[00:00:42] Speaker 03:
Next case is ExoTech versus the United States, 2019-1743.

[00:00:50] Speaker 03:
Mr. Welch, we're ready when you are.

[00:01:03] Speaker 04:
Thank you, Your Honors.

[00:01:05] Speaker 04:
My name's Bill Welch for the appellant here.

[00:01:11] Speaker 04:
The issue here is the interpretation of a regulation in the program for the service disabled veteran company preference established by the Small Business Administration.

[00:01:30] Speaker 04:
We have no basic disputes between the parties on the facts.

[00:01:36] Speaker 04:
The question really involves the interpretation

[00:01:40] Speaker 04:
of the control requirement under the regulations.

[00:01:44] Speaker 02:
Can I just ask you, is one of the facts that both sides accepts that if the two non-veteran managers entered into a contract, it would bind the company and the ability of the veteran, 90% owner, to fire those two people would not automatically undo that contract?

[00:02:12] Speaker 04:
It would not undo the contract, but that situation really is not any different than a situation of apparent authority when you have executives involved.

[00:02:22] Speaker 04:
An executive in the operation of a company would have an apparent authority to enter into a contract that wouldn't immediately be able to be reversed in the situation of

[00:02:40] Speaker 04:
of the enforcement by a third party of the contract, what would have to happen in this case would be that, in fact, in that situation, that contract would never be reversed, but the executive of the corporation or ultimately the members of the LLC would have the ability to remove the individual who made the errant contract and

[00:03:10] Speaker 04:
The contract basically would have to be handled one way or the other, but it could never be voided.

[00:03:16] Speaker 04:
So I don't see any difference in the control requirement in that respect and the control requirement that Judge Toronto has just mentioned.

[00:03:25] Speaker 04:
It is possible for the two managers

[00:03:31] Speaker 04:
to be in a situation to enter into a contract but ultimately if the contract for example is executory there could be enough time to remove the two offending managers

[00:03:49] Speaker 04:
and reverse the contract.

[00:03:53] Speaker 02:
But that might depend on whether the counterparty felt interested in having the thing reversed.

[00:04:00] Speaker 04:
That is true.

[00:04:01] Speaker 04:
But that is also true in a situation of apparent authority.

[00:04:06] Speaker 04:
So frankly, I don't see any difference in the two situations.

[00:04:12] Speaker 04:
Where I do see the difference is that the ultimate power of the other two managers

[00:04:18] Speaker 04:
is contingent and derivative on the power vested through the management control of the service disabled veteran.

[00:04:30] Speaker 04:
In this case, you have a service disabled veteran who owns and controls 90% of the voting interests of the LLC.

[00:04:39] Speaker 04:
There's nothing in the operating agreement that surrenders without remedy.

[00:04:47] Speaker 04:
Ultimately controlled by the management, which is ultimately controlled by, in this case, the service disabled veteran, Gary Murillo.

[00:04:59] Speaker 04:
And Mr. Murillo would have the power to reconstitute the board if he wants, or if there's some sort of rebellion, so to speak, against him by his wife and son in this situation.

[00:05:14] Speaker 04:
But again,

[00:05:16] Speaker 04:
It's something that could be remedied internally, but it's still something that might result in a binding contract.

[00:05:28] Speaker 04:
But again, no different in a situation where you have, for example, a larger, sophisticated company that has executives who, for all appearances, would have the authority to enter into a contract.

[00:05:46] Speaker 04:
I don't see the difference there.

[00:05:49] Speaker 04:
So, you know, again, part of this is sort of, frankly, I believe, a vestige of the fact that these regulations were set up with respect to fairly small companies that are veteran owned.

[00:06:08] Speaker 04:
When you get to a level of sophistication such as this company,

[00:06:13] Speaker 04:
where you're talking about average revenue in the neighborhood of $35 million, when you're talking about contracts that range in the $70 million range, multiple contracts, actually in this case, in the $70 million range, and 400 employees.

[00:06:34] Speaker 04:
So when you get to that sophisticated level,

[00:06:37] Speaker 03:
But the size of the company isn't inconsistent with having one person in control.

