Fourth-quarter awards can strain a small firm’s cash. A large order or a new service contract may require hiring, materials and subcontractor payments weeks before the first invoice is paid. One tool that can help is financing secured by the contract itself, made possible by a law that has been on the books since 1940. Understanding how it works before summer awards arrive gives you time to talk with a lender rather than scrambling after the fact.
Why a special law is needed
In ordinary commerce, a business can usually assign its right to receive payment to a lender. Federal law takes a different starting point. Longstanding statutes generally prohibit transferring a government contract or assigning claims against the United States, protecting the government from having to deal with unknown parties and conflicting demands for the same payment. The Assignment of Claims Act of 1940 created an exception so that contractors could use federal contracts to obtain private financing, which mattered greatly as the country began expanding defense production before World War II.
The basic conditions
In general terms, an assignment under the Act must meet several conditions, which the FAR implements in Subpart 32.8:
- The contract must meet a minimum dollar value and must not prohibit assignment.
- The assignment must be made to a bank, trust company or other financing institution, including a federal lending agency.
- It must cover all amounts payable under the contract that have not already been paid, rather than a slice of individual payments.
- It generally may be made to only one party, although that party may act as agent or trustee for several lenders, and further assignment is limited.
- The assignee must send written notice of the assignment, with a true copy of the instrument, to the contracting officer, to any surety on a bond and to the disbursing officer designated to make payment.
Once the government receives proper notice and acknowledges it, payments are directed to the assignee. Until then, the government may continue to pay the contractor.
What it means in practice
For a lender, an assignment provides comfort that payments under the contract will flow to it, which can make a line of credit or working capital loan possible for a firm with a strong award but a thin balance sheet. For the contractor, it means coordinating carefully. Invoices continue to be submitted as the contract requires, but payment goes to the lender, and both parties need a clear agreement on how funds will be released back to the business.
Some contracts include a provision under which the government agrees not to reduce payments to the assignee for certain liabilities of the contractor, sometimes called a no-setoff commitment. It can make financing easier to obtain, but it is used only in limited circumstances.
Factoring and other arrangements
Some firms consider selling their receivables to a factoring company. When the receivables are federal contract payments, the anti-assignment rules still apply, so a factor generally must qualify as a financing institution and follow the Act’s notice requirements before the government will pay it directly. Arrangements that skip those steps can lead to confusion over who is entitled to payment.
Getting the right help
Financing decisions affect your firm’s risk and cash flow for the life of the contract. Talk with a financial advisor or lender experienced with government contractors, and have a lawyer review any assignment documents before you sign. The SBA’s lending programs, described at sba.gov, are another option worth exploring, and the FAR’s current rules on assignments are at acquisition.gov.