Piliero Mazza & Pargament, PLLC Vol. 4, Issue 6 November/December 2002

An Update for Federal Contractors and Commercial Businesses


  A R T I C L E S

"Other Transactions" Likely to Play Critical Role in Homeland Security

Contractor Data Provided to Homeland Security May Be Protected From FOIA

Funding Small Businesses for the War on Terrorism


With Research and Development (R&D) encompassing a large portion of the homeland security efforts, "other transactions" (OT) are destined to play a vital role in the government's procurement policies. This means of  procuring high tech goods has been used by the Defense Department since the early 1990's to attract technology companies which are hesitant to enter into a contract, grant or cooperative agreement because of restrictions mandated by the Federal Acquisition Regulation (FAR). However, OTs are not subject to the FAR, and therefore have offered the government flexibility when acquiring advanced R&D for defense purposes. Now, that same flexibility will be utilized to achieve the government's objectives when it comes to homeland security.

In its Fiscal Year 2003 budget proposal, the Office of Management and Budget seeks $37.7 billion for homeland security -- up f rom $19.5 billion in 2002. Of this request, approximately $6 billion is earmarked to defend against bioterrorism, including R&D funds for finding ways to fight deadly diseases, such as anthrax, and develop diagnostic tests. Further, one of the critical functions of the proposed Department of Homeland Security (DHS) will be to develop technologies that not only detect biological, chemical, and nuclear weapons, but also treat and protect citizens exposed to those weapons.

Among the tools Congress anticipates making available to the new DHS will be OTs. The intent is to attract non-traditional contractors who offer innovative and cutting-edge homeland security technologies. DOD has long recognized that small start-up companies produce much of the nation's advance technology. However, these companies are hesitant to enter into standard government contracts, which often contain rigid requirements. For example, R&D companies have long complained about standard clauses incorporated pursuant to the Bayh‑Dole Act. These clauses require a government contractor to issue the government a non-exclusive, non‑transferable, irrevocable, paid‑up license to practice or have practiced, throughout the world, on behalf of the government any invention which results from government funding. Further, these clauses often require the contractor to report their inventions, preventing R&D companies from using trade secrets laws to protect their work. Instead of subjecting themselves to these terms, R&D companies sometimes choose not to do business with the government.

OTs, on the contrary are not so rigid. The best way to describe what an OT is, is to describe what it is not. An OT is not a contract, cooperative agreement, or grant, and it is not subject to traditional government procurement statutes or regulations, including: the FAR; the Defense Supplemental to the FAR; the Armed Services Procurement Act of 1947; the Competition in Contracting Act of 1984; the Federal Acquisition Streamlining Act of 1994; the Clinger-Cohen Act or the Federal Grant and Cooperative Agreement Act.  In addition, OTs are not subject to the Small Business Act, which is a double-edged sword for small businesses. While agencies are not required to meet the goals under SBA, small business concerns can receive sole source awards under an OT.

OTs have been used by DOD to enter into more commercial-like agreements, including teaming and cost‑sharing agreements. In teaming agreements, OTs permit the government to enter into multiparty consortium agreements, allowing the government to utilize multiple resources and technical know‑how from industry, academia and government labs. On the contrary, standard procurement regulations prohibit the government from entering into such a consortium made up of private and nonprofit entities. Accordingly, homeland security contractors can expect the government to utilize OTs to enter into science and technology agreements to explore -- among other things -- new technologies and systems for safeguarding nuclear material stockpiles and for detecting the movement of those materials. 

The government also plans to utilize the flexibility of OTs to develop prototypes, in which a contractor adapts, tests or integrates its commercial items for homeland security purposes. As the President has explained, the mission of homeland security will include both "evolutionary improvements to current capabilities, as well as the development of revolutionary new capabilities," to prevent "large-scale loss of life and major economic impact."

In addition to teaming agreements and prototypes agreements, the government is expected to utilize OTs to enter into homeland security cost sharing agreements, in which the contractor -- as a condition to receiving government funding -- will make payments to the government in the form of cash contributions or in‑kind contributions. Although considered unconventional, cost sharing under an OT will allow the government to leverage the private sector's financial investment to reduce homeland security costs. 

