Gain Electronics Corporation Appellant
SBA No. 2779SBA No. 2779November 25, 1987
SBA No. 2779 (S.B.A.), SBA No. 2779, 1987 WL 93728
Small Business Administration (S.B.A.)
Office of Hearings and Appeals
[Size Appeal]
*1 GAIN ELECTRONICS CORPORATION, APPELLANT
*1 Docket No. SIZ-87-9-10-156
*1 Solicitation Nos. DAAL02-86-C-0032
*1 DAAL01-87-C-0736
*1 (SBIR Phase I Awards)
*1 Department of the Army
*1 U.S. Army Laboratory Command
*1 Fort Monmouth, New Jersey
*1 November 25, 1987
DIGEST
When two major stockholders (or groups of stockholders) of an otherwise small firm, which is legally controlled by its directors, agree that they will each elect two directors and that those four directors will agree upon two additional directors, the two stockholders (whether individual entities or groups of persons) share control of the firm, and, if one of the two stockholders is an other-than-small firm, the firm is affiliated with that firm, and it is not small.
DECISION
USHER, Administrative Judge, Presiding:
Jurisdiction
*1 This decision is rendered pursuant to the provisions of the Small Business Act of 1958, 15 U.S.C. 632 et seq., and the regulations codified at 13 CFR Part 121.
Issue
*1 The question is whether, despite its bylaws and agreements among its stockholders, the Appellant is controlled by an other-than-small Japanese firm and its U.S. affiliate, who together own 46.4 percent of its stock.
Facts
*1 The Army Laboratory Command has awarded these Small Business Innovation Research Program contracts to Gain Electronics Corporation (Gain). The Standard Industrial Classification code is 7391, and the small business size standard is 500 or fewer employees.
*1 On July 28, 1987, the Chief of the Small and Disadvantaged Business Utilization Office at Fort Monmouth, New Jersey requested a formal size determination of Gain because “the firm has submitted a SBIR Phase II proposal and award is pending.” Furthermore, according to the request, “... information received by the contracting officer, as a result of preaward survey, [indicated] that the firm is 56% owned by a Japanese firm, Mitsui.” The New York Regional Office initiated a size investigation of Gain and required submissions, including completed SBA Forms 355 and 1340 and supporting information. Having evaluated the information submitted, on September 1, 1987, the Regional Office issued its determination.
*1 There appears to be no contradiction of the assertion that the bid date here is December 31, 1986, and it is agreed, therefore, that Gain must establish its small business size status as of that date. The evidence adduced for the record further establishes the following facts. The two Mitsui firms, Mitsui & Co. (U.S.A.), Inc. and Mitsui & Co., Ltd. (collectively referred to as Mitsui) are other-than-small businesses, and, on the bid date, they owned 46.4 percent of Gain. According to its bylaws, Gain is managed and controlled by its Directors,1 and, further, according to its bylaws, Gain's six Directors (as of December 1, 1986) were to be selected as follows: two were chosen by Mitsui, two by Gain's senior management, and two were to be independent and unaffiliated with any large shareholder and selected by the other four. Since January 15, 1987, a seventh Director was designated by principal investors other than Mitsui.2
*2 At the time of the bid submission, six Directors had been named. Two of those were Mitsui's designees and two were “Gain-employee representatives.” The other two, described as “independent,” were Richard Hodgson, appointed on October 24, 1986 and George Kozmetsky, appointed on November 11, 1986.
*2 The “voting agreement” provides, in pertinent part:
*2 AGREEMENT dated as of October 18, 1985 by and among GAIN ELECTRONICS CORPORATION, a Delaware corporation (the “Company”), MITSUI & CO. (U.S.A.), INC., a New York corporation (“Mitsui”), EDELSON TECHNOLOGY PARTNERS, L.P., a Delaware limited partnership (“Edelson”), PIVOT III-V CORPORATION, a Delaware corporation (“Pivot”), RAYMOND DINGLE, an individual (“Dingle”), REGINALD R. BUCKLEY, an individual (“Buckley”), RUDI H. HENDEL, an individual (“Hendel”), G. MICHAEL CONLEE, an individual (“Conlee”) and MICHAEL D. LOGAN, an individual (“Logan”). Mitsui, Edelson, and Pivot are hereinafter collectively referred to as the “Purchasers.” Pivot, Dingle, Buckley, Hendel and Conlee are hereinafter collectively referred to as the “Founders”.
