Are you the successor-in-interest? When a company inherits a government contract through a corporate transactionGlobal Government Contracting: Insight Series
Recent cases reinforce the long-established principle that companies inheriting government contracts through a corporate transaction can be considered a successor-in-interest, even without an approved novation agreement, despite anti-assignment laws applicable to government contracts.
The Anti-Assignment Acts: What are they?
The Assignment of Contracts Act, 41 U.S.C. § 6305, and the Assignment of Claims Act, 31 U.S.C. § 3727, together make up the “Anti-Assignment Acts.” These Acts generally prohibit the transfer of a US government contract from a contractor to a third party unless the government approves it expressly by novation or implicitly by ratification or waiver.
By preventing a contractor from unilaterally substituting another party as the prime contractor, the Acts seek to make clear the identity of the contracting parties and, as such, the entities to which the government may be liable. But courts consider exempt from the Acts any assignment that does not present the dangers that the Acts were designed to obviate. Generally, this includes transfers: by interstate succession or testamentary disposition; incident to proceedings in bankruptcy or receivership; by judicial sale; by subrogation to an insurer; or by statutory merger or corporate conversion. These types of assignments are considered to be “by operation of law.”
For government contractors, perhaps the most significant exception recognized “by operation of law” is when the transfer of a claim or contract is effectuated by statutory merger or corporate conversion. When an assignment is recognized as exempt, no government approval (explicit or otherwise) is required to recognize the assignee’s rights under the contract. We note that this exception is distinguished from “change of control” transactions and direct sales of equity securities by shareholders, which are not typically considered to be transactions that result in an assignment at all.
The exemption as applied to mergers and corporate conversions
The “by operation of law” exemption has been recognized since the Supreme Court’s 1878 decision in Erwin v. United States, 97 U.S. 392, 397 (1878), where the Court applied the exception to assignments when “there has been a transfer of a title.” In that case, the Court identified only two fundamental scenarios where this exemption should apply – intestacy and bankruptcy. However, the law has continued to develop. Indeed, more recent decisions have confirmed that government contracts that have been assigned through a corporate merger or conversion are, in fact, exempt from the Acts where – after the transaction – the government continues to deal with essentially the same entity with which it first contracted (ie, the entity with the same management, personnel, processes, and financial capability). See L-3 Commc’ns Integrated Sys. v. United States, 84 Fed. Cl. 768, 776 (2008); see also Johnson Controls World Servs., Inc. v. United States, 44 Fed. Cl. 334 (1999).
Most recently, in Oxy USA, Inc. v. United States, 163 Fed. Cl. 75 (Feb. 8, 2023), the US Court of Federal Claims found that the “by operation of law” exception applied to a corporate reorganization resulting in the assignment of the “rights and benefits” of a government contract from an aviation-fuel refinery to a successor entity. In this case, the successor entity filed a claim for indemnification costs under the contract, but the government moved to dismiss the claim, alleging that the successor entity lacked jurisdiction because it was not a recognized contracting party under the Acts.
The court’s conclusion that the “by operation of law” exception applied was based, in large part, on the court finding that substantially all of the refining business had been transferred and the successor entity possessed the same assets and management team as the original contractor. In support of its analysis, the court explained that it is imperative to consider whether – for all intents and purposes – the subject government contract (and any obligations thereunder) continues with essentially the same entity.
In this regard, the court found that the nature of the corporate reorganization ensured that the successor entity had the same key management, assets, and financial resources to perform the government contract as the original contractor possessed. The court explained that these factors conform to the “Act’s policy goals” of ensuring the government would not be subject to multiple or duplicative obligations, and that it was always cognizant of the contracting party. Id. at *90-91.
Likewise, in another 2022 case, ATS Trans LLC DBA Around the Sound/Transpro, Appellant, 22-1 B.C.A. (CCH) ¶ 38151 (June 27, 2022), the Civilian Board of Contract Appeals found that the surviving entity of a merger could submit a Contracts Disputes Act claim without a novation agreement formally recognizing the surviving entity as the successor-in-interest. In that case, the original contractor merged with and into a successor entity in 2016, and the successor entity survived the merger and assumed all of the original contractor’s assets and liabilities (often referred to as a forward merger – as opposed to a reverse triangular merger which structurally results in the original government contractor being the surviving entity). As a result of the merger, the original contractor ceased to exist as a separate legal entity, but the successor entity continued to perform the contractual obligations of the original contractor, including its government contracts. The successor entity informed the contracting agency of the merger, but no novation agreement was ever effectuated, and the agency continued paying the successor entity’s invoices.