Finally, OTs will permit the government to employ more commercial‑like business practices when acquiring homeland security R&D than currently permissible under standard procurement regulations. The government will no longer be limited by procurement clauses, such as the Bayh-Dole Act, affording homeland security contractors the ability to negotiate intellectual property terms.

Whether pursuing prototypes which guard us against bioterrorism or investing in science and technology research to combat anthrax, contractors can expect the government to use OTs for homeland security purposes. As the President has stated, the government must do "everything possible to protect our citizens and strengthen our nation against the ongoing threat of another attack."


Contractor Data Provided to Homeland Security May Be Protected From FOIA

The nation's homeland security effort has raised concerns for a number of organizations, who wonder whether proprietary data shared with the government will be released under the Freedom of Information Act (FOIA). More specifically, the government is calling on organizations to voluntarily share information related to the nation's critical infrastructural assets. Recent studies suggest that up to ninety percent of the nation's infrastructure is controlled by private industry.  However, voluntary information sharing with the government understandably raises concerns among those who fear the adverse effect of the disclosure of business information that may be confidential in a competitive free‑market. This fear is augmented by the public availability of information submitted to the government under FOIA.

FOIA was enacted in 1966 and provides that any person has the right to request access to federal agency records or information. All agencies of the federal government are required to disclose records upon receiving a written request for them, except for those records that are protected from disclosure by the nine exemptions and three exclusions of the FOIA. These exemptions cover a variety of areas, including the protection of: national defense and foreign policy secrets, government personnel information, records otherwise exempt by statute, trade secrets and financial information, inter‑agency and intra‑agency memoranda, non-governmental personnel and medical files, records "compiled for law enforcement purposes," records involving the "regulation or supervision of financial institutions," and geological data concerning wells.

Given the breadth of information available to the public through FOIA, Congress has sought to alleviate concerns related to information sharing by amending the Homeland Security bill. More specifically, Section 724 of the Homeland Security Bill currently being debated in Congress provides that critical infrastructure information, shared in good faith, is exempt from disclosure under FOIA. This exemption, however, would require that the party submitting the information include an express statement on the documents noting that the information has been voluntarily submitted to the government in the expectation that the disclosure will be exempt under the provision. The clause prevents the dissemination of this information without the express consent of the party submitting it.

Section 724 of the proposed Homeland Security bill also limits the extent to which governmental agencies may use the voluntarily shared information. More specifically, governmental agencies are prohibited from using the information in connection with a civil action and from disseminating the information to state and local officials. Furthermore, the information is not subject to agency rules or judicial doctrine governing " ex parte" communications and the governmental agencies may only disclose the information for limited purposes. Finally, the section provides that violations of the provision by a government official are punishable by fines, imprisonment or both. 

In addition to protection under the Homeland Security bill, organizations that voluntarily submit homeland security information to the government, may be able to prevent the dissemination of that information under the Cyber Security Information Act. This bill, which was referred last July, 2001 to House Subcommittee on Government Efficiency, Financial Management and Intergovernmental Relations, encourages the prompt, voluntary, candid, and thorough, but secure and protected, disclosure and exchange of information related to the cyber security of entities, systems, and infrastructure. If passed, the new law would enjoy many of the same FOIA and Antitrust protections outlined in the current Homeland Security Bill.


Funding Small Businesses for the War on Terrorism

As our nation undertakes a massive effort against terrorism here at home, the government will be looking towards small businesses for everything from counter bioterrorism support services to innovative technologies that detect anthrax. Recently, U.S. Senator John Kerry, Chairman of the Senate Committee on Small Business and Entrepreneurship said: "The question today is whether we are going to unleash the capacity of our small businesses - our engineers and entrepreneurs - to meet the singular challenge that unites us . . . achieving security for all Americans." In fact, the Homeland Security Act of 2002 includes a 23 percent small business contracting goal.  Towards this goal, the government will depend on programs, such as SBA=s Small Business Investment Company Program to help fund small business ventures. To better understand exactly what this program provides and how it can help small businesses in the war on terrorism, the Legal Advisor provides the following " question and answer"analysis.

What is the SBIC Program, and How Does it Operate?

