Piliero Mazza &
Pargament, PLLC

Vol. IV, Issue 4
May-June 1999

An Update for Federal Contractors and Commercial Businesses


Status of Cases
Challenging Preferential
Procurement Programs

Estate Planning:
A Business Decision
That Should Not
Be Avoided



Status of Cases Challenging Preferential
Procurement Programs

Following the Supreme Court’s landmark decision in Adarand Constructors v. Peña, a number of lawsuits were filed challenging the constitutionality of the Small Business Administration’s ("SBA") 8(a) program. Although several of those cases have been dismissed, there are still lawsuits pending which seek to have the 8(a) program declared unconstitutional. In addition, suits have been filed challenging small disadvantaged business set-asides. Given the threat these cases pose to minority business procurement programs and the resulting impact that they could have on business planning, business owners should be aware of the status of these challenges.

In 1995, C.S. McCrossan Construction Company, a white-owned commercial construction contractor, filed one of the first suits challenging the constitutionality of the 8(a) program. The case, entitled C.S. McCrossan Construction Company, Inc. v. Jan Cook, et al., was filed in the United States District Court for the District of New Mexico. The plaintiff sought to enjoin an anticipated 8(a) competitive award of a highway construction contract at White Sands Missile Range ("WSMR") by the U.S. Army Corps of Engineers. The gist of the plaintiff’s complaint is that the 8(a) program, as applied to construction contracts at WSMR, is unconstitutional.

The case has been in litigation for the last three years and was recently referred to a magistrate for an initial ruling on several procedural matters. The parties have filed cross motions for summary judgment seeking to obtain a final ruling on the merits. Although the case could be decided on the motions, the plaintiff has requested an evidentiary hearing. If a hearing is granted, a decision on the merits is not likely until the end of this year.

Another case filed in 1995, entitled DynaLantic Corp. v. U.S. Department of Defense, sought to enjoin the Department of the Navy from awarding a contract for the design, installation and testing of the UH-1N Helicopter Aircrew Procedures Trainer. The case was brought in the U.S. District Court for the District of Columbia. The plaintiff, DynaLantic, claimed that the set-aside for competition among 8(a) firms constituted an unconstitutional race-based classification and could not be justified under strict scrutiny because there is no evidence of past discrimination in the military simulator manufacturing industry.

DynaLantic’s complaint was initially dismissed by the district court on standing grounds. In other words, the court found that DynaLantic did not have a sufficient stake in the controversy to obtain judicial relief. The Circuit Court for the District of Columbia, however, reversed the district court’s decision and allowed the plaintiff to amend its complaint to challenge the program. The case is currently before the district court on remand, and is in the discovery stage. We understand that the Department of Justice ("DOJ") intends to file a motion for summary judgment at the end of this summer. A decision on the merits is likely by the end of the year.

Two legal challenges to the 8(a) program that were unsuccessful are SRS Technologies Inc. v. U.S. Department of Defense, et al. and Ellsworth Associates, Inc. v. United States of America. In SRS, the plaintiff sought to enjoin the commencement of performance of a Department of Defense ("DOD") contract for engineering services at the Pacific Missile Range Facility in Kauai, Hawaii. SRS claimed that the DOD’s set-aside of the contract to an 8(a) firm -- HTS --constituted an improper race-based classification in violation of the Constitution.

HTS filed a motion to dismiss the complaint, alleging that SRS lacked standing to challenge the 8(a) award because SRS itself was owned by a socially disadvantaged individual. The court agreed and dismissed the complaint in its entirety. Following the dismissal, SRS appealed the decision. After the district court’s decision was affirmed by the Fourth Circuit, SRS appealed to the Supreme Court which denied SRS’s petition to review the case.

Similarly, in Ellsworth Associates, Inc., the plaintiff sought to enjoin the federal government from awarding a National Oceanic and Atmospheric Administration ("NOAA") contract to an 8(a) firm. Ellsworth claimed that NOAA’s set-aside of the contract constituted an improper race-based classification in violation of the Constitution and other laws. The DOJ moved to dismiss for lack of standing because Ellsworth’s owner was a socially-disadvantaged individual. The motion was granted and the case dismissed for lack of standing. Since the dismissal, there has been no further activity on the case.

The 8(a) program has not been the only preferential procurement program subject to challenge. Since the Adarand decision, challenges have also been made to preferential procurement programs of state and federal agencies. The most recent successful challenge was brought by three sodding companies in a case entitled In re Sherbrooke Sodding that was brought against the U.S. Department of Transportation ("U.S. DOT") and the Minnesota Department of Transportation ("MDOT"). In Sherbrooke, the plaintiffs, white male-owned subcontractors, contended that they had been illegally discriminated against when bidding on road construction projects because of their race due to the preference given to members of minority groups under Minnesota’s Disadvantaged Business Enterprise ("DBE") program. The U.S. District Court for the District of Minnesota agreed and permanently enjoined MDOT from soliciting bids for highway programs which incorporate DBE participation requirements. According to the district court, Minnesota’s DBE program is unconstitutional under the standard established in Adarand.

The DOJ has appealed the decision. In addition to defending the constitutionality of Minnesota’s DBE program, the DOJ is contending that the case is moot under the new federal DOT DBE regulations. The parties are currently briefing the issue and a decision should be rendered later in the year.

