As the construction industry still struggles in a weak economy, contractors continue to explore new opportunities for work. This may be why many of our clients want to find a way to participate in programs designed for Minority Business Enterprises (MBE), Women Business Enterprises (WBE), Disadvantaged Business Enterprises (DBE) or any of the other programs for contractors that qualify for "set-asides," or who get a preference or other special consideration.

Inquiries into these programs typically involve two questions. The first question is, "Can I qualify as an M/W/DBE?" The short answer to this is usually, "Yes, if your firm is truly owned and controlled by a qualifying individual (a woman, minority, or service disabled veteran) and it meets various other requirements." This usually results in the second question, "If I don't qualify, can I somehow participate in the DBE type programs?" In other words, they want to know if they can get a piece of the action by selling part of their business to someone who would qualify, or setting up a joint venture or LLC with a firm that already qualified, etc. The short answer to this question is probably not.

When exploring the idea of participating in a set aside program, the most important question to ask yourself may be, “Why do I want this status?” The answer to this question will then determine the path that you take:

  • Some larger purchasers of construction are private firms who have a commitment to diversity, but no legal obligation to hire any disadvantaged business. These firms tend to have the most flexible rules and are the easiest to qualify for.
  • Some private companies get large government contracts (in the aerospace industry, for example), and a requirement of their contracts is that, in all of their purchasing, including construction, they must include such participation. Often, however, it is not necessary to meet the same stringent standards as a true government contractor.
  • The U.S. Government has a very complete set of regulations, in fact, many different sets of regulations since various federal agencies have their own regulations. These are generally on websites that are well maintained and easy to navigate. The penalties for violating federal regulations are severe.
  • Many state and local governments and agencies have their own programs with their own rules, some of which require minimal paperwork and are easy to meet.

While all of these programs have their own rules, which can differ widely, a few general principals seem to be found in most of them, which illustrate the problems associated with MBE/WBE work for non-qualifying firms.

First, nearly every program requires that the qualifying individual or individuals own at least 51% of the entity and actually control it. This makes it impossible for a minority shareholder (in the less-than-50% ownership definition of minority shareholder) to protect its investment. Phantom stock deals and side agreements might sound good in theory, but could prevent certification and they cannot be reliably enforced if there is a dispute.

Second, the person or persons who are the minority or female members who run the company have to show that they actually have a background in the area of construction of the company. The point of this is simple. How can someone with no relevant experience actually control the company? They can't, of course, and the certifying authorities know this, which is why they ask tough questions. A woman who was a hairdresser until the company was formed, or a minority who was a doctor until asked to be president of a paving operation (both real situations) will not be able to convince the certifying agency that they have the requisite experience to control a contracting company.

Third, the person who is supposedly running the operation has to have a salary and benefits commensurate with that level of corporate position. This can mean making more money than the estimators, project managers, etc. It also means having the authority to hire and fire anyone and everyone, including senior managers and directors.

Fourth, the set-aside contractor has to have full control, including financial control. Progress payments need to go to the set-aside contractor’s account, and the set-aside contractor has to have complete control over the checkbook. If a non set-aside contractor is concerned about what his or her partner is doing with funds, there is not much he or she can do to stop it. And remember, the qualifying woman or minority owner must have the absolute right to decide what projects to accept or reject, and generally is the one to sign the contracts.

Generally, a set-aside contractor only needs a non-set-aside contractor as a partner, with whom he has to share profits, because he can’t finance or perform the work on his own. Where the work is public work, and the contractor has to give a surety bond, this often translates into the non-set-aside contractor guaranteeing the surety bonds for the set-aside contractor or joint venture. Usually, the government agency involved knows this, that the “small, disadvantaged business” can’t come up with a $10,000,000 bond, but that doesn’t mean that it will permit the non-set-aside partner who is backing the bonds to protect its interests. The lack of control can create serious risk for the no set-aside contractor in this situation.

Just as there is no free lunch, there is no trick, back-door, risk-free way to participate in set-aside work. Then again, the whole point of set aside programs is to encourage participation by socially disadvantaged individuals, so it should not be surprising that the rules make it difficult for non-qualifying individuals to directly profit from these programs. Anyone thinking of going into such a venture, particularly on public work, needs to ask many questions and get satisfactory answers in advance. This is one area where due diligence is absolutely essential.

Michael Callahan is a partner at Stinson Morrison Hecker LLP (the same firm as long-time columnist Susan McGreevy) where he assists clients with all aspects of their construction law needs, including litigation.