A unique aspect of doing business with the federal government is the built-in limits on a contractor’s right to assign the contract or the right to payment under the contract to third parties. The Anti-Assignment Act (41 U.S.C. § 6305) prohibits the transfer of a government contract or interest in a government contract to a third party. An assignment of a contract in violation of this law voids the contract except for the Government’s right to pursue a breach of contract remedies. What’s a contractor to do when it is acquired/merged with another firm, is restructured, or goes through a variety of other types of corporate transaction? The Federal Acquisition Regulations recognize that firms involved in government contracts get bought and sold from time to time and includes procedures for the novation of contracts in certain situations to avoid a potential violation of the Anti-Assignment Act.
What is a novation?
A novation is a three-party agreement between the United States, the original contractor, and the new contractor offering to assume the government contract. The purpose the novation is to allow the Government to recognize a new contractor as the successor-in-interest to a government contract and avoid a violation of the Anti-Assignment Act. The novation process typically begins when the contractor presents a proposed novation agreement to the contracting officer along with various other materials discussed below. If a firm has multiple government contracts, even with different federal agencies, they will typically be included with one omnibus novation agreement with the agency and contracting officer with which the transferring contractor has its largest contract. The Government is not required to enter into a novation agreement when requested, but may do so when it finds it to be in its best interest. As a practical matter, contracting officers are typically cooperative in the novation process.
A novation agreement is straightforward. The new contractor (“transferee”) must agree, among other things, to be bound by all obligations, liabilities, and claims of the old contractor (“transferor”) and to ratify all actions taken by the transferor. The transferee must also agree that all payments/ reimbursements previously made by the Government to the transferor are considered discharged. In turn, the transferor must agree to waive all claims and rights against the Government in connection with the novated contracts. The transferor must also agree to guarantee payment of all liabilities and the performance of all obligations of the transferor assumes under the novation.
A form Novation Agreement is found at the end of FAR 42.1204 – Applicability of novation agreements.
When is a novation necessary?
A novation is necessary when a third party acquires all of the assets of a contractor. Additionally, a novation is needed when a third party acquires the assets involved in the performance of a government contract through a sale of assets (with assumption of liabilities), a transfer of assets through a merger or corporate consolidation, or through incorporation or formation of a partnership. A novation agreement is typically not required when the ownership of a contractor changes as a result of a stock purchase, provided that there is no legal change in the contracting party, and the contracting party continues to perform the contract and remains in control of the assets necessary for contract performance.
Contents of the novation submission
Here are the documents the Government requires from a contract seeking novation of its government contracts:
- Three signed copies of the proposed novation agreement
- Copy of the purchase/sale agreement between the transferor and transferee
- List of contracts that the transferor has with the Government, including (a) contract number and type; (b) name and address of contracting office; (c) total contract value; and (d) approximate remaining unpaid balance
- Evidence of the transferee’s capability to perform
- Any other relevant information requested by the contacting officer
- Authenticated copy instrument effecting the transfer of assets (e.g. bill of sale)
- Certified copy of each resolution of the corporate party’s board of directors authorizing the transfer of assets
- Certified copy of the stockholder meeting minutes for the transferor and transferee showing approval of the transfer of assets
- Authenticated copy of the transferee’s certificate and articles of incorporation;
- Opinion of legal counsel for the transferor and transferee stating the transfer was properly effected under applicable law and the effective date of the transfer;
- Balance sheets of the transferor and transferee as of the dates immediately before and after the sale audited by independent accounts;
- Evidence that any security clearance requirements have been met; and
- The consent of sureties on all contracts if bonds are required or a statement from the seller that none are required.
Every corporate transaction is unique. In some situations, a change in corporate ownership/structure or other circumstances might not neatly qualify as a situation where novation is prescribed by FAR 42.1204(a). The Government has authority in those situations to approve an atypical novation agreement or to waiver the requirement for a novation entirely. This authority arises directly from the Anti-Assignment Act which serves two purposes: (1) to avert fraud by “preventing persons of influence from buying up claims against the United States, which might then be improperly urged upon officers of the Government”; and (2) to avoid multiple litigation by enabling the United State “‘to deal exclusively with the original claimant instead of several parties,’ thereby eliminating the confusion and conflicting demand for payment and the chances of multiple litigation.” United International Investigative Sers. v. United States, 26 Cl. Ct. 892, 898 (1992) (quoting Tuftco Corp. v. United States, 614 F.2d 740, 744 (Cl. Ct. 1980)). The Anti-Assignment Act exists solely for the benefit of the Government. As such, the Government has the discretion to waive the Act and agree to an assignment of a contract. Johnson Control World Servs., Inc. v. United States, 44 Fed. Cl. 334, 342 (1999). But, the Government’s ability to agree to assignment is not strictly limited to the situations described in FAR Subpart 42.12. For instance, in Johnson Control, the court found that the Air Force could waive application of the Anti-Assignment Act and recognize the transfer of a contract by operation of a corporate restructuring.
Commence the novation process early
Government contractors contemplating a corporate transaction that may require a novation should approach their government customer as early as practical. Ideally, significant details of the novation can be worked out between the Government and contractor in advance of closing. Failure to take these steps impacts the timing for closing the transaction or requires an extended bridge agreement between the transferor and transferee to allow the transferor to continue performance of outstanding government contracts pending execution of the novation by the Government.