The recent Government Accountability Office (GAO) decision in the case of Knudsen Systems, Inc. has cast a spotlight on the application of the “Rule of Two” in federal procurement set-asides for small businesses. The rule, detailed in Federal Acquisition Regulation (FAR) 19.502-2(b), mandates that agencies must reserve procurements over $150,000 for small businesses if market research confirms that at least two responsible small business offerors can meet the requirements at a fair market price. Remarkably, this GAO decision marks the first time in nearly a decade that a protest against setting aside a procurement for small businesses has been upheld.
The Controversial Rule of Two
Forms of Rule of Two Protests
The Rule of Two protests generally manifest in two distinct ways: small businesses contest the adequacy of market research leading to a non-set-aside procurement, or larger businesses challenge the decision to set aside a procurement, arguing that the Rule of Two analysis was irrational. This latter context formed the crux of the GAO’s decision in the Knudsen case, mirroring a similar instance from over nine years ago involving Triad Isotopes, Inc. This litigation serves as a critical benchmark for analyzing the intricate procedures agencies must follow to ensure compliance with federal regulations during the procurement process.
In the Knudsen case, the procurement in question involved the Navy’s acquisition of SONAR equipment, initially designated as a small business set-aside. This designation was premised on the Navy’s erroneous belief that a waiver for the nonmanufacturer rule had been issued. The nonmanufacturer rule typically requires the awardee to provide products from a domestic small business manufacturer unless a waiver is obtained, carrying significant implications for small business procurements. The Navy’s initial market research mistakenly communicated to potential offerors that this rule was not applicable, thus leading the agency to receive responsive bids from three small businesses. Unfortunately, these bids were based on inaccurate information.
The Case of Knudsen Systems, Inc.
Upon discovering that the nonmanufacturer rule did indeed apply, the Navy amended the solicitation accordingly but chose not to reassess its decision to pursue a small business set-aside. This amendment led Knudsen, a small business planning to source its equipment from a Canadian manufacturer, to file a protest. Knudsen argued that the Navy’s initial market research had inadequately considered small businesses’ capabilities to comply with the nonmanufacturer rule, effectively disqualifying them from performing the contract under the revised terms. This failure to re-evaluate the market research in light of the new, applicable rule was the cornerstone of Knudsen’s protest.
The GAO sustained the protest, concurring that the Navy’s initial set-aside decision was predicated on flawed and incomplete market research. GAO emphasized that market research must not only identify potential small business offerors but also assess their ability to meet all contractual obligations, including compliance with the nonmanufacturer rule if applicable. This highlights the essentiality of comprehensive and correct market assessments in supporting procurement decisions under the Rule of Two. It also underscores the broader implications and complications that can arise from incorrect assumptions about regulatory waivers.
Importance of Thorough Market Research
Consequences of Inadequate Market Research
The GAO’s decision signals the necessity of meticulous, accurate market research in federal procurements and solidifies the critical role such research plays in determining the feasibility of small business set-asides. Accurate market research ensures that agencies can make informed decisions that are both defensible and in line with FAR requirements. It particularly reinforces the point that making assumptions regarding regulatory waivers can dramatically impact procurement strategies and outcomes. In the Knudsen case, the Navy’s initial missteps exemplify the far-reaching repercussions of inadequate research and incorrect regulatory assumptions.
This ruling serves as a crucial reminder to all federal agencies about the thoroughness required in their market assessments. It calls for a more rigorous examination of potential offerors’ capabilities, taking into full account all applicable regulations, including the nonmanufacturer rule. This level of scrutiny is imperative not just to ensure compliance with existing regulations but to uphold the integrity and objectives of procurement policies aimed at supporting small businesses. The GAO’s decision thereby reiterates the importance of these detailed analyses in avoiding the pitfalls and legal challenges that can arise from oversights.
Broader Implications for Federal Procurement
The recent Government Accountability Office (GAO) decision in the case of Knudsen Systems, Inc. has brought significant attention to the “Rule of Two” in federal procurement set-asides for small businesses. This rule, outlined in Federal Acquisition Regulation (FAR) 19.502-2(b), requires that federal agencies must reserve procurements exceeding $150,000 exclusively for small businesses if market research finds that at least two capable small business offerors can meet the requirements at a fair market price. The GAO’s decision is notable as it represents the first instance in almost a decade where a protest against reserving a procurement for small businesses has been sustained. This decision underscores the importance of ensuring fairness and competitive opportunities for small businesses in federal contracting. It also highlights the critical role of thorough market research in determining whether such set-asides are appropriate and justified. The “Rule of Two” is a crucial mechanism to encourage small business participation, fostering a more diverse and competitive marketplace.