[00:06:43] Speaker 03:
Every company virtually has a CEO.

[00:06:46] Speaker 04:
Right.

[00:06:47] Speaker 04:
That's true.

[00:06:48] Speaker 04:
And in fact, in this case, even though I guess you may want to say there's some dispute as to who the CEO is in this particular case,

[00:07:02] Speaker 04:
In this case, there is a chief operating officer who is different from Mr. Murillo.

[00:07:08] Speaker 04:
And that chief operating officer operates the company under Mr. Murillo's guidance on a day-to-day basis, but still has the apparent authority to run and enter into contracts with other parties.

[00:07:26] Speaker 03:
But manager decisions, major decisions require a majority vote of the top three people.

[00:07:34] Speaker 04:
That's correct, Your Honor.

[00:07:35] Speaker 03:
Which means one of them is no one that has total control.

[00:07:40] Speaker 04:
Right.

[00:07:40] Speaker 04:
But one of them has non-derivative, non-contingent powers.

[00:07:45] Speaker 04:
The other two's powers are

[00:07:50] Speaker 04:
are solely contingent and solely derivative in their procedures within the operating agreement by which Mr. Murillo can remove both of them.

[00:07:59] Speaker 04:
And that's true also on the executive side as well.

[00:08:03] Speaker 04:
You have a situation where you have an executive, where you have executive officers that

[00:08:13] Speaker 04:
have the authority to enter into contracts such as a five-year lease on an automobile, for example, which is one of the court's examples.

[00:08:23] Speaker 04:
A situation where Mr. Marullo cannot simply make, given the size of the company, cannot simply make every decision that's available to be made.

[00:08:41] Speaker 04:
In fact,

[00:08:41] Speaker 04:
I think one way of really understanding the problem here is that the government, the SBA, and even the court below found that really control means to make the decision.

[00:08:58] Speaker 04:
Make the decision on the spot.

[00:09:01] Speaker 04:
When you, and this is where, where size becomes relevant.

[00:09:05] Speaker 04:
Um, if you have a situation where you're going to force your service disabled veteran to make the decision, every decision, every contractual decision on the spot, that's going to necessarily limit, um, the capacity of the company to grow, uh, which I'm sure that Congress did not intend.

[00:09:28] Speaker 04:
But if you have the power, as the regulations certainly do seem to imply, you have the power of delegation, a revocable delegation, then you have a situation where the

[00:09:50] Speaker 04:
the veteran can delegate some authority to make a decision while also maintaining control of that same decision.

[00:10:00] Speaker 04:
Is it always going to be exactly the decision that the veteran would make in that same situation?

[00:10:07] Speaker 04:
Not necessarily.

[00:10:09] Speaker 04:
But again, it's a contingent delegation

[00:10:15] Speaker 04:
that the veteran makes.

[00:10:16] Speaker 04:
And the veteran with a company of this size, the veteran has to make that type of delegation to operate a company of this level of sophistication.

[00:10:30] Speaker 04:
And when you're talking about

[00:10:33] Speaker 04:
government logistics contracts for the US Army.

[00:10:37] Speaker 04:
You know, you're talking about doing operations that will sometimes require spur of the moment type decisions.

[00:10:46] Speaker 04:
Are they always the correct decisions?

[00:10:47] Speaker 04:
Are they always the decisions of the veteran?

[00:10:50] Speaker 04:
No, not necessarily.

[00:10:52] Speaker 04:
But the veteran has to be able to control

[00:10:56] Speaker 04:
in a broader sense control the ultimate decisions to be made by the company.

[00:11:04] Speaker 04:
Might there be binding decisions that would saddle the company just as you would a decision by a three-member board?

[00:11:18] Speaker 04:
Yes, that is possible but again the ultimate control the fact that there's a non

[00:11:26] Speaker 04:
revocable delegation to other managers doesn't mean that he has lost control of the company.

[00:11:36] Speaker 04:
He can get that control back at any time.

[00:11:39] Speaker 04:
He could have given it up if he wanted in the operating agreement, but he didn't.

[00:11:42] Speaker 04:
He didn't because he needed to maintain control as the disabled veteran.

