M&A transactions involving government contractors carry several regulatory and industry-specific considerations that can materially impact all aspects of the deal—from high-level structuring considerations to risk allocation for compliance issues to additional administrative checklist items. If neglected or overlooked, they can result in major headaches. This three-part series outlines certain key issues to consider before, during, and after transactions involving government contractors.
The Anti-Assignment Act (41 U.S.C. § 6305) generally prohibits companies from selling government contracts. However, the Federal Acquisition Regulation (FAR) permits the government to recognize a transferee of a contract following a transfer of all of a company’s assets involved in performing the contract through the novation process. Novation is only required for asset acquisitions, not for changes in ownership as a result of equity acquisitions. A drawback to transactions requiring novation is that novation adds uncertainty and delay to the acquisition, as the government may decline to novate contracts if it determines that novation is not in the government’s best interest or if it finds the transaction to be a mere sale of a contract in violation of the Anti-Assignment Act. Further, because an application for novation may only be submitted following consummation of the transfer of assets, parties to the transaction must expend significant resources and assume risk post-closing before they have assurance that the contract transfer will be permitted. As a result, parties involved in acquisitions involving prime federal contracts often lean strongly towards transactions structured as acquisitions of equity rather than assets. The impact of novation should be considered at the structuring stages, in addition to traditional tax, liability, and operational considerations.
Any acquirer considering a target with small business set-aside contracts should understand how its own size and how acquisition of, and subsequent affiliation with, the target may affect the size of the acquirer, its current affiliates, the target, and any post-closing affiliates. A company’s size for this purpose is determined under contract-specific North American Industry Classification System (NAICS) codes based on gross revenues or number of employees of the company and its “affiliates.” Under Small Business Administration affiliation rules, if one company owns more than 50% of another company, the companies are affiliated, so traditional business acquisitions will typically result in affiliation of the constituent parties for size purposes. Minority equity investment transactions can also trigger affiliation if the investor acquires too much control over the management and decision-making of the company. Whether affiliation will put a company over its NAICS code size standard should be determined early in a transaction, as it could impact the future value of the company’s contracts. The affiliation analysis will also influence any post-closing recertification.