The COVID-19 pandemic is creating challenges for many contractors, and for those already struggling with legal and/or financial issues before the pandemic, the risk of crisis is even more real today.
The pandemic, however, is also creating acquisition opportunities. Buying a government contractor in financial or legal distress can be lucrative if appropriate due diligence is conducted and the buyer proceeds with a clear understanding of the target company’s liabilities and potential exposure.
Through our collaborative work together as government contracts counsel, we periodically learn of sophisticated companies acquiring government contractors without appropriate due diligence only later to be surprised with a formal notice of proposed debarment, notice of suspension or show cause letter stemming from the alleged past misconduct of the target, or its former management or owners.
Now that promising acquisition has turned into a crisis and requires the immediate attention of leadership, a diversion of resources to this crisis and a significant investment of capital to address. Upon receipt of that debarment notice, immediately company leadership and its board of directors find themselves asking could we have done more diligence to avoid this situation.
In most of these cases, that debarment notice was avoidable had the buyer conducted more rigorous due diligence to better understand the risks involved and thereafter taken appropriate risk-mitigation measures to reduce, if not eliminate, the risk of debarment.
Let’s pretend you have not yet acquired that government contractor and there is still time to mitigate the risk of debarment. Imagine a scenario where you are evaluating the acquisition of a government contractor in financial or legal distress.
You are interested because that contractor offers some incredible synergies to your existing business and contract portfolio. You are also interested in several of the target’s significant government contracts and see opportunities for growth and expansion.
However, during the due diligence phase, you are informed that one or more of the company’s former management personnel are under criminal investigation by the U.S. Department of Justice for alleged misconduct relating to their prior roles in performing government contracts for the company. That information is quickly followed by the representation that such should not be a concern because the government has declined to pursue the company criminally.
Upon hearing this news, some may conclude that the matter is resolved, and the company is free and clear of any financial or legal exposure.
While it is certainly favorable news that the company is not being pursued criminally, the company is not necessarily free and clear from the other remedies in the government’s arsenal.
Indeed, the company could still face contractual remedies, civil False Claims Act exposure, including treble damages and penalties, and, as addressed herein, the risk of suspension and debarment under Federal Acquisition Regulation, or FAR, Subpart 9.4 looms large.
For buyers desiring to eliminate the risk of debarment for the alleged past misconduct, there’s some hope. This is truly one of those situations where an ounce of prevention is worth a pound of the cure.
Prior to acquiring the target or its assets, we want to ensure that the target has conducted an appropriate investigation and prepared an investigative report laying out the factual findings.
Without such a baseline level of knowledge, you are truly taking a gamble, much like walking into a casino and laying your entire investment on a hand of blackjack. Do you feel lucky? Do you know the dealer’s hand? Do you know how those ahead of you in the dealing line are going to play their hands? Unless you are clairvoyant, you are gambling. The risk is total loss.
Buying a distressed contractor can cost you far more than your investment including, the debarment of the target company, treble damages and penalties under the FCA, the risk that the government imputes the target company’s debarment to the buyer and other affiliates as defined in FAR 9.403, reputational harm to the target company and buyer, and, of course, substantial legal fees and costs, among others.
With a clear accounting of what happened, you can negotiate terms for the acquisition or asset purchase that protect you financially from exposure, including provisions providing for representations and warranties, indemnification, advancement of legal fees and holdbacks, among other protections.
These facts will enable you to evaluate whether appropriate corrective actions and remedial measures have been implemented to mitigate significantly the risk of reoccurrence. For example, assume the misconduct involved kickbacks. Here’s a few questions that come to mind:
- Does the target have a values-based ethics and compliance program satisfying FAR 52.203-13, Contractor Code of Business Ethics & Conduct?
- Does the target have a code of business ethics and conduct?
- Does the target have an anti-kickback compliance policy?
- Does the target have a gift policy and a conflict-of-interest policy?
- Does the target provide live compliance training to personnel addressing these subjects?
- How does the target evaluate the responsibility and ethics of its vendors and suppliers?
- Does the target maintain financial controls requiring employees to document and memorialize any gifts they have provided or accepted involving customers, vendors, and suppliers? Same for business development expenditures?
- What type of financial controls are in place?
These are just some of the questions that should be asked in evaluating the state of the target’s response to the events and its overall ethics and compliance program.
Once you understand what happened and how the company responded, if at all, to mitigate reoccurrence, you can begin assessing how the company, if acquired by you, would fare under a present responsibility assessment using the mitigating factors and remedial measures set forth at FAR 9.406-1. Explore the types of targeted remedial measures that you would need to undertake to show the government that you have done all you can to mitigate reoccurrence.
Additionally, you will want to be in a position to demonstrate that the company’s ethics and compliance program satisfies FAR Section 52.2013-13 and includes the following components: core values; an ethics and compliance officer to manage the day-to-day operations of the program; an ethics helpline allowing for anonymous reporting; an investigations policy; compliance policies and procedures; effective training programs and testing of such programs to gauge effectiveness; a disciplinary program; and a disclosure policy.
Once you have completed your due diligence on the target and assuming you decide to proceed with the acquisition, consider requiring as a condition to closing that you have the opportunity to proactively engage with and disclose the facts to the lead agency suspension and debarment official, or SDO, and ideally to receive comfort from the SDO’s office that they are satisfied with the company’s response to the events and do not intend to take administrative action (i.e., debarment) against the entity.
In some instances, the SDO’s office may desire a long-term compliance agreement, referred to as an “administrative agreement,” which has significant cost considerations and compliance obligations, including possible independent monitoring by a third party, quarterly reporting and enhancements to the existing compliance program, among other terms.
Administrative agreements are manageable, however, and often strengthen the company and make it even more valuable, but they do come at a cost that needs to be factored into the acquisition. If time does not exist before the closing of the transaction to eliminate the risk of debarment, make sure the acquisition agreement offers you appropriate financial protections to guard against a significant investment in remediation, an administrative agreement, independent monitoring, or debarment and loss of revenues for a period of time.
By engaging with the lead agency SDO’s office proactively, you are walking into the proverbial lion’s den, so it is important to be prepared.
In our experience, typically SDOs welcome proactive engagement by contractors and view such as an indication that the contractor is responsible and can be trusted. Moreover, if done prior to the acquisition, the SDO’s office is likely to be impressed with the buyer’s preacquisition due diligence.
Conversely, SDOs look less favorably upon buyers who proceed with an acquisition without appropriate due diligence. And, in most instances, the benefit of engaging with the SDO’s office proactively, whether before or after closing, is that you eliminate the risk of a surprise debarment notice at the most inopportune time and typically can resolve the SDO’s concerns.
By proactively engaging with the lead agency SDO’s office, you are investing in the future, mitigating the risk of debarment and gaining peace of mind. Otherwise, each day in front of you could bring an unfortunate surprise and one that will be far more costly to address in a crisis. Buying a distressed government contractor can be lucrative as long as you take appropriate measures to ensure you understand the risks and are protected.