What You Need to Know About Mergers and Acquisitions Involving Government Contractors and Their Suppliers: Volume VI —Organizational Conflicts of Interest: When the Whole Is Less Than the Sum of Its Parts

by Sheppard Mullin Richter & Hampton LLP

An organizational conflict of interest (“OCI”) arises when the performance of one contract undermines a contractor’s objectivity or creates an unfair competitive advantage with respect to another contract.  An agency cannot issue an award to a contractor that possesses an OCI unless that OCI has been avoided, mitigated, or waived.  Many government contracts include clauses that require contractors to avoid potential OCIs, to notify the Government of any OCIs that arise after award, and to work with the Government to mitigate any such OCIs.  Some contracts also avoid OCIs proactively by precluding the contractor from performing specific types of work.

Most sophisticated government contractors have processes and procedures to screen for OCIs.  This allows a contractor to comply with OCI prohibitions and also to analyze the impact of each opportunity on its portfolio of government business, so that it can avoid competing for current contracts that would unacceptably restrict its ability to obtain significant future work.

Mergers and acquisitions bring together previously independent businesses.  By combining two or more distinct portfolios of government contracts, they have the potential to create OCIs where none previously existed.  The identification, assessment, and mitigation of such OCIs is essential – not only from a compliance perspective, but also in determining whether the transaction is viable and in valuing the target.

What is an OCI?

An OCI arises where, because of other activities or relationships, a contractor is potentially unable to render impartial assistance or advice to the Government, or the contractor’s objectivity in performing the contract work might be impaired, or the contractor has an unfair competitive advantage.  There are three general categories of OCIs:  (1) unequal access to information; (2) impaired objectivity; and (3) biased ground rules.

An unequal access to information OCI arises where a contractor has access to nonpublic information as part of its performance of a government contract and where that information may provide the contractor an unfair competitive advantage in a later competition for a government contract.  Such non-public information may include proprietary or source selection information, as well as other information beyond that available to a typical incumbent contractor.

An impaired objectivity OCI typically occurs where a contractor’s work under one government contract could entail evaluating itself, its affiliates, or its/their competitors either through an assessment of performance under another contract or an evaluation of proposals.  The concern in these cases is that the firm’s ability to render impartial advice could appear to be undermined by its relationship to the evaluated entity.

A biased ground rules OCI typically occurs where a contractor, as part of its performance of a government contract, has set the ground rules for another procurement, e.g., by drafting specifications or the statement of work.  In these cases, the primary concern is that a contractor could skew a competition, whether or not intentionally, in favor of its own products or services or those of an affiliate.

A contractor and its affiliates are treated as a single entity for purposes of analyzing impaired objectivity and biased ground rules OCIs.  Acquiring a government contractor, therefore, can create an OCI even if the target will remain a separate legal entity.

How do you diligence OCIs?

Identifying OCIs requires understanding the target’s business.  The offering memorandum and the target’s website are the best places to start.  These materials often provide enough information to identify potential “deal breakers” and to gauge whether OCI issues are likely to become a significant issue in the transaction.

It is also necessary to do a “deep dive” on the terms and conditions and statements of work for all of the target’s significant contracts.  Pay special attention to contracts that include express OCI clauses or preclusions on future work.  Also insist on copies of all OCI mitigation plans.

Remember that it is not simply the nature of the target’s work – but the nature of that work in relation to the buyer’s work – that creates the potential for OCIs.  Analyzing the OCI implications of a transaction, therefore, often requires the buyer to conduct at least some diligence on its own contracts, including the statements of work, the terms and conditions, and any applicable OCI mitigation plans.

How do you mitigate OCIs?

Unequal access to information OCIs rarely have a significant impact on transactions.  They can be mitigated by a firewall that precludes the sharing of information.  The typical components of such a mitigation plan include, without limitation, nondisclosure agreements, physical and electronic access controls, regular training, and periodic audits.

Impaired objectivity and biased ground rules OCIs are more difficult to mitigate.  The typical strategy is to subcontract out the work that would create the OCI to a third party, and then have that third party report directly to the Government.  If, for example, the buyer has a contract to prepare statements of work for aircraft maintenance services generally, and the target provides maintenance services for a particular aircraft, the Government may agree to allow the buyer to subcontract out preparing the statement of work for the specific aircraft maintenance services that the target desires to perform.  The subcontractor would then report directly to the Government to ensure that the buyer does not in any way influence the statement of work.

This strategy requires entering into a bilateral OCI mitigation plan with the Government.  The Government may not be inclined to approve such a plan.  It may prefer to have the prime contractor perform the work.  It also may not want to accept the additional administrative burden of interacting directly with a firewalled subcontractor.  In some cases, the Government may determine that the OCI is simply too pervasive to mitigate.  If, for example, the buyer has a contract to supply a system for which the target provides systems engineering and technical assistance, mitigating the OCI using a firewalled subcontractor would require subcontracting out the entirety of the target’s contract, which simply is not practical.  The Government’s discretion to reject an OCI mitigation plan for any of these reasons, once a contract has been awarded, is extraordinarily broad.

Biased ground rules OCIs present an additional difficulty.  Once a contractor has drafted the specifications or statement of work for a procurement, there is no generally accepted approach to mitigate the OCI.  In this scenario, the key question is likely to be whether the specifications or statement of work were drafted before or after the merger or acquisition was contemplated.  If they were drafted before the transaction was envisioned, one could argue that there was no biased ground rules OCI because the party drafting the specifications or statement of work had no economic incentive to favor the other parties’ capabilities at the time the work was performed.  If, however, the specifications or statement of work was drafted or modified after the parties had entered into negotiations for the merger or acquisition, preclusion is significantly more likely.

In cases where an OCI cannot be mitigated by traditional means, it may be necessary to divest a portion of the buyer’s business or the target’s business.  Government consent will not be required in the rare case where the buyer desires to spin off a separately incorporated division or affiliate.  If, on the other hand, the divestiture takes the form of an asset sale, a novation agreement will be required.  Not only the contract that gives rise to the OCI, but also all of the assets involved in performing that contract, would need to be included in the asset sale.

With the exception of selling or spinning off a separately incorporated entity, all of the OCI mitigation strategies identified above generally require government consent (i.e., approval of an OCI mitigation plan or consent to assignment).  It is therefore critical for the parties to open up a dialogue with the relevant contracting officers as early as possible to determine whether and how any OCIs resulting from a merger or acquisition can be mitigated.

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.

© Sheppard Mullin Richter & Hampton LLP | Attorney Advertising

Written by:

Sheppard Mullin Richter & Hampton LLP

Sheppard Mullin Richter & Hampton LLP 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.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

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.


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.