Mid-year is a common time for business owners to consider selling a company, buying one or restructuring. For a federal contractor, any of those moves raises a question that commercial deals rarely face: what happens to the government contracts? The answer runs through a process called novation. This overview is general information; any transaction involving federal contracts should involve a lawyer experienced in the area.
Why can’t a contract simply transfer with the business?
Federal law generally prohibits transferring a government contract from one party to another. The government chose its contractor after evaluating that specific company’s capability, responsibility and price, and it does not want to find itself bound to a party it never evaluated. The government can, however, recognize a third party as the successor in interest to a contract when the contractor’s assets, or the part of the business involved in performing the contract, are transferred. It does so through a novation agreement.
When is a novation needed, and when is it not?
A novation is generally needed when the contracting entity itself changes: for example, when one company sells the assets and operations that perform a contract to another company, or when a merger leaves a different legal entity holding the work. A novation is generally not required when only the ownership of the contracting company changes, such as when its stock is sold and the same legal entity remains the contractor. If a company simply changes its name, a simpler change-of-name agreement is used instead.
What does the process involve?
The transferor, which is giving up the contract, and the transferee, which is taking it on, submit a request to the responsible contracting officer. When the affected contracts are held with more than one agency, one responsible office generally processes the novation on behalf of the others. The FAR describes the documents usually required, which include:
- The proposed novation agreement, typically following the format in the FAR
- A list of the affected contracts, with details such as contract numbers and unpaid balances
- Documents describing and authorizing the transaction, such as the purchase agreement and corporate resolutions
- Evidence of the transferee’s capability to perform
- Financial statements and opinions of legal counsel, as the regulation describes
In a standard novation agreement, the transferee assumes the obligations under the contracts and the transferor generally guarantees the transferee’s performance. The government reviews whether recognizing the transferee is in its interest. Novations can take months, so start early.
What happens to small business status?
Under SBA rules and the corresponding FAR clause, a contractor generally must rerepresent its size within a short period after a novation, merger or acquisition, whether or not a novation agreement is required. If the combined or acquiring company is not small, agencies generally can no longer count future options and orders under the affected contracts toward their small business goals, and the change can affect eligibility for orders set aside for small businesses. Status in programs such as 8(a), HUBZone, WOSB and SDVOSB can be affected as well.
How should owners prepare?
- Inventory all federal contracts and subcontracts, including options and vehicles, before negotiations begin.
- Identify which contracts depend on small business or socioeconomic status, and how the deal will affect them.
- Allow for the time a novation takes in the deal’s structure and closing conditions.
- Coordinate SAM.gov registrations, invoicing arrangements and personnel transitions.
A well-planned transaction keeps contracts performing and payments flowing. Current FAR requirements are in Subpart 42.12 at acquisition.gov, and SBA size rules are available at sba.gov.