Conditioned Agreements to Negotiate (CAN)

When acquiring or selling small businesses, government contractors need to be cognizant of the Small Business Administration’s (SBA) “present effect rule.” Under this rule, SBA will find that certain letters of intent (LOI) or other agreements to merge have a “present effect” on the buyer’s ability to control the small business seller. Numerous decisions by the SBA’s Office of Hearings and Appeals (OHA) have discussed the acceptable parameters of LOIs.

In a recent decision, OHA further refined the elements considered in the determination of whether an LOI amounts to an “agreement in principle.” In Size Appeal of Telecommunication Support Services, Inc., SBA No. SIZ-5953 (2018), OHA reviewed an LOI that:

  1. specified a purchase price and an anticipated closing date;
  2. contained exclusivity provisions; and
  3. discussed the terms of the purchase in detail, including shares to be purchased, valuation of shares, and assumption of contracts, management, and employee base.

Despite these seemingly definite terms, OHA determined the concerns were not affiliated because an LOI cannot be considered an agreement in principle when it can “fall apart after the date to determine size based on the unilateral actions of one of the parties.”

The LOI was framed as non-binding, general terms and conditions setting forth the terms under which the buyer would purchase the seller. Despite the specified pricing, OHA favorably considered the fact that the pricing was conditioned upon the seller meeting certain financial conditions. In addition, specific pricing does not establish an agreement in principle, rather it indicates more serious negotiations. The LOI was also conditioned upon the buyer’s right to conduct extensive due diligence prior to closing. Finally, the LOI permitted either party to withdraw from the agreement. The combination of all these factors led OHA to conclude that the LOI was not an agreement in principle and therefore, did not trigger the present effect rule.

Bottom Line: While it is still a fact-specific inquiry, it is possible to successfully avoid a finding of affiliation in acquisitions with a properly drafted “CAN.”

Should you have any questions about the SBA “present effect rule,” please contact one of the authors of this blog post.