The Small Business Investment Company (SBIC) program was created by Congress to fill in the gap between available venture capital and the needs of small start-up businesses. SBICs are private investment firms which make venture capital investments in small businesses.  More specifically, SBICs provide qualified small businesses with equity capital, long‑term loans, debt‑equity investments or management assistance. The SBIC Program focuses on all types of manufacturing and service industries, and although some of the SBICs specialize in a particular field, such as computer security software, most of the SBICs will consider a wide variety of investment opportunities.

While SBICs are profit‑motivated businesses, they are regulated by the SBA. The funds utilized by SBICs are made up of thecompany's own capital, along with money it can borrow at favorable rates and which is guaranteed by the SBA. 

Does a Small Business Have to Be Socially or Economically Disadvantaged to ReceiveFunding?

No. Typically, there are two types of SBICs: regular SBICs and specialized SBICs. Regular SBICs invest in all types of small businesses. On the other hand, specialized SBICs invest only in small businesses owned by entrepreneurs who are socially or economically disadvantaged.  While the Small Business Program Improvement Act of 1996 ended the creation of new specialized SBICs, those in existence at the passage of the Act were "grandfathered" in and are still in operation today.

What Sort of Funding Do the SBICs Provide Small Businesses?

SBICs can offer several different types of funding vehicles to small start-up businesses. Probably the most typical funding comes in the form of long‑term loans to assist the small start-up business with the necessary financing to grow, modernize, and its business. The SBIC regulations require that these loans are of sound value and have a maturity date of no longer than 20 years. However under certain conditions, the regulations do allow the SBIC to renew or extend a loan's maturity for an additional ten years. SBICs can also supplement their own private investment capital with funds borrowed from the federal government at favorable rates. Under SBIC regulations, the minimum number of years in terms of repayment is five years, although the regulations do allow for the right to prepay a loan provided a reasonable penalty is required.

Loans and debt securities with terms less than five years are acceptable only when they are necessary to protect existing financings, are made in contemplation of long‑term financing, or are made to finance a change of ownership.

In addition to long term loans, an SBIC can also lend money to a small start-up business in the form of " debt securities." This means that the SBIC has a right to purchase equity in the small business itself. Many of these securities also have special subordination and amortization terms.  Finally, small businesses may qualify for assistance from a SBIC in the form of equity capital or management assistance.

Are There Any Limitations on the Types of Small Businesses Which Can Receive Loans from SBICs?

Yes. SBICs may invest only in qualifying small business concerns as defined by SBA regulations. Under the SBA regulations, SBICs are prohibited from funding a company whose primary business involves the directly or even indirect lending of funds to others, including the purchasing of debt obligations, factoring, or even leasing equipment on a long‑term basis with no provision for maintenance or repair. However, SBICs can fund a company which engages in relending or reinvesting activities (except agricultural credit companies, and those banking and savings and loan institutions not insured by agencies of the federal government). Finally, SBICs may not invest in other SBICs, unimproved real estate companies and companies with less than one‑half of their assets and operations in the United States, or companies which intend to use the funding to purchase farm land.

How Much Can an SBIC Invest in a Small Business?

The SBIC regulations allow an SBIC to invest up to 20 percent in any one small business.  Typically, this 20 percent includes securities, commitments, and/or guarantees. Under limited circumstances, an SBIC can receive permission from the SBA to invest more than 20 percent.

How Can a Small Business with an Idea for a Product or Service That Combats Terrorism or Supports Homeland Security Obtain a List of SBICs?

An SBIC can be organized in any state, as either a corporation, limited partnership, or a limited liability company. Typically, SBICs are owned by small groups of local investors, although others are owned by commercial banks and still others are corporations with publicly traded stock. A list of SBICs can be viewed at: http://www.sba.gov/INV/overview.html

If a Small Business Seeks Funding Under the SBIC Program, Will That Small Business Lose Control of its Operations?

No. In fact, the SBIC regulations prohibit an SBIC or its associates from taking control, either directly or indirectly, over any small business on a permanent basis. In addition, the SBIC is prohibited from controlling a small business being funded by another SBIC. There are limited circumstances in which an SBIC can receive permission from the SBA to assume temporary control of a small business. However, these requests are approved only when the SBIC needs to assume control in order to protect its investment, and the SBA will require both the SBIC and the small business to have an SBA‑approved plan for the divestiture of the SBIC once its interests are secured.









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