Tuesday Insight – May 11th, 2021

May 14, 2021

Novation Agreements Under Federal Contracts

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.

What is a novation?

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.

When is a novation necessary?

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 that 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.

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