Federal Contracts When Selling a Business

by Smith Anderson
Contact

When selling a business, the owner must balance deal certainty, tax consequences, speed, regulatory clearances, third party consents and liability allocation. Owners selling a business that holds prime federal contracts have additional considerations that may limit the structure of the transaction and the categories of available buyers. This Client Alert provides a high-level overview of one issue unique to federal contractors — the Anti-Assignment Act.

Overview:

One diligence consideration in the sale of any business is whether vendor and customer contracts can be transferred to the buyer. For non-Government contracts, applicable laws generally favor the free assignability of contracts. For commercial contracts, silence generally equals the consent to the transfer.

By contrast, the Anti-Assignment Act, 41 USC § 15 (the “Act”), expressly prohibits the transfer of a federal contract. Despite the Act’s absolute prohibition on transfers, courts have made clear that the Government may consent to a transfer, and that certain transfers are allowed even without Government consent. If the Act applies, and the Government withholds consent, or if the contractor does not follow the applicable Federal Acquisition Regulations (“FAR”), then the Government may terminate the contract or hold the seller in breach.

What Types of Transfers Are Subject to the Anti-Assignment Act?

According to FAR 42.1204(a), “novation agreements” with the Government are required if a federal contractor transfers all of the assets involved in performing a federal Government contract, including:

•  the sale of these assets with a provision for assuming liabilities;

•  the transfer of these assets incident to a merger or corporate consolidation; or

•  the contribution of these assets in connection with formation of a new business entity.

A novation agreement is required if a forward merger or asset purchase agreement results in the transfer of a Government contract or all of the assets involved in performing that contract. Some case law suggests that the Act does not always apply to a forward merger, but our experience has been that most buyers in a forward merger will require a novation agreement rather than risk a conflict with the contracting officer overseeing the contract being transferred.

What Transfers Are Not Subject to the Anti-Assignment Act?

FAR 42.1204(b) suggests that novation agreements are not required when a contractor changes ownership as a result of a stock purchase, with no legal change in the party to the Government contract, and when that contracting party remains in control of the assets and is the party performing the contract. (However, even if consent is not required, other FAR provisions may require notice of ownership changes since the ownership change may result in changes to asset valuations or other changes affecting allowable costs.)

Case law interpreting the Act has made clear that a novation agreement is not required where the contract essentially continues with the same entity after closing. This “operation of law” exception to the Act has been held to apply to a reverse triangular merger where the seller merges into a subsidiary of the buyer, and the seller is the surviving company in the merger. The cases determined that the assets of the seller were not transferred in the merger.

Asset sales under Section 363 of the Bankruptcy Code also should not require a novation agreement pursuant to this “operation of law” exception to the Act recognized by the courts.

How Do I Obtain a Novation Agreement?

Business owners accustomed to obtaining a third party’s consent to the assignment of a commercial contract are often surprised by the cost, complexity and time needed to complete a novation agreement with the federal Government. If a novation agreement is required, FAR 42.1024(e) and (f) require the seller to submit the following information to the responsible contracting officer (“RCO”):

•  three signed copies of the proposed novation agreement;

•  the purchase/sale agreement or memorandum of understanding;

•  a list of all affected contracts between the seller and the Government, as of the date of sale or transfer of assets, showing for each, as of that date, the --

-  contract number and type;

-  name and address of the contracting office;

-  total dollar value, as amended; and

-  approximate remaining unpaid balance.

•  evidence of the buyer’s capability to perform;

•  an authenticated copy of the instrument effecting the transfer of assets;

•  a certified copy of each company’s board resolutions authorizing the asset transfer;

•  a certified copy of the minutes of each corporate party’s stockholder meeting necessary to approve the asset transfer;

•  an authenticated copy of the buyer’s certificate and articles of incorporation, if a corporation was formed for the purpose of receiving the assets;

•  legal opinions of counsel for each of the buyer and seller stating that the transfer was properly effected under applicable law and the effective date of the transfer;

•  balance sheets of the buyer and seller as of the dates immediately before and after the transfer of assets, audited by independent accountants;

•  evidence that any security clearance requirements have been met;

•  the consent of sureties on all affected contracts if bonds are required, or a statement from the seller that none are required; and

•  any other relevant information requested by the RCO.

Our clients have found most burdensome the requirements for audited pre- and post-closing financial statements and formal legal opinions from legal counsel for each of the buyer and seller. Sometimes these requirements are waived by the Government, but even when they are, the FAR novation process is time-consuming when compared to obtaining consent to transfer commercial contracts, which often can be accomplished by seller and the consenting third party signing a one-page consent letter. To avoid the cost and time involved, clients often seek to avoid the novation process by choosing a stock purchase or a reverse triangular merger transaction structure, as these structures are effective in avoiding the requirements for novation.

Government Approval Process

If a business sale cannot avoid the novation process, the seller will need to submit the novation documentation to the RCO, who is responsible for coordinating with all Government offices interested in the contracts being transferred.

The RCO determines whether it is in the Government’s interest to allow the transfer to the buyer based upon information received from Government officials, the buyer’s status as a responsible contractor, and any other factors relating to the buyer’s performance that the Government determines would aid or impair the buyer’s ability to perform.

Novations are often approved by the Government, but the process can take several weeks to six months or more to complete. For this reason, parties generally do not make the Government’s novation a condition to closing and instead will covenant to pursue the novation agreement on a post-closing basis. Or, the parties will enter into an interim subcontract whereby the buyer will perform on behalf of the seller pending completion of the novation process. Additionally, the parties may provide for a purchase price adjustment, indemnity, or permanent subcontract if the novation is denied.

If the RCO determines that a novation is not in the Government’s interest, the seller will remain obligated under the contracts, and the contracts could be terminated for default if the seller does not or can no longer perform. Generally, however, special arrangements, such as subcontracting arrangements between the seller and the buyer, or termination for convenience, are agreed to by the Government for contracts that cannot be transferred.

Bottom line: If other important transaction objectives can be achieved, consider structuring acquisitions of federal contracts to avoid the requirement of entering into a novation agreement with the federal Government. If a novation agreement cannot be avoided, involve your legal counsel early and be prepared for a more costly and protracted process than for other contract transfers.

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.

© Smith Anderson | Attorney Advertising

Written by:

Smith Anderson
Contact
more
less

Smith Anderson on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!