[00:11:58] Speaker 03:
We're about to get into your rebuttal time.

[00:12:00] Speaker 03:
You can continue if you like, or we will save it.

[00:12:03] Speaker 04:
I'd like to save it if you don't mind.

[00:12:05] Speaker 03:
We will do that.

[00:12:09] Speaker 03:
Mr. Lovegraven.

[00:12:16] Speaker 01:
Good morning and may it please the court.

[00:12:18] Speaker 01:
Exotec was ineligible to compete as a service disabled veteran owned small business for the solicitation at issue in this case because it didn't meet the requirement that a service disabled veteran control all decisions.

[00:12:30] Speaker 01:
Now Exotec structured itself so that management of the company was run by a group of three.

[00:12:35] Speaker 01:
and decisions would be made by two out of three votes.

[00:12:40] Speaker 01:
The problem for Exotec is that two out of the three, the majority of the managers are non-veterans.

[00:12:46] Speaker 01:
So any decision that, any management decision that Exotec makes is necessarily contingent on the vote of a non-veteran and also two non-veterans could make those decisions on their own.

[00:12:59] Speaker 03:
But those two non-veterans are removable at the choice of the veteran.

[00:13:04] Speaker 03:
Isn't that correct?

[00:13:05] Speaker 01:
That's correct.

[00:13:06] Speaker 01:
But we've talked in terms of disputes.

[00:13:10] Speaker 01:
But I think the basic point is that even if everyone agreed on a specific course of action, Mr. Gary Marullo could not make that decision on his own.

[00:13:20] Speaker 01:
He would need the vote of one of the other managers.

[00:13:22] Speaker 02:
But just focusing on removal.

[00:13:26] Speaker 02:
There are certain contexts, such as constitutional contexts, in which the ability to remove is viewed as the ability to control.

[00:13:35] Speaker 02:
Why should this not be read in the same way?

[00:13:39] Speaker 01:
Well, as an initial matter, at the time that Exotec submitted its bid, those managers were there.

[00:13:46] Speaker 01:
And that's the constitution that counts when you're submitting an offer.

[00:13:50] Speaker 01:
It's the time that you submit the offer.

[00:13:52] Speaker 01:
So at that time, those managers were there.

[00:13:54] Speaker 01:
The basic point is that even though

[00:13:59] Speaker 01:
He could theoretically remove them.

[00:14:01] Speaker 01:
The point is until he does, those managers are still there and they're still have empowered to make decisions, you know, subject to two of them are empowered to make decisions on behalf of the regulatory standard that he be able to control all decisions.

[00:14:19] Speaker 01:
Well, that's one of the standards.

[00:14:20] Speaker 01:
In a limited liability company, you need to control, you need to retain control over all decisions.

[00:14:26] Speaker 02:
That's the standard that was found to be flunked here, is that right?

[00:14:31] Speaker 02:
That's correct, Your Honor.

[00:14:32] Speaker 02:
So why is it that

[00:14:34] Speaker 02:
his ability to remove his wife and son from the positions isn't sufficient to control the decisions that the two of them, while not yet removed, would be making.

[00:14:49] Speaker 01:
Because those people are still there, so he can't, until he does remove them, you know, as it exists, as Exotex exists, Mr. Murillo cannot do anything without one of their votes.

[00:15:03] Speaker 01:
So until they are removed, they're there.

[00:15:05] Speaker 02:
If he removed them and didn't put in place two additional managers,

[00:15:11] Speaker 02:
And he was the only manager left.

[00:15:13] Speaker 02:
Could he make the decisions, the managerial decisions himself?

[00:15:16] Speaker 01:
Do we know?

[00:15:17] Speaker 01:
I'd have to look into that point.

[00:15:18] Speaker 01:
The operating agreement has certain sorts of restrictions on it, whether or not he has to then amend the operating agreement to change it, to change the amount of managers, because one out of three wouldn't be a quorum.

[00:15:34] Speaker 01:
I can't speak to that point.

[00:15:36] Speaker 01:
I think the general point, though, is that

[00:15:39] Speaker 01:
As ExoTech structured itself, there were three managers.

