GAO pushes back on SBA interpretation of novation rules

If your company is involved in mergers and acquisitions – and whose isn’t – then you will need to read the Government Accountability Office’s recent decision involving American Systems Corp. and its acquisition of DDL Omni Engineering.

American Systems bought DDL in August 2018 and the acquisition brought about 250 more employees and a variety of systems engineering and development work.

DDL brought to its new owner a set of Small Business Innovation Research grants that include work with the Defense Health Agency and its Theater Medical Information Program-Joint system.

TMIP-J is a system of systems and supports the U.S. military with health care data and logistics for service members deployed around the world. The system is currently in sustainment and hasn’t been updated in 20 years. DHA awarded SBIR Phase I and Phase II grants to DDL to look for ways to transform and modernize the system.

Fast forward to September, when American Systems awarded a Phase III SBIR to build out what had been developed under the Phase I and Phase II. ASRC Federal Data Network Technologies subsequently filed a protest saying that American Systems wasn’t eligible for the award. ASRC Federal is one of the sustainment contractors for maintaining the current TMIP-J system.

GAO agreed with ASRC Federal and ruled that the Defense Health Agency needs to re-evaluate its requirements and determine the best to buy the services it needs to transform TMIP-J.

The reasoning behind GAO’s decision gets convoluted, but here is what happened.

GAO disagreed with how both the Defense Health Agency and Small Business Administration interpreted SBA regulations governing how SBIR grants are novated and what happens after a company is acquired.

For a company to win a Phase III award, it must have done the Phase I and Phase II work. If the company is acquired, it should have its Phase I and Phase II awards novated. SBA argued that the use of the phrase “for example” in the regulation means that there are circumstances when an award can be made without novation, especially when it is clear who the “successor in interest” is. In this case that is because American Systems acquired DDL.

But American Systems did not specifically novate DDL’s Phase I and Phase II grants for TMIP-J. American Systems did novate a different Phase III grant.

GAO disagreed with SBA and said the use of the word “must” in the SBA policy directive makes a novation a requirement. American Systems didn’t novate those SBIR grants and therefore wasn’t eligible for the award.

It doesn’t matter that American Systems acquired DDL, who was doing the work under Phase I and Phase II. American Systems was clearly the “successor in interest.” That was good enough for SBA and DHA, but not for GAO.

That’s the warning here, especially when buying a small business. SBA might sign off on something, but you have to be ready for other challenges to the work you are acquiring.

Another interesting point here is that ASRC isn’t eligible for the Phase III work either because they didn’t do the Phase I or Phase II work.

But in essence, DHA can’t move forward with a Phase III award. DHA will need to go the route of a traditional procurement.

ASRC Federal, American Systems and others will face each other in a competition. That’s what ASRC Federal wanted to accomplish via its protest: argue they can do the necessary work and get the chance to compete for it.

I guess it is another consideration for due diligence.