ESOP Client Alert – Game Changer: 100% ESOP-Owned Government Contractors Eligible for Sole Source Awards on Follow-On Contracts

Kaufman & Canoles

Kaufman & Canoles

Employee stock ownership plan (ESOP) owned government contractors received a holiday gift last week when President Biden, on December 27, 2021, signed the National Defense Authorization Act (the “NDAA”). 

NDAA contains a first-ever government contracting program to encourage ESOPs—specifically, government contractors which are, or transition to, 100% ESOP-owned. Section 874 of the new law creates a Department of Defense (DoD) pilot program which allows companies that are or become 100% ESOP-owned to qualify for a sole source award on a follow-on contract. 

This is a game-changer for ESOP-owned government contractors. Previously, small businesses which met set aside criteria, e.g. 8(a), service-disabled veteran, or women-owned, could only have 49% ESOP ownership without losing small business status. Under this new DoD pilot program, qualifying small businesses may be able to transition to 100% ESOP ownership and qualify for a sole source award on a follow-on set aside contract, even after they no longer meet otherwise applicable small business set-aside requirements.

The awards on the follow-on contract under the DoD pilot program will be contingent on a finding that the contractor’s past performance on the prior contract was satisfactory or better. The pilot program will run for five years, beginning January 1, 2022.

Below is the applicable language from NDAA:

Notwithstanding the requirements of section 2304 of title 10, United States Code, in the case of a follow-on contract for the continued development, production, or provision of products or services that are the same as or substantially similar to the products or services procured by the Department of Defense under a prior contract held by a qualified business wholly owned through an Employee Stock Ownership Plan, such products or services may be deemed to be available only from the holder of the prior contract and may be procured by the Department of Defense through procedures other than competitive procedures if the performance of the qualified business wholly owned through an Employee Stock Ownership Plan on the prior contract was rated as satisfactory (or the equivalent) or better in the applicable past performance database.

The language above makes it clear that the program is limited to “follow-on” contracts. This will enable certain small business set-aside government contractors to maintain their current backlog of set-aside contracts—in other words, the contractor will now qualify for a sole source award on a follow-on contract.

However, the statutory language does not provide for small business set-aside status for an ESOP contractor competing for a new contract. Questions remain as to the breadth of this benefit for 100% ESOP-owned contractors that are bidding on contracts other than follow-on contracts.

Additionally, for businesses that are no longer small businesses, it is unclear if the DoD pilot program will apply. While the law appears to provide that the business should qualify, the final report accompanying the bill is ambiguous with regard to contractors who become too large—i.e., they exceed employee headcount or revenue thresholds for small business status. We will have to wait to see what language is included in the final regulations for clarity.

The ESOP-related provisions in NDAA are a product of the Employee-Owned Contractors Roundtable, a coalition of federal government contractors that are organized as private S corporations wholly-owned through an ESOP. The Roundtable plans to work on further projects to qualify 100% ESOP-owned companies for contracting preferences in other agencies.

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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