[00:15:43] Speaker 01:
He was the only service disabled veteran, there was only one of them.

[00:15:46] Speaker 02:
Were there employees below those three managers?

[00:15:50] Speaker 01:
As I understand it, ExoTech has several, about 400 employees, I believe.

[00:15:55] Speaker 02:
So how is it, and any decision that those people would make would be controlled or not controlled by somebody higher up?

[00:16:06] Speaker 02:
As long as they're in office.

[00:16:09] Speaker 01:
There's a distinction.

[00:16:11] Speaker 01:
As an initial matter, the operating agreement doesn't say anything about delegation.

[00:16:17] Speaker 01:
as it's written, certain types of these management decisions are controlled by this group of three.

[00:16:23] Speaker 01:
One of the powers that managers have is a power to hire and fire and define employees' duties.

[00:16:29] Speaker 01:
So any delegation to employees is a delegation of manager power.

[00:16:34] Speaker 01:
It's a delegation of the three.

[00:16:36] Speaker 01:
So Mr. Merola, on his own, could not delegate management authority, at least under the operating agreement, as it existed at the time they submitted their proposal.

[00:16:45] Speaker 02:
I guess I'm thinking just about the kind of situation that Mr. Welch was talking about.

[00:16:54] Speaker 02:
Unless this regulatory scheme was meant to apply only to companies that stay very small, there's no chance in the world that lots of decisions are not going to be made within a company by lower level people

[00:17:12] Speaker 02:
who presumably have some authority to take actions.

[00:17:20] Speaker 01:
I understand what Your Honor is saying, and I just want to respond with two points.

[00:17:23] Speaker 02:
But I guess as a common sense matter, if those people can be removed, could be fired, why isn't the person who can fire them in control?

[00:17:38] Speaker 01:
to the extent that managers delegate, let's say, accounting, you know, preparation of taxes or something like that to a chief financial officer.

[00:17:47] Speaker 01:
Let's say the managers as a group do that.

[00:17:49] Speaker 02:
No, buying pencils, put in a third party.

[00:17:52] Speaker 01:
Sorry, so they delegate to an employee?

[00:17:55] Speaker 02:
Yeah, go and buy, forget about pencils, too trivial, buy a computer.

[00:17:59] Speaker 01:
Sure, and enter into a contract on behalf of the company.

[00:18:02] Speaker 01:
The managers can authorize

[00:18:05] Speaker 01:
According to these terms, again, this is the terms of their operating agreement.

[00:18:09] Speaker 01:
The way their operating agreement is structured, the managers can authorize, you know, upon a majority vote, one of the managers to enter into contracts that bind the company.

[00:18:22] Speaker 01:
That's how Exotec structured itself.

[00:18:24] Speaker 01:
If this were a different company, the answer would be different.

[00:18:27] Speaker 01:
But Exotec structured itself so managers would, as a majority, delegate one of them to enter into a contract for the purchase of goods.

[00:18:38] Speaker 02:
And your argument does depend on saying that Mr. Maruo, even though he can fire the other two managers, doesn't control their decisions.

[00:18:48] Speaker 01:
That's correct, yes.

[00:18:51] Speaker 03:
Unless and until that occurs, we have the particular structure, it's tripartite.

[00:18:59] Speaker 01:
Yes, Your Honor.

[00:19:00] Speaker 03:
And isn't there a distinction between major decisions and lesser decisions?

[00:19:05] Speaker 01:
Well, there are distinctions between member decisions and manager decisions.

[00:19:10] Speaker 01:
And the member decisions are generally transformational, you know, reorganization or bankruptcy.

[00:19:17] Speaker 01:
So those decisions are controlled by Gary Marullo.

[00:19:21] Speaker 02:
Is there a distinction between the major and minor decisions in the regulations?

[00:19:27] Speaker 01:
And the regulations, well, one of the requirements, not necessarily in terms of making the decisions, the service disabled veteran needs to conduct both the long-term planning and the day-to-day operations.

[00:19:39] Speaker 01:
That's what the regulation requires.

[00:19:41] Speaker 01:
But that's a different question than the decision-making.

