Bye-Bye, "Three-in-Two" Joint Venture Rule

If you’ve attended one of my presentations on joint ventures over the years, you’ve probably heard me climb up on my soapbox and proclaim that the so-called “three in two” joint venture rule is one of my least favorite rules in government contracting. If you ask me, the rule is both terribly confusing and so easily circumvented as to be largely meaningless.

Perhaps the SBA was listening to me and others who strongly dislike the rule, because the the three-in-two rule is going away. Effective November 16, 2020, the SBA will replace the three-in-two rule with a different and much less confusing requirement–basically, a “two” rule.

First things first: the three-in-two rule is an affiliation rule, not a hard limit on what joint ventures can and cannot do. When the three-in-two rule is violated, the SBA may find that the joint venture partners are affiliated for all purposes.

Affiliation is not a good thing, but being affiliated with your joint venture partner is different than being prohibited from working with that partner at all. That said, because affiliation can cause joint venturers to lose small business eligibility, it’s reasonable for most joint venturers to essentially treat the three-in-two rule as a hard limit (which is what many people already believe it to be).

There have been a few iterations of the three-in-two rule over the years. Under the version in effect as of the date of this post (October 2020), when a joint venture wins its first contract, a two-year window opens. During the two-year window, the joint venture can submit additional offers, until the joint venture receives its third award. If the joint venture submits an offer after the two-year window closes, or after the joint venture has received three awards (whichever comes first), the SBA may find that the joint venture partners are affiliated.

The three-in-two rule has long been very confusing–especially the “three” part. “Three contracts” sounds simple enough, but what exactly is a “contract”? Do subcontracts qualify? Commercial contracts? Orders under IDIQs? How about blanket purchase agreements, which, technically, aren’t contracts at all? The SBA has provided a few answers over the years, but not nearly enough to dispel the confusion surrounding the requirement.

Fortunately, the SBA’s new rule is significantly less confusing. The new rule simply deletes the “three” part, imposing an across-the-board two year window on joint venture bids:

[A] specific joint venture entity generally may not be awarded contracts beyond a two-year period, starting from the date of the award of the first contract, without the partners to the joint venture being deemed affiliated for the joint venture. Once a joint venture receives a contract, it may submit additional offers for a period of two years from the date of that first award. An individual joint venture may be awarded one or more contracts after that two-year period as long as it submitted an offer including price prior to the end of that two-year period. SBA will find joint venture partners to be affiliated, and thus will aggregate their receipts and/or employees in determining the size of the joint venture for all small business programs, where the joint venture submits an offer after two years from the date of the first award.

Under the current three-in-two rule, savvy joint venture partners can can circumvent the two-year restriction under the new rule simply by forming new joint ventures. In one rather eye-opening case, two joint venture partners won 15 contracts together over a four-year period. But these partners were smart: they won those contracts using eight different joint venture entities. The result? No affiliation!

The new rule maintains the ability to easily circumvent the two-year restriction. It says:

The same two (or more) entities may create additional joint ventures, and each new joint venture entity may submit offers for a period of two years from the date of the first contract to the joint venture without the partners to the joint venture being deemed affiliates. At some point, however, such a longstanding interrelationship or contractual dependence between the same joint venture partners will lead to a finding of general affiliation between and among them.

The circumvention provision is so broad that the rule ends up being little but a de facto “gotcha” for people who don’t know how the rule works. Two companies who do a relatively small amount of business together can be found affiliated merely because they didn’t know they were supposed to form a new joint venture after two years. Meanwhile, two companies who do a lot more business are fine, because they trotted off to the local Secretary of State (or, more likely, went to the Secretary’s website) to fill out a one-page form, registering a new unpopulated entity. Affiliation can severely harm or even destroy a company’s government contracting business. To me, it’s unfair to impose such a devastating penalty for this sort of ticky-tack administrative oversight.

That quibble aside, the new “two” rule is, in my opinion, a significant improvement over the three-in-two rule. A simple two-year clock will make it much easier for joint venture partners to understand and comply with the rule. Just remember to circle that two-year deadline on your calendar when your joint venture wins its first contract, because missing it could be a very bad thing.

Questions about this post? Or need help with a government contracting legal issue? Email us or give us a call at 785-200-8919.

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