Purchasing a government contractor presents unique issues that must be fully explored and understood during the merger and acquisition (M&A) due diligence process. Government contractors operate in a highly regulated environment, and as a result are faced with additional requirements and risks beyond the normal business and legal risks encountered in a typical commercial M&A transaction. This article outlines some of the additional risks to be evaluated during due diligence, and reflects the current laws and regulations as well as current case law.
As an initial consideration, the Anti-‐Assignment Act, 41 U.S.C. 15 (2000), generally prohibits transferring a government contract to another party. That is potentially bad news for prospective Buyers because the value of a government contractor is closely tied to the value of the contracts that can be transferred. The good news for Buyers is the Act permits transfers if the government consents. Express government consent can be provided through a procedure called the novation process, which is detailed in the Federal Acquisition Regulation (FAR) Subpart 42.12. The government will consent to the transfer when it is in the government’s interest, and both the Buyer and Seller are jointly liable under the novated contract. Although the government must consent to any transfer, the novation process may only start after the purchase has closed, which creates risk that the government may not approve the transfer and the Buyer may not have standing to bring a claim or other action. To minimize the risk it is recommended the relevant Administrative Contracting Officer (ACO) be contacted during the due diligence period to discuss the potential transfer to explore and mitigate any foreseen government objection. If significant issues appear regarding novation of a large revenue contract it may be a showstopper for the transaction.
Many other unique issues may be identified during due diligence, such as:
Small business issues: Special issues are presented in the purchase of a small business that has received contracts under a set-‐aside or other preference, or under the Small Business Administration (SBA) 8(a) program. In 2007 the SBA revised 13 C.F.R. 121.404 (g) to require recertification of small business status within 30 days following novation. If the combination of the purchased and acquired business no longer qualifies as a small business the government may terminate the contract for convenience. For a contract awarded under the SBA 8(a) program the result is even harsher—if the combination of the purchased and acquired business no longer qualifies as an 8(a) entity the contract must be terminated for convenience unless the Administrator of the SBA waives the termination requirement. The impact of no longer qualifying as a small business for new competitions, and the potential to lose existing small business contracts, must be evaluated during the due diligence process and subtracted from the purchase price.
Organizational Conflicts of Interest (OCI): Under FAR 9.5, an OCI is created when a company that has a contract gains an actual or perceived advantage from holding other contracts. The issue often arises when a contractor provides services to the government such as drafting technical requirements or providing reviews, and the contractor also performs work, or competes for work, on the same or similar contracts. If the combination of the Buyer and Seller create a potential OCI it must be identified and mitigated or avoided before the closing.
Security clearance issues: Classified contracts may only be transferred to a Buyer that has a valid facility clearance at the same or higher level. Detailed rules are contained in DOD Regulation 5220-‐22-‐M. The issue is heightened if the Buyer is a foreign concern, or when transferring the contracts could threaten national security.
Cost issues: Cost reimbursement contracts have a multitude of certifications and administration requirements. Many of the certifications and requirements carry criminal as well as civil penalties for violation. Each contract must be closely examined to ensure the certifications are current, accurate and complete and all administrative requirements have been met. These contracts are fully audited by the government; however, the audit agencies currently are backlogged three to five years on incurred cost audits. Thus, there may be criminal or civil liability for many years into the future that must be identified.
Internal control: Government contracts require complex internal control systems that must be operational. Additionally, FAR 3.10 has recently been revised to require contractors to report “credible evidence” of certain misconduct. The requirement carries both civil and criminal penalties for violation. All material produced by the internal control system must be examined during due diligence to determine if there is credible evidence of misconduct, and whether it has been properly reported.
Labor law compliance: Federal contractors are subject to the full range of labor laws that apply to businesses. In addition, federal contractors are subject to additional labor laws, compliance with which must be assessed during due diligence. Examples of these laws include the Walsh-‐Healy Public Contracts Act, the McNamara-‐O’Hara Service Contract Act, the Davis-‐Bacon Act, and the Copeland Act.
The unique risks involved in purchasing a government contractor must be evaluated during a careful and thorough due diligence process. Professional due diligence allows the Buyer and Seller to agree to an equitable allocation of risk, assures proper mitigation is in place where necessary, and the value of the transaction is properly assessed. Contact the professionals at Williamson Law Group P.C. for any questions or to perform a complete and thorough due diligence process involving the transfer of a government contractor.
Scott Williamson formed Williamson Law Group (www.williamsonlawgroup.com) in Frederick, MD, in 2010. The practice focuses primarily on government contract matters, compliance and ethics in federal procurement, and intellectual property in government contracts. He is licensed in Maryland, North Carolina, Nevada, and to practice before the U.S. Supreme Court, and is a registered patent attorney. Scott can be e-mailed at email@example.com