[00:19:44] Speaker 00:
What is the day-to-day operations versus decision-making on minor matters?

[00:19:48] Speaker 00:
How do they differ?

[00:19:49] Speaker 01:
Well, I mean, the

[00:19:54] Speaker 01:
I think it depends on, I mean, if we're talking about minor decisions, the service-disabled veteran needs to at least be able to control them.

[00:20:03] Speaker 01:
So if there's a decision that he disagrees with or she disagrees with, as the case may be, then they'd have to have the ability to say,

[00:20:12] Speaker 01:
you know, to say, no, you need to make a different decision.

[00:20:15] Speaker 01:
But in terms of Exotec's operating agreement, things like procuring insurance or bringing this litigation, those are decisions that the managers have to make, and those reflect an exercise of manager authority.

[00:20:31] Speaker 01:
Again, this is, you know, we can easily see how a, I mean, this is a family, we understand, but can easily see how this type of structure could be abused.

[00:20:42] Speaker 01:
You could have a service-disabled veteran who has no interest in operating the business at all and who's just happy to gain some sort of profits.

[00:20:49] Speaker 01:
And that's not why this regulatory program was, and it's actually statutory program, was put into place.

[00:20:54] Speaker 01:
It was to benefit, you know, service-disabled veterans who own small businesses.

[00:21:02] Speaker 03:
In other words, there's a benefit program here, and if someone wants to meet the terms of it, they should structure their organization accordingly.

[00:21:10] Speaker 01:
Correct.

[00:21:12] Speaker 01:
And just to follow up with that point, if it's in fact correct that in substance Mr. Marullo does in fact control all decisions and operate as such, then ExoTech can easily amend its operating agreement to reflect that reality and to meet the requirements of the regulation.

[00:21:32] Speaker 01:
And just to follow up with, just to respond to.

[00:21:36] Speaker 02:
What would the change, what change would be sufficient in a company that has many hundreds of employees?

[00:21:46] Speaker 01:
Well, I can't speak to it, but as you know, what precise change would be required.

[00:21:50] Speaker 01:
But as a basic matter, he would need to be able to control all decisions.

[00:21:56] Speaker 01:
And that does mean, even if he doesn't make all decisions, he needs to be able to, he needs to have the power to do so.

[00:22:01] Speaker 02:
By something other than being able to fire the person.

[00:22:09] Speaker 01:
That's correct.

[00:22:10] Speaker 01:
It needs to be structured in a way that anticipates that the service disabled veteran does in fact exercise control over all those decisions.

[00:22:20] Speaker 01:
I just respond to the apparent authority point.

[00:22:23] Speaker 01:
Well, there's a distinction between apparent authority and actual authority.

[00:22:27] Speaker 01:
Here, non-veterans have actual authority.

[00:22:30] Speaker 01:
So the hypothetical about apparent authority, first of all, only applies in some very narrow circumstances, like the principal tells somebody that the employee has actual authority or makes public statements to that effect.

[00:22:42] Speaker 01:
So there's a difference there.

[00:22:49] Speaker 01:
the point about that he could have maintained control, but structured the operating agreement in this way to give it to a group of three managers.

[00:22:58] Speaker 01:
Well, they can amend the agreement to reflect that and to put themselves into compliance with the regulation.

[00:23:04] Speaker 02:
And the amendment, give me one example of an amendment that would work.

[00:23:09] Speaker 01:
Sure.

[00:23:09] Speaker 01:
Let's say instead of three managers, they reverted to their prior structure, which only had one manager.

[00:23:15] Speaker 01:
And that would be at least one thing that would have to be him.

[00:23:18] Speaker 01:
And it would have to be the service-disabled veteran.

[00:23:20] Speaker 01:
Or he had three managers, but they were all service-disabled veterans.

[00:23:24] Speaker 01:
And that's another way that service-disabled veterans can still maintain control while having the benefit of three other minds in making those kinds of decisions.

[00:23:34] Speaker 01:
But again, you know,

[00:23:37] Speaker 01:
This is a public program designed to benefit a certain class of people.

[00:23:42] Speaker 01:
The agency that's responsible for administering that program has set up the requirements.

