Novations in the New Economy

June 27, 2014

As many contractors have seen federal government dollars shrink over the past few years, the buying and selling of companies has transitioned from an exit strategy to a survival technique. A thorough understanding of rules surrounding the transfer of government contracts remains critical, whether the transfer results from an open market negotiation or from the forced sale of a troubled company.

One of the unique aspects of mergers and acquisitions within the government contracting world is the novation requirement. Federal law generally prohibits the assignment of government contracts from one party to another, unless the parties receive explicit written permission from the appropriate government authority.

Contractors who have gone through a novation understand the significant amount of documentation required by the Federal Acquisition Regulation (FAR) and individual agencies to successfully novate a contract. Parties typically must create a novation agreement, along with a file of supporting documentation that includes a description of the transaction, balance sheets of both companies and the opinion of legal counsel that the transfer meets applicable legal requirements. Upon review of the novation package, a contracting officer may deny the novation – forcing the companies to unwind their transaction.

For troubled contractors who don’t find buyers on the open market, bankruptcy may be the unfortunate last option. As usual, the insertion of government contracts adds a layer of complexity to an already difficult situation.

The FAR requires a contractor to notify the government within five days that it has filed a bankruptcy petition. Contracting officers then must follow multiple procedures intended to protect the interest of the government – which may include a re-examination of a contractor’s present responsibility and possible termination of the contract. If the bankrupt contractor eventually sells its assets out of bankruptcy, then the buyer should weigh the cost and risk of negotiating a novation with the government. Unlike most assignments of contracts under bankruptcy law, the government maintains legal authority to prevent the transfer if the cognizant contracting officer decides a novation would not further the best interests of the government.

Although the “new normal” may cause sleepless nights for government contractors competing for shrinking federal dollars, the resulting industry shake-up also creates opportunities. Mergers and acquisitions on the open market can create leaner companies, each prepared to meet more of the government’s requirements as a single company – typically more efficiently than a subcontracting or joint venture relationship can. Also, contractors looking to grow may find valuable assets at significant discounts through bankruptcy proceedings. No matter the scenario, a thorough understanding of the novation process remains critical to success any time a government contract changes hands.