Another case on which a decision is pending is Rothe Development, Inc. v. Department of Defense. The case was filed in October 1998 in the District Court for the Western District of Texas against the DOD’s 10% price evaluation adjustment for small disadvantaged businesses ("SDBs"). The complaint seeks to enjoin the Air Force from using the 10% price preference in connection with the award of a contract for telephone maintenance services at Columbus Air Force Base in Mississippi. The plaintiff alleges that the price evaluation adjustment is unconstitutional under Adarand. Following the denial of the plaintiff’s motion for a preliminary injunction, the parties engaged in discovery and filed cross motions for summary judgment. A decision on the merits is imminent.

It is unclear what impact an adverse decision on any of the cases discussed above will have on minority business procurement programs. Most of the cases were filed before the SBA’s 8(a) regulations were amended and the new SDB program was implemented. For example, an adverse decision in Rothe may only affect the award in that case given the DOD’s recent suspension of the SDB program on DOD procurements. In any event, these cases could potentially affect preferential procurement programs in the future. Accordingly, we will continue monitoring these cases as well as any new challenges to minority business programs.


Estate Planning: A Business Decision
That Should Not Be Avoided

Successful business owners often credit their success to long term business planning. A very common but often overlooked aspect of running a business is estate planning. Like many people, many business owners tend to view estate planning as only requiring the preparation of a will. However, estate planning encompasses much more, particularly when a business is at stake. Sound estate planning can help preserve a family business which could be lost unless a strategy is implemented to transfer the sale of the business upon the death of the owner.

Estate planning involves financial, tax and business issues, as well as the preparation of a will. Depending on the particular circumstances of the business, the process may be simple or complex. The size of the business and how ownership is held are factors that must be considered. For example, the 100% owner of a small business should plan for the transfer of leadership as well as the transfer of ownership. In contrast, the owner of less than 100% of a large or small business may need a buy-sell agreement, delineating how much stock must be sold back to the company or to other owners, thereby allowing heirs to cash out of the business.

One of the major reasons for estate planning is to reduce probate costs and estate taxes. In many cases, the tax liabilities on inherited property and probate costs are so high that the intended beneficiary of the bequest has to sell the transferred assets to pay those costs. When a business is at stake, it is critical that the business owner plan ahead for the payment of those expenses.

There are a number of measures that can be taken by a business owner to reduce probate costs and the tax liability of heirs. One of the most commonly used measures is the creation of a living or family trust. Such trusts involve the creation of a written agreement which provides for the transfer of the stock of the business into a trust. Otherwise known as a "revocable inter vivos trust," this mechanism allows business owners to retain control of their businesses and make changes to the trust instrument at any time. The assets held in trust ( i.e., the business) are immediately transferred at the time of death to the beneficiaries without the expense or delay of probate court. Although the tax advantages of a revocable trust are not the same as for irrevocable trusts, it allows an owner to retain control over the business and immediately transfer it upon death.

There are other kinds of trusts that eliminate estate tax liabilities altogether. For example, under a "grantor retained annuity trust," the business is transferred to a trust and the owner receives income from the trust for a designated period. The transfer, however, is irrevocable and not subject to change.

Two other techniques often used to avoid estate taxes are gifts and family partnerships. Under current law, assets or property of up to $10,000 per year may be transferred without triggering gift taxes. A business owner can take advantage of this law by giving shares of company stock or cash on a regular basis to heirs, thereby reducing the value of the estate before estate taxes take their bite. When coupled with the exemption from federal estate taxes -- which will be increased from $650,000 in 1999 to $1 million in 2006 – business owners can protect a significant portion of their estates from taxes. The downside of gifting stock, of course, is that a portion of ownership of the company is irrevocably transferred. The new owner could cause unexpected problems in the operation of the business. Extreme caution, therefore, should be exercised in gifting stock to family members for the purpose of reducing taxes.

Family partnerships may also be established to avoid estate taxes. Under this mechanism the stock of a family business may be transferred to a partnership without any tax liabilities. As a family owned partnership, the IRS treats the shares as less valuable because of their lack of liquidity. As a result, the shares can later be passed on to family members at lower tax rates.

In addition to tax issues, business owners should consider obtaining insurance to cover the unavoidable costs of settling the estate. Depending on the size of the company, estate settlement costs may take thousand of dollars and years to complete, draining the estate of significant assets. Life insurance policies on the owner can defray those costs. There are two kinds of insurance policies that may be purchased to cover the expenses associated with settling the estate. One type of insurance is a permanent policy, which covers estate taxes at the time of the owner’s death. Another type of insurance is "key-man" insurance, which provides a cash disbursement to be used for working capital. This second type of insurance may be of particular value while new management takes over the business and heirs settle the estate.

In short, successful business owners need to plan ahead for the inevitable – death and taxes – just as they do for other important milestones in their business. Consideration should be given to entering into a buy-sell agreement if ownership in the company is shared with another person. The agreement should state how much stock must be sold back to the company under circumstances such as the death of a partner or co-owner. Such an agreement allows heirs to cash out of the business while co-owners stay in control of the company. In addition, there are many tax saving vehicles that may be used that protect the business owners’ interests while ensuring the long term value of the business to heirs. Assets can be held and transferred in a variety of ways, allowing business owners to reduce estate taxes. Because these vehicles involve the transfer of the owner’s interest in the business while he/she is still living, these cost savings measures should be taken only when the owner is comfortable relinquishing a portion of his/her ownership to third parties. If the owner has identified close family members or other trustworthy individuals to continue the business, then these options should be considered so that years of hard work and sacrifice in a business are not squandered when the inevitable comes to pass.


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