[00:23:47] Speaker 01:
And to the extent that a company wants to participate in that program, it's their job to structure themselves accordingly.

[00:23:53] Speaker 01:
So given that, with that really, we really just respectfully request, unless the court has further questions, we respectfully request that the court affirm the judgment below.

[00:24:06] Speaker 03:
Thank you.

[00:24:07] Speaker 03:
Councilman Welch has some more bottle time.

[00:24:15] Speaker 04:
Thank you, Your Honor.

[00:24:16] Speaker 04:
I just wanted to make a couple of quick points.

[00:24:23] Speaker 04:
To follow up on Judge Taranto's question about what sort of examples would you need to amend the operating agreement to give the disabled veteran the type of

[00:24:43] Speaker 04:
actual control that is necessary.

[00:24:47] Speaker 04:
I would say frankly that it's impossible.

[00:24:50] Speaker 04:
What we do in this situation, and we weren't involved in the drafting of this gargantuan operating agreement, but what we normally do is we set up a situation where

[00:25:06] Speaker 04:
If we have a board for an LLC, we allow votes if we have multiple board members, but we also allow that the veteran must always be in the majority.

[00:25:22] Speaker 04:
decision.

[00:25:24] Speaker 04:
That only takes care of the very uppermost measure of decisions that the company makes.

[00:25:37] Speaker 04:
When you have a company this size,

[00:25:40] Speaker 04:
you're always going to be faced with a situation where you have to delegate to other executives.

[00:25:50] Speaker 04:
And counsel had mentioned that, let's see.

[00:26:05] Speaker 04:
Well, let me make a few points.

[00:26:07] Speaker 04:
Counsel had mentioned that

[00:26:10] Speaker 04:
And I think the best way to look at this, let me put it this way, the best way to look at this situation is that the way the SBA and the government has been reading this requirement is that they've always been reading the requirement as that the veteran must be able to control and the only way to maintain 100% control is to make every decision.

[00:26:39] Speaker 04:
But that's not feasible in this situation.

[00:26:43] Speaker 04:
There's no question in this case that the veteran is entitled to make every decision because... Well, in the...

[00:27:00] Speaker 04:
in the sense that the veteran will always have removal power of the person who is making a decision that would be contrary to the decision of the veteran.

[00:27:15] Speaker 04:
So in that respect, he always maintains control.

[00:27:22] Speaker 02:
Does the regulation go beyond requiring ability to control to require actual control?

[00:27:29] Speaker 02:
I thought the language was owned and controlled.

[00:27:34] Speaker 04:
This is the regulation at 13 CFR 125 13 D

[00:27:43] Speaker 04:
control over, and there's a specific requirement for limited liability companies, control over limited liability companies.

[00:27:50] Speaker 04:
In the case of a limited liability company, one or more service disabled veterans, and then there's a situation where the veteran

[00:28:02] Speaker 04:
Let me just read it without the parenthetical.

[00:28:04] Speaker 04:
I don't think the parenthetical here is applicable.

[00:28:08] Speaker 04:
But one or more service disabled veterans must serve as managing members with control over all decisions of the limited liability company.

[00:28:19] Speaker 04:
So you're talking about control over all decisions.

[00:28:22] Speaker 04:
And we believe that the only feasible way

[00:28:28] Speaker 04:
that control here can be meaningful of a company of any size other than a mom-and-pop type company is that the veteran must be able to either make the decision or to remove the person who is going to make a contrary decision or remove the person who has the parent authority to make a contrary decision.

[00:28:56] Speaker 04:
So it's essentially a combination of the veteran either has to make the decision or control the person who attempts to make the decision.

[00:29:08] Speaker 03:
Thank you, counsel, as you see.

[00:29:10] Speaker 03:
Thank you, Your Honor.

[00:29:11] Speaker 03:
The red light is on.

[00:29:11] Speaker 03:
The case is submitted.

[00:29:13] Speaker 03:
Thank you.

[00:29:18] Speaker 03:
All rise.

[00:29:20] Speaker 03:
The court is adjourned until Monday morning.

[00:29:23] Speaker 03:
It's an o'clock a.m.