In this second article about Disadvantage Business Enterprises (“DBEs”) we discuss the policy behind the DBE program and whether it actually achieves its goal of leveling the playing field for socially and economically disadvantaged businesses. This article will also discuss how contractors can avoid DBE fraud through due diligence.
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 California outlawed 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 equally opportunities for socially and economically disadvantaged individuals who are underrepresented in the construction industry.
Business Relationships Complicate the Process
The DBE program seems viable, but can suffer from the realities of the construction business. 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.
Barriers Still Exist to Improving DBE Participation
The statutory scheme also fails to address that DBE participation suffers from certain structural barriers that exist for certain minority groups and women to enter and move up in the construction and professional services industries. These barriers include education, career advancement, and access to capital.
Many occupations require, at minimum, a high school education and professional services occupations require a minimum four-year college degree. The lack of college education appears to be a barrier for Black Americans, Hispanic Americans, and Native Americans, which ultimately affects their representation of these groups in the California professional services industry. Minority groups are also often unable to obtain relevant work experience which has been shown to be important for business ownership and success. Caltrans reports that the employment of Black Americans in the construction industry is relatively low compared to other industries in California even within entry-level jobs.
Further, the employment of women in the California construction industry as a whole is relatively low, with the majority (94 percent) working in secretarial positions. Minority- and woman-owned businesses face substantial difficulties accessing business credit. Research from Caltrans has shown that Black American-owned and Hispanic American-owned businesses are more likely to be denied business credit, even after accounting for various race- and gender-neutral factors. In addition, women are less likely to apply for credit and receive smaller loans. Without equal access to business capital, minority- and woman-owned businesses must rely more on personal finances for their businesses, which leaves them at a disadvantage when trying to start and operate successful businesses. The ability to qualify for required bonding and insurance undoubtedly impacts a minority- and/or woman-owned firm’s success in obtaining work on public construction projects.
Until these structural barriers are adequately addressed and recognized, DBE participation and achievement goals will continue to lag across numerous fields.
“Pass Through” DBEs
DBE requirements vary depending on the underlying construction contract. Typically, a contract will require at least 10% participation by a certified DBE. General contractors and subcontractors have adopted various means to meet this requirement.
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, he must fulfill the DBE requirements. So what is his solution? The subcontractor finds a “pass through” DBE.
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 percentage. 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.
With respect to using “pass through” DBEs for 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.
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.
At the end of the day, the knowing use of a certified DBE as a mere pass through to meet project requirements is fraud. It can be investigated by the Office of Inspector General of the U.S. Department of Transportation and criminally prosecuted. Law abiding contractors can protect themselves by performing due diligence to confirm that the DBE is performing a “commercially useful function” on the project. According to federal regulations, a DBE performs a “commercially useful function” on a project if it is “responsible for execution of the work of the contract and is carrying out its responsibilities by actually performing, managing, and supervising the work involved.” 49 CFR §26.55(c). When a pass-through DBE is used, the DBE is not actually performing, managing, or supervising any work because its function is purely as a paper-pusher, marking up the invoices and billings of the non-DBE subcontractor or supplier actually performing the work. Such conduct defeats the entire goal of the DBE program, which is to provide profits and project experience to historically disenfranchised businesses.
The effectiveness and pitfalls of the DBE program continue be hot button topics in the construction industry. Contractors need to know how to best protect themselves from participating in DBE fraud or contractual engagements which bypass the law. If you have specific questions about your company’s requirements under the DBE program as a subcontractor or materials supplier (or any other questions about the DBE program), please contact me at by email at email@example.com or call me at 949/852-1800.