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.
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.
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 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.
Here are the documents the government requires from a contract seeking novation of its government contracts:
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:
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.
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.
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