Corporate acquisitions involving government contractors: DOD codifies significant security clearance-related risk

The US Department of Defense has published an Interim Final Rule assigning responsibilities and establishing requirements related to the National Industrial Security Program (NISP).  See 79 Fed. Reg. 19467. 

Effective on April 9, the day it was published, the rule is intended to “ensure maximum uniformity and effectiveness for both DoD and non-DoD Components … for which the Department serves as the Cognizant Security Agency … and provides industrial security services.”  

Although the rule does not change the substance of DoD 5220.22-M (National Industrial Security Program Operating Manual) or levy new security clearance requirements on US contractors, it codifies at 32 C.F.R. Part 117 DoD’s NISP policy and procedures concerning, among other things, (1) the initial facility security clearance (FCL) eligibility for companies that may be subject to foreign ownership, control or influence (FOCI) and (2) the continued FCL eligibility for contractors subject to FOCI. 

Depending on the nature and extent of FOCI, DoD negates FOCI by implementing a FOCI mitigation plan consisting of mechanisms such as a voting trust agreement, proxy agreement, special security agreement or a security control agreement.  Such measures provide protection from the unauthorized transfer of classified information to foreign interests.

With regard to a foreign company’s acquisition of a US government contractor performing contracts with security clearance requirements, the rule codifies one of the more significant security clearance-related risks associated with such a transaction  – i.e., invalidation of the contractor’s FCL by the Defense Security Service (DSS) due to an unmitigated FOCI, thereby rendering impossible the contractor’s performance. 

Specifically, the rule states:

"When a merger, sale, or acquisition involving a foreign interest and a contractor is finalized prior to having an acceptable FOCI mitigation or negation agreement in place, DSS will invalidate any existing FCL until such time as DSS determines that the contractor has submitted an acceptable FOCI action plan … and has agreed to interim measures that address FOCI concerns pending formal execution of a FOCI mitigation or negation agreement.  Invalidation renders the contractor ineligible to receive new classified material or to be on new classified contracts."

See 79 Fed. Reg. 19472 (emphasis added). 

Given the risk that an invalidation of a contractor’s FCL can potentially run for a lengthy period of time, companies involved in the sale or acquisition of a government contractor should reasonably clear all potential or actual FOCI hurdles prior to finalizing the transaction.  Failure to do so could impact the government contractor’s ability to continue performing its contractual obligations and, as a result, reduce the immediate and long-term value of the government contractor.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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