*2 In order to induce the Company, the Purchasers and the Founders to enter into and perform the Preferred Stock Purchase Agreement dated the date hereof among such parties (the “Purchase Agreement”), the parties hereto hereby agree as follows:
*2 1. The Purchasers, the Founders and Logan shall act in all capacities and vote the shares of stock of the Company now or hereafter owned or controlled by them so as to cause and maintain the election of the Board of Directors of the Company (the “Board”) of (a) two (2) designees of Mitsui, (b) Dingle, (c) one designee of Dingle, and (d) a person mutually acceptable to Dingle and Mitsui.
*2 The minutes of a November 11, 1986 meeting of the Directors reveals that that agreement was amended to simply provide for a sixth Director, without any indication as to how that Director is to be chosen, viz.,
*2 Mr. Hodgson moved that Article II, page 7, last line of the By-Laws of GAIN Electronics Corporation be amended to read “than six (6) Directors, who need not be stockholders of the ”. [sic] This action increases the size of GAIN Board of Directors from 5 to 6. Dr. Hwang seconded the motion and it was adopted by affirmative vote of all Directors present.
*2 Mr. Dingle moved that Dr. George Kozmetsky be appointed to the newly created sixth Director position of the Corporation. Mr. Hodgson seconded the motion and its was enthusiastically adopted.
*2 The Regional Office determination reads, in pertinent part, as follows:3
*2 The size standard for this solicitation is 500 employees. The protest alleges that Gain's affiliation with (control by) a large concern renders Gain ineligible to compete for small business set-aside contracts.
*2 Gain, by its attorneys, asserts that on the bid submission date, (Dec. 31, 1986) Mitsui (USA) and Mitsui (Tokyo) (collectively “Mitsui”) owned less than 50% of Gain's stock and therefore, “did not reach this regulatory level of presumptive control (Attorney's letter memorandum in support of Gain dated August 10, 1987, hereinafter referred to as “Gain's memo”). Gain's memo goes on to state that Gain can rebut this presumption if SBA finds Mitsui control on the bid date.
*3 An analysis of the facts in existence on the bid date reveals that while Mitsui owned less than 50% of Gain's stock, Mitsui shared control of Gain's Board of Directors. As of the bid date, Gain's Board was governed by the October, 1985 “Statement of Consent” in which the sole shareholder and director amended the By-Laws to provide for a five (5) person Board and appointed three (3) persons to the post. The fifth position was never filled. Two of the four directors are Mitsui representatives.
*3 As Gain's memo points out, Delaware corporate law vests management of a corporation in its Board of Directors. Thus, as of the bid date, Mitsui had negative control of Gain.
*3 It may be that Mitsui's subsequent stock acquisitions were made pursuant to an option agreement, in which case both majority stock ownership plus the “Amended and Restated Voting Agreement” (the Agreement) would be deemed exercised and controlling for size purposes (13 CFR 121.3(a)(iv)). Since this point is unclear, and in order to give Gain the benefit of this ambiguity, an analysis of the Agreement was taken. Gain's memo asserts that Mitsui, by the Agreement, has relinquished control of Gain's Board. An analysis of the Agreement for size purposes must be two pronged: to determine how directors are appointed; and how the Agreement may be amended.
APPOINTMENT OF DIRECTORS
*3 The Agreement provides that the number of directors be increased to seven (7). It is mandated that the directors be chosen in the following manner:
*3 1. Raymond Dingle (if he is an employee. If not, the management gets 2 directors).
*3 2. Designee of Management of Company (chosen by majority of 5 senior ranking officers.
*3 3 & 4. Independent of any stockholder owning 5%; these persons must be acceptable to:
*3 a) majority of 5 senior officer [sic] of company, and
*3 b) purchasers (holding majority of Preferred Stock outstanding) (Mitsui).
*3 5 & 6. Designees of Mitsui Japan and Mitsui USA, acting jointly.
*3 7. Designee of majority of outstanding preferred stock not held by Mitsui.
*3 As of this date, there have been only 6 directors appointed to the Board.
*3 An analysis of director appointment clearly shows that Management does not have unequivocal control of the company. Management has power to appoint two directors, and both management and Mitsui must agree on the appointment of the two independent directors. For size purposes, Mitsui has negative control of 4 of the 7 Directors of the board. Mitsui shares control of Gain with Management. As SBA regulations provide at 13 C.F.R. 121.3(a)(i) (cited earlier), control may be positive or negative, and it matters not whether this power is exercised (i.e., whether the vacant spot reflects an unexercised Mitsui appointment).
