Roadmap to obtaining government consent for corporate transactions involving government contractors

September 2016 | PROFESSIONAL INSIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Many corporate transactions involving government contractors, including asset sales and forward mergers, are subject to anti-assignment statutes that require government consent. That consent customarily takes the form of a ‘novation’ agreement. This article addresses the who, what, when and how of novating a government contract.

The first step is to identify the one contracting officer who will be the single point of contact for the novation of all government contracts to be transferred. The regulations provide the following roadmap: (i) if any of the transferor’s affected government contracts have been assigned to an administrative contracting officer (ACO), that ACO will process the novation; (ii) if the contracts are in more than one plant or division of the transferor, the ACO for the transferor’s corporate office will process the novation; (iii) if none of the transferor’s contracts has been assigned to an ACO, the contracting officer responsible for the largest unsettled contract dollar balance will process the novation; and (iv) if multiple transferors are involved, the ACO administering the largest unsettled dollar balance or the contracting officer (or ACO) designated by the agency having the largest unsettled dollar balance, will be responsible.

A novation agreement with the government, unlike consent to assign a commercial contract, cannot be processed until after the government contract has been transferred – the novation always follows the closing. Nevertheless, reaching out to the responsible contracting officer earlier has numerous advantages. Specifically, it allows you to establish a good working relationship to make your case for the novation before the transfer has occurred, to identify and address potential concerns before closing, to discuss the waiver of certain potentially burdensome documentation requirements, and to assess whether there is a risk that the government may deny the novation request. The more progress you can make before closing, the quicker it is to obtain the novation agreement after closing.

The Federal Acquisition Regulation (FAR) identifies numerous documents that must be submitted to the responsible contracting officer. Many, including the following, can and should be submitted before the transaction closes: (i) three signed copies of the proposed novation agreement; (ii) the document describing the proposed transaction (e.g., the purchase agreement); (iii) a list of the affected contracts and orders, including the government contract number and type, the name and address of the contracting office, the total dollar value as amended and the approximate remaining unpaid balance; (iv) evidence of the transferee’s capability to perform; and (v) any other information requested by the contracting officer.

Evidence of the transferee’s capability to perform is important and could include information regarding the transferee’s financial stability, its experience with similar work, its performance of other government contracts, its applicable certifications and qualifications, its business systems, its favourable audit history, its possession of relevant security clearances, its management, and any other information bearing on its responsibility.

The FAR also lists additional documents that you must provide to the contracting officer as they become available after the deal has closed, including: (i) an authenticated copy of the bill of sale, certificate of merger, contract, deed, agreement or court decree regarding the transaction; (ii) certified copies of board resolutions and/or stockholder minutes approving the transfer; (iii) an authenticated copy of the transferee’s certificate and articles of incorporation (if a corporation was formed to receive assets involved in performing government contracts); (iv) opinion of legal counsel for the transferor and the transferee that the transfer complied with applicable law and its effective date; (v) balance sheets of both parties immediately before and after the transfer of assets, independently audited; (vi) evidence that any security clearance requirements have been met; and (vii) the consent of sureties on all contracts transferred or a statement from the transferor that none is required.

Most of this information is relatively easy and inexpensive to obtain. Opinions of counsel should be concise and assumptions should be minimised to avoid rejection. Contracting officers may waive the requirement for audited balance sheets, particularly for smaller contractors.

The government requires a standard form novation agreement and generally will not accept modifications to the key terms. Proposing significant changes serves little purpose, other than to delay approval.

Many provisions in the novation agreement are what you would expect. The transferor relinquishes its rights under the contract; the transferee agrees to be bound by the contract; the government recognises the transferee as the successor in interest to the transferor; the parties agree that the government will pay the transferee rather than the transferor; and the contracts remain in full force and effect. Lurking within the standard novation agreement, however, are several unusual terms that strongly favour the government. The terms are essentially non-negotiable, but you should be aware of their implications.

The transferor is required to waive any claims and rights it may have against the government, but the government is not required to waive its claims against the transferor. In fact, the transferor guarantees the transferee’s payment of all liabilities and performance of all obligations under the contract, including those the transferee may undertake in any future modification to the government contract – whether or not the transferor receives notice of, or consents to, that modification. As an alternative, the government may accept a performance bond in lieu of a guarantee.

The agreement also makes unallowable government contract costs exceeding those that would have been incurred by the transferor, even if the novation decreases the overall cost to the government. For example, the government could forbid cost increases resulting from a higher overhead rate, even if those costs were more than offset by a decrease in the applicable general and administrative expense (G&A) rate.

Upon receipt of a novation request, the contracting officer will notify each contract administration office and contracting office, provide them with a list of affected contracts, and request any comments or objections within 30 days. The responsible contracting officer must then determine whether it is in the best interest of the government to grant the novation. This determination often involves an analysis of information available from the government’s Contractor Performance Assessment Reporting System. The responsible contracting officer is also required to identify and evaluate any significant organisational conflicts of interest.

There is no mandatory deadline for the responsible contracting officer to act upon a novation request. The process typically takes two to six months. Longer timeframes may be required for very large deals or if the responsible contracting officer has concerns regarding the transferee’s ability to perform.

Most novation requests are approved. Contractors have little recourse for a denial. A claim for denial of a novation request may be a theoretical possibility, but the probability of success would be very low due to the extraordinarily broad discretion that is afforded to contracting officers in this area. That is why ‘advance work’ with the contracting officer is so important.

Because government consent can only be obtained after a government contract has been transferred, most purchase agreements include a provision requiring the parties to cooperate to obtain the novation after closing.

Pending approval, the parties customarily enter into a pre-novation subcontract whereby: (i) the transferor subcontracts the work to the transferee; and (ii) the transferor agrees pay the transferee for that work. Pre-novation subcontracts are more complex than traditional subcontracts because they allow the subcontractor maximum control over the business it has just purchased. Yet the prime contractor still remains in privity with the government, meaning that affording the subcontractor complete control can create significant liability and risk for the prime. This risk is typically mitigated through a broad indemnification provision. A pre-novation subcontract requires the transferor to remain in existence as a legal entity, to have at least one employee with authority to bind the transferor, and to maintain its SAM registration.

It is also common for the purchase agreement to address what happens in the event the novation request is denied. Potential strategies include indemnification, a purchase price adjustment, and/or a permanent subcontract similar to the pre-novation subcontract described above.

John Chierichella and Keith Szeliga are partners at Sheppard Mullin. Mr Chierichella can be contacted on +1 (202) 747 1903 or by email: jchierichella@sheppardmullin.com. Mr Szeliga can be contacted on +1 (202) 747 1927 or by email: kszeliga@sheppardmullin.com.

John Chierichella and Keith Szeliga

Sheppard Mullin