All was well with this relationship until 2021, when the successor entity submitted a claim to the contracting officer, asserting that the procuring agency had constructively changed the contract’s requirements. The agency filed a motion to dismiss, arguing that the successor entity lacked privity of contract with the government necessary to bring its appeal. However, in ruling against the agency, the Board held that – notwithstanding the fact that there was no executed novation agreement or other ratification of the successor entity – there was a valid merger between the original contractor and the successor entity such that, by operation of law, the subject contract had been assigned to the successor entity.
These recent cases are consistent with the long-established principle that companies inheriting contracts through a corporate transaction can be considered a successor-in-interest, notwithstanding the anti-assignment laws applicable to government contracts. However, these holdings are not altogether consistent with Subpart 42.12 of the Federal Acquisition Regulation (FAR), which sets forth the requirements for effectuating a contract novation.
Specifically, FAR 42.1204(a) provides that a formal novation agreement is necessary when, following a transfer of assets to a third party, the third party in receipt of the assets desires to be recognized as the successor-in-interest to the original government contractor. As such, in accordance with these regulations, because a merger and/or a corporate conversion arguably results in the technical transfer of assets from one corporate entity to another, a formal novation typically is required by the government.
However, as confirmed by the cases referenced above, because a corporate conversion under state law and the merger of the original contractor into a successor entity with the successor entity surviving the merger does not involve the transfer of assets to a “third party,” the government’s express approval via an executed novation agreement is unnecessary, as a matter of law, for the successor entity to be recognized as the successor-in-interest.
From an operating and corporate perspective, at least with regard to corporate conversions, this makes sense. Indeed, it is consistent with how corporate conversions are typically treated under state law. For example, under California General Corporation Law, an entity that converts into another entity is for all purposes treated as the same entity that existed before the conversion and, importantly, the conversion is not considered to be a transfer of property. See CA Corp. Code Ch. 11.5.
The same is true in many other states. See, e.g., Va. Code § 13.1-944.6 (“When an entity conversion under this article becomes effective, with respect to that entity: The resulting entity is deemed to: Be the same entity without interruption as the converting entity that existed before the conversion; and Have been organized on the date that the converting entity was originally incorporated, organized, or formed”); 2 DE Code § 18-216 (stating that, when a corporate entity has been converted to a Delaware limited liability company, the conversion shall constitute a continuation of the existence of the converting other entity in the form of a domestic limited liability company.)
What does this mean for government contractors?
Although not new developments, the recent court and board rulings solidify the principle that contractors who are assigned contracts through a corporate merger or corporate conversion can be considered the successor-in-interest to a government contract under the Acts’ “by operation of law” exemption, without needing a novation agreement approved by the contracting officer in accordance with FAR 42.1204. This ostensibly provides more flexibility in structuring M&A transactions or internal reorganizations and expands the types of mergers that would be deemed to satisfy the exemption.
As discussed in the cases, however, it is important to be able to demonstrate that – for all intents and purposes – the government contract continues to be performed by essentially the same entity and, as such, there is no risk of the government incurring duplicative obligations.
In the merger context, evidence of this might reasonably include the fact that the original contractor is no longer an ongoing business concern. In the corporate conversion context, evidence might include the obligation to assume liabilities under state law and/or the fact that the converted entity has the same unique tax identification number as the original entity.
To the extent the “by operation of law” exception clearly applies, contractors should consider whether they can avoid the often burdensome, costly, and time-consuming process of obtaining a formal novation agreement approved by the responsible contracting officer. Alternatively, if a novation is deemed prudent for practical reasons, contractors should consider whether they can treat the assignment of contracts as legally effective – and thus avoid establishing interim, subcontracting agreements between the assignor and assignee – while a novation agreement with the government is pending.
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