*3 The case at bar does not, as it is argued, fall squarely within the precedential case relied upon in Gain's memo. In the Size Appeal of Adolphe LaFont USA, Inc., Appeal No. 2434 (June 1986) (LaFont), LaFont, though the majority stockholder, forever surrendered its ability to control ALUSA's board by restricting its appointment to one director out of three. The agreement could be amended only with the consent of all parties. LaFont did not retain negative control of a second director, to create a shared management, as is the case with Mitsui and Gain. That this agreement can be amended only with the consent of all parties is moot. The Agreement does not rest control of Gain with its management. SBA finds Gain to be affiliated with Mitsui. Gain's affiliation with Mitsui renders Gain other-than-small and ineligible to compete for this procurement.
*4 Gain shall not self-certify as small with the same or a lower employee or annual receipts size standard (whichever is applicable) unless it is recertified. [Emphasis in original.]
*4 Gain, by its Counsel, filed a timely appeal of the Regional Office determination on September 10, 1987.
*4 The essence of the basis for the appeal is stated as follows: “the actual workings of the Gain Board clearly demonstrate the independence of the non-Mitsui directors from the Mitsui directors.”
Discussion
*4 We come to a different conclusion when considering the facts as set forth by the Appellant's Counsel. As of December 31, 1986, there were six Directors of Gain; two were Mitsui representatives, two were “Gain officer/employee directors, independent of Mitsui,” and two were “totally independent persons who were mutually acceptable to Gain and Mitsui.” Based upon that factual situation, we find that Gain is controlled equally by “Gain-officer/employee” representatives and representatives of Mitsui, with resulting affiliation between the two. Thus, on the basis of the voting agreement, Mitsui and the “officer/employee” group of stockholders have equal control of the firm. This is true despite the facts set forth by Counsel, and argued at length, that Hodgson and Kozmetsky, the fifth and sixth Directors are “independent,” meaning they have no allegiance to either the two “officer/employee” directors or the Mitsui Directors. Their elevation to the Board was the result of a mutual agreement by and among the other Directors. The argument that Mitsui had no power to block the election of these two Directors is not factually correct, but if it were, it would be immaterial. Likewise, it is irrelevant that neither group of Directors, on its own, can remove Hodgson or Kozmetsky. Counsel argues that “the actual workings of the Gain Board clearly demonstrate the independence of the non-Mitsui directors from the Mitsui directors” and cites examples. This fact is equally irrelevant. Mitsui and the “officer/employee” group share the power to control the firm, and the failure of either to exercise that control independently is not determinative of the existence of the power. When two persons or two entities of any kind share power equally, there is resulting negative power, whether exercised or not.
*4 The Regional Office finding that this factual situation differs significantly from that obtaining in Size Appeal of Adolphe Lafont USA, Inc., No. 2434 (June 19, 1986), is correct, and the stated reasoning for that difference is also correct. The decision most analogous to this situation is Size Appeal of Zygo Corporation, No. 2514 (October 8, 1986). There we held that each of three entities, which together owned the largest block of shares, had the power to control, even though their individual holdings were only 21.9 percent, 15.6 percent, and 12 percent of the whole. In Size Appeal of Ochoco Lumber Company, No. 541 (1972), the Size Appeals Board noted that every concern must be controlled by someone or some group at all times, and, in Zygo, we held that “ ‘the minority stock presumption’ logically follows from that acknowledgment.” What can be said for voting stockholders and groups of voting stockholders can likewise be said of the Directors who represent them.
*5 For these reasons and the reasons stated by the Assistant Regional Administrator in his September 1, 1987 determination, Mitsui has the power to control Gain, and Gain is, therefore, affiliated with Mitsui. That affiliation renders Gain an other-than-small business.
Conclusion
*5 The Regional Office determination that Gain Electronics Corporation is other than small for this procurement is AFFIRMED, and the appeal is DENIED.
*5 This constitutes the final decision of the Small Business Administration. See 13 CFR 121.11(t), (u), and (v).
Footnotes
Counsel for Gain points out that Delaware law, under which Gain is incorporated, also provides for management and control of a corporation by its Board of Directors.
This procedure for selecting Directors was initiated pursuant to a “Voting Agreement,” dated October 18, 1985, and amended on November 11, 1986. That agreement was superceded by the “Amended and Restated Voting Agreement,” dated January 15, 1987, which provides for seven directors.
inasmuch
as the self-certification date is December 31, 1987, the latter amendment is of no consequence here.
Some of the facts recited by the Regional Office are at variance with the record.
SBA No. 2779 (S.B.A.), SBA No. 2779, 1987 WL 93728
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