Assignments and Novations

Typically, government contracts cannot be assigned from one contractor to another. However, the law recognizes that it is in the government’s best interest to allow government contractors to undertake a merger or acquisition. Therefore, the law provides for assignment of contracts in the context of a merger or acquisition through a process known as novation. Business owners or companies interested in buying or selling a company performing government contracts need to first understand FAR 42.1204, the federal government’s rules for novations, before consummating the transaction.

FAR 42.1204:

“The government has the option to recognize a third party as a ‘successor in interest’ to a Government contract only when there is a transfer of: (1) all the contractor’s assets; or (2) the entire portion of the contractor’s assets involved in performing the contract.” FAR 42.1204(a). Once the government recognizes a potential third party, certain documents must be furnished to the contracting officer responsible for the contract at question. Such documents will include minutes of boards of directors authorizing the transfer, opinions of legal counsel, etc. Most importantly, a novation agreement must provide:

  • the transferee assumes all the transferor’s obligations under the contract, and is receiving all the assets devoted to the contract;
  • the transferor guarantees performance of the contract by the transferee (a bond may be used);
  • the transferor waives all rights under the government contract; and
  • both transferor and transferee must comply with all Federal laws.

Without FAR 42.104 the assignment or sale of a government contract would be prohibited. Specifically, 41 USC 6305 (“The Contracts Act”) protects the government from “secret assignment arrangements, to prevent possible multiple claims, and to make unnecessary the investigation of alleged assignments. Thus, the government knows with whom it is dealing, and is protected from the potential of duplicate claims.” Am. Gov’t Properties v. United States, 118 Fed. Cl. 61, 66 (2014). However, the government may give “clear assent to the assignment” of the contract to a third party if it is in the government’s best interest. Id. To do so the third party’s interest must arise out of the transfer of the original contractor’s assets or the entire portion of the assets involved in performing the contract. If the government decides not to recognize a third-party successor then the original contractor remains liable for the performance of the contract.  Ultimately the decision to recognize a third-party successor lies with the relevant contracting officer. It is the responsibility of the contracting officer to determine if there are any significant conflicts of interest. Even if some exist, a contracting officer may determine the novation is still in the government’s best interest. If that’s the case, the contracting officer can then seek out a waiver.

Requirements

The parties to a novation will need to gather the relevant documentation before requesting approval.  Specifically, the contractor will need:

  • Three signed copies of the proposed novation agreement;
  • The document describing the proposed transaction (e.g., purchase/sale agreement or the memorandum of understanding;
  • A list of all the affected contracts between the transferor and the Government as of the date of sale or transfer of assets;
  • Evidence of the transferee’s capability to perform;
  • An authenticated copy of the instrument effecting the transfer of assets (e.g., bill of sale, certificate of merger, contract, deed, agreement, or court decree);
  • A certified copy of each resolution of the corporate parties’ boards of directors authorizing the transfer of assets
  • A certified copy of the minutes of each corporate party’s stock holder meeting necessary to approve the transfer of assets;
  • An authenticated copy of the transferee’s certificate and articles of incorporation, if a corporation was formed for the purpose of receiving the assets involved in performing the government contracts;
  • The opinion of legal counsel for the transferor and transferee stating that the transfer was properly effected under applicable law and the effective date of transfer;
  • Balance sheets of the transferor and transferee 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; and
  • The consent of sureties on all contracts affected contracts if bods are required, or a statement from the transferor that none are required.

If the responsible contracting officer determines the recognition of a third-party successor to a contract is in the government’s best interest, he or she will execute a novation agreement.  Generally speaking, the novation agreement will provide that the transferee assumes all the transferor’s obligations under the contract, that the transferor waives all rights under the contract, and that the transferor guarantees performance of the contract by the transferee.

The exact requirements of a novation can vary depending on the form of the transaction, the agency, or the preferences of the responsible contracting officer. The federal rules for the novation process allow a responsible contracting officer to have a large amount of discretion in deciding whether or not the assignment is in the government’s best interest. Therefore, it is best to get the responsible contracting officer involved as early as possible, before a company submits any required paperwork. Additionally, the government’s rules for novation don’t specify any deadlines that responsible contracting officers must meet. This can become an issue in a merger and acquisition context. M&A agreements should account for performance on any government contracts by the original entity to continue until all novations are approved. In some cases, a purchaser will want to position itself as a subcontractor until the necessary approval is made. In other situations, agreements should include rescission provision to unwind the transaction in case the novation is denied.

Government contracts have little to no flexibility when it comes to the reassignment or sale to a third party. However, through novation, where the government gives formal written approval after submission of its specific information and assurances, a contract can be transferred or reassigned. The steps required by novation are strict but assure that companies and businesses are able to acquire contracts correctly through FAR 42.104.