 C.F.R. section 121.103(d)(2), which provides that “agreements to open or continue negotiations” are not considered agreements in principle and are not given present effect, and 13 C.F.R. § 121.103(d)(3), which states that agreements that are subject to improbable conditions, which are unenforceable under federal or state law, or where there is just a remote likelihood of the transaction actually occurring, are also not given present effect. LOIs should fall squarely into one of these exceptions. Until OHA’s recent decision, most practitioners could have felt fairly comfortable that they did. In the case at bar, the LOI was executed on September 21, the proposal was submitted on October 29, the deal was consummated on November 19, and the contract was awarded on July 8 of the following year. Based on this series of events, as well as a review of whether the terms in the LOI were similar to the executed deal and other post-submission factors, OHA held that the LOI constituted an “agreement in principle” between the parties as that term is used in the present effect rule. Because an “agreement in principle” was found as of the date the proposal was submitted, the two entities were affiliated and the small business was deemed ineligible for the small business set-aside. This holding has been appealed to the U.S. Court of Federal Claims, and oral arguments were presented Dec. 9. The resolution of the appeal may provide more guidance regarding when, if ever, a nonbinding LOI may be considered an “agreement in principle” for purposes of the present effect rule. In the meantime, while an LOI remains a useful tool in the acquisition process, contractors must be aware that merely saying the LOI is nonbinding may not be sufficient to avoid affiliation. The specific terms of the LOI and final deal, as well as the conduct of the parties before and after it is signed, may be examined. Accordingly, small businesses would be wise to consider the potential for affiliation at all stages of an acquisition. Alan D. Titus is counsel with PilieroMazza PLLC. He has a multidisciplinary commercial and tax practice including corporate transactions and corporate counseling, estate planning and probate administration. To learn more about Mr. Titus, visit his attorney page at www.pilieromazza.com.