In this second post about disadvantage business enterprises (DBEs), we discuss statues and regulations that attempt to level the playing field for socially and economically disadvantaged businesses. We also discuss ways in which some contractors try to avoid those statues and regulations.
State & Local Policy
The California Legislature declared that it is the state’s policy “to aid the interests of minority, women, and disabled veteran business enterprises in order to preserve reasonable and just prices and a free competitive enterprise, to ensure that a fair proportion of the total number of contracts or subcontracts for commodities, supplies, technology, property, and services are awarded to minority, women and disabled veteran business enterprises, and to maintain and strengthen the overall economy of the state” California Public Contract Code §10115.10(a)(1–4).
Although that statute was deemed unenforceable when the citizens of California voted to outlaw affirmative action, for all intents and purposes it remains the state’s policy and the policy of all local public entities, with the goal to provide equal opportunities for socially and economically disadvantaged individuals who are underrepresented in the construction industry.
Business Relationships Complicate the Process
In concept, the DBE program may seem viable, but ask many people—DBE owners and/or managers, as well as those that would contract with them—and they will tell you based on a variety of reasons and personal experience that the system does not work as planned.
In almost all businesses, one of the biggest keys to success is the quality and quantity of a person’s relationships. That’s right: relationships matter. The construction industry is no different, but those relationships often are in conflict with the goal of leveling the playing field for DBEs.
If a decision maker for the owner has an excellent relationship with a particular general contractor, the probability of that general contractor winning the bid for a project goes up exponentially. General contractors who win large public works projects are never DBEs. Even if a socially disadvantaged individual owns the general contracting business, the company could never qualify as an “economically disadvantaged” enterprise, so it fulfills DBE requirements for the project through its subcontractors or material suppliers.
This “relationships matter” concept continues on the many occasions when specialty contractors also are not DBEs. The general contractor is confident in the skills and experience of these subcontractors and believes that using them will ensure a successful project. As a result, it falls to the specialty contractor (subcontractor) to fulfill the DBE requirements.
“Pass Through” DBEs
DBE requirements vary with the contract, but they will always require at least 3 percent participation by a disabled American veteran. Typically, the contract also will require at least 10 percent, sometimes more, participation by other socially and economically individuals. It is at this level that problems occur.
Sometimes the subcontractor does not want to give up the work to a DBE. Sometimes the subcontractor believes that certified DBEs in appropriate trade(s) are not sufficiently qualified. And sometimes the subcontractor would rather work with a non-DBE subcontractor with whom he or she has a good relationship. But the subcontractor wants the work from the general contractor. And to get it, the subcontractor must fulfill the DBE requirements. So what is his or her solution?
How it Works
The subcontractor finds a legitimate, certified DBE through which the subcontractor can “pass through” labor or materials that are part of the scope of the project. That is, the subcontractor uses a certified DBE as a conduit for materials or labor.
In the case of materials, the subcontractor provides the non-DBE material supplier with a list of materials needed for the project. But the subcontractor tells the material supplier to invoice a separate company (a DBE) that will in turn invoice the subcontractor and tack on an extra 2 percent to the bill. The subcontractor tells the material supplier not to worry because that DBE has its own warehouse and supplies materials from time to time. The material supplier then ships materials directly to the job site and the DBE that served as the middleman business never touches them or does anything at all with the materials. The general contractor usually knows what is going on—often he or she recommended the DBE as the middleman business.
With respect to labor, there are two approaches. Both options require the subcontractor to find a DBE holding the same type of license that the subcontractor holds for the required work:
- In the most common instance, the DBE contracts with the general contractor. After taking a small cut, the DBE turns around and subcontracts most, if not all, of its scope of work to the subcontractor with whom the general contractor wanted to work with in the first place.
- Less frequently, the non-DBE subcontractor contracts with the general contractor and then subcontracts a portion of the work to a certified DBE (sufficient to satisfy the DBE requirements). The DBE then subcontracts a significant portion of the work to a non-DBE subcontractor who just happens to be owned by the same people who own the first-tier subcontractor. Voilà—everyone is happy!
Common But Not Legal
It would be nice if this was just an occasional occurrence, but it is not. It is quite common. Does it satisfy the requirements of the DBE statutes, regulations, and contract provisions? No. Is it legal? No. Could the participants to the pass-through enterprise suffer economic harm? Absolutely.
In the third and final installment in this series relating to DBEs, we will discuss the legal requirements in the use of a DBE and why the pass-through operations described above do not comply with the law. We will also discuss potential penalties, as well as a few strategies to protect yourself if you are involved in a pass-through working arrangement.
If you have specific questions about your company and the role of DBE subcontractors or materials suppliers (or any other questions about the DBE program), please contact me at by email at JWakefield@cwlawyers.com or call me 949/852-1800.