on April
21, 2016
Volume 2 – Obtaining Consent to Assign a Government Contract
This posting
is the second in a ten-part series on unique issues that arise in the
acquisition and disposition of a company that performs government contracts or
subcontracts.
Part 1 focused on the types of deal structures
that are subject to the anti-assignment statutes, and therefore require
Government consent. We explained that consent is not required for stock
purchases, is required for asset sales, and may be required for other types of
transactions, including mergers. This posting, Part 2, addresses the
consent process, including the who, what, when, and how of obtaining a novation
agreement. It also includes practical tips, based on our experience, for
navigating the novation process efficiently and successfully.
The Novation Process
The first step in the novation
process is to identify the responsible contracting officer. The FAR
contemplates that one responsible contracting officer will be the single point
of contact for the novation of all of the government contracts to be
transferred. If any of the affected government contracts held by the
transferor have been assigned to an administrative contracting officer (“ACO”),
that ACO will be the responsible contracting officer. FAR
42.1202(a)(1). If the affected government contracts are in more than one
plant or division of the transferor, the responsible contracting officer will
be the ACO responsible for the transferor’s corporate office. FAR
42.1202(a)(2). If none of the transferor’s government contracts have been
assigned to an ACO, the responsible contracting officer is the contracting
officer responsible for the largest unsettled dollar balance – including both
unbilled and billed but not yet paid. FAR 42.1202(b).
Finally, if
several transferors are involved, such as where two or more independently
incorporated affiliates, or the assets of two or more such affiliates, are
being acquired in a single transaction, the responsible contracting officer is
the ACO administering the largest unsettled dollar balance or the contracting
officer (or ACO) designated by the agency having the largest unsettled dollar
balance, if none of the affected contracts have been assigned to an ACO.
FAR 42.1202(c).
The FAR does
not require a contractor to submit a formal novation request to the responsible
contracting officer, and a novation agreement cannot be processed, until the
government contract has been transferred. Put more crisply – the novation
always follows the closing. Nevertheless, it is the best practice to
contact the responsible contracting officer much earlier in the process.
The responsible contracting officer has extraordinarily broad discretion in
determining whether it is in the best interest of the Government to grant or
deny the novation request, what documentation to require in support of the
novation, and how quickly the novation process moves. See FAR 42.1203(c); FAR 42.1204(e)(4); FAR
42.1204(g). Reaching out to the responsible contracting officer well in
advance of the transfer has numerous advantages. Specifically, it allows
you to establish a good working relationship with the responsible contracting
officer, 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 with the responsible contracting
officer before closing, the less time it will take to
obtain the novation agreement after closing.
With regard to the formal
novation request, the FAR identifies numerous documents that must be submitted
to the responsible contracting officer. Many of those documents can and
should be submitted before the transaction closes. Those include:
1.
Three signed copies of the proposed novation agreement;
2.
The document describing the proposed transaction (g., the purchase agreement);
3.
A list of the affected contracts and orders, including (a) the government
contract number and type; (b) the name and address of the contracting office;
(c) the total dollar value as amended; and (d) the approximate remaining unpaid
balance;
4.
Evidence of the transferee’s capability to perform; and
5.
Any other information requested by the contracting officer.
FAR 42.1204(e). The
fourth category of information bears particular emphasis and explanation.
Providing evidence of the transferee’s capability to perform is your “sales
pitch” for persuading the responsible contracting officer to grant the novation
request. Such evidence could include, without limitation, 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 favorable audit
history, its possession of relevant security clearances, its management, and
any other information bearing on its responsibility and ability to perform the
contracts in accordance with their requirements.
The FAR also lists additional
documents that you must provide to the responsible contracting officer as they
become available, generally after the deal has closed. These include:
1.
An authenticated copy of the instrument affecting the transfer (g., bill of sale, certificate of merger, contract,
deed, agreement, or court decree);
2.
Appropriate corporate approval of the transfer consisting of certified
copies of board resolutions and/or stockholder minutes;
3.
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);
4.
Opinion of legal counsel for the transferor and the transferee stating that
the transfer was properly effected under applicable law and the effective date
of the transfer;
5.
Balance sheets of the transferor and the transferee as of the dates
immediately before and after the transfer of assets, audited by independent
accountants;
6.
Evidence that any security clearance requirements have been met; and
7.
The consent of sureties on all contracts transferred or a statement from
the transferor that none are required.
FAR 42.1204(f). Most of
this information is relatively easy and inexpensive to obtain. The
requirement for audited balance sheets, however, can be burdensome. Some
contractors, including most small businesses, do not maintain audited financial
statements. Requiring such contractors to obtain audited balance sheets
would be costly and could also significantly delay the novation process.
Accordingly, many contracting officers will waive this requirement, and instead
accept unaudited balance sheets or other proof that all of the assets have been
transferred.
The requirement for opinions
of counsel also merits brief attention. These need not and should not be
lengthy or elaborate documents. Corporate counsel for the transferor and
the transferee should be able to prepare such opinions quickly and
inexpensively since they are familiar with the transaction. While it will
be necessary for the opinion to include some assumptions and caveats, these
should be kept to a minimum, typically no more than a few paragraphs, in order
to avoid rejection by the responsible contracting officer. We often find
it useful to have our clients submit drafts of the opinion letters, before the
formal novation request, so their form and content can be approved in advance.
The Novation Agreement
As noted
above, the FAR requires submission of three signed copies of the “proposed”
novation agreement. The FAR includes a standard form novation agreement
for the assignment of government contracts. FAR 42.1204(i). The
standard form is required where the transferor and transferee are corporations
and all of the transferor’s assets are transferred. Id. The form may be adapted for use in other
contexts, but the Government generally will not accept modifications to the key
terms. Id. In our experience,
proposing significant changes to those terms serves little purpose, other than
to delay approval of the novation agreement.
Many provisions in the
novation agreement are what you would expect in a consent to assignment.
The transferor relinquishes its rights under the contract; the transferee
agrees to be bound by the contract; the Government recognizes 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 favor the
Government. There is little you can do to change these terms, 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 any rights or claims it
may have against the transferor. Novation Agreement, ¶¶ (b)(1),
(b)(5).
In fact, the transferor must guarantee the transferee’s payment
of all liabilities and performance of all obligations under the contract. Id., ¶ (b)(8). This guarantee applies not only to
liabilities and obligations that exist at the time of the novation, but also to
liabilities or obligations 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. Id. As an alternative, the Government may accept
a performance bond in lieu of a guarantee. FAR 42.1204(h)(3).
The requirement for a
guarantee may have little practical significance in cases where the transferee
is purchasing all of the transferor’s assets, such that the transferee has no
assets left to make good on the guarantee. Where only a portion of the
transferee’s assets are being transferred, on the other hand, such as in the case
of selling an unincorporated division, the requirement to guarantee the
transferee’s performance can expose the transferor to significant risk.
In these cases, it is in the transferor’s interest to ensure that the
transferee is a responsible contractor with sufficient resources and capability
to perform the transferred contracts, including any foreseeable
modifications. Indemnification is possible, but the Government would have
little incentive to pursue a transferee with few resources unless and until
the transferor’s assets have been exhausted.
The standard novation
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. Novation Agreement, ¶ (b)(7). For
example, the Government could disallow 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. This
provision is relevant not only to valuing the transferred contracts but also to
post-transfer compliance with cost accounting requirements.
The FAR further provides that
any separate agreement between the transferor and the transferee regarding assumption
of liabilities should be referenced specifically in the novation
agreement. FAR 42.1203(e). Examples of liabilities identified in
this provision include long-term incentive compensation plans, cost accounting
standards non-compliances, environmental cleanup costs, and final overhead
costs.
The Approval Process
Upon receipt of a novation
request, the responsible contracting officer is required to notify each
contract administration office and contracting office of the request, provide
those offices with a list of affected contracts, and request submission of any
comments or objections to the proposed transfer within 30 days after their
receipt of such notification. FAR 42.1203(b)(2), (b)(3). The
responsible contracting officer must then determine whether it is in the best
interest of the Government to grant the novation. FAR 42.1203(c).
In addition to the formal novation submission provided by the contractor, the
responsible contracting officer is required to consider:
1.
The comments received from the affected contract administration offices and
contracting offices;
2.
The transferee’s responsibility under FAR Subpart 9.1, Responsible
Prospective Contractors; and
3.
Any factor relating to the transferee’s performance of government contracts
that could impair the transferee’s ability to perform the contract
satisfactorily.
FAR 42.1203(c). With
regard to the third “catchall” category of information, responsible contracting
officers often consult the Contractor Performance Assessment Reporting System
(“CPARS”).
When
considering whether to grant a novation request, the responsible contracting
officer is also required to identify and evaluate any significant
organizational conflicts of interest (“OCIs”). FAR 42.1204(d). A
responsible contracting officer generally will not allow the novation of a
government contract to a transferee with a significant OCI unless that OCI can
be avoided or mitigated. However, if the responsible contracting officer
determines that a conflict of interest cannot be resolved, but nevertheless
finds that it is in the best interest of the Government to approve the novation
request, he or she may submit a request for higher-level approval to waive the
OCI. Id.
There is no mandatory deadline
for the responsible contracting officer to act upon a novation request.
In our experience, the process typically requires between two and 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. If your
request is denied, the best course of action typically is to have your attorney
reach out to agency counsel to discuss whether there are any circumstances
under which the Government might agree to the novation. Although a claim
for denial of a novation request may be a theoretical possibility, the
probability of success would be very low due to the extraordinarily broad
discretion that is afforded to contracting officers in this area.
Novation Deal Terms
Novation cannot, by its
nature, be a condition to closing, since formal Government approval can only be
obtained after a government contract has been transferred. Instead, most
purchase agreements include a provision requiring the parties to cooperate with
each other to obtain the novation after closing. Such cooperation is
critical. Although the FAR requires the transferee to submit the novation
packet, much of the necessary information – including financial statements,
corporate approvals, and other documents – will be in the transferor’s
possession.
While the approval process is
pending, it is common for the parties to enter into a pre-novation subcontract
whereby: (1) the transferor, who the Government still regards as the
entity holding the contract, subcontracts all of the work to the transferee,
and (2) the transferor agrees pay the transferee for that work.
Pre-novation subcontracts are more complex than traditional subcontracts in at
least one important respect. They are intended to allow the subcontractor
maximum control over the business it has just purchased, in effect allowing the
subcontractor to act as though it were the prime contractor. 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. Separately, it should be noted that 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.
Next Month
This posting
addressed the process for novating existing government
contracts. Our ten-part series will continue next month with a discussion
of the impact of corporate transactions on pending bids and proposals